Attached files

file filename
EX-10.1 - EXHIBIT 10.1 - CAROLINA BANK HOLDINGS INCv393065_ex10-1.htm
EX-31.1 - EXHIBIT 31.1 - CAROLINA BANK HOLDINGS INCv393065_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - CAROLINA BANK HOLDINGS INCv393065_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - CAROLINA BANK HOLDINGS INCv393065_ex32-1.htm
EXCEL - IDEA: XBRL DOCUMENT - CAROLINA BANK HOLDINGS INCFinancial_Report.xls

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014                          

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________ to _________________

 

Commission File Number: 000-31877                                            

 

Carolina Bank Holdings, Inc.
(Exact name of registrant as specified in its charter)

 

North Carolina 56-2215437
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

101 North Spring Street, Greensboro, North Carolina 27401
(Address of principal executive offices) (Zip Code)

 

(336) 288-1898
(Registrant’s telephone number, including area code)
 
n/a
(Former name, former address and former fiscal year, if changed since last report)

 

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.          x Yes ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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 ¨ (Do not check if a smaller reporting company) 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 x No

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

There were 3,434,680 shares of the Issuer’s common stock, $1.00 par value, outstanding as of November 13, 2014.

 

 
 

 

CAROLINA BANK HOLDINGS, INC.

 

INDEX

 

  Page
   
PART I.    FINANCIAL INFORMATION  
   
Item 1.   Financial Statements (unaudited)  
   
Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013 2
   
Consolidated Statements of Income for the three and nine months  ended September 30, 2014 and 2013 3
   
Consolidated Statements of Comprehensive Income for the three and nine months  ended September 30, 2014 and 2013 4
   
Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2014 and 2013 5
   
Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 6
   
Notes to Consolidated Financial Statements 7
   
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations 32
   
Item 4.  Controls and Procedures 41
   
PART II.    OTHER INFORMATION  
   
Item 1. Legal Proceedings 42
   
Item 6. Exhibits 42
   
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
   
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
   
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350  

 

1
 

 

ITEM 1. Financial Statements

 

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Balance Sheets

 

   September 30,   December 31, 
   2014   2013 
   (unaudited)     
   (in thousands, except share data) 
Assets          
Cash and due from banks  $7,484   $6,037 
Interest-bearing deposits with banks   20,426    58,859 
Bank term deposits   13,359    11,118 
Securities available-for-sale, at fair value   56,090    62,016 
Securities held-to-maturity (fair values of $16,047 in 2014 and $14,462 in 2013)   15,928    14,810 
Loans held for sale   43,950    28,382 
Loans   470,782    444,087 
Less allowance for loan losses   (6,546)   (7,663)
Net loans   464,236    436,424 
Premises and equipment, net   18,582    18,261 
Other real estate owned   5,587    2,329 
Bank-owned life insurance   11,393    11,129 
Other assets   11,994    12,442 
Total assets  $669,029   $661,807 
           
Liabilities and Stockholders' Equity          
Deposits          
Non-interest bearing demand  $93,832   $84,911 
NOW, money market and savings   343,107    342,970 
Time   150,001    151,216 
Total deposits   586,940    579,097 
           
Advances from the Federal Home Loan Bank   2,810    2,885 
Securities sold under agreements to repurchase   -    3,032 
Subordinated debentures   19,610    19,610 
Other liabilities and accrued expenses   8,317    7,579 
Total liabilities   617,677    612,203 
           
Commitments  and contingencies - Note O          
Stockholders' equity          
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding 10,994 shares   10,994    10,994 
Common stock, $1 par value; authorized 20,000,000 shares; issued and outstanding 3,434,680 in 2014 and 3,428,776 in 2013   3,435    3,429 
Additional paid-in capital   16,295    16,226 
Retained earnings   19,677    18,336 
Stock in directors' rabbi trust   (1,384)   (1,347)
Directors' deferred fees obligation   1,384    1,347 
Accumulated other comprehensive income   951    619 
Total stockholders’ equity   51,352    49,604 
Total liabilities and stockholders’ equity  $669,029   $661,807 

 

See accompanying notes to consolidated financial statements.

 

2
 

  

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Income (unaudited)

 

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2014   2013   2014   2013 
   (in thousands, except per share data) 
Interest income                    
Loans  $6,139   $5,659   $17,751   $18,500 
Investment securities, taxable   385    323    1,216    831 
Investment securities, non taxable   131    137    409    350 
Interest from deposits in banks   41    91    150    176 
Total interest income   6,696    6,210    19,526    19,857 
                     
Interest expense                    
NOW, money market, savings   240    260    716    856 
Time deposits   396    469    1,221    1,492 
Other borrowed funds   168    179    496    554 
Total interest expense   804    908    2,433    2,902 
                     
Net interest income   5,892    5,302    17,093    16,955 
Provision for loan losses   270    600    1,386    1,100 
Net interest income after provision for loan losses   5,622    4,702    15,707    15,855 
Non-interest income                    
Service charges   320    301    940    848 
Mortgage banking income   2,114    2,413    5,401    9,894 
Gain on sale of investment securities available-for-sale   113    80    256    272 
Other   55    111    95    411 
Total non-interest income   2,602    2,905    6,692    11,425 
                     
Non-interest expense                    
Salaries and benefits   4,522    4,003    12,373    13,361 
Occupancy and equipment   767    742    2,321    2,236 
Foreclosed property expense   11    84    174    962 
Professional fees   403    385    1,407    926 
Outside data processing   274    189    800    643 
FDIC insurance   132    135    399    383 
Advertising and promotion   222    162    716    653 
Stationery, printing and supplies   148    144    426    478 
Other   350    385    1,260    1,503 
Total non-interest expense   6,829    6,229    19,876    21,145 
                     
Income before income taxes   1,395    1,378    2,523    6,135 
Income tax expense   383    355    496    1,924 
Net income   1,012    1,023    2,027    4,211 
Dividends and accretion on preferred stock   248    247    686    858 
Net income available to common stockholders  $764   $776   $1,341   $3,353 
Net income per common share                    
Basic  $0.22   $0.23   $0.39   $0.98 
Diluted  $0.22   $0.23   $0.39   $0.98 

 

See accompanying notes to consolidated financial statements.

 

3
 

  

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (unaudited)

 

   Three Months   Nine Months 
   Ended September 30,   Ended September 30, 
   2014   2013   2014   2013 
   (in thousands) 
                 
Net income  $1,012   $1,023   $2,027   $4,211 
                     
Other comprehensive income (loss):                    
Investment securities available-for-sale:                    
Unrealized holding gains (losses)   (102)   417    759    (770)
Tax effect   35    (142)   (258)   262 
Reclassification of gains recognized in net income   (113)   (80)   (256)   (272)
Tax effect   38    27    87    92 
    (142)   222    332    (688)
                     
Comprehensive income  $870   $1,245   $2,359   $3,523 

 

See accompanying notes to consolidated financial statements.

 

4
 

  

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statement of Stockholders' Equity (unaudited)

Nine months ended September 30, 2014 and 2013

 

                       Stock in   Directors'   Accumulated     
           Common   Additional       Directors'   Deferred   Other     
   Preferred   Common   Stock   Paid-In   Retained   Rabbi   Fees   Comprehensive     
   Stock   Stock   Warrants   Capital   Earnings   Trust   Obligation   Income   Total 
   (in thousands)     
                                     
Balance, December 31, 2013  $10,994   $3,429   $-   $16,226   $18,336   $(1,347)  $1,347   $619   $49,604 
                                              
Net income   -    -    -    -    2,027    -    -    -    2,027 
Other comprehensive income,  net of tax   -    -    -    -    -    -    -    332    332 
Directors' fees deferred less payment of deferred fees   -    -    -    -    -    (37)   37    -    - 
Stock options exercised   -    6    -    47    -    -    -    -    53 
Stock options expensed   -    -    -    22    -    -    -    -    22 
Preferred stock dividends   -    -    -    -    (686)   -    -    -    (686)
                                              
Balance, September 30, 2014  $10,994   $3,435   $-   $16,295   $19,677   $(1,384)  $1,384   $951   $51,352 
                                              
Balance, December 31, 2012  $15,573   $3,387   $1,841   $15,906   $15,408   $(1,050)  $1,050   $1,747   $53,862 
                                              
Net income   -    -    -    -    4,211    -    -    -    4,211 
Other comprehensive loss,  net of tax   -    -    -    -    -    -    -    (688)   (688)
Directors' fees deferred less payment of deferred fees   -    -    -    -    -    (207)   207    -    - 
Stock options exercised   -    42    -    287    -    -    -    -    329 
Repurchase of warrant   -    -    (1,841)   41    -    -    -    -    (1,800)
Repurchase of preferred stock   (4,950)   -    -    (8)   -    -    -    -    (4,958)
Accretion of preferred stock discount   285    -    -    -    (285)   -    -    -    - 
Preferred stock dividends   -    -    -    -    (573)   -    -    -    (573)
                                              
Balance, September 30, 2013  $10,908   $3,429   $-   $16,226   $18,761   $(1,257)  $1,257   $1,059   $50,383 

 

See accompanying notes to consolidated financial statements.

 

5
 

  

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

 

   Nine Months 
   Ended September 30, 
   2014   2013 
  (in thousands) 
Cash flows from operating activities    
Net income  $2,027   $4,211 
Adjustments to reconcile net income to net cash provided by (used for) operating activities          
Provision for loan losses   1,386    1,100 
Depreciation   659    632 
Increase in cash surrender value of bank-owned life insurance   (264)   (274)
Deferred income taxes   304    1,758 
Stock based compensation expense   22    - 
Amortization (accretion), net   87    (25)
Amortization of subordinated debt discount   -    47 
(Increase) decrease in fair value of loans held for sale   (221)   1,172 
Gain on sale of other real estate owned   (129)   (42)
Gain on sale of investments   (256)   (272)
Gain on sale of loans held for sale   (5,291)   (11,459)
Impairment of other real estate owned   152    632 
Proceeds from sale of loans held for sale   401,229    874,435 
Originations of loans held for sale   (411,285)   (760,978)
(Increase) decrease in other assets   (27)   3,209 
Increase (decrease) in other liabilities and accrued expenses   684    (1,249)
Net cash provided by (used for) operating activities   (10,923)   112,897 
           
Cash flows from investing activities          
Increase in bank term deposits   (2,241)   (6,894)
Purchases of investment securities available-for-sale   (5,171)   (24,185)
Purchases of investment securities held-to-maturity   (2,015)   (12,168)
Maturities and calls of securities available-for-sale   2,093    534 
Maturities and calls of securities held-to-maturity   293    53 
Repayments from mortgage-backed securities available-for-sale   2,407    1,560 
Repayments from mortgage-backed securities held-to-maturity   515    129 
Net (increase) decrease in loans   (33,578)   26,029 
Proceeds from sales of investment securities   7,358    1,886 
Improvements to other real estate owned   (872)   (155)
Purchases of premises and equipment   (980)   (116)
Proceeds from sales of other real estate owned   1,971    3,679 
Net cash used for investing activities   (30,220)   (9,648)
           
Cash flows from financing activities          
Net increase (decrease) in deposits   7,843    (6,431)
Net decrease in Federal Home Loan Advances   (75)   (13,072)
Increase (decrease) in securities sold under agreements to repurchase   (3,032)   1,000 
Proceeds from exercise of stock options   53    329 
Repurchase of common stock warrants   -    (1,800)
Repurchase of preferred stock   -    (4,958)
Preferred stock dividends paid   (632)   (1,424)
Net cash provided by (used for) financing activities   4,157    (26,356)
           
Net increase (decrease) in cash and cash equivalents   (36,986)   76,893 
Cash and cash equivalents at beginning of period   64,896    15,099 
Cash and cash equivalents at end of period  $27,910   $91,992 
           
Supplemental disclosure of cash flow information          
Cash paid during the period for interest  $2,438   $2,939 
Cash paid during the period for income taxes  $5   $821 
Supplemental disclosure of non-cash transactions          
Transfer of loans to other real estate owned  $4,380   $1,620 
Accretion of preferred stock discount  $-   $285 
Change in unrealized gains (losses) on securities available-for-sale, net of tax  $332   $(688)

 

See accompanying notes to consolidated financial statements.

 

6
 

  

Carolina Bank Holdings, Inc. and Subsidiary

Notes to Consolidated Financial Statements

 

Note A – Summary

 

Carolina Bank Holdings, Inc. (the “Holding Company”) is a North Carolina corporation organized in 2000. In August 2000 pursuant to the plan of exchange approved by the shareholders of Carolina Bank (the “Bank”), all of the outstanding shares of common stock of the Bank were exchanged for shares of common stock of the Holding Company. The Holding Company presently has no employees.

 

The Bank was incorporated in August 1996, and began banking operations in November 1996. It is engaged in lending and deposit gathering activities in Guilford, Alamance, Randolph and Forsyth counties of North Carolina and operates under the laws of North Carolina, the Rules and Regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank has four locations in Greensboro and an office in Asheboro, Burlington, High Point and Winston-Salem. In addition, the Bank has a second office under construction in Winston-Salem with an estimated opening date in the first quarter of 2015. All banking offices are in the Piedmont Triad region of North Carolina. A wholesale mortgage division is located at the Greensboro corporate headquarters, and mortgage loan production offices are located in Burlington, Chapel Hill, Pinehurst, Raleigh, and Sanford.

 

The Holding Company files periodic reports with the Securities and Exchange Commission and is also subject to regulation by the Federal Reserve Board.

 

Note B – Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. The Bank also owns two limited liability companies for the purpose of holding foreclosed real estate, the assets and operations of which are consolidated into Carolina Bank and included herein. All significant inter-company and intra-company transactions and balances have been eliminated.

 

Note C – Basis of presentation

 

In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and nine months ended September 30, 2014 and 2013, in conformity with accounting principles generally accepted in the United States of America. Operating results for the three and nine months ended September 30, 2014 and 2013 are not necessarily indicative of the results that may be expected for future annual periods.

 

The Company’s financial statements are presented in accordance with Accounting Standards Codification (“ASC”) Topic 105, “The FASB Accounting Standards Codification and The Hierarchy of Generally Accepted Accounting Principles”, which codifies generally accepted accounting principles (GAAP) in the United States.

 

The organization and business of the Company, accounting policies followed, and other information are contained in the notes to the financial statements of the Company as of and for the years ended December 31, 2013 and 2012, filed with the Securities and Exchange Commission as part of the Company’s annual report on Form 10-K. These interim financial statements should be read in conjunction with the Company’s annual financial statements.

 

7
 

  

Note D - Use of estimates

 

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of other real estate owned.

 

Note E - Stock compensation plans

 

The Company’s shareholders approved the 2009 Omnibus Stock Ownership and Long Term Incentive Plan (“Omnibus Plan”) in 2009 to replace three expired stock option plans, a nonqualified plan for directors (Director Plan) and two incentive stock option plans for management and employees (Employee Plans). The Omnibus Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock, long-term incentive compensation units and stock appreciation rights to employees and directors. An aggregate of 500,000 shares of the Company’s common stock were reserved for issuance under the terms of the Omnibus Plan, and 490,000 shares remain outstanding at September 30, 2014.

 

The fair value of employee plan stock options granted in July 2014 was $22,000 and was expensed in the third quarter of 2014. There was $22,000 and $0 in compensation expense in the nine months ending September 30, 2014 and 2013, respectively, related to stock options. At September 30, 2014, there was no unrecognized compensation cost related to unvested share-based compensation.

 

5,904 shares of common stock were issued in the first nine months of 2014 as a result of the exercise of incentive stock options.

 

Note F - Earnings per common share

 

Earnings per common share has been determined on a basic basis and a diluted basis which considers potential stock issuances. For the three and nine months ended September 30, 2014 and 2013, basic earnings per common share has been computed based upon the weighted average common shares outstanding as shown below.

 

The only potential issuances of Company stock are stock options granted to various officers of the Bank.

 

8
 

  

The following is a summary of the diluted earnings per common share calculation for the three and nine months ended September 30, 2014 and 2013.

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
   (in thousands, except per share data) 
                 
Net income available to common stockholders  $764   $776   $1,341   $3,353 
                     
Weighted average outstanding shares - basic   3,432    3,424    3,430    3,405 
Dilutive effect of stock options   -    11    3    18 
Weighted average shares - diluted   3,432    3,435    3,433    3,423 
                     
Diluted net income per share  $0.22   $0.23   $0.39   $0.98 

 

For the three months ended September 30, 2014 and 2013, there were stock options covering 61,620 and 32,070 shares, respectively, that were excluded in computing diluted common shares outstanding given that they were anti-dilutive since the exercise price exceeded the average market price for the period.

 

Note G – Preferred stock and common stock warrants

 

In December 2008, the shareholders of the Company approved an amendment to the Articles of Incorporation authorizing the issuance of up to 1,000,000 shares of preferred stock, no par value. In January 2009, the Company issued 16,000 shares of preferred stock to the U.S. Treasury and received $16 million under the Capital Purchase Program. The Company granted a warrant to purchase 357,675 shares of common stock at a price of $6.71 per share to the U.S. Treasury as part of the preferred stock transaction. In accordance with accounting principles, the preferred stock and common stock warrant were valued independently and their relative fair market values were allocated to the $16 million received. Under the relative value method, $14,159,000 was allocated to the preferred stock and $1,841,000 to the common stock warrant. The discount of $1,841,000 on the preferred stock was accreted over five years using the effective yield method, thereby increasing preferred stock dividends. The accretion of the discount was $0 and $75,000 for the three months ended September 30, 2014 and 2013, respectively, and was $0 and $285,000 for the first nine months of 2014 and 2013, respectively. Dividends at 5% per annum were payable quarterly for the first five years; the dividend increased to 9% per annum after the fifth year effective February 16, 2014.

 

The U.S. Treasury sold its holding of $16 million in preferred stock to private investors in February 2013, and the warrant to the U.S. Treasury was repurchased by the Company for $1.8 million in April 2013. The Company retired 5,006 shares of its outstanding preferred stock for $4,958,000 in August 2013 and currently has 10,994 shares outstanding with an aggregate liquidation value of $10,994,000.

 

9
 

  

Note H – Subordinated debentures

 

In December 2004, the Company issued $10,310,000 of unsecured junior subordinated debentures which accrue and pay interest quarterly at three month LIBOR plus 2% per annum. These debentures were issued to Carolina Capital Trust (“Carolina Trust”), a subsidiary of the Company which is not consolidated in these consolidated financial statements pursuant to accounting principles governing Consolidated Variable Interest Entities. Carolina Trust acquired these debentures using the proceeds of its offerings of common securities to the Company and $10 million of Trust Preferred Securities to outside investors. The Trust Preferred Securities qualify as Tier 1 capital under current Federal Reserve Board guidelines. The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminated trust preferred securities as an element of Tier 1 capital for certain institutions. However, bank holding companies with assets of less than $15 billion as of December 31, 2009, are permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital. The Company has entered into contractual arrangements which, in the aggregate, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Carolina Trust under the Trust Preferred Securities. The Trust Preferred Securities are redeemable upon maturity of the debentures on January 7, 2035, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Carolina Trust in whole or in part at any time.

 

In August and September of 2008, Carolina Bank issued $9,300,000 of unsecured junior subordinated notes to outside investors which accrue and pay interest quarterly at three month LIBOR plus 4% per annum. The notes qualify as Tier 2 capital for the Bank, subject to a 20% reduction per year which began on October 1, 2013 and continues each year thereafter until maturity. The notes are redeemable upon maturity on September 30, 2018, or earlier at the Bank’s option, in whole or in part subject to regulatory approval, beginning September 30, 2013. The expenses of the offering of $373,000 were capitalized at issuance and were amortized over sixty months. The notes are subordinate to the rights of payment to depositors, bankers acceptances, letters of creditors and general creditors.

 

Note I – Operating segments

 

The Company is considered to have three principal business segments in 2014 and 2013, the Commercial/Retail Bank, the Mortgage Division, and the Holding Company. The Mortgage Division began originating home mortgage loans through third parties and selling these loans to investors in late 2007. A retail mortgage operation was added to the mortgage division in July 2010.

 

10
 

  

Financial performance, reflective of inter-company and intra-company eliminations, for the three and nine months ended September 30, 2014 and 2013, and selected balance sheet information, reflective of inter-company eliminations, at September 30, 2014 and 2013 for each segment is as follows:

 

   Three months ended September 30, 2014   Three months ended September 30, 2013 
   Commercial/Retail   Mortgage   Holding       Commercial/Retail   Mortgage   Holding     
   Bank   Division   Company   Total   Bank   Division   Company   Total 
   (in thousands)   (in thousands) 
Interest income  $6,194   $500   $2   $6,696   $5,849   $360   $1   $6,210 
Interest expense   243    503    58    804    488    360    60    908 
Net interest income (loss)   5,951    (3)   (56)   5,892    5,361    -    (59)   5,302 
Provision for loan losses   270    -    -    270    600    -    -    600 
Net interest income (loss) after  provision for loan losses   5,681    (3)   (56)   5,622    4,761    -    (59)   4,702 
Non-interest income   487    2,115    -    2,602    495    2,410    -    2,905 
Non-interest expense   4,458    2,370    1    6,829    3,755    2,450    24    6,229 
Income (loss) before income taxes   1,710    (258)   (57)   1,395    1,501    (40)   (83)   1,378 
Income tax (benefit) expense   501    (98)   (20)   383    402    (19)   (28)   355 
Net income (loss)  $1,209   $(160)  $(37)  $1,012   $1,099   $(21)  $(55)  $1,023 

 

   Nine months ended September 30, 2014   Nine months ended September 30, 2013 
   Commercial/Retail   Mortgage   Holding       Commercial/Retail   Mortgage   Holding     
   Bank   Division   Company   Total   Bank   Division   Company   Total 
   (in thousands)   (in thousands) 
Interest income  $18,420   $1,101   $5   $19,526   $18,228   $1,624   $5   $19,857 
Interest expense   1,157    1,102    174    2,433    1,098    1,625    179    2,902 
Net interest income (loss)   17,263    (1)   (169)   17,093    17,130    (1)   (174)   16,955 
Provision for loan losses   1,386    -    -    1,386    1,100    -    -    1,100 
Net interest income (loss) after  provision for loan losses   15,877    (1)   (169)   15,707    16,030    (1)   (174)   15,855 
Non-interest income   1,292    5,400    -    6,692    1,536    9,889    -    11,425 
Non-interest expense   13,150    6,650    76    19,876    12,830    8,166    149    21,145 
Income (loss) before income taxes   4,019    (1,251)   (245)   2,523    4,736    1,722    (323)   6,135 
Income tax (benefit) expense   1,053    (473)   (84)   496    1,351    683    (110)   1,924 
Net income (loss)  $2,966   $(778)  $(161)  $2,027   $3,385   $1,039   $(213)  $4,211 
                                         
Total assets  $623,836   $44,791   $402   $669,029   $637,852   $29,543   $438   $667,833 
Net loans   464,236    43,950    -    508,186    423,035    28,592    -    451,627 
Equity   2,966    (778)   49,164    51,352    3,385    1,039    45,959    50,383 

 

The Mortgage Division experienced strong growth in originations from 2007 through 2012 due to low interest rates and due to the acquisition of a retail loan production office in July of 2010. Originations decreased after the increase in mortgage rates in the second quarter of 2013 which curtailed much of the refinancing by borrowers that had dominated earlier periods. Loan originations dropped approximately 46% in the first nine months of 2014 from the first nine months of 2013. Interest rate risk has been minimized by obtaining optional loan sales commitments when loan origination commitments are made or by entering into hedging transactions whereby mortgage backed securities are sold for the estimated closing value of loan commitments. Borrower fraud is a risk that has been minimized by prudent underwriting and by obtaining indemnification from the originating bank or broker for the risks the Company assumes. Warranty provisions and related warranty liabilities were established in 2009 to provide for potential claims that might arise from borrower fraud or underwriting errors. Warranty expenses were $40,000 and $84,000 for the three months ended September 30, 2014 and 2013, respectively, and were $111,000 and $393,000 for the nine months ended September 30, 2014 and 2013, respectively. The warranty liability, which is available to fund future warranty claims, was $1,417,000 and $1,401,000 at September 30, 2014 and December 31, 2013, respectively. Fourteen warranty claims or losses and four fair value adjustments from repurchases totaling $1,036,000 have been incurred since establishment of the mortgage division in 2007. All claims or losses pertain to originations made in 2008 and 2009. In addition, seven loans with a total current carrying balance, including fair value loss adjustments recorded when transferred, of $1,484,000 have been repurchased and are included in loans held for investment. One loan with a current principal balance of $199,000 and fair value of $174,000 has been repurchased and is included in loans held for sale at fair value.

 

11
 

  

Note J - Securities

 

A summary of the amortized cost, gross unrealized gains and losses and estimated fair values of securities available-for-sale and held-to-maturity follows:

 

       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
       (in thousands)     
September 30, 2014                    
                     
Available-for-sale                    
Municipal securities  $19,829   $845   $145   $20,529 
FNMA, FHLMC, and GNMA mortgage-backed securities   19,149    475    8    19,616 
Corporate securities   13,780    210    8    13,982 
Asset-backed securities   1,847    43    -    1,890 
Unrestricted stock   42    31    -    73 
   $54,647   $1,604   $161   $56,090 
                     
Held-to-maturity                    
Municipal securities  $7,838   $157   $46   $7,949 
FNMA mortgage-backed securities   6,113    16    62    6,067 
Asset-backed securities   1,977    54    -    2,031 
   $15,928   $227   $108   $16,047 
                     
December 31, 2013                    
                     
Available-for-sale                    
Municipal securities  $23,395   $705   $491   $23,609 
FNMA, FHLMC, and GNMA mortgage-backed securities   20,479    548    65    20,962 
Corporate securities   15,147    222    63    15,306 
Asset-backed securities   2,015    45    -    2,060 
Unrestricted stock   42    37    -    79 
   $61,078   $1,557   $619   $62,016 
                     
Held-to-maturity                    
Municipal securities  $8,178   $-   $180   $7,998 
FNMA mortgage-backed securities   6,632    -    168    6,464 
   $14,810   $-   $348   $14,462 

 

12
 

  

The scheduled maturities of debt securities at September 30, 2014 were as follows:

 

   Bullet Securities   Declining  Balance Securities   Total 
       Estimated       Estimated       Estimated 
   Amortized   Fair   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value   Cost   Value 
   (in thousands) 
Available-for-sale                        
Due in one year or less  $1,998   $2,000   $214   $216   $2,212   $2,216 
Due from one to five years   10,353    10,631    12,588    12,960    22,941    23,591 
Due from five to ten years   11,114    11,544    8,060    8,196    19,174    19,740 
Over ten years   10,144    10,336    134    134    10,278    10,470 
   $33,609   $34,511   $20,996   $21,506   $54,605   $56,017 
Held-to-maturity                              
Due in one year or less  $-   $-   $-   $-   $-   $- 
Due from one to five years   -    -    1,663    1,680    1,663    1,680 
Due from five to ten years   4,467    4,559    4,450    4,387    8,917    8,946 
Over ten years   5,348    5,421    -    -    5,348    5,421 
   $9,815   $9,980   $6,113   $6,067   $15,928   $16,047 

 

The Company sold several mortgage-backed securities, three municipal securities, and an asset-backed security with total book values of $7,102,000 at gains of $256,000 during the first nine months of 2014. Sales of mortgage-backed securities and a municipal security with total book values of $1,614,000 generated investment gains of $272,000 in the first nine months of 2013.

 

Securities with a carrying value of approximately $27,872,000 and $4,622,000 were pledged to secure retail repurchase agreements and certain deposits at September 30, 2014 and December 31, 2013, respectively.

 

Management evaluates securities for other-than-temporary impairment at least quarterly. Consideration is given to the length of time and the extent to which the fair values have been less than amortized cost, the financial condition and near-term prospects of the security issuers, and the intent and ability to retain impaired investments for a period to allow recovery in fair value.

 

At September 30, 2014, one corporate debt security with $971,000 in fair value, two mortgage-backed securities with $6,162,000 in fair value, and seven municipal securities with $7,270,000 in fair value had total unrealized losses of $269,000. Values on these securities with unrealized losses fluctuate based on changes in the values of U.S. Treasury bonds with similar characteristics, debt ratings changes of the issuing institutions, financial performance of the related institutions, world events, and demand for the securities. As management has the ability and intent to hold these debt securities until maturity, no declines are deemed to be other-than-temporary.

 

13
 

  

Information pertaining to securities with gross unrealized losses at September 30, 2014 and December 31, 2013, by category and length of time that individual securities have been in a continuous loss position follows:

 

   Less Than 12 Months   12 Months or Greater   Total 
   Number       Gross   Number       Gross   Number       Gross 
   of   Fair   Unrealized   of   Fair   Unrealized   of   Fair   Unrealized 
   Securities   Value   Losses   Securities   Value   Losses   Securities   Value   Losses 
   (dollars in thousands) 
September 30, 2014:                                             
Municipal securities   3   $4,194   $117    4   $3,076   $74    7   $7,270   $191 
FNMA and  FHLMC mortgage-backed securities   -    -    -    2    6,162    70    2   $6,162   $70 
Corporate securities   -    -    -    1    971    8    1    971    8 
Total   3   $4,194   $117    7   $10,209   $152    10   $14,403   $269 
                                              
December 31, 2013:                                             
Municipal securities   15   $18,585   $620    1   $541   $51    16   $19,126   $671 
FNMA and  FHLMC mortgage-backed securities   4    10,024    233    -    -    -    4    10,024    233 
Corporate securities   4    3,919    55    1    492    8    5    4,411    63 
Total   23   $32,528   $908    2   $1,033   $59    25   $33,561   $967 

 

14
 

 

Note K - Loans and allowance for loan losses

 

The activity in the allowance for loan losses for the first nine months of 2014 and 2013 and related asset balances at September 30, 2014 and December 31, 2013 is summarized as follows:

 

   Construction &   Commercial   Home Equity   Residential   Commercial   Consumer         
   Development   Real Estate   Lines   Real Estate   & Industrial   & Other   Unallocated   Total 
  (in thousands) 
Allowance for loan losses:                                        
2014                                        
Beginning of year balance  $1,459   $2,564   $580   $472   $2,562   $17   $9   $7,663 
Provision for loan losses   (183)   438    224    229    492    105    81    1,386 
Charge-offs   (22)   (837)   (244)   (106)   (1,608)   (100)   -    (2,917)
Recoveries   -    32    2    11    364    5    -    414 
Balance at September 30,  $1,254   $2,197   $562   $606   $1,810   $27   $90   $6,546 
2013                                        
Beginning of year balance  $2,349   $4,068   $609   $863   $1,885   $133   $37   $9,944 
Provision for loan losses   (513)   2,490    102    (450)   1,916    (67)   (28)   3,450 
Charge-offs   (418)   (4,000)   (133)   (97)   (1,703)   (81)   -    (6,432)
Recoveries   41    6    2    156    464    32    -    701 
Balance at December 31,  $1,459   $2,564   $580   $472   $2,562   $17   $9   $7,663 
                                         
Balances at September 30, 2014                                        
Allowance for loan losses:                                        
Balance at September 30,  $1,254   $2,197   $562   $606   $1,810   $27   $90   $6,546 
Ending balance individually evaluated for impairment  $-   $341   $24   $292   $336   $-   $-   $993 
Ending balance collectively evaluated for impairment  $1,254   $1,856   $538   $314   $1,474   $27   $90   $5,553 
Loans Outstanding:                                        
Balance at September 30,  $70,215   $220,387   $69,044   $50,516   $58,215   $2,405   $-   $470,782 
Ending balance individually evaluated for impairment  $1,377   $13,066   $619   $6,097   $1,386   $-   $-   $22,545 
Ending balance collectively evaluated for impairment  $68,838   $207,321   $68,425   $44,419   $56,829   $2,405   $-   $448,237 
                                         
Balances at December 31, 2013                                        
Allowance for loan losses:                                        
Balance at December 31,  $1,459   $2,564   $580   $472   $2,562   $17   $9   $7,663 
Ending balance individually evaluated for impairment  $-   $541   $24   $102   $1,396   $-   $-   $2,063 
Ending balance collectively evaluated for impairment  $1,459   $2,023   $556   $370   $1,166   $17   $9   $5,600 
Loans Outstanding:                                        
Balance at December 31,  $50,397   $212,272   $66,926   $54,115   $55,504   $4,873   $-   $444,087 
Ending balance individually evaluated for impairment  $1,800   $17,633   $554   $5,466   $3,815   $-   $-   $29,268 
Ending balance collectively evaluated for impairment  $48,597   $194,639   $66,372   $48,649   $51,689   $4,873   $-   $414,819 

 

15
 

 

A loan is past due when the borrower has not made a payment by the contractual due date. The following table presents the carrying value of loans that are past due thirty days or more. Loans which are ninety days or more past due are generally on non-accrual status, at which time all accrued interest is removed from interest income. All non-accrual loans are reflected in the past due ninety days or more category shown in the following table:

 

                           Loans Past 
   Number of Days Past Due               Due 90 Days 
           90 Days   Total       Total   or More 
   30-59 Days   60-89 Days   or More   Past Due   Current   Loans   & Accruing 
   (in thousands) 
At September 30, 2014                                   
Real Estate Loans:                                   
Construction & development  $-   $-   $1,298   $1,298   $68,917   $70,215   $- 
Commercial real estate   -    -    5,262    5,262    215,125    220,387    - 
Home equity lines   98    -    360    458    68,586    69,044    - 
Residential real estate   44    80    2,464    2,588    47,928    50,516    - 
Total real estate   142    80    9,384    9,606    400,556    410,162    - 
Commercial & industrial   -    -    964    964    57,251    58,215    - 
Consumer & other   53    -    -    53    2,352    2,405    - 
Total loans  $195   $80   $10,348   $10,623   $460,159   $470,782   $- 
                                    
At December 31, 2013                                   
Real Estate Loans:                                   
Construction & development  $-   $-   $1,695   $1,695   $48,702   $50,397   $- 
Commercial real estate   222    -    9,067    9,289    202,983    212,272    - 
Home equity lines   60    -    402    462    66,464    66,926    - 
Residential real estate   750    100    2,153    3,003    51,112    54,115    - 
Total real estate   1,032    100    13,317    14,449    369,261    383,710    - 
Commercial & industrial   9    -    3,414    3,423    52,081    55,504    - 
Consumer & other   -    -    -    -    4,873    4,873    - 
Total loans  $1,041   $100   $16,731   $17,872   $426,215   $444,087   $- 

 

Loans are determined to be impaired when, based on current information and events, it is probable that all amounts will not be collected when due according to the contractual terms of the original loan agreement. At September 30, 2014 and December 31, 2013, the total recorded investment in impaired loans amounted to approximately $22,545,000 and $29,268,000, respectively. Of these impaired loans, $10,348,000 and $16,731,000 were on non-accrual at September 30, 2014 and December 31, 2013, respectively.

 

16
 

  

The recorded investment and related information for impaired loans is summarized as follows:

 

   Impaired Loans 
   At end of period   For Period Ended 
       Unpaid   Related   Average   Interest 
   Recorded   Principal   Loan Loss   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
September 30, 2014  (in thousands) 
With no related allowance recorded                         
Real Estate Loans:                         
Construction & development  $1,377   $1,377   $-   $1,262   $4 
Commercial real estate   9,398    12,500    -    12,638    402 
Home equity lines   428    633    -    633    20 
Residential real estate   4,625    4,891    -    4,950    154 
Total real estate   15,828    19,401    -    19,483    580 
Commercial & industrial   203    600    -    600    - 
Consumer & other   -    -    -    -    - 
Total loans   16,031    20,001    -    20,083    580 
With an allowance recorded                         
Real Estate Loans:                         
Construction & development   -    -    -    -    - 
Commercial real estate   3,668    3,904    341    3,943    128 
Home equity lines   191    245    24    245    10 
Residential real estate   1,472    1,584    292    1,620    54 
Total real estate   5,331    5,733    657    5,808    192 
Commercial & industrial   1,183    2,086    336    2,118    19 
Consumer & other   -    -    -    -    - 
Total loans   6,514    7,819    993    7,926    211 
Total impaired loans  $22,545   $27,820   $993   $28,009   $791 
                          
December 31, 2013                         
With no related allowance recorded                         
Real Estate Loans:                         
Construction & development  $1,800   $2,101   $-   $2,101   $48 
Commercial real estate   13,247    16,943    -    18,001    646 
Home equity lines   353    548    -    549    23 
Residential real estate   3,654    3,914    -    4,099    210 
Total real estate   19,054    23,506    -    24,750    927 
Commercial & industrial   1,850    2,950    -    3,071    97 
Consumer & other   -    25    -    25    1 
Total loans   20,904    26,481    -    27,846    1,025 
With an allowance recorded                         
Real Estate Loans:                         
Construction & development   -    -    -    -    - 
Commercial real estate   4,386    4,619    541    4,679    206 
Home equity lines   201    245    24    245    14 
Residential real estate   1,812    1,878    102    1,928    79 
Total real estate   6,399    6,742    667    6,852    299 
Commercial & industrial   1,965    2,443    1,396    2,556    82 
Consumer & other   -    -    -    -    - 
Total loans   8,364    9,185    2,063    9,408    381 
Total impaired loans  $29,268   $35,666   $2,063   $37,254   $1,406 

 

17
 

 

Loans that are past due 90 days or more or where there is serious doubt as to collectability are placed on non-accrual status. Non-accrual loans are not returned to accrual status unless principal and interest are current and borrowers have demonstrated the ability to make contractual payments. Accrued interest is reversed through a charge to income when loans are placed on non-accrual and future payments on non-accrual loans are generally applied to principal. The following is a summary of non-accrual loans at September 30, 2014 and December 31, 2013:

 

   September 30,   December 31, 
   2014   2013 
   (in thousands) 
Real Estate Loans:          
Construction & development  $1,298   $1,695 
Commercial real estate   5,262    9,067 
Home equity lines   360    402 
Residential real estate   2,464    2,153 
Total real estate   9,384    13,317 
Commercial & industrial   964    3,414 
Consumer & other   -    - 
Total loans  $10,348   $16,731 

 

Loans are graded according to an internal loan rating classification system when originated. Loan grades are periodically re-evaluated during servicing, internal loan reviews, and external loan reviews. The general categories of the internal loan rating classification are:

·Pass - Acceptable loans
·Special Mention - Loans with potential identified weaknesses in administration or servicing
·Criticized - Adversely classified loans with identified weaknesses, and potential or identified losses of principal and/or interest due

 

The following is a breakdown of loans by the general categories of the internal rating system:

 

   Outstanding Loans at September 30, 2014 and December 31, 2013 
   Construction & Development   Commercial   Home Equity 
   Development   Real Estate   Lines of Credit 
   2014   2013   2014   2013   2014   2013 
   (in thousands) 
Pass  $68,488   $47,826   $205,129   $193,183   $67,546   $65,429 
Special Mention   429    881    5,512    4,035    41    113 
Criticized   1,298    1,690    9,746    15,054    1,457    1,384 
TOTAL  $70,215   $50,397   $220,387   $212,272   $69,044   $66,926 

 

   Residential   Commercial &   Consumer 
   Real Estate   Industrial   & Other 
   2014   2013   2014   2013   2014   2013 
   (in thousands) 
Pass  $43,794   $48,838   $56,828   $51,639   $2,405   $4,870 
Special Mention   2,762    979    33    82    -    3 
Criticized   3,960    4,298    1,354    3,783    -    - 
TOTAL  $50,516   $54,115   $58,215   $55,504   $2,405   $4,873 

 

18
 

 

During 2014 and 2013, the Company restructured certain loans to improve the likelihood that the loans would be repaid in full under the modified terms in accordance with reasonable repayment schedules. Management evaluates each of these loans in accordance with generally accepted accounting principles to determine whether they should be reported as troubled debt restructurings.

 

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories:

 

·Rate Modification - A modification in which the interest rate is changed

 

·Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed

 

·Interest Only Modification – A modification in which the loan is converted to interest only payments for a period of time

 

·Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above

 

·Combination Modification – Any other type of modification, including the use of multiple categories above

 

There was $148,000 of available commitments for troubled debt restructurings outstanding at September 30, 2014.

 

19
 

 

The following tables present troubled debt restructurings as of September 30, 2014 and December 31, 2013:

 

   Troubled Debt Restructurings 
   September 30, 2014 
       Non-Accrual   Total 
   Accrual Status   Status   Modifications 
   #   Amount   #   Amount   #   Amount 
   ($ in thousands)     
Real Estate Loans:                              
Construction & development   1   $79    5   $1,298    6   $1,377 
Commercial real estate   12    7,421    4    2,453    16    9,874 
Home equity lines   0    -    0    -    0    - 
Residential real estate   10    1,961    5    927    15    2,888 
Total real estate   23    9,461    14    4,678    37    14,139 
Commercial & industrial   2    422    2    11    4    433 
Consumer & other   0    -    0    -    0    - 
Total loans   25   $9,883    16   $4,689    41   $14,572 

 

   December 31, 2013 
       Non-Accrual   Total 
   Accrual Status   Status   Modifications 
   #   Amount   #   Amount   #   Amount 
   ($ in thousands)     
Real Estate Loans:                              
Construction & development   1   $105    6   $1,111    7   $1,216 
Commercial real estate   12    7,783    6    2,860    18    10,643 
Home equity lines   0    -    0    -    0    - 
Residential real estate   11    2,103    2    246    13    2,349 
Total real estate   24    9,991    14    4,217    38    14,208 
Commercial & industrial   2    390    2    432    4    822 
Consumer & other   0    -    0    -    0    - 
Total loans   26   $10,381    16   $4,649    42   $15,030 

 

The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

 

Troubled debt restructurings are classified as impaired loans when modified, and fair value calculations are performed to determine the specific reserves required in the allowance for loan losses related to these loans. Troubled debt restructurings can be removed from such status and returned to non-impaired status in years subsequent to restructure if the interest rate charged at restructure was greater than or equal to the rate charged for a new extension of credit with comparable risk and if the loan is performing and there is no available information to indicate that performance will not continue.

 

20
 

 

The following tables present newly restructured loans that occurred during the three months ended September 30, 2014 and 2013, respectively:

 

   New Troubled Debt Restructurings 
   Three Months Ended September 30, 2014 
   Rate   Term   Payment   Combination   Total 
   Modifications   Modifications   Modifications   Modifications   Modifications 
   #   Amount   #   Amount   #   Amount   #   Amount   #   Amount 
   ($ in thousands) 
Pre-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    1   $-    0   $-    1   $- 
Residential real estate   0    -    0    -    1    234    0    -    1    234 
Total real estate   0    -    0    -    2    234    0    -    2    234 
Consumer & other   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    0   $-    2   $234    0   $-    2   $234 
                                                   
Post-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    1   $156    0   $-    1   $156 
Residential real estate   0    -    0    -    1    231    0    -    1    231 
Total real estate   0    -    0    -    2    387    0    -    2    387 
Consumer & other   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    0   $-    2   $387    0   $-    2   $387 

 

   Three Months Ended September 30, 2013 
Pre-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    2   $-    0   $-    2   $- 
Commercial real estate   0    -    0    -    1    527    0    -    1    527 
Residential real estate   0    -    0    -    1    244    0    -    1    244 
Total real estate   0    -    0    -    4    771    0    -    4    771 
Consumer & other   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    0   $-    4   $771    0   $-    4   $771 
                                                   
Post-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    2   $525    0   $-    2   $525 
Commercial real estate   0    -    0    -    1    527    0    -    1    527 
Residential real estate   0    -    0    -    1    244    0    -    1    244 
Total real estate   0    -    0    -    4    1,296    0    -    4    1,296 
Consumer & other   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    0   $-    4   $1,296    0   $-    4   $1,296 

 

21
 

 

The following tables present newly restructured loans that occurred during the nine months ended September 30, 2014 and 2013, respectively:

 

   New Troubled Debt Restructurings 
   Nine Months Ended September 30, 2014 
   Rate   Term   Payment   Combination   Total 
   Modifications   Modifications   Modifications   Modifications   Modifications 
   #   Amount   #   Amount   #   Amount   #   Amount   #   Amount 
   ($ in thousands) 
Pre-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    1   $-    0   $-    1   $- 
Residential real estate   0    -    1    410    1    234    0    -    2    644 
Total real estate   0    -    1    410    2    234    0    -    3    644 
Consumer & other   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    1   $410    2   $234    0   $-    3   $644 
                                                   
Post-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    1   $156    0   $-    1   $156 
Residential real estate   0    -    1    403    1    231    0    -    2    634 
Total real estate   0    -    1    403    2    387    0    -    3    790 
Consumer & other   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    1   $403    2   $387    0   $-    3   $790 

 

   Nine Months Ended September 30, 2013 
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    4   $-    0   $-    4   $- 
Commercial real estate   0    -    0    -    1    527    0    -    1    527 
Residential real estate   0    -    0    -    1    244    0    -    1    244 
Total real estate   0    -    0    -    6    771    0    -    6    771 
Commercial & industrial   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    0   $-    6   $771    0   $-    6   $771 
                                                   
Post-Modification Outstanding Recorded Investment:                               
Real Estate Loans:                                                  
Construction & development   0   $-    0   $-    4   $869    0   $-    4   $869 
Commercial real estate   0    -    0    -    1    527    0    -    1    527 
Residential real estate   0    -    0    -    1    244    0    -    1    244 
Total real estate   0    -    0    -    6    1,640    0    -    6    1,640 
Commercial & industrial   0    -    0    -    0    -    0    -    0    - 
Total loans   0   $-    0   $-    6   $1,640    0   $-    6   $1,640 

 

There were no financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and nine months ended September 30, 2014. The following table represents financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and nine months ended September 30, 2014 and 2013, respectively:

 

22
 

 

TDRs with a payment default occurring within 12 months of restructure

 

   During the three months ended 
   September 30, 2014   September 30, 2013 
   #   Amount   #   Amount 
   ($ in thousands) 
Real Estate Loans:                    
Commercial real estate   0   $-    1   $200 
Total real estate   0    -    1    200 
Commercial & industrial   0    -    0    - 
Total loans   0   $-    1   $200 

 

TDRs with a payment default occurring within 12 months of restructure

 

   During the nine months ended 
   September 30, 2014   September 30, 2013 
   #   Amount   #   Amount 
   ($ in thousands) 
Real Estate Loans:                    
Commercial real estate   0   $-    2   $311 
Total real estate   0    -    2    311 
Total loans   0   $-    2   $311 

 

Troubled debt restructuring defaults can result in a higher allowance for loan losses and a corresponding higher provision for loan losses because defaults generally negatively impact the timing of and expected collections from these impaired loans. Impaired loans, which include troubled debt restructurings, are evaluated for specific additions to the allowance for loan losses by subtracting the recorded investment in these impaired loans from their fair values. Fair value is generally determined by the present value of future cash flows, collateral value, or liquidation value. Defaults generally reduce the present value of the future cash flows and can negatively impact the collateral values if declining real estate values are impacting the sale of collateral.

 

Note L – Fair value measurements

 

The Company has adopted the accounting standards within FASB Accounting Standards Codification (ASC) 820 “Fair Value Measurements and Disclosures”, which provides a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company has not elected the fair value option to value liabilities. Securities available-for-sale and loans held for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

 

When measuring fair value, valuation techniques should be appropriate in the circumstances and consistently applied. A hierarchy is used to prioritize valuation inputs into the following three levels to determine fair value:

 

Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities

 

23
 

 

Level 2 – observable inputs other than the quoted prices included in Level 1

Level 3 – unobservable inputs

 

Fair Value on a Recurring Basis. The Company measures certain assets at fair value on a recurring basis and the following is a general description of the methods used to value such assets.

 

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities and certain corporate bonds that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and most corporate debt securities. Securities classified as Level 3 include asset-backed securities and corporate debt securities in less liquid markets.

 

Loans Held for Sale

The Company opted to account for loans held for sale at fair value which is measured based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to recurring fair value adjustments as Level 2 valuation.

 

Interest Rate Lock Commitments

The Mortgage Division of the Company hedged some of its residential mortgage loans held for sale by selling mortgage-backed securities on a forward basis between 2011 and 2013. The forward sale mortgage-backed securities are later purchased or closed when mandatory loan sales are consummated for the related mortgages that are originated. The value of the estimated loan commitments and open hedges are marked to market through the income statement. The significant unobservable input used in the Level 3 fair value measurement of the Company’s Interest Rate Lock Commitments (IRLCs) on hedged loans held for sale is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally, the fair value of an IRLC is positive (negative) if the prevailing interest rate is lower (higher) than the IRLC rate. Therefore, an increase in the closing ratio (i.e., higher percentage of loans are estimated to close) will result in the fair value of the IRLC to increase if in a gain position, or decrease if in a loss position. The closing ratio is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The closing ratio is computed by management using historical data.

 

The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing between the commitment date and period end, typically month end. The Company classifies interest rate lock commitments as Level 3. Gain or loss on interest rate lock commitments for the period is included in mortgage banking income of non-interest income on the Consolidated Statements of Income. There were no changes in valuation techniques for the three months ended September 30, 2014; however, the Mortgage Division discontinued hedging during the first quarter of 2013 due to economic factors. Residential mortgage loans are currently sold on a “best efforts” basis where optional commitments are made with investors to sell loans shortly after optional commitments are consummated to originate loans with borrowers. Hedging and the use of mandatory commitments is expected to resume in the fourth quarter of 2014.

 

24
 

 

Below is a summary of activity related to interest rate lock commitments for the nine months ended September 30, 2014 and 2013.

 

   Interest Rate Lock Commitments 
   Level 3 
   Fair Value   Fair Value 
   (in thousands) 
         
Balance, December 31, 2013 and 2012  $-   $56 
Gains (losses) included in other income   -    (56)
Transfers in and out   -    - 
Balance, September 30, 2014 and 2013  $-   $- 

 

Assets measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013 are summarized below:

 

   Assets             
   Measured at   Fair Value Measured Using 
Description  Fair Value   Level 1   Level 2   Level 3 
   (in thousands) 
                 
At September 30, 2014:                    
Securities available-for-sale:                    
Municipal securities  $20,529   $-   $20,529   $- 
Mortgage-backed securities   19,616    -    19,616    - 
Corporate securities   13,982    -    13,982    - 
Asset-backed securities   1,890    -    1,890    - 
Unrestricted stock   73    73    -    - 
Total available-for-sale securities   56,090    73    56,017    - 
Loans held for sale   43,950    -    43,950    - 
Total  $100,040   $73   $99,967   $- 
                     
At December 31, 2013:                    
Securities available-for-sale:                    
Municipal securities  $23,609   $-   $23,609   $- 
Mortgage-backed securities   20,962    -    20,962    - 
Corporate securities   15,306    -    15,306    - 
Asset-backed securities   2,060    -    2,060    - 
Unrestricted stock   79    79    -    - 
Total available-for-sale securities   62,016    79    61,937    - 
Loans held for sale   28,382    -    28,382    - 
Total  $90,398   $79   $90,319   $- 

 

25
 

 

Fair Value on a Non-recurring Basis. The Company measures certain assets at fair value on a non-recurring basis and the following is a general description of the methods used to value such assets.

 

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Impaired loans are recorded at fair value less estimated selling costs. Once a loan is identified as individually impaired, the Company measures impairment. Fair values of impaired loans are generally estimated using one of several methods, including collateral value, liquidation value, discounted cash flows and, in rare cases, the market value of the note. Those impaired loans not requiring an allowance represent loans for which the net present value of the expected cash flows or fair value of the collateral less costs to sell exceed the recorded investments in such loans. At September 30, 2014 and December 31, 2013, a majority of the total impaired loans were evaluated based on the fair value of the collateral. When the fair value of the collateral is based on an executed sales contract with an independent third party, the Company records the impaired loans as nonrecurring Level 1. If the collateral is based on another observable market price or a current appraised value, the Company records the impaired loans as nonrecurring Level 2. When an appraised value is not available or the Company determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s effective interest rate. The measurement of impaired loans using future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

 

Other Real Estate Owned and Repossessed Assets

Properties acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying value or the new fair value less estimated selling costs. Fair value is generally based upon current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the asset as nonrecurring Level 2. However, the Company also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals such as changes in absorption rates or market conditions from the time of valuation. In situations where an appraisal less estimated selling costs is used to determine fair value, management adjustments are significant to the fair value measurements, or other means are used to estimate fair value in the absence of an appraisal, the Company records the impaired loan as nonrecurring Level 3 within the valuation hierarchy.

 

Assets measured at fair value on a non-recurring basis at September 30, 2014 and December 31, 2013 are summarized below:

 

26
 

 

   Assets             
   Measured at   Fair Value Measured Using 
Description  Fair Value   Level 1   Level 2   Level 3 
   (in thousands) 
                 
At September 30, 2014:                    
Impaired loans  $21,552   $-   $-   $21,552 
Other real estate owned   5,587    -    -    5,587 
                     
At December 31, 2013:                    
Impaired loans  $27,205   $-   $-   $27,205 
Other real estate owned   2,329    -    -    2,329 

 

Fair Value on a Recurring or Non-recurring Basis – Unobservable Inputs for Level 3. For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2014, the significant unobservable inputs used in the fair value measurements were as follows:

 

          Significant  Significant
       Valuation  Unobservable  Unobservable
Description  Fair Value   Technique  Inputs  Input Value
   ($ in thousands)          
At September 30, 2014:              
Impaired loans  $21,552   Discounted appraisals  Collateral discounts  8.00%-10.00%
        Discounted cash flows  Cash flow estimates/  0% - 100% /
           discounted rates  original note rate
Other real estate owned  $5,587   Discounted appraisals  Collateral discounts  8.00%-10.00%
               
At December 31, 2013:              
Impaired loans  $27,205   Discounted appraisals  Collateral discounts  8.00%-10.00%
        Discounted cash flows  Cash flow estimates/  0% - 100% /
           discounted rates  original note rate
Other real estate owned   2,329   Discounted appraisals  Collateral discounts  8.00%-10.00%

 

Fair Value of items not valued as such. The Company measures certain financial assets and liabilities at fair value for disclosure purposes only. The assumptions used in estimating the fair value of these financial instruments are detailed below:

 

Securities Held to Maturity

The fair values of securities held to maturity are recorded on a non-recurring basis when an impairment in value that is deemed to be other than temporary occurs.  Fair value measurement is based upon quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. At September 30, 2014, there were no fair value adjustments related to $15,928,000 of securities held to maturity.

 

Net non-impaired loans held for investment: For variable rate loans, fair values are based on carrying values. Fixed rate commercial, other installment, and certain real estate mortgage loans are valued using discounted cash flows. The discount rates used to determine the present value of these loans are based on interest rates currently being charged by the Company on comparable loans as to credit risk and term.

 

27
 

 

Time deposits: Discounted cash flows have been used to value fixed rate and variable rate term deposits. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.

 

Subordinated debentures: Subordinated debentures consist of trust preferred debt with a carrying value of $10,310,000 and fair value of $7,540,000 and of bank subordinated debt with a carrying value and fair value of $9,300, 000. The fair value of trust preferred debt was determined by discounting cash flows using a rate 300 basis points higher than the actual current rate over an estimated remaining term of 12.75 years in 2014 and 13.50 years in 2013. The trust preferred debt was issued at favorable rates in 2004, and current rates are approximately 300 basis points higher if available. The Basel III capital guidelines allow for inclusion of trust preferred securities as Tier 1 capital for banks with less than $15 billion in assets. The bank subordinated debt matures on September 30, 2018 and its fair value approximates carrying value due to rate and maturity structure.

 

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of financial instruments at September 30, 2014 and December 31, 2013. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and due from banks and interest-bearing deposits with banks, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as non-interest bearing demand deposits, NOW, money market and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

 

           Fair Value Measurements 
           Quoted         
           Prices in         
           Active Markets   Significant     
           for Identical   Other   Significant 
           Assets or   Observable   Unobservable 
   Carrying   Fair   Liabilities   Inputs   Inputs 
   Amount   Value   (Level 1)   (Level 2)   (Level 3) 
  (in thousands) 
September 30, 2014    
Financial Instruments - Assets                         
Investment securities held-to-maturity  $15,928   $16,047   $-   $16,047   $- 
Net non-impaired loans held for investment   442,684    442,476    -    -    442,476 
                          
Financial Instruments - Liabilities                         
Time deposits   150,001    150,596    -    -    150,596 
Subordinated debentures   19,610    16,840    -    -    16,840 
                          
December 31, 2013                         
Financial Instruments - Assets                         
Investment securities held-to-maturity  $14,810   $14,462   $-   $14,462   $- 
Net non-impaired loans held for investment   409,219    411,871    -    -    411,871 
                          
Financial Instruments - Liabilities                         
Time deposits   151,216    152,710    -    -    152,710 
Subordinated debentures   19,610    16,732    -    -    16,732 

 

28
 

 

Note M – Derivatives and financial instruments

 

A derivative is a financial instrument that derives its cash flows and value by reference to an underlying instrument, index contract or referenced interest rate. These instruments are designed to hedge exposures to interest rate risk or for speculative purposes.

 

Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

 

The Mortgage Division of the Company began hedging its governmental mortgage loans, primarily FHA and VA loans in October 2010 by selling mortgage-backed securities on a forward basis. The forward sale mortgage-backed securities are later purchased or closed when mandatory loan sales are consummated for the related mortgages that are originated. The value of the estimated loan commitments and open hedges are marked to market through the income statement. Hedging was discontinued in the first quarter of 2013 due to economic reasons but is expected to resume in the fourth quarter of 2014. There were no derivative instruments outstanding at September 30, 2014 or December 31, 2013.

 

The Company currently sells mortgage loans on a best efforts basis whereby optional commitments to sell mortgage loans are consummated at approximately the same time that optional commitments are given to borrowers to originate the loans. The table below presents the aggregate fair value and aggregate unpaid principal of loans held for sale at September 30, 2014 and December 31, 2013:

 

   September 30, 2014   December 31, 2013 
           Aggregate Fair           Aggregate Fair 
           Value Less           Value Less 
       Aggregate   Aggregate       Aggregate   Aggregate 
   Aggregate   Unpaid   Unpaid   Aggregate   Unpaid   Unpaid 
   Fair Value   Principal   Principal   Fair Value   Principal   Principal 
   (in thousands) 
Loans held for sale, at fair value  $43,950   $43,532   $418   $28,382   $28,185   $197 

 

Interest income on loans held for sale is recognized based on contractual rates and is reflected in interest income on loans in the consolidated statements of operations. The following table details net gains (losses) resulting from changes in fair value of these loans which were recorded in mortgage banking income in the consolidated statements of operations during the nine months ended September 30, 2014 and 2013, respectively. These changes in fair value are mostly offset by economic hedging activities and also fluctuate based on the change in the aggregate loan principal outstanding. An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk.

 

29
 

 

   Loans Held for Sale, At Fair Value 
   Nine Months Ended September 30, 
   2014   2013 
   (in thousands) 
Net gains (losses) resulting from changes in fair value  $221   $(1,172)

 

Note N – Impact of recently adopted accounting standards

 

On January 17, 2014, the FASB issued ASU 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force), to clarify when an in substance repossession or foreclosure occurs, and address the diversity in practice regarding when a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be reclassified as real estate property (i.e., taken possession of the real estate). Specifically, an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) obtaining legal title upon completion of a foreclosure or (2) obtaining interest in the property in satisfaction of the loan through a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the ASU requires interim and annual disclosure of both (1) the amount of foreclosed real estate held and (2) the recorded investment in mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments will be effective for the Company on a prospective basis for interim and annual reporting periods beginning January 1, 2015. Early adoption and a modified retrospective application are permitted. These amendments are not expected to have a material effect on the Company’s statement of financial position.

 

On January 15, 2014, the FASB issued ASU 2014-01, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force), to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low income housing tax credit. The ASU modifies the conditions that an entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. The ASU permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if those conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). Further, the decision to apply the proportional amortization method of accounting is an accounting policy decision that should be applied consistently to all qualifying affordable housing project investments rather than a decision to be applied to individual investments. An entity that has used the effective yield method to account for its investments in qualified affordable housing before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments will be effective for the Company on a retrospective basis for interim and annual reporting periods beginning January 1, 2015. Early adoption is permitted. The Company has a $3 million qualified affordable housing investment of which $960,000 has been amortized through non-interest income over the past few years. The amount of amortization, which reduced non-interest income, was $214,000 and $135,000 for the nine months ending September 30, 2014 and 2013, respectively. Income tax credits which reduced income tax expense were $247,000 and $274,000 for the nine months ending September 30, 2014 and 2013, respectively. Under the proportional amortization method, part of the amortization which has reduced non-interest income will be reclassified to increase income tax expense. The Company is currently evaluating the impact of the amendments on its consolidated financial statements.

 

30
 

 

In February 2013, the FASB issued ASU No. 2013-02 on the topic of Comprehensive Income. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, in certain circumstances the amendments do require an entity to present, either on the face of the statement where net income is presented or in the notes, the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. The amendments were effective for the Company on a prospective basis beginning January 1, 2013. These amendments did not have a material effect on the Company’s consolidated financial statements.

 

In July 2013, the FASB issued ASU No. 2013-11 on the topic of Income Taxes. The amendments eliminate the diversity in practice regarding presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Under the provisions of the ASU, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset unless certain criteria are met. The amendments were effective for the Company on a prospective basis beginning January 1, 2014. These amendments did not have a material effect on the Company’s consolidated financial statements.

 

Several other accounting standards have been issued or proposed by the FASB or other standards-setting bodies during the periods presented or will be effective subsequent to September 30, 2014. None of these new standards had or is expected to have a material impact on the Company’s consolidated financial statements.

 

Note O - Commitments

 

In the normal course of business there are outstanding commitments for the extension of credit which are not reflected in the financial statements. At September 30, 2014 and December 31, 2013, pre-approved but unused lines of credit for loans totaled approximately $161,945,000 and $159,756,000, respectively. In addition, we had $1,685,000 and $1,701,000 in standby letters of credit at September 30, 2014 and December 31, 2013, respectively. These commitments represent no more than the normal lending risk that we commit to borrowers. If these commitments are drawn, we will obtain collateral if it is deemed necessary based on our credit evaluation of the counter-party. We believe these commitments can be funded through normal operations.

 

The Company leases land for its main office, four loan production offices, and two branch facilities under operating leases. Total future minimum lease payments, excluding renewal options, at September 30, 2014 under the leases are as follows:

 

Future Mininum Lease Payments at September 30, 2014
   (in thousands) 
Due in one year  $592 
Due in Years 2 and 3   713 
Due in Years 4 and 5   671 
Due after Year 5   2,923 
   $4,899 

 

31
 

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion is intended to assist in understanding our financial condition and results of operations. Because we have no material operations and conduct no business on our own other than owning our subsidiaries, Carolina Bank and Carolina Capital Trust, and because Carolina Capital Trust has no operations other than the issuance of its trust preferred securities, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of Carolina Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, Carolina Bank Holdings, Inc. and Carolina Bank are collectively referred to herein as “we”, “our” or “us” unless otherwise noted.

 

Forward-looking Statements

 

This report contains forward-looking statements with respect to our financial condition and results of operations and business. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following:

·General economic conditions may deteriorate and negatively impact the ability of our borrowers to repay loans and our depositors to maintain balances.
·Changes in interest rates could reduce our net interest income.
·Competitive pressures among financial institutions may increase.
·Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which we are engaged.
·New products developed and new methods of delivering products could result in a reduction in our business and income.
·Increases in interest rates, increases in warranty losses, or changes in the securitization of mortgages could negatively impact our mortgage banking income.
·Adverse changes may occur in the securities market.
·Technology fraud and related losses may become a major threat to banks of all sizes and to bank customers.
·Local, state or federal taxing authorities may take tax positions that are adverse to us.
·Unpredictable natural and other disasters could have an adverse effect on our operations or on the willingness of our customers to access our financial services.

 

Comparison of Financial Condition

 

Assets. Our total assets increased by $7.2 million, or 1.1%, from $661.8 million at December 31, 2013, to $669.0 million at September 30, 2014. During the nine months ended September 30, 2014, cash and due from banks, interest-bearing deposits with banks, bank term deposits and investment securities decreased by $39.6 million while loans held-for-sale increased $15.6 million, and loans held for investment increased $26.7 million. Average loans held for investment have increased for the past five quarters which reverses a 3.5 year decline. Our mortgage division sells residential mortgage loans originated through other banks, brokers, our retail offices and four loan production offices. Originations for the first nine months of 2014 were approximately $411 million compared to $761 million in the first nine months of 2013. The decline in originations in 2014 was due to a decrease in refinancing by borrowers due to higher interest rates and by severe weather in the first quarter of 2014. Although non-performing assets declined during the first nine months of 2014, other real estate owned increased from $2.3 million at December 31, 2013 to $5.6 million at September 30, 2014 from the foreclosure of a golf course, a large home, and various development lots. The golf course and home are under contract to be sold in the fourth quarter of 2014.

 

32
 

 

Liabilities. Total deposits increased by $7.8 million, or 1.4%, from $579.1 million at December 31, 2013, to $586.9 million at September 30, 2014. Due to adequate liquidity, most of our deposit products were not promoted during 2014; however, we continue our focus on increasing noninterest bearing demand deposits which are more profitable than time deposits. Noninterest bearing demand deposits increased 10.5% from December 31, 2013 to $93.8 million at September 30, 2014 while time deposits decreased 0.8% during the first nine months of 2014 to $150.0 million at September 30, 2014. Our branching activities are designed to enhance customer convenience and related deposit gathering activities as well as provide new sources for loans. While deposit growth has historically been a goal, wholesale sources of funding such as Federal Home Loan Bank (“FHLB”) advances and repurchase borrowings, may be utilized where cost beneficial and when necessary to meet liquidity or asset liability requirements. Retail repurchase agreements decreased $3.0 million and FHLB advances decreased $0.08 million during the first nine months of 2014. We had approximately $20.1 million in out-of-market time deposits from other institutions and $19.3 million in brokered deposits at September 30, 2014, a decrease of $2.1 million in these two types of accounts from December 31, 2013.

 

Stockholders’ Equity. Total stockholders’ equity increased $1.8 million at September 30, 2014 to $51.4 million from $49.6 million at December 31, 2013, due primarily to net income less preferred dividends paid and due to an increase in other comprehensive income.

 

Comparison of Results of Operations for the Three Months Ended September 30, 2014 and 2013

 

General. Net income was $1,012,000 and $1,023,000 for the third quarter of 2014 and 2013, respectively. Net income available to common stockholders was $764,000, or $0.22 per diluted share, for the three months ended September 30, 2014 compared to $776,000, or $0.23 per diluted share, for the three months ended September 30, 2013. Net income available to common stockholders represents net income less preferred stock dividends and related discount accretion. While net interest income was sharply higher and our provision for loan losses was much lower, mortgage banking income declined and expenses increased in the third quarter of 2014 from the third quarter of 2013. Our mortgage division incurred a net loss of $160,000 and $21,000 in the third quarter of 2014 and 2013, respectively. The commercial/retail bank realized net income of $1,209,000 and $1,099,000 in the third quarter of 2014 and 2013, respectively. Our primary markets in the Triad of North Carolina experienced deteriorating economic conditions in 2009 through 2011 which negatively impacted our borrowers as evidenced by increasing defaults and loan charge-offs. Economic conditions have gradually improved since 2011 in our primary markets as evidenced by decreasing loan charge-offs and impaired loans.

 

Net interest income. Net interest income of $5,892,000 for the three months ended September 30, 2014 increased $590,000 from the third quarter of 2013. The net yield on interest earning assets, adjusted to a fully taxable basis, increased to 3.81% in the third quarter of 2014 from 3.38% in the third quarter of 2013. The increase in the net yield on interest-earning assets resulted from a decline in yields on interest-bearing liabilities and from a shift in average interest-earning assets from interest earning deposits that have the lowest asset yield to higher yielding investments and loans. Average non-interest bearing demand deposits which increased 12.0% in the third quarter of 2014 from the third quarter of 2013 are a major focus of the Bank. The increase in average non-interest bearing demand deposits contributed to the higher net yield. The five year compounded annual growth rate for non-interest bearing demand deposits was 23.7% as of December 31, 2013.

 

33
 

  

The table below provides an analysis of the effective yields and rates on the categories of interest-earning assets and interest-bearing liabilities for the periods indicated.

 

Net Interest Income and Average Balance Analysis

 

   For the Three Months Ended September 30, 
   2014   2013 
   Average   Interest   Average   Average   Interest   Average 
   Balance (1.)   Inc./Exp.   Yield/Cost   Balance (1.)   Inc./Exp.   Yield/Cost 
   (Dollars in thousands) 
Interest-earning assets                              
Interest earning deposits  $33,664   $41    0.48%  $102,994   $91    0.35%
Non-taxable investments (2.)   17,660    196    4.40%   17,614    205    4.62%
Taxable investments   56,725    385    2.69%   48,251    323    2.66%
Loans held for sale   49,444    500    4.01%   35,864    360    3.98%
Loans  (2.) (3.)   466,268    5,672    4.83%   425,271    5,299    4.94%
Interest-earning assets   623,761    6,794         629,994    6,278      
Interest-earning assets             4.32%             3.95%
                               
Non interest-earning assets   45,407              41,638           
                               
Total assets  $669,168             $671,632           
                               
Interest-bearing liabilities                              
Interest checking  $45,720   $8    0.07%  $40,872   $8    0.08%
Money market and savings   298,374    232    0.31%   296,046    252    0.34%
Time certificates and IRAs   147,521    396    1.06%   162,108    469    1.15%
Other borrowings   23,536    168    2.83%   27,207    179    2.61%
Total interest-bearing liabilities   515,151    804         526,233    908      
Cost on average Interest-bearing liabilities             0.62%             0.68%
Non-interest-bearing liabilities                              
Demand deposits   96,248              85,972           
Other liabilities   6,706              7,276           
Total non-interest-bearing liabilities   102,954              93,248           
Total liabilities   618,105              619,481           
Stockholders' equity   51,063              52,151           
Total liabilities and equity  $669,168             $671,632           
Net interest income       $5,990             $5,370      
Net yield on average interest-earning assets             3.81%             3.38%
Interest rate spread             3.70%             3.27%

 

(1.)Average balances are computed on a daily basis.
(2.)Interest income and yields related to certain investment securities and loans exempt from federal income tax are stated on a fully taxable basis using a 34% federal tax rate, reduced by the nondeductible portion of interest expense.
(3.)Nonaccrual loans are included in the average loan balance.

 

34
 

  

Provision for loan losses. The provision for loan losses amounted to $270,000 and $600,000 for the three months ended September 30, 2014 and 2013, respectively. The amount of the provision for loan losses decreased in the third quarter of 2014 due to improving credit quality. Impaired loans, which generally require additional loan loss reserves, and the historical loss ratios used to provide loan loss reserves on non-impaired loans both decreased in the third quarter of 2014. We believe the allowance for loan losses is appropriate based on asset quality indicators and other factors.

 

Non-interest income. Non-interest income was $2,602,000 for the three months ended September 30, 2014 compared to $2,905,000 for the three months ended September 30, 2013. Mortgage banking income decreased $299,000, or 12.4% due to a decrease of approximately 10% in residential mortgage loan originations in the third quarter of 2014 from the third quarter of 2013. Gain on the sale of investment securities was $113,000 and $80,000 in the third quarter of 2014 and 2013, respectively. Other non-interest income declined $56,000 in the third quarter of 2014 compared to the third quarter of 2013 due to a change in the sale of non-deposit investment products which was contracted to a third party in 2014.

 

Non-interest expense. Total non-interest expense amounted to $6,829,000 and $6,229,000 for the three months ended September 30, 2014 and 2013, respectively. Salaries and employee benefits increased $519,000, or 13.0%, from resumption of accruals of incentive compensation in our retail/commercial bank and from higher commissions earned by our retail mortgage loan officers during the third quarter of 2014. Outside data processing increased $85,000 to $274,000 for the third quarter of 2014 due to implementation costs of mobile banking and from additional security costs related to debit card processing.

 

Income taxes. Income tax expense was $383,000, or 27.5% of income before income taxes, for the three month period ended September 30, 2014, as compared to $355,000, or 25.8% of income before income taxes, for the three month period ended September 30, 2013.

 

Comparison of Results of Operations for the Nine Months Ended September 30, 2014 and 2013

 

General. Net income was $2,027,000 and $4,211,000 for the nine months ended September 30, 2014 and 2013, respectively. Net income available to common stockholders was $1,341,000, or $0.39 per diluted share, for the nine months ended September 30, 2014 compared to $3,353,000, or $0.98 per diluted share, for the nine months ended September 30, 2013. Lower net income in 2014 resulted primarily from lower mortgage banking income due to a drop of approximately 46% in loan originations in 2014.

 

Net interest income. Net interest income of $17,093,000 for the nine months ended September 30, 2014 increased $138,000 from the nine months ended September 30, 2013 due to an increase in the net yield on interest earning assets. The net yield on interest earning assets, adjusted to a fully taxable basis, increased to 3.75% in the first nine months of 2014 from 3.64% in the first nine months of 2013 due to an increase in the yield on interest-earning assets and a decline in the yield on interest-bearing liabilities. The yield on interest-earning assets improved in 2014 from a shift in the asset mix to higher yielding loans and investments from lower yielding interest earning deposits. Average assets and liabilities contracted in 2014 which negatively impacted net interest income in 2014, but an increase in non-interest-bearing demand deposits and lower non-interest-earning assets positively impacted net interest income.

 

35
 

  

The table below provides an analysis of effective yields and rates on categories of interest-earning assets and interest-bearing liabilities for the nine months ended September 30, 2014 and 2013.

 

Net Interest Income and Average Balance Analysis

 

   For the Nine Months Ended September 30, 
   2014   2013 
   Average   Interest   Average   Average   Interest   Average 
   Balance (1.)   Inc./Exp.   Yield/Cost   Balance (1.)   Inc./Exp.   Yield/Cost 
   (Dollars in thousands) 
Interest-earning assets                              
Interest earning deposits  $45,614   $150    0.44%  $84,510   $176    0.28%
Non-taxable investments (2.)   18,360    613    4.46%   13,991    524    5.01%
Taxable investments   59,565    1,216    2.73%   38,323    831    2.90%
Loans held for sale   35,903    1,101    4.10%   59,591    1,624    3.64%
Loans (2.) (3.)   458,746    16,700    4.87%   432,765    16,876    5.21%
Interest-earning assets   618,188    19,780         629,180    20,031      
Interest-earning assets             4.28%             4.26%
                               
Non interest-earning assets   43,137              44,712           
                               
Total assets  $661,325             $673,892           
                               
Interest-bearing liabilities                              
Interest checking  $44,525   $24    0.07%  $41,229   $31    0.10%
Money market and savings   297,039    692    0.31%   296,283    825    0.37%
Time certificates and IRAs   146,719    1,221    1.11%   168,627    1,492    1.18%
Other borrowings   24,585    496    2.70%   26,750    554    2.77%
Total interest-bearing liabilities   512,868    2,433         532,889    2,902      
Cost on average Interest-bearing liabilities             0.63%             0.73%
Non-interest-bearing liabilities                              
Demand deposits   91,375              80,441           
Other liabilities   6,612              6,800           
Total non-interest-bearing liabilities   97,987              87,241           
Total liabilities   610,855              620,130           
Stockholders' equity   50,470              53,762           
Total liabilities and equity  $661,325             $673,892           
Net interest income       $17,347             $17,129      
Net yield on average interest-earning assets             3.75%             3.64%
Interest rate spread             3.64%             3.53%

 

(1.)Average balances are computed on a daily basis.
(2.)Interest income and yields related to certain investment securities and loans exempt from federal income tax are stated on a fully taxable basis using a 34% federal tax rate, reduced by the nondeductible portion of interest expense.
(3.)Nonaccrual loans are included in the average loan balance.

 

36
 

 

Provision for loan losses. The provision for loan losses amounted to $1,386,000 and $1,100,000 for the nine months ended September 30, 2014 and 2013, respectively. The amount of the provision for loan losses increased in 2014 primarily because of additional impairments on three loan relationships involving the untimely death of a borrower, the foreclosure of a golf course and related development, and the closing of an industrial operation. We believe the allowance for loan losses is appropriate based on asset quality indicators and other factors.

 

Non-interest income. Total non-interest income declined to $6,692,000 for the nine months ended September 30, 2014 from $11,425,000 for the nine months ended September 30, 2013. The decrease in 2014 resulted primarily from a decline in mortgage banking income of $4,493,000 to $5,401,000 for the nine months ended September 30, 2014. Other non-interest income also declined for the nine months ended September 30, 2014 due to increased amortization of an investment in low income housing and due to outsourcing the sale of non-deposit investment products in 2014.

 

Non-interest expense. Total non-interest expense amounted to $19,876,000 and $21,145,000 for the nine months ended September 30, 2014 and 2013, respectively. Salaries and employee benefits decreased $988,000, or 7.4%, from reductions in administrative positions in our mortgage division and from sharply lower incentive compensation in our mortgage division along with lower incentive compensation in our retail/commercial bank. The number of full-time equivalent employees decreased to 193 at September 30, 2014 from 203 at September 30, 2013. Foreclosed property expense declined $788,000, or 81.9% to $174,000 in the first nine months of 2014 due to decreased real estate impairment charges and lower expenses maintaining real estate owned properties. Professional fees increased $481,000, or 51.9% in the 2014 period to $1,407,000, primarily for legal fees involving several major loan collection efforts.

 

Income taxes. Income tax expense was $496,000, or 19.7% of income before income taxes, for the nine months ended September 30, 2014, compared to $1,924,000, or 31.4% of income before income taxes, for the nine months ended September 30, 2013. Tax credits and non-taxable income represented a larger percentage of income in the 2014 period which accounted for the lower income tax rate in 2014.

 

Asset Quality

 

Non-performing assets, composed of other real estate owned and non-accrual loans, totaled $16,085,000 at September 30, 2014, compared to $19,060,000 at December 31, 2013. Non-performing assets, as a percentage of total assets, was 2.40% at September 30, 2014, compared to 2.88% at December 31, 2013. There were no loans 90 days or more past due and still accruing interest at September 30, 2014 or December 31, 2013. Other real estate owned increased to $5,587,000 at September 30, 2014 from $2,329,000 at December 31, 2013, primarily from the foreclosure of a golf course and lots and a large home in 2014. Non-performing assets have declined substantially from 2010 and 2011 due to success in disposing of problem loans and assets, from reduction in new additions to non-performing assets, and from an improved economy. Impaired but still performing loans were $12,197,000 and $12,537,000 at September 30, 2014 and December 31, 2013, respectively.

 

Loans are graded according to an internal loan rating classification system, and “criticized loans” represent adversely classified loans with identified weaknesses and potential or identified losses of principal and/or interest due. Criticized loans decreased to $17,815,000 at September 30, 2014 from $26,209,000 at December 31, 2013 and $37,820,000 at December 31, 2012 due to continuing efforts to improve asset quality. Loan rating classification information is detailed in Note K to the consolidated financial statements as of September 30, 2014.

 

37
 

  

The decrease in criticized loans in 2014 and 2013 from 2012 resulted from success in disposing of problem loans, from reduction in new additions to criticized loans as a result of an improved credit culture, and from an improving economy. The economic conditions in our primary markets in North Carolina, have improved as evidenced by a drop in the unemployment rate. The seasonally adjusted unemployment rate in North Carolina decreased to 6.7% in September 2014 from 7.7% in September 2013. North Carolina’s seasonally adjusted unemployment rate of 6.7% compares to 5.9% for the United States. A large portion of our loans are made to businesses and real estate developers and are secured by real estate. Real estate prices have improved in our markets but are still lower than in 2008 in many areas.

 

Our allowance for loan losses is composed of two parts, a specific portion related to non-performing loans and performing impaired loans and a general section related to non-impaired loans. The specific portion of our allowance for loan losses, which relates to impaired loans, decreased to $993,000 at September 30, 2014 from $2,063,000 at December 31, 2013, and impaired loans decreased to $22,545,000 at September 30, 2014 from $29,268,000 at December 31, 2013. The specific portion of our allowance relating to impaired loans decreased in 2014 primarily because of greater loan charge-offs of impaired allowances in 2014 than 2013. The general portion of our allowance for loan losses decreased to $5,553,000 on non-impaired loans of $448,237,000 at September 30, 2014 from $5,600,000 on non-impaired loans of $414,819,000 at December 31, 2013. The general portion of our allowance applies to non-impaired loans and was determined by applying estimated loss ratios inherent in the loan portfolio, ranging from 0.10% on loans for purchasing or carrying securities to 2.61% on construction and development loans, to categories of non-impaired loans at each period end. We changed in the third quarter of 2014 to using the latest sixteen quarters from the latest twelve quarters to determine the estimated loss ratios inherent in the loan portfolio. We had previously used the latest twelve quarters since 2012. We believe that using sixteen quarters to calculate the estimated loss ratios more accurately reflects expected losses over time, and the change to sixteen quarters produced a slightly higher allowance than using twelve quarters. The general section of our allowance also includes a qualitative component which is calculated based on nine environmental factors such as the changes in economic and business conditions that affect the collectability of the loan portfolio and changes in the value of collateral dependent loans. The qualitative component of the general section of our allowance for loan losses, including a minor unallocated allowance, was $882,000 and $708,000 at September 30, 2014 and December 31, 2013, respectively.

 

The allowance for loan losses is increased by direct charges to operating expense, the provision for loan losses. Losses on loans or charge-offs are deducted from the allowance in the period that loans are deemed to become uncollectible or in the period that updated appraisals indicate a loss in value of non-performing, collateral dependent, real estate loans. Recoveries of previously charged-off loans are added back to the allowance. Net loan charge-offs (charge-offs minus recoveries) totaled $2,503,000 for the nine months ended September 30, 2014 compared to $3,343,000 for the same period in 2013.

 

Liquidity and Capital Resources

 

The objective of our liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses our ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.

 

Our primary sources of internally generated funds are principal and interest payments on loans receivable, non-interest income and proceeds from loans sales related to residential mortgage banking, and cash flows generated from operations. External sources of funds include increases in deposits, repurchase agreements, lines of credit from banks, including the Federal Reserve, and advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

 

38
 

  

Carolina Bank is required under applicable federal regulations to maintain specified levels of liquid investments in qualifying types of investments. Cash and due from banks, interest-bearing deposits in banks, bank term deposits, investment securities available-for-sale, and loans held for sale by our mortgage division are the primary liquid assets of Carolina Bank. We regularly monitor Carolina Bank’s liquidity position to ensure its liquidity is sufficient to meet its needs. During the first nine months of 2014, our levels of short-term liquidity decreased due to growth in loans. Short-term liquidity in the form of cash and due from banks and interest-bearing deposits in banks, decreased to $27.9 million at September 30, 2014 from $64.9 million at December 31, 2013. The decline in short-term liquidity at September 30, 2014 assisted our efforts to improve our net interest margin. Our current liquidity levels are near historical peaks and are adequate to meet our anticipated future needs. We also have substantial secondary sources of liquidity in the form of unused secured lines of credit from the FHLB and the Federal Reserve of approximately $178 million at September 30, 2014.

 

We are subject to various regulatory capital requirements administered by the banking regulatory agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly discretionary actions by the regulators that, if undertaken, could have a material adverse effect on our financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. Capital ratios for Carolina Bank were as follows at September 30, 2014 and December 31, 2013, respectively: Tier 1 leverage – 9.03%, 8.86%; Tier 1 risk-based – 11.05%, 11.19%; Total risk-based – 13.61%, 13.85%. The 2014 risk-based ratios declined due to increased loans which generally have higher risk weights. As of September 30, 2014 and December 31, 2013, our levels of capital exceeded all applicable published regulatory requirements.

 

Due to our historical growth, the recent difficult economic environment, increased regulatory capital requirements, and our anticipation of continued growth, we issued $16 million in preferred stock to the United States Treasury under the Capital Purchase Program in January 2009 to increase our capital which could further support future growth and assist us in meeting future regulatory capital requirements. The United States Treasury sold our preferred stock to private investors in 2013, and we subsequently repurchased $5.0 million of the preferred stock from private investors. We also repurchased a warrant for common stock granted to the United States Treasury as part of the Capital Purchase Program for $1.8 million in 2013. As a result of these repurchases, our capital ratios declined slightly during 2013.

 

During 2013, Basel III capital requirements were adopted by United States banking regulators. The Basel III regulations establish a common equity Tier 1 capital requirement of 4.5% in 2015 and 7.0% by 2019. The new regulations change risk weights for certain on and off balance sheet assets and require deductions from capital for certain types of assets. We are currently evaluating the new Basel III capital requirements but believe we will be in compliance prior to the effective dates.

 

Interest Rate Sensitivity

 

Interest rate sensitivity management is concerned with the timing and magnitude of re-pricing assets compared to liabilities and is a part of asset/liability management. It is the objective of interest rate sensitivity management to generate stable growth in net interest income, and to control the risks associated with interest rate movements. We measure interest rate risk by using simulation analysis. Prior to 2010, simulation analysis indicated, in the absence of growth or changes in the mix of assets and liabilities, our net interest income generally increased when short-term interest rates rose and declined when short-term interest rates fell. In late 2010, we set our Carolina Bank prime at 4.50% when the Wall Street Journal Prime declined to 3.25% with the expectation that the Carolina Bank prime would rise less than the Wall Street Journal Prime until both indexes reach parity at 7.25%. Our simulation analysis as of September 30, 2014 indicates that our net interest margin will decline approximately 1.70% in one year, if interest rates rise gradually 1% over a one year time period, and will decline 1.5% over a one year time period if interest rates rise gradually 4% over a one year time period. The delay in adjusting our loans tied to the Carolina Bank prime or at floors is a reason for the potential decline in net interest income as the Wall Street Journal Prime increases. We have also increased our fixed rate loans and investments in recent quarters, and customers have shown an increased preference for short-term deposits over the past few years, all of which have increased our risk to higher interest rates. If more stressed conditions exist than those assumed in our simulation analysis, such as no adjustment in the Carolina Bank prime until the Wall Street Journal Prime reaches 4.50% or if deposit rates rise faster than expected, then the decline in our net interest margin would be greater than the aforementioned amounts.

 

39
 

  

Inflation

 

Since our assets and liabilities are primarily monetary in nature, our performance is more affected by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not necessarily be the same. If inflation is accompanied by a rise in interest rates, our net interest income will fall as noted under “Interest Rate Sensitivity” and our mortgage banking income could fall as fewer borrowers qualify for new loans.

 

While the effect of inflation on a financial institution is normally not as significant as is its influence on those businesses which have large investments in plant and inventories, it does have an effect. During periods of high inflation, there are normally corresponding increases in the money supply, and financial institutions will normally experience above average growth in assets, loans and deposits. Also, general increases in the prices of goods and services will result in increased operating expenses.

 

40
 

 

ITEM 4. Controls and Procedures

 

Our Chief Executive Officer and Chief Financial Officer have conducted an evaluation of our disclosure controls and procedures as of September 30, 2014. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the applicable Securities and Exchange Commission Rules and Forms. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation of these controls by our Chief Executive Officer and Chief Financial Officer.

 

Management of the Company has evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, changes in the Company's internal controls over financial reporting (as defined in Rule 13a−15(f) and 15d−15(f) of the Exchange Act) during the third quarter of 2014. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the third quarter that have materially affected or are reasonably likely to materially affect, the Company's internal control over financial reporting.

 

41
 

  

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

There are various claims and lawsuits in which the Company and the Bank are periodically involved incidental to their business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.

 

Item 6. Exhibits

 

Exhibit No. Description of Exhibit
10.1 Salary Continuation Agreement with John Richard Spiker, II.
   
31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
   
31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
   
32.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.
   
101 Interactive data files providing financial information from the Registrant’s Quarterly report on Form 10-Q for the quarterly period ended September 30, 2014, in XBRL (eXetensible Business Reporting Language).

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  Carolina Bank Holdings, Inc.
     
Date: November 14, 2014 By: /s/ Robert T. Braswell
    Robert T. Braswell
    President and Chief Executive Officer
     
Date: November 14, 2014 By: /s/ T. Allen Liles
    T. Allen Liles
    Chief Financial and Principal Accounting Officer

 

42
 

  

Exhibit Index

 

Exhibit No. Description of Exhibit
10.1 Salary Continuation Agreement with John Richard Spiker, II.
   
31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
   
31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
   
32.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.
   
101 Interactive data files providing financial information from the Registrant’s Quarterly report on Form 10-Q for the quarterly period ended September 30, 2014, in XBRL (eXetensible Business Reporting Language).

 

43