UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-K

 

x

Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For The Fiscal Year Ended: December 31, 2016.

 

¨

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 000-51907

 

Independence Bancshares, Inc.
(Exact name of registrant as specified in its charter)

 

South Carolina	20-1734180
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
500 E. Washington Street, Greenville	29601
(Address of principal executive offices)	(Zip Code)
864-672-1776
(Registrant’s telephone number, including area code)   Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 Act). Yes ¨   No x

 

As of June 30, 2016, the aggregate market value of the issued and outstanding common stock held by non-affiliates of the registrant, based upon an estimate the last sales price of the registrant’s common stock of $0.19 was approximately $3,895,524.

 

The number of shares outstanding of the issuer’s common stock, as of March 23, 2017 was 20,502,760.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

PART I

 

As used in this Annual Report on Form 10-K, “we,” “our” and “us” refer to Independence Bancshares, Inc. and its subsidiaries, collectively unless the context requires otherwise.

 

Cautionary Note Regarding Forward-Looking Statements

 

This Annual report on Form 10-K, including information included or incorporated by reference in this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in our forward-looking statements include, but are not limited, to the following:

 

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strategies for growth and sources of new operating revenues, including the Bank’s expansion of its consumer lending program to target prime and super-prime borrowers in its current market areas as well as throughout South Carolina;

 

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suspension of business divisions or segments, including digital banking or consumer lending;

 

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operating revenues, expenses, effective tax rates, and other results of operations;

 

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current and future products and services and plans to develop and promote them;

 

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capital expenditures and our estimates regarding our capital expenditures;

 

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liquidity, working capital requirements and access to funding;

 

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cybersecurity risks, business disruptions or financial losses and changes in technology;

 

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our shareholder relations;

 

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defense of litigation brought by current and/or former officers, directors and/or shareholders;

 

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mergers and acquisition activity;

 

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use of proceeds from sales of our securities;

 

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our ability to comply with regulations;

 

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relations with federal and state regulators;

 

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listing our shares, including any listing on a national securities exchange;

 

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changes in economic conditions;

 

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credit losses;

 

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the rate of delinquencies and amount of loans charged-off;

 

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allowances for loan losses and loan loss provisions;

 

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the lack of loan growth in recent years;

 

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our ability to attract and retain key personnel;

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our ability to protect, use, develop, market and otherwise exploit our proprietary technology and intellectual property;

 

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our ability to retain our existing customers;

 

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increases in competitive pressure in the banking and financial services industries;

 

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adverse changes in asset quality and resulting credit risk related losses and expenses;

 

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changes in the interest rate environment, business conditions, inflation and changes in monetary and tax policies;

 

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changes in political, legislative or regulatory conditions;

 

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loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;

 

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changes in deposit flows;

 

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changes in accounting policies and practices; and

 

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other risks and uncertainties detailed in our other filings with the SEC.

 

All forward-looking statements in this Annual Report on Form 10-K are based on information available to us as of the date of this Annual Report on Form 10-K. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of this Annual Report on Form 10-K. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

Item 1. Business.

 

General

 

Independence Bancshares, Inc. (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Banking and Branching Efficiency Act of 1996, and to own and control all of the capital stock of Independence National Bank (the “Bank”), a national association organized under the laws of the United States. Since opening for business on May 16, 2005, the Bank has operated as a traditional community bank in Greenville, South Carolina, fulfilling the financial needs of individuals and small businesses in its market. The Bank provides traditional checking and savings products insured by the Federal Deposit Insurance Corporation (the “FDIC”) and consumer, commercial and mortgage loans, as well as ATM and online banking, cash management and safe deposit boxes.

 

As previously reported, on September 25, 2015, the Company suspended development of its digital banking, payments and transaction services business and subsequently began evaluating strategic alternatives for the Company. A key goal of the Company’s digital banking business was to reduce costs for banking activities and operate more efficiently through utilizing mobile and online delivery channels. In furtherance of this goal and based in part upon the institutional knowledge acquired in the pursuit of the digital banking strategy, the Company plans to supplement its current lending strategy by expanding its consumer lending program with online offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. The Company’s board of directors is focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of its consumer lending program which may include purchases of in-market consumer loans that meet our underwriting criteria.

 

Banking Services

 

Market

 

Our primary focus and target market is to fulfill the financial needs of individual consumers, small business owners, the legal and medical communities, insurance agencies, and clients owning and developing income producing properties primarily in the Greenville metropolitan area. In our consumer lending line of business, we focus on a broader market area that currently includes the entire state of South Carolina. We intend to use our “closeness” to the market via local ownership, quick response time, pricing discretion, person-to-person relationships and an experienced, well known senior management team in leveraging our market share in the greater

Greenville area while looking for ways to differentiate the Bank from our competition. Our new on-line consumer lending program is one of these ways we seek to differentiate the Bank from our competition.

 

Location and Service Area

 

Our primary market is Greenville County, which is located in the upstate region of South Carolina. The cities of Fountain Inn, Greenville, Greer, Mauldin, Simpsonville, and Travelers Rest make up Greenville County. The Greenville metropolitan area, positioned on the I-85 corridor, is home to one of the strongest manufacturing centers in the country, including approximately 250 international companies, such as the North American headquarters of BMW and Michelin, as well as Fluor Corporation, General Electric, and Lockheed Martin. Greenville County has a population of approximately 492,000, with a five-year projected annual growth rate of approximately 2.1%, according to the South Carolina Community Profiles published by the South Carolina Budget and Control Board’s Office of Research and Statistics. The area’s demographics have changed considerably over the past 10 years and currently over 42,000 businesses are operating within the county limits, according to the U.S. Census Bureau.

 

Our main office is located in Greenville, South Carolina, one block off a major artery, and provides excellent visibility for the Bank. We also have full-service branches on Wade Hampton Boulevard in Taylors, South Carolina and in Simpsonville, South Carolina. These branch offices have extended the market reach of our Bank and have increased our personal service delivery capabilities to all of our customers. We plan to continue to take advantage of existing contacts and relationships with individuals and companies in this area to more effectively market the banking services of the Bank.

 

With respect to our on-line consumer lending program, we believe that because the business has been structured to be overwhelmingly conducted on-line, we will be able to expand our lending area outside of the area served by our physical branch network.

 

Competition

 

The Greenville market is highly competitive, with all of the largest banks in the state, as well as super regional banks, represented in our market area. The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits. In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies. Size gives larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina. As a result, we do not generally attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and retail customers. We believe we have competed effectively in this market by offering quality and personal service.

 

With respect to our on-line consumer lending program, our greatest source of competition is non-bank lenders and we believe that we can effectively compete in this product through utilizing mobile and online delivery channels as well as advantages – such as state law preemption – afforded to us as a national bank.

 

Products and Services

 

The Bank is primarily engaged in the business of accepting demand and time deposits and providing consumer, commercial and mortgage loans to the general public. With respect to our on-line consumer lending business, we provide unsecured consumer loans up to $35,000 to individual borrowers. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is currently set at $250,000 per depositor. Other services which the Bank offers include mobile banking, online banking, commercial cash management, remote deposit capture, safe deposit boxes, bank official checks, traveler’s checks, and wire transfer capabilities.

 

Lending Activities

 

General. We emphasize a range of lending services, including commercial, real estate, unsecured consumer loans and equity-line consumer loans to individuals and small- to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in our market area. The larger, well-established banks in our service area make proportionately more loans to medium- to large-sized businesses than we do. Our small- to medium-sized borrowers may be less able to withstand competitive, economic, and financial conditions than larger borrowers. Our underwriting standards vary for each type of loan, as described below. We compete for these loans with competitors who are well established in our service area and have greater resources and lending limits.

Loan Approval. Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and client lending limits, a multi-layered approval process for larger loans, documentation examination, and follow-up procedures for exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds an individual officer’s lending authority, the loan request will be considered by an executive officer with a higher lending limit, executive officers combining authority or the directors’ loan committee. We do not make any loans to any director or executive officer of the Bank unless the loan is approved by the full board of directors of the Bank and is on terms not more favorable than would be available to a person not affiliated with the Bank.

 

Credit Administration and Loan Review. We maintain a continuous loan review system. We also apply a credit grading system to each loan, and we use an independent consultant to review the loan files on a test basis to confirm our loan grading. Each loan officer is responsible for each loan he or she makes, regardless of whether other individuals or committees joined in the approval. This responsibility continues until the loan is repaid or until the loan is officially assigned to another officer.

 

Lending Limits. Our lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. These limits will increase or decrease in response to increases or decreases in the Bank’s level of capital. We are able to sell participations in our larger loans to other financial institutions, which allows us to manage the risk involved in these loans and to meet the lending needs of our clients requiring extensions of credit in excess of these limits.

 

Consumer Loans. We have historically made a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit but have this year increased our focus on this line of business by implementing an on-line unsecured consumer loan product to individual borrowers of up to $35,000 per loan. Consumer loans are underwritten based on the borrower’s income, current debt level, past credit history, and the availability and value of collateral, if a secured loan. Consumer rates are both fixed and variable, with terms negotiable. Our installment loans typically amortize over periods up to 60 months. We will offer consumer loans with a single maturity date when a specific source of repayment is available. We typically require monthly payments of interest and a portion of the principal on our revolving loan products. Consumer loans are generally considered to have a greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value than real estate.

 

Real Estate Mortgage Loans. The principal component of our loan portfolio is loans secured by real estate mortgages. We obtain a security interest in real estate whenever possible, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan. At December 31, 2016, loans secured by mortgages on real estate — first mortgages of approximately $45.2 million and second mortgages of approximately $3.9 million — made up approximately 71% of our loan portfolio.

 

These loans generally fall into one of four categories: commercial real estate loans, construction and development loans (including land loans), residential real estate loans, or home equity loans. Most of our real estate loans are secured by residential or commercial property. Interest rates for all categories may be fixed or adjustable, and will more likely be fixed for shorter-term loans. We generally charge an origination fee for each loan. Other loan fees consist primarily of late charge fees or prepayment penalties. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower’s cash flow, credit-worthiness, and ability to repay the loan.

 

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Commercial Real Estate Loans. Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 85% at origination. We generally require that debtor cash flow exceed 120% of monthly debt service obligations. We typically review all of the personal financial statements of the principal owners and require their personal guarantees. These reviews generally reveal secondary sources of payment and liquidity to support a loan request.

 

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Construction and Development Real Estate Loans (Including Land Loans). We offered adjustable and fixed rate residential and commercial construction loans in the past. We continue to offer construction and development loans on a limited basis to certain qualified borrowers. The terms of construction and development loans have generally been limited to eighteen months, although some payments have been structured on a longer amortization basis. Most loans mature and require payment in full upon the sale of the property. We believe that construction and development loans generally carry a higher degree of risk than long term financing of existing properties. Repayment depends on the ultimate completion of the project and usually on the sale of the property. Specific risks include:

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cost overruns;

 

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mismanaged construction;

 

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inferior or improper construction techniques;

 

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economic changes or downturns during construction;

 

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a downturn in the real estate market;

 

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rising interest rates which may prevent sale of the property; and

 

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failure to sell completed projects in a timely manner.

 

We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We previously reduced risk by selling participations in larger loans to other institutions when possible.

 

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Residential Real Estate Loans and Home Equity Loans. We generally do not originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. Generally, we limit the loan-to-value ratio on our residential real estate loans to 80% at origination. We offer fixed and adjustable rate residential real estate loans with terms of up to 30 years. We typically offer these fixed rate loans through a third party rather than originating and retaining these loans ourselves. We typically originate and retain residential real estate loans only if they have adjustable rates. We also offer home equity lines of credit. Our underwriting criteria and the risks associated with home equity loans and lines of credit are generally the same as those for first mortgage loans. Home equity lines of credit typically have terms of fifteen years or less. We generally limit the extension of credit to 90% of the available equity of each property, although we may extend up to 100% of the available equity.

 

Commercial Business Loans. We make commercial loans across various lines of business. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the security may be difficult to assess and more likely to decrease than real estate.

 

Equipment loans typically will be made for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Generally, we limit the loan-to-value ratio on these loans to 80% or less at origination. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange will generally be handled through a correspondent bank as agent for the Bank.

 

Deposit Services

 

Our principal source of funds is core deposits. We offer a full range of deposit services, including checking accounts, commercial accounts, NOW accounts, savings accounts, and time deposits of various types, ranging from daily money market accounts to long-term certificates of deposit. We solicit these accounts from individuals, businesses, associations, organizations and governmental authorities. Deposit rates are reviewed regularly by senior management of the Bank and the asset/liability management committee (“ALCO”) of the Bank’s board of directors. We believe that the rates we offer are competitive with those offered by other financial institutions in our area.

 

Credit Cards

 

The Bank offers Visa branded credit cards for personal and business clients in coordination with a third party vendor known as ServisFirst Bank. Two types of credit cards are offered to consumers and businesses: Visa Platinum Card with no annual fee and Visa Platinum Card with cash back feature that is charged an annual fee. Clients enjoy the freedom of Visa acceptance worldwide with available 24/7 customer support as well as protection and security services.

Merchant Services

 

The Bank offers merchant transaction processing and equipment for clients in coordination with a third party vendor known as Merchants’ Choice Payment Solutions. Clients enjoy the capability, as well as the specialized equipment, to accept debit and credit card transactions to conduct business with speed, ease and security. Clients are able to accept payments from Visa, MasterCard, American Express and Discover. Equipment and services available include POS terminals, wireless units, web based processing, online debit and TeleCheck services.

 

Other Banking Services

 

We offer other community bank services including cashier’s checks, banking by mail, direct deposit, remote deposit capture, United States Savings Bonds, and travelers’ checks. We earn fees for most of these services, in addition to fees earned from debit and credit card transactions, sales of checks, and wire transfers. We are associated with the Plus and Star ATM networks, which are available to our clients throughout the country. We offer merchant banking and credit card services through a correspondent bank. We also offer online banking services, bill payment services, and cash management services.

 

Market Share

 

As of June 30, 2016, the most recent date for which FDIC deposit market share data is available, total deposits in the Greenville-Anderson-Mauldin, South Carolina MSA were over $15.4 billion, an increase of approximately 3.5% from $14.8 billion as of June 30, 2015. At June 30, 2016 and 2015, the Bank’s deposits represented 0.53% and 0.62% of this market, respectively.

 

Research and Development

 

All costs incurred to establish the technological feasibility of computer software to be sold, leased or otherwise marketed as research and development are expensed as incurred. Once technological feasibility has been established, the subsequent costs of producing, coding and testing the products should be capitalized. The expensing of computer software costs is discontinued when the product is available for general release for customers. The Company did not achieve technological feasibility in connection with the development its digital banking, payments and transaction services business and therefore expensed all computer software purchases and development expenses related to research and development. On September 25, 2015 the Company suspended the development of its digital banking business. During the year ended December 31, 2016 and 2015, we incurred product research and development expenses of approximately $250,000 and $2.2 million, respectively. The 2016 expenses related to remaining monthly contract costs which have since been completed.

 

Employees

 

As of March 23, 2017, we had 33 full-time employees and two part-time employees.

 

Business Segments

 

The Company reports its activities as four business segments - Community Banking, Transaction Services, Asset Management and Parent Only. In determining proper segment definition, the Company considers the materiality of a potential segment and components of the business about which financial information is available and regularly evaluated, relative to a resource allocation and performance assessment. Please refer to “Note 19 — Business Segments” for further information on the reporting for the four business segments.

 

Supervision and Regulation

 

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions on and provide for general regulatory oversight of virtually all aspects of our operations. These laws and regulations are generally intended to protect depositors, federal insurance deposit funds, and the banking system as a whole and not our shareholders. Changes in applicable laws or regulations may have a material effect on our business and prospects.

 

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations. It is intended only to briefly summarize some material provisions. The following summary is qualified by reference to the statutory and regulatory provisions discussed.

General Overview

 

Compliance with legal and regulatory requirements is a highly complex and integral part of our day-to-day operations. Our products and services are generally subject to federal, state and local laws and regulations, including:

 

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anti-money laundering laws;

 

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privacy and information safeguard laws;

 

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consumer protection laws; and

 

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bank regulations.

 

These laws are often evolving and sometimes ambiguous or inconsistent, and the extent to which they apply to us or our customers is at times unclear. Any failure to comply with applicable law — either by us or by our third-party vendors and service providers, over which we have limited legal and practical control — could result in restrictions on our ability to provide our products and services, as well as the imposition of civil fines and criminal penalties and the suspension or revocation of a license or registration required to sell our products and services. See “Risk Factors” under Part I, Item 1A for additional discussion regarding the potential effects of changes in laws and regulations to which we are subject and failure to comply with existing or future laws and regulations.

 

We continually monitor and enhance our compliance program to stay current with the most recent legal and regulatory changes. We also continue to implement policies and programs and to adapt our business practices and strategies to help us comply with current legal standards, as well as with new and changing legal requirements affecting particular services or the conduct of our business generally. These programs include dedicated compliance personnel and training and monitoring programs, as well as support and guidance to our third-party vendors and service providers on compliance programs.

 

Privacy and Information Safeguard Laws

 

In the ordinary course of our business, we collect certain types of data, which subjects us to certain privacy and information security laws in the United States, including, for example, the Gramm-Leach-Bliley Act of 1999, or the “GLBA,” and other laws or rules designed to regulate consumer information and mitigate identity theft. We are also subject to privacy laws of various states. These state and federal laws impose obligations with respect to the collection, processing, storage, disposal, use and disclosure of personal information, and require that financial institutions have in place policies regarding information privacy and security. In addition, under federal and certain state financial privacy laws, we must provide notice to consumers of our policies and practices for sharing nonpublic information with third parties, provide advance notice of any changes to our policies and, with limited exceptions, give consumers the right to prevent use of their nonpublic personal information and disclosure of it to unaffiliated third parties. Certain state laws may, in some circumstances, require us to notify affected individuals of security breaches of computer databases that contain their personal information. These laws may also require us to notify state law enforcement, regulators or consumer reporting agencies in the event of a data breach, as well as businesses and governmental agencies that own data. In order to comply with the privacy and information safeguard laws, we have confidentiality/information security standards and procedures in place for our business activities and with network acceptance members and our third-party vendors and service providers. Privacy and information security laws evolve regularly, requiring us to adjust our compliance program on an ongoing basis and presenting compliance challenges.

 

Consumer Protection Laws

 

We are subject to state and federal consumer protection laws, including laws prohibiting unfair and deceptive practices, regulating electronic fund transfers and protecting consumer nonpublic information. We believe that we have appropriate procedures in place for compliance with these consumer protection laws, but many issues regarding our service have not yet been addressed by the federal and state agencies charged with interpreting the applicable laws.

 

Although not expressly required to do so under the Electronic Fund Transfer Act and Regulation E of the Federal Reserve, we disclose, consistent with banking industry practice, the terms of our electronic fund transfer services to consumers prior to their use of the service, provide 21 days’ advance notice of material changes, establish specific error resolution procedures and timetables, and limit customer liability for transactions that are not authorized by the consumer.

Recent Legislative and Regulatory Developments

 

Although the financial crisis has now passed, two legislative and regulatory responses - the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the Basel III-based capital rules – continue to have an impact on our operations.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act specifically impacts financial institutions in numerous ways, including:

 

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The creation of a Financial Stability Oversight Council responsible for monitoring and managing systemic risk;

 

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Granting additional authority to the Board of Governors of the Federal Reserve “(Federal Reserve”) to regulate certain types of nonbank financial companies;

 

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Granting new authority to the FDIC as liquidator and receiver;

 

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Changing the manner in which deposit insurance assessments are made;

 

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Requiring regulators to modify capital standards;

 

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Establishing the Consumer Financial Protection Bureau (the “CFPB”);

 

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Capping interchange fees that banks with assets of $10 billion or more charge merchants for debit card transactions;

 

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Imposing more stringent requirements on mortgage lenders; and

 

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Limiting banks’ proprietary trading activities.

 

There are many provisions in the Dodd-Frank Act mandating regulators to adopt new regulations and conduct studies upon which future regulation may be based. While some have been issued, many remain to be issued. Governmental intervention and new regulations could materially and adversely affect our business, financial condition and results of operations.

 

Basel Capital Standards. Regulatory capital rules released in July 2013 to implement capital standards referred to as Basel III and developed by an international body known as the Basel Committee on Banking Supervision, impose higher minimum capital requirements for bank holding companies and banks. The rules apply to all national and state banks and savings associations, regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. More stringent requirements are imposed on “advanced approaches” banking organizations— those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime. The requirements in the rule began to phase in on January 1, 2015 for the Bank. The requirements in the rule will be fully phased in by January 1, 2019.

 

The rule includes certain new and higher risk-based capital and leverage requirements than those currently in place. Specifically, the following minimum capital requirements apply to the Bank:

 

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a new common equity Tier 1 risk-based capital ratio of 4.5%;

 

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a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);

 

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a total risk-based capital ratio of 8% (unchanged from the former requirement); and

 

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a leverage ratio of 4% (also unchanged from the former requirement).

 

Under the rule, Tier 1 capital is redefined to include two components: Common Equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock Tier 1 capital generally consists of instruments that previously qualified as Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital; except that the rule permits bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital (but not in Common Equity Tier 1 capital), subject to certain restrictions. Accumulated other comprehensive income (AOCI) is

presumptively included in Common Equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

 

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019 and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2016, we are required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.

 

In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in Common Equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.

 

Volcker Rule. Section 619 of the Dodd-Frank Act, known as the “Volcker Rule”, prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds”. Proprietary trading is, in general, trading in securities on a short-term basis for a banking entity’s own account. Funds subject to the ownership and sponsorship prohibition are those not required to register with the SEC because they have only accredited investors or no more than 100 investors. In December 2013, our primary federal regulators, the Federal Reserve and the FDIC, together with other federal banking agencies, the SEC, and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule. At December 31, 2016, the Company has evaluated our securities portfolio and has determined that we do not hold any covered funds.

 

Independence Bancshares, Inc.

 

The Company owns 100% of the outstanding capital stock of the Bank, and therefore is considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “BHCA”). As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Federal Reserve under the BHCA and its regulations promulgated thereunder. Moreover, as a bank holding company of a bank located in South Carolina, the Company is also are subject to the South Carolina Banking and Branching Efficiency Act.

 

Permitted Activities. Under the BHCA, a bank holding company is generally permitted to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

 

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banking, managing or controlling banks;

 

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furnishing services to or performing services for our subsidiaries; and

 

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any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In summary, a financial holding company can engage in activities that are financial in nature or incidental or complimentary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities. We have not sought financial holding company status but may elect such status in the future as our business matures. If we were to elect financial holding company status, each insured depository institution we control would have to be well capitalized, well managed, and have at least a satisfactory rating under the Community Reinvestment Act, or “CRA” (discussed below).

 

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

 

Change in Control. Two statutes, the BHCA and the Change in Bank Control Act, together with regulations promulgated under them, require some form of regulatory review before any company may acquire “control” of a bank or a bank holding company. Under the BHCA, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the

management or policies of a bank or bank holding company. In guidance issued in 2008, the Federal Reserve has stated that it would not expect control to exist if an investor acquires, in aggregate, less than 33% of the total equity of a bank or bank holding company (voting and nonvoting equity), provided such investor’s ownership does not include 15% or more of any class or voting securities. Prior Federal Reserve approval is necessary before an entity acquires sufficient control to become a bank holding company. Natural persons, certain non-business trusts, and other entities are not treated as companies (or bank holding companies), and their acquisitions are not subject to the review under the Bank Holding Company Act. State laws generally, including South Carolina law, require state approval before an acquirer may become the holding company of a state bank.

 

Under the Change in Bank Control Act, a person or company is required to file a notice with the Federal Reserve if it will, as a result of the transaction, own or control 10% or more of any class of voting securities or direct the management or policies of a bank or bank holding company and either if the bank or bank holding company has registered securities or if the acquirer would be the largest holder of that class of voting securities after the acquisition. For a change in control at the holding company level, both the Federal Reserve and the subsidiary bank’s primary federal regulator must approve the change in control; at the bank level, only the bank’s primary regulator is involved. Transactions subject to the BHCA are exempt from Change in Bank Control Act requirements. For state banks, state laws, including that of South Carolina, typically require approval by the state bank regulator as well.

 

Source of Strength. There are a number of obligations and restrictions imposed by law and regulatory policy on bank holding companies with regard to their depository institution subsidiaries that are designed to minimize potential loss to depositors and to the FDIC insurance funds in the event that the depository institution becomes in danger of defaulting under its obligations to repay deposits. Under a policy of the Federal Reserve, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. Under the Federal Deposit Insurance Corporate Improvement Act of 1991, to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” within the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

 

Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of a bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.

 

In addition, the “cross guarantee” provisions of the FDIA require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC’s claim for damages is superior to claims of shareholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

 

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision would give depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of the Bank.

 

Further, any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

 

Capital Requirements. Although the Company is not subject to the same regulatory capital requirements that apply to the Bank, the Federal Reserve nevertheless may impose specific requirements on the Company or direct the Company to raise capital either to be held at the Company or to be contributed to the Bank. We may borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

 

Dividends. Since the Company is a bank holding company, its ability to declare and pay dividends is dependent on certain federal and state regulatory considerations, including the guidelines of the Federal Reserve. The Federal Reserve has issued a policy statement

regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The Federal Reserve’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Further, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

 

In addition, since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it, which is also subject to regulatory restrictions as described below in “Independence National Bank — Dividends.”

 

South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions (the “SCBFI”). We are not required to obtain the approval of the SCBFI prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must obtain approval from the SCBFI prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

 

Independence National Bank

 

The Bank operates as a national banking association incorporated under the laws of the United States and subject to examination by the OCC. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is currently $250,000 per depositor. The OCC and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

 

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security devices and procedures;

 

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adequacy of capitalization and loss reserves;

 

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loans;

 

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investments;

 

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borrowings;

 

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deposits;

 

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mergers;

 

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issuances of securities;

 

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payment of dividends;

 

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interest rates payable on deposits;

 

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interest rates or fees chargeable on loans;

 

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establishment of branches;

 

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corporate reorganizations;

 

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maintenance of books and records; and

 

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adequacy of staff training to carry on safe lending and deposit gathering practices.

 

These agencies, and the federal and state laws applicable to the Bank’s operations, extensively regulate various aspects of our banking business, including among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of reserves on demand deposit liabilities, and the safety and soundness of our banking practices.

Prompt Corrective Action. As an insured depository institution, the Bank is required to comply with the capital requirements under the FDIA and the OCC’s prompt corrective action regulations, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:

 

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Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well-capitalized institution (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage capital ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. In addition, an institution is well capitalized only if it is not subject to any written agreement, order or capital directive, or prompt corrective action directive issued by the OCC to meet and maintain a specific capital level for any capital measure.

 

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Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, and (iii) has a common equity Tier 1 risk-based capital ratio of 4.5%, and (iv) has a leverage capital ratio of 4% or greater.

 

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Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a common equity Tier 1 risk-based capital ratio is less than 4.5% or greater, or (iv) has a leverage capital ratio of less than 4%.

 

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Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 3% or greater, or (iv) has a leverage capital ratio of less than 3%.

 

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Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

 

If the OCC determines, after notice and an opportunity for hearing, that the Bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the Bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

 

If a bank is not well capitalized, it cannot accept brokered time deposits without prior regulatory approval, and if approval is granted, it cannot offer an effective yield in excess of 75 basis points on interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area or the national rate paid on deposits of comparable size and maturity for deposits accepted outside a bank’s normal market area.

 

If the Bank becomes less than adequately capitalized, it would become subject to increased regulatory oversight and would be increasingly restricted in the scope of its permissible activities. The Bank would be required to adopt a capital restoration plan acceptable to the OCC that is subject to a limited performance guarantee by the Company. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. If an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency, the appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution. Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

 

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or capital distribution would cause the Bank to become undercapitalized, it could not pay a management fee or dividend to the bank holding company.

Standards for Safety and Soundness. The FDIA also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Under the regulations, if the OCC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the OCC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

 

Regulatory Examination. The OCC requires the Bank to prepare annual reports on the Bank’s financial condition and to conduct an annual audit of its financial affairs in compliance with its minimum standards and procedures. All insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate federal banking agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

 

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internal controls;

 

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information systems and audit systems;

 

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loan documentation;

 

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credit underwriting;

 

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interest rate risk exposure; and

 

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asset quality.

 

Insurance of Accounts and Regulation by the FDIC. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OCC an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

 

As an FDIC-insured bank, the Bank must pay deposit insurance assessments to the FDIC based on its average total assets minus its average tangible equity. The Bank’s assessment rates are currently based on its risk classification (i.e., the level of risk it poses to the FDIC’s deposit insurance fund). Institutions classified as higher risk pay assessments at higher rates than institutions that pose a lower risk. In addition, following the fourth consecutive quarter (and any applicable phase-in period) where an institution’s total consolidated assets equal or exceed $10 billion, the FDIC will use a performance score and a loss-severity score to calculate an initial assessment rate. In calculating these scores, the FDIC uses an institution’s capital level and regulatory supervisory ratings and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The FDIC also has the ability to make discretionary adjustments to the total score based upon significant risk factors that are not adequately captured in the calculations. In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances.

 

The FDIC’s deposit insurance fund is currently underfunded, and the FDIC has raised assessment rates and imposed special assessments on certain institutions during recent years to raise funds. Under the Dodd-Frank Act, the minimum designated reserve ratio for the deposit insurance fund is 1.35% of the estimated total amount of insured deposits. In October 2010, the FDIC adopted a restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.

In addition, FDIC insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019. The amount assessed on individual institutions is in addition to the amount, if any, paid for deposit insurance according to the FDIC’s risk-related assessment rate schedules. Assessment rates may be adjusted quarterly to reflect changes in the assessment base.

 

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management of the Bank is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

 

Transactions with Affiliates and Insiders. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.

 

Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit by a bank to any affiliate, including its holding company and on a bank’s investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of any affiliates of the bank. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.

 

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.

 

The affiliates of a bank include any holding company of the bank, any other company under common control with the bank (including any company controlled by the same shareholders who control the bank), any subsidiary of the bank that is itself a bank, any company in which the majority of the directors or trustees also constitute a majority of the directors or trustees of the bank or holding company of the bank, any company sponsored and advised on a contractual basis by the bank or an affiliate, and any mutual fund advised by a bank or any of the bank’s affiliates. Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates.

 

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates, and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

 

Dividends. The Company’s principal source of cash flow, including cash flow to pay dividends to its shareholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company. As a general rule, the amount of a dividend may not exceed, without prior regulatory approval, the sum of net income in the calendar year to date and the retained net earnings of the immediately preceding two calendar years. A depository institution may not pay any dividend if payment would cause the institution to become undercapitalized or if it already is undercapitalized. The OCC may prevent the payment of a dividend if it determines that the payment would be an unsafe and unsound banking practice. The OCC also has advised that a national bank should generally pay dividends only out of current operating earnings.

 

Branching. Federal legislation permits out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks. The Dodd-Frank Act removed previous state law restrictions on de novo interstate branching in states such as South Carolina. This change effectively permits out-of-state banks to open de novo branches in states where the laws of such state would permit a bank chartered by such state to open a de novo branch.

 

Community Reinvestment Act. The CRA requires that the OCC evaluate the record of the Bank in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers,

acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank.

 

The GLBA made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made available to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a satisfactory CRA rating in its latest CRA examination.

 

As of February 11, 2013, the date of the most recent examination, the Bank received a satisfactory CRA rating.

 

Consumer Protection Regulations. Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:

 

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the Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

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the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

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the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

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the Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;

 

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the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

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the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

The deposit operations of the Bank also are subject to:

 

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the Federal Deposit Insurance Act, which among other things, limits the amount of deposit insurance available per account to $250,000 and imposes other limits on deposit-taking;

 

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the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

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the Electronic Funds Transfer Act and Regulation E which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

 

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the Truth in Savings Act and Regulation DD, which requires depository institutions to provide disclosures so that consumers can make meaningful comparisons about depository institutions and accounts.

 

Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA PATRIOT Act, enacted in 2001 and renewed through 2019. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions that have not complied with these requirements.

 

USA PATRIOT Act and Bank Secrecy Act. The USA PATRIOT Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism

and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

Under the USA PATRIOT Act, the FBI can send to the banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The Bank can be requested to search its records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

 

OFAC is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

 

Privacy, Data Security and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law. The OCC and the federal banking agencies have prescribed standards for maintaining the security and confidentiality of consumer information. The Bank is subject to such standards, as well as standards for notifying consumers in the event of a security breach.

 

Recent cyberattacks against banks and other institutions that resulted in unauthorized access to confidential customer information have prompted the Federal banking agencies to issue several warnings and extensive guidance on cyber security. The agencies are likely to devote more resources to this part of their safety and soundness examination than they have in the past.

 

In addition, pursuant to the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) and the implementing regulations of the federal banking agencies and the Federal Trade Commission, the Bank is required to have in place an “identity theft red flags” program to detect, prevent, and mitigate identity theft. The Bank has implemented an identity theft red flags program designed to meet the requirements of the FACT Act and the joint final rules. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.

 

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, which is one of 12 regional FHLBs that administer home financing credit for depository institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Financing Board. All advances from the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.

 

Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the U.S. government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in U.S. government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies. On December 15, 2016, the Federal

Open Market Committee raised the federal funds target rate by 25 basis points, the second increase in as many years. An additional increase to the federal funds target rate of 25 basis points was made on March 16, 2017. Further increases may occur in 2017, but, if so, there is no announced timetable.

 

Incentive Compensation. The Dodd-Frank Act requires the federal bank regulators and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal stockholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011. However, the 2011 proposal was replaced with a new proposal in May 2016, which makes explicit that the involvement of risk management and control personnel includes not only compliance, risk management and internal audit, but also legal, human resources, accounting, financial reporting and finance roles responsible for identifying, measuring, monitoring or controlling risk-taking. A final rule had not been adopted as of December 31, 2016.

 

In June 2010, the Federal Reserve, the OCC and the FDIC issued a comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation agreements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation agreements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation agreements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

 

Corporate Information

 

Our corporate headquarters is located at 500 East Washington Street, Greenville, South Carolina, 29601, and our telephone number is (864) 672-1776. Our Bank primary website is located at www.independencenb.com and our on-line consumer lending website is located at www.inb-loans.com. The information on these websites are not incorporated by reference into this report.

 

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any reports, statements or other information that we file at the SEC’s public reference facilities at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at (800) SEC-0330 for further information regarding the public reference facilities. The SEC maintains a website, http://www.sec.gov, which contains reports, proxy statements and information statements and other information regarding registrants that file electronically with the SEC, including us. Our SEC filings are also available to the public from commercial document retrieval services.

 

You may also request a copy of our filings at no cost by writing to us at Independence Bancshares, Inc., 500 East Washington Street, Greenville, South Carolina, 29601, Attention: Ms. Martha L. Long, Chief Financial Officer, or calling us at: (864) 672-1776.

 

Item 1A. Risk Factors.

 

The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently now to us or that we currently deem immaterial may also impact our business operations. If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected.

Risks Related to Our Business

 

If we do not generate positive earnings, there will be an adverse effect on our future results of operations.

 

For the years ended December 31, 2016 and 2015, we incurred net losses of $2.6 million and $4.8 million, respectively. For 2016, the $2.6 million loss was largely due to $1.1 million in professional fees, $407,000 in provisions for loan losses and $511,268 in expenses related to real estate owned. For 2015, the $4.8 million loss was largely due to $2.2 million in expenses for product research and development relating to our technology and infrastructure investments, $275,000 in license fees, and $457,173 in expenses related to real estate owned. Our failure to generate earnings could result in negative consequences, including that the regulatory authorities could implement enforcement actions against the Company and/or the Bank.

 

Working capital needs could adversely affect our results of operations and financial condition.

 

Our Bank’s primary funding sources are customer deposits and loan repayments. Deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Scheduled loan repayments are a relatively stable source of funds; however, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors outside of our control, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Accordingly, we may be required from time to time to rely on secondary sources of working capital to meet withdrawal demands or otherwise fund operations. Those sources may include borrowings from the FHLB or Federal Reserve, federal funds lines of credit from correspondent banks and brokered deposits, to the extent allowable by regulatory authorities. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future working capital demands, particularly if we were to experience atypical deposit withdrawal demands, increased loan demand or if regulatory decisions should limit available funding sources such as brokered deposits. We may be required to slow or discontinue loan growth (including through our new consumer lending program), capital expenditures or other investments or liquidate assets should those sources not be adequate.

 

We may need to raise additional capital and that capital may not be available on favorable terms, if at all.

 

Our management may adopt or deploy business strategies or plans, such as our new consumer lending program, the execution of which requires securing additional capital. Our ability to raise additional capital will depend on a number of factors outside of our control, including conditions in the capital markets. There is a risk we will not be able to raise the capital we need at all or upon favorable terms. If we cannot raise capital when needed, we would not be able to implement any such strategies or plans developed by management and we may be subject to increased regulatory supervision and restriction. Any restrictions imposed by regulators could have a material adverse effect on our financial condition and results of operations, whether directly or indirectly.

 

The Company may pursue additional financings to maintain adequate capital resources and/or execute on business strategies. Financings, if any, may include the issuance of debt or equity securities, which issuances could dilute the percentage ownership interests of our shareholders and dilute the per share book value of our stock. In addition, new investors could have rights, preferences, and privileges senior to our current shareholders.

 

The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets and lines of business in which we intend to expand.

 

To expand our franchise successfully, we must identify and retain experienced key management members with expertise and relationships in particular markets or lines of business. We expect that competition for qualified management in the markets in which we may expand will be intense and that there will be a limited number of qualified persons with knowledge of and experience in the banking industry in these markets or lines of business. Even if we identify individuals that we believe could assist us in establishing a presence in a new market or line of business, we may be unable to recruit these individuals away from more established financial institutions. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy requires both management and financial resources and is often lengthy. Our inability to identify, recruit, and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition, and results of operations.

A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.

 

Economic conditions have improved since the end of the economic recession; however, economic growth has been slow and uneven, unemployment remains relatively high, and concerns still exist over the federal deficit, government spending and economic risks. A return of recessionary conditions and/or negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.

 

Furthermore, the Federal Reserve, in an attempt to help the overall economy, has among other things, kept interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. The Federal Reserve increased the target range for the federal funds rate by 25 basis points in December 2016 and indicated the potential for further gradual increases in the target rate depending on the economic outlook. As the federal funds rate increases, market interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery.

 

A continuation of the current low interest rate environment or subsequent movements in interest rates may have an adverse effect on our profitability.

 

Changes in the interest rate environment may materially affect our business. Changes in interest rates affect the following areas, among others, of our business:

 

•

the level of net interest income we earn;

 

	•	the volume of loans originated and prepayment of loans;
	•	the market value of our securities holdings; and
	•	gains from sales of loans and securities.

 

In recent years, it has been the policy of the Federal Reserve to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, yields on securities purchased, and market rates on the loans originated, have been at levels lower than were available prior to 2008. Consequently, the average yield on our interest-earning assets has decreased during the recent low interest rate environment. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets; however, our ability to lower interest expense has been limited at these interest rate levels, while the average yield on interest-earning assets has continued to decrease. If a low interest rate environment persists, net interest income may further decrease, which may have an adverse effect on our profitability.

 

Our net interest margin would narrow if the cost of funding increases without a correlative increase in the interest we earn from loans and investments. Because we rely extensively on deposits to fund operations, our cost of funding would increase if there is an increase in the interest rate we are required to pay customers to retain their deposits. In addition, if the interest rates we are required to pay in respect of other sources of funding, either in the interbank or capital markets, increases, our cost of funding would increase. If either of these risks occurs, our net interest margin would narrow without a correlative increase in the interest we earn from loans and investments. Our assets currently reprice faster than our liabilities, which would result in a benefit to net interest income as interest rates rise; however, the benefit from rising rates could be less than assumed as interest rates rise if increased competition for deposits causes the deposit expense to rise faster than assumed.

 

In addition, increases in interest rates may decrease customer demand for loans as the higher cost of obtaining credit may deter customers from new loans. Further, higher interest rates might also lead to an increased number of delinquent loans and defaults, which would impact the value of our loans.

 

We cannot control or predict with certainty changes in interest rates. Global, national, regional and local economic conditions, competitive pressures and the policies of regulatory authorities, including monetary policies of the Federal Reserve, affect interest income and interest expense. Although we have policies and procedures designed to manage the risks associated with changes in market interest rates, changes in interest rates still may have an adverse effect on profitability.

 

If our assumptions regarding borrower behavior are wrong or overall economic conditions are significantly different than we anticipate, then risk mitigation may be insufficient to protect against interest rate risk and net income would be adversely affected.

Competition with other financial institutions may have an adverse effect on our ability to retain and grow our client base, which could have a negative effect on our financial condition or results of operations.

 

The banking and financial services industry is very competitive and includes services offered from other banks, savings and loan associations, credit unions, mortgage companies, other lenders, and institutions offering uninsured investment alternatives. Legal and regulatory developments have made it easier for new and sometimes unregulated businesses to compete with us. The financial services industry has and is experiencing an ongoing trend towards consolidation in which fewer large national and regional banks and other financial institutions are replacing many smaller and more local banks. These larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources and a wider geographic presence or greater accessibility. In some instances, these larger entities operate without the traditional brick and mortar facilities that restrict geographic presence. Some competitors have more aggressive marketing campaigns and better brand recognition, and are able to offer more services, more favorable pricing or greater customer convenience than the Bank. In addition, competition has increased from new banks and other financial services providers that target our existing or potential customers. As consolidation continues among large banks, we expect other smaller institutions to try to compete in the markets we serve. This competition could reduce our net income by decreasing the number and size of the loans that the Bank originates and the interest rates the Bank charges on these loans. Additionally, these competitors may offer higher interest rates, which could decrease the deposits the Bank attracts or require it to increase rates to retain existing deposits or attract new deposits.

 

Increased deposit competition could adversely affect the Bank’s ability to generate the funds necessary for lending operations, which could increase the cost of funds.

 

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge as part of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Technological developments have allowed competitors, including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers. If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost efficiencies necessary to compete in the industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.

 

Clients could pursue alternatives to bank deposits, causing us to lose a relatively inexpensive source of funding.

 

Checking and savings account balances and other forms of client deposits could decrease if clients perceive alternative investments, such as the stock market, provide superior expected returns. When clients move money out of bank deposits in favor of alternative investments, we can lose a relatively inexpensive source of funds, increasing our funding costs.

 

We may be adversely affected by credit exposures to other financial institutions.

 

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

 

Negative public opinion could damage our reputation and adversely affect earnings.

 

Reputation risk, or the risk to our business, earnings and capital from negative public opinion, is inherent in our operations. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action and adversely affect our results of operations. Although we take steps to minimize reputation risk in dealing with clients and communities, this risk will always be present given the nature of our business.

 

We are subject to a variety of operational risks, including reputational risk, legal risk and regulatory and compliance risk, and the risk of fraud or theft by employees or outsiders, which may adversely affect business and results of operations.

 

We are exposed to many types of operational risks, including reputational risk, legal, regulatory and compliance risk, the risk of fraud or theft by employees or outsiders, including unauthorized transactions by employees, or operational errors, such as clerical or

record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. In addition, negative public opinion can adversely affect our ability to attract and keep customers and can expose it to litigation and regulatory action. Actual or alleged conduct by us can result in negative public opinion about our other business. Negative public opinion could also affect our credit ratings, which are important to its access to unsecured wholesale borrowings.

 

Our business involves storing and processing sensitive consumer and business customer data. If personal, nonpublic, confidential or proprietary information of customers in its possession were to be mishandled or misused, we could suffer significant regulatory consequences, reputational damage and financial loss. Such mishandling or misuse could include, for example, if such information were erroneously provided to parties who are not permitted to have the information, either by fault of our systems, employees or counterparties, or where such information is intercepted or otherwise inappropriately taken by third parties.

 

Because the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. Our necessary dependence upon automated systems to record and process transactions and its large transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. We also may be subject to disruptions of operating systems arising from events that are wholly or partially beyond our control, such as computer viruses, electrical or telecommunications outages, natural disasters, or other damage to property or physical assets which may give rise to disruption of service to customers and to financial loss or liability. We are further exposed to the risk that its external vendors may be unable to fulfill our contractual obligations, or will be subject to the same risk of fraud or operational errors by their respective employees as it is, and to the risk that our, or our vendors’, business continuity and data security systems prove to be inadequate. The occurrence of any of these risks could result in a diminished ability to operate our business, as well as potential liability to clients, reputational damage and regulatory intervention, which could adversely affect our business, financial condition or results of operations.

 

Our operational or security systems may experience an interruption or breach in security.

 

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, including as a result of cyber-attacks, could result in failures or disruptions in our customer relationship management, deposit, loan, and other systems and also the disclosure or misuse of confidential or proprietary information. While we have systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

 

Furthermore, information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. Our technologies, systems, networks, and our customers’ devices may become the target of cyberattacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information, or otherwise disrupt our or our customers’ or other third parties’ business operations. As cyber threats continue to evolve, we may also be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.

 

While we have not experienced any material losses relating to cyberattacks or other information security breaches to date, we may suffer such losses in the future and any information security breach could result in significant costs to us, which may include fines and penalties, potential liabilities from governmental or third party investigations, proceedings or litigation, legal, forensic and consulting fees and expenses, costs and diversion of management attention required for investigation and remediation actions, and the negative impact on our reputation and loss of confidence of our customers and others, any of which could have a material adverse impact on our business, financial condition and operating results.

 

Our controls and procedures may fail or be circumvented.

 

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

If our nonperforming assets increase, earnings will be adversely affected.

 

At December 31, 2016, our nonperforming assets (which consist of nonaccrual loans and other real estate owned) totaled $2.5 million, or 2.8% of total assets. At December 31, 2015, our nonperforming assets were $2.9 million, or 3.1% of total assets. Our nonperforming assets adversely affect our earnings in various ways:

 

•

We do not record interest income on any nonperforming assets.

 

•

We must provide for probable loan losses through a charge to the provision for loan losses.

 

•

Noninterest expense increases when we must write down the value of properties in our other real estate owned portfolio to reflect changing market values.

 

•

There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to other real estate owned.

 

•

The resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity.

 

If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our results of operations.

 

We have previously sustained losses from a decline in credit quality and may see further losses.

 

Our ability to generate earnings is significantly affected by the ability to properly originate, underwrite and service loans. We have previously sustained losses primarily because borrowers, guarantors or related parties have failed to perform in accordance with the terms of their loans and we failed to detect or respond to deterioration in asset quality in a timely manner. We could sustain additional losses for these reasons. Further problems with credit quality or asset quality could cause interest income and net interest margin to further decrease, which could adversely affect our business, financial condition and results of operations. We have identified credit deficiencies with respect to certain loans in our loan portfolio which were primarily related to the downturn in the real estate industry. As a result of the decline of the residential housing market between 2007 and 2012, property values for this type of collateral declined substantially. In response to this determination, we increased our loan loss reserve throughout 2010 and 2011 to address the risks inherent within our loan portfolio. Since that time, we consistently applied our methodology in calculating the reserve, and because charge offs dropped and market conditions stabilized, our reserve has declined from its peak. At December 31, 2016, our loan loss reserve was $1.3 million, or 2.21% of gross loans. Although credit quality has generally improved, future deterioration in the South Carolina real estate market as a whole or individual deterioration in the financial condition of our borrowers may cause management to adjust its opinion of the level of credit quality in our loan portfolio. Such a determination may lead to an increase in our provisions for loan losses, which could also adversely affect our business, financial condition, and results of operations.

 

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market hurt our business.

 

As of December 31, 2016, approximately 71% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could adversely affect our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

We are subject to certain risks related to originating and selling mortgages. We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, or borrower fraud, and this could harm our liquidity, results of operations and financial condition.

 

We originate and often sell mortgage loans. When we sell mortgage loans, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event that we breach certain of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. Therefore, if a purchaser enforces its remedies against us, we may not be able to recover our losses from third parties. We have received repurchase and indemnity demands from purchasers. These have resulted in an increase in the amount of losses for repurchases. While we have taken steps to enhance its underwriting policies and procedures, these steps will not reduce risk associated with loans sold in the past. If repurchase and indemnity demands increase materially, then our results of operations may be adversely affected.

 

Our decisions regarding the allowance for loan losses and credit risk may materially and adversely affect our business.

 

Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:

 

•

the duration of the credit;

•

credit risks of a particular customer;

•

changes in economic and industry conditions; and

•

in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

 

We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including, but not limited to:

 

•

an ongoing review of the quality, mix, and size of our overall loan portfolio;

•

historical loan loss experience;

•

evaluation of economic conditions;

•

regular reviews of loan delinquencies and loan portfolio quality;

•

ongoing review of financial information provided by borrowers; and

•

the amount and quality of collateral, including guarantees, securing the loans.

 

The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.

 

While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. We are permitted to hold loans that exceed supervisory guidelines up to 100% of our regulatory capital. We have made loans that exceed our internal guidelines to a limited number of customers who have significant liquid assets, net worth, and amounts on deposit with the Bank. As of December 31, 2016, approximately $1.8 million of our loans, or a loan balance equal to 18.5% of the Bank’s regulatory capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines. In addition, supervisory limits on commercial loan-to-value exceptions are generally set at 30% of the Bank’s capital. At December 31, 2016, $691,746 of our commercial loans, or a loan balance equal to 7.0% of the Bank’s regulatory capital, exceeded the supervisory loan-to-value ratio. The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

An economic downturn, in particular an economic downturn in South Carolina, could reduce our customer base, level of deposits, and demand for financial products such as loans.

 

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. Although negative developments that began in the latter half of 2007 have shown signs of improvement in recent years both nationally and in our primary markets of South Carolina, if the communities in which we operate do not grow or if economic conditions locally or nationally are unfavorable, our business may not succeed. An economic downturn or prolonged recession would likely result in further deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately 92% of our interest income for the year ended December 31, 2016. If we experience an economic downturn or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of the real estate or other collateral that secures our loans was adversely affected by the recent economic downturn, and a more severe economic downtown or a prolonged economic recession could further negatively affect such values. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. An economic downturn could, therefore, result in losses that materially and adversely affect our business.

 

Our small- to medium-sized business target markets may have fewer financial resources to weather financial stress.

 

We target the banking and financial services needs of small- and medium-sized businesses. These businesses generally have fewer financial resources in terms of capital borrowing capacity than larger entities. If general economic conditions negatively impact these businesses in the markets in which we operate, our business, financial condition, and results of operation may be adversely affected.

 

Lack of seasoning of loans may increase the risk of credit defaults in the future.

 

Due to the periodic addition of new loans in our loan portfolio, there is a relatively short credit history on some of our loans. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio includes new loans, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.

 

Consumers may decide not to use banks to complete their financial transactions.

 

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

 

Failure to keep pace with technological change could adversely affect our business.

 

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

 

We depend on third-party providers, and the inability of these providers to deliver, or their refusal to deliver, necessary technological and customer services support for our systems in a timely manner at prices, quality levels, and volumes acceptable to us could have material adverse effects on our financial condition and operating results.

 

Our existing digital banking services, including mobile banking, online banking, and remote deposit capture use third-party providers for technological and customer service support. We also outsource check processing, check imaging, electronic bill

payment, statement rendering, internal audit and other services to third-party vendors. While we believe that such providers will be able to continue to supply us with these essential services, they may be unable to do so in the short term or at prices or costs that are favorable to us, or at all. In addition, our agreements with each service provider are generally cancelable without cause by either party upon specified notice periods. If one of our third-party service providers terminates its agreement with us and we are unable to replace it with another service provider, our operations may be interrupted. In particular, while we believe that we will be able to secure alternate providers for most of this essential technological and customer services support in a relatively short time frame, qualifying alternate providers or developing our own replacement technology services may be time consuming, costly, and may force us to change our services offered. If an interruption were to continue for a significant period of time, our earnings could decrease, we could experience losses, and we could lose customers. In addition, we are obligated to exercise comprehensive risk management and oversight of third-party providers involving critical activities, including through the adoption of risk management processes commensurate with the level of risk and complexity of our third-party providers. If in the future we expand our digital banking and payment and transaction services, our dependence on third-party providers will likely increase, and more robust compliance policies and procedures to monitor third party providers will need to be implemented.

 

If our security is breached, our business could be disrupted, our operating results could be harmed, and customers could be deterred from using our products and services.

 

Our business relies on the secure electronic transmission, storage, and hosting of sensitive information, including financial information and other sensitive information relating to our customers. As a result, we face the risk of a deliberate or unintentional incident involving unauthorized access to our computer systems that could result in misappropriation or loss of assets or sensitive information, data corruption, or other disruption of business operations. To our knowledge, the Company has not experienced a data breach. In light of this risk, we have devoted significant resources to protecting and maintaining the confidentiality of our information, including implementing security and privacy programs and controls, training our workforce, and implementing new technology. We have no guarantee that these programs and controls will be adequate to prevent all possible security threats. We believe that any compromise of our electronic systems, including the unauthorized access, use, or disclosure of sensitive information or a significant disruption of our computing assets and networks, would adversely affect our reputation and our ability to fulfill contractual obligations, and would require us to devote significant financial and other resources to mitigate such problems, and could increase our future cyber security costs. Moreover, unauthorized access, use or disclosure of such sensitive information could result in significant contractual, supervisory or other liability, or exposure of our trade secrets or other confidential or proprietary information. In addition, any real or perceived compromise of our security or disclosure of sensitive information may result in lost revenues by deterring customers from using or purchasing our products and services in the future or prompting them to use competing service providers.

 

Risks Related to the Legal and Regulatory Environment

 

We are subject to extensive regulation that could limit or restrict our activities, have an adverse impact on our operations, and impose financial requirements or limitations on the conduct of our business.

 

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. We are subject to Federal Reserve regulation. The Bank is subject to extensive regulation, supervision, and examination by our primary federal regulators, the OCC and the FDIC, the regulating authority that insures customer deposits. Also, as a member of the FHLB, the Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Regulation by these agencies is intended primarily for the protection of the Bank’s depositors and the Deposit Insurance Fund and not for the benefit of our shareholders. The Bank’s activities are also regulated under consumer protection laws applicable to its lending, deposit, and other activities. A sufficient claim against the Bank under these laws could have a material adverse effect on our results of operations.

 

Further, changes in laws, regulations and regulatory practices affecting the financial services industry could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

Failure to comply with government regulation and supervision could result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation.

 

Our operations are subject to extensive regulation by federal, state, and local governmental authorities. Given the current disruption in the financial markets, we expect that the government will continue to pass new regulations and laws that will impact us. Compliance with such regulations may increase our costs and limit our ability to pursue business opportunities. Failure to comply with laws, regulations, and policies could result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation. While we have policies and procedures in place that are designed to prevent violations of these laws, regulations, and policies, there can be no assurance that such violations will not occur.

 

The final Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could adversely affect our financial condition and operations.

 

In July 2013, the federal bank regulatory agencies issued a final rule that will revise their risk based capital requirements and the method for calculating risk weighted assets to make them consistent with agreements that were reached by Basel III and certain provisions of the Dodd Frank Act. This rule substantially amended the regulatory risk based capital rules applicable to us. The requirements in the rule began to phase in on January 1, 2015 for the Bank. The requirements in the rule will be fully phased in by January 1, 2019.

 

The rule includes certain new and higher risk-based capital and leverage requirements than those currently in place. Specifically, the following minimum capital requirements apply to us:

 

•

a new common equity Tier 1 risk-based capital ratio of 4.5%;

 

•

a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);

 

•

a total risk-based capital ratio of 8% (unchanged from the former requirement); and

 

•

a leverage ratio of 4% (also unchanged from the former requirement).

 

Under the rule, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, common equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital. Accumulated other comprehensive income (AOCI) is presumptively included in common equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

 

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2017, we are required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.

 

In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in Common Equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.

 

In addition, in the current economic and regulatory environment, bank regulators may impose capital requirements that are more stringent than those required by applicable existing regulations. The application of more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if we are unable to comply with such requirements. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital or additional capital conservation buffers, could result in

management modifying our business strategy and could limit our ability to make distributions, including paying dividends or buying back our shares.

 

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

 

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, the Bank is required to pay quarterly deposit insurance premium assessments to the FDIC. Although the Bank cannot predict what the insurance assessment rates will be in the future, deterioration in the Bank’s risk-based capital ratios or adjustments to the base assessment rates could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

 

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulation, which risk increases as we expand our business model.

 

The Bank Secrecy Act, the USA PATRIOT Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, established by the U.S. Treasury to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to potentially obtain regulatory approvals to further expand our new consumer lending program, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

 

Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.

 

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected from liability to a borrower for failing to make the necessary determinations. In either case, we may find it necessary to tighten our mortgage loan underwriting standards in response to the CFPB rules, which may constrain our ability to make loans consistent with our business strategies. It is our policy not to make predatory loans and to determine borrowers’ ability to repay, but the law and related rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.

 

We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.

 

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely affect the Bank’s rating under the CRA and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.

 

The Federal Reserve may require us to commit capital resources to support the Bank.

 

The Federal Reserve requires a bank holding company to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. In addition, the Dodd-Frank Act directs the federal bank regulators to require that all companies that directly or indirectly control an insured depository institution

serve as a source of strength for the institution. Under these requirements, in the future, we could be required to provide financial assistance to the Bank if the Bank experiences financial distress.

 

A capital injection may be required at times when we do not have the resources to provide it, and therefore we may be required to borrow the funds. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely affect the holding company’s cash flows, financial condition, results of operations and prospects.

 

Our business is subject to laws and regulations regarding privacy, data protection, and other matters. Many of these could result in claims, changes to our business practices, increased cost of operations, or otherwise harm our business.

 

We are subject to a variety of laws and regulations in the United States that involve matters central to our business, including user privacy, electronic contracts and other communications, consumer protection, taxation, and online payment services. These U.S. federal and state laws and regulations, which can be enforced by private parties or government entities, are constantly evolving and can be subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. These existing and proposed laws and regulations can be costly to comply with and can delay or impede the development of new products, and a failure to comply with such laws and regulations could result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to inquiries or investigations, claims or other remedies, including fines or demands that we modify or cease existing business practices.

 

Changes in accounting standards could materially affect our financial statements.

 

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board (the “FASB”), the SEC and our bank regulators change the financial accounting and reporting standards, or the interpretation thereof, and guidance that govern the preparation and disclosure of external financial statements. For example, in 2012, the FASB issued a proposed standard on accounting for credit losses. The standard would replace multiple existing impairment models, including replacing an “incurred loss” model for loans with an “expected loss” model. The FASB has indicated a tentative effective date of January 1, 2019, and final guidance is expected to be issued in the second quarter of 2016. These changes are beyond our control, can be hard to predict and could materially impact how we report and disclose our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, or apply an existing standard differently, also retrospectively, which under some circumstances could potentially result in a need to revise or restate prior period financial statements.

 

Risks Related to our Common Stock

 

We are a holding company and depend on the Bank for dividends, distributions, and other payments.

 

Substantially all of our activities are conducted through the Bank, and consequently, as the parent company of the Bank, we receive substantially all of our revenue as dividends from the Bank. We are currently prohibited from paying dividends without the prior approval Federal Reserve Bank of Richmond. There can be no assurance such approvals would be granted or with regard to how long these restrictions will remain in place. In the future, any declaration and payment of cash dividends will be subject to the board’s evaluation of our operating results, financial condition, future growth plans, general business and economic conditions, and tax and other relevant considerations. The payment of cash dividends by us in the future will also be subject to certain other legal and regulatory limitations (including the requirement that our capital be maintained at certain minimum levels) and ongoing review by our banking regulators.

 

There is no liquid market for our shares.

 

There is currently no established trading market for our common stock. As a result, any investor in shares of our common stock may find it difficult or impossible to resell such shares.

 

If securities or industry analysts publish inaccurate or unfavorable research about our business, our stock price could decline.

 

The trading market for the common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrades the common stock or publishes inaccurate or unfavorable research about our business, the common stock price would likely decline.

Our securities are not FDIC insured.

 

Our securities, including the outstanding shares of common stock, are not savings or deposit accounts or other obligations of ours and are not insured by the Deposit Insurance Fund, the FDIC, or any other governmental agency, and therefore are subject to investment risk, including the possible loss of the entire investment.

 

Item 1B. Unresolved Staff Comments.

 

Not Applicable.

 

Item 2. Properties.

 

Our principal executive offices consist of 6,500 square feet of leased space in downtown Greenville, South Carolina. The Bank has two branch offices located in Taylors, South Carolina, and Simpsonville, South Carolina. We lease our Greenville and Taylors offices in South Carolina and believe these premises will be adequate for present and anticipated needs and that we have adequate insurance to cover our owned and leased premises. For each property that we lease, we believe that upon expiration of the lease we will be able to extend the lease on satisfactory terms or relocate to another acceptable location.

 

Item 3. Legal Proceedings.

 

In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

 

Item 4. Mine Safety Disclosures.

 

Not Applicable.

PART II

 

Item 5. Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information, Holders, and Dividends

 

No established public trading market exists for our common stock, and there can be no assurance that a public trading market for our common stock will develop. Our common stock is quoted on the OTC Bulletin Board under the symbol “IEBS,” and we have a sponsoring broker-dealer to match buy and sell orders for our common stock. Although we are quoted on the OTC Bulletin Board, the trading markets on the OTC Bulletin Board lack the depth, liquidity, and orderliness necessary to maintain a liquid market, and trading and quotations of our common stock have been limited and sporadic. The OTC Bulletin Board prices are quotations, which reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.

 

The following table sets forth for the period indicated the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated:

 

2016		High		Low
Fourth Quarter		0.18		0.12
Third Quarter		0.21		0.13
Second Quarter		0.21		0.11
First Quarter		0.38		0.18
2015
Fourth Quarter		0.43		0.23
Third Quarter		0.59		0.43
Second Quarter		0.56		0.42
First Quarter		0.60		0.42

 

As of March 23, 2017, there were 20,502,760 shares of common stock outstanding held by approximately 580 shareholders of record, and 8,425 shares of series A preferred convertible stock outstanding held by 11 shareholders.

 

We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future, we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay dividends depends on the ability of the Bank to pay dividends to the Company. As a national bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, the Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the Bank’s net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the OCC will be required if the total of all dividends declared in any calendar year by the Bank exceeds the Bank’s net profits to date for that year combined with its retained net profits for the preceding two years less any required transfers to surplus. The OCC also has the authority under federal law to enjoin a national bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances.

 

Equity-Based Compensation Plan Information

 

For information regarding equity-based compensation awards outstanding and available for future grants at December 31, 2016, see Part III, Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” included in this Annual Report on Form 10-K.

 

Item 6. Selected Financial Data.

 

Not applicable.

Item 7. Management’s Discussion and Analysis or Plan of Operation.

 

Overview

 

We derive the majority of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income earned on our interest-earning assets, such as loans and investments, and the expense cost of our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

 

The Company has reported losses from operations during 2016 and 2015, primarily due to expenses incurred in 2016 as a result of professional fees relating to the expansion of the Bank’s consumer lending program, credit write-downs, and losses on other real estate owned sold and due to expenses incurred in 2015 related to the costs associated with the transaction services segment, credit write-downs, and losses on other real estate owned sold. Due to regulatory restrictions, the Bank may not be a source of cash or capital for affiliates, including the Company, and may not be relied on as a source of financing. The foregoing discussion is a summary only and is qualified by reference to the report of the Company’s independent registered public accounting firm, Elliott Davis Decosimo, LLC, on page F-2 and the disclosure in other sections of this Form 10-K, including this section, the Risk Factors and our financial statements.

 

The Consolidated Company

 

At December 31, 2016, we had total assets of $90.5 million, a decrease of $7.0 million, or 7.2%, from total assets of $97.5 million at December 31, 2015. This decrease in assets was primarily driven by a decrease in investment securities of $8.2 million, a decrease in net loans of $7.3 million, and a decrease in cash and due from banks and federal funds sold of $3.1 million, partially offset by an increase in interest-bearing deposits in other institutions of $9.0 million and an increase in bank-owned life insurance of $2.5 million. Total assets at December 31, 2016 consisted of cash and due from banks of $4.6 million, interest bearing deposits in other institutions of $10.5 million, federal funds sold of $6.1 million, investment securities available for sale of $2.5 million, bank-owned life insurance of $2.5 million, non-marketable equity securities of $380,050, property, equipment and software of $2.0 million, other real estate owned and repossessed assets of $2.2 million, loans net of allowances for loan losses of $59.1 million, and accrued interest receivable and other assets of $358,277. Total liabilities at December 31, 2016 were $80.5 million compared to $84.8 million at December 31, 2015, a decrease of $4.3 million, or 5.1%. At December 31, 2016, liabilities consisted of deposits of $79.7 million, securities sold under agreements to repurchase of $113,598, and accrued interest payable and accounts payable and accrued expenses of $683,446. Shareholders’ equity at December 31, 2016 was $9.9 million, compared to $12.6 million at December 31, 2015, a decrease of $2.7 million or 21.4%. This decrease was primarily due to the recognition of a net loss of $2.6 million and a decrease in the unrealized gain on investment securities of $121,902.

 

Our net loss for the year ended December 31, 2016 was $2.6 million, or $0.13 per share, a decrease in loss of $2.2 million, or 46.7%, compared to a net loss of $4.8 million for the year ended December 31, 2015, or $0.23 per share. The Company’s decrease in net loss for the year was primarily driven by a decrease in noninterest expenses due to the suspension of further development of its digital banking business in September 2015. As a result, product research and development decreased $2.0 million. In addition, compensation and benefits expenses decreased $392,994, despite expenses incurred as a result of the filling of open positions during the year. Each of these components is discussed in greater detail below.

 

The Company

 

The Company’s cash balances, independent of the Bank, were $1.8 million and its real estate held for sale was zero at December 31, 2016 compared to cash balances of approximately $2.9 million and real estate held for sale of $631,320 at December 31, 2015. The Company’s accrued and other liabilities, independent of the Bank, were $304,346 at December 31, 2016 compared to $905,824 at December 31, 2015. The decrease in liquid assets of approximately $1.1 million and the decrease in payables of $601,478 is due primarily to a decrease in expenses incurred related to the transaction services segment as the Company suspended further development of its digital banking, payments and transaction services business in September 2015. The existing liabilities for the Company are related to deferred director fees and accrued audit and professional fees. See “Note 22 — Parent Company Financial Information” for additional information related to the transaction services segment.

 

The Bank

 

At December 31, 2016, we had total assets at the Bank of $90.4 million compared to $96.6 million at December 31, 2015. Total assets at December 31, 2016 consisted of cash and due from banks of $4.6 million, federal funds sold of $6.1 million, investment securities available for sale of $2.5 million, nonmarketable equity securities of $380,050, property, equipment, and software of $2.0 million, other real estate owned and repossessed assets of $2.23 million, net loans of $59.1 million, interest-bearing deposits in other

institutions of $10.5 million, bank-owned life insurance of $2.5 million and accrued interest receivable and other assets of $731,838. At December 31, 2016, we had total liabilities at the Bank of approximately $82.0 million compared to approximately $86.8 million at December 31, 2015. The largest components of total liabilities at the Bank are deposits which were $81.6 million, respectively. We have included a number of tables to assist in our description of our results of operations. For example, the “Average Balances” table shows the average balance during 2016 and 2015 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we have channeled a substantial percentage of our earning assets into our loan portfolio. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included a table to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, and our deposits and other borrowings.

 

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a detailed discussion of this process.

 

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expenses, in the following discussion.

 

Throughout our discussion we have identified significant factors that we believe have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

 

Critical Accounting Policies

 

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our audited consolidated financial statements as of December 31, 2016.

 

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

Provision and Allowance for Loan Losses

 

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

 

Other Real Estate Owned and Repossessed Assets

 

Real estate and other property acquired in settlement of loans is recorded at the lower of cost or fair value less estimated selling costs, establishing a new cost basis when acquired. Fair value of such property is reviewed regularly and write-downs are recorded when it is determined that the carrying value of the property exceeds the fair value less estimated costs to sell. Recoveries of value are recorded only to the extent of previous write-downs on the property in accordance with FASB ASC Topic 360 “Property, Plant, and Equipment”. Write-downs or recoveries of value resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are charged against income. Costs relating to the development and improvement of such properties are capitalized.

Income Taxes

 

We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our consolidated financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.

 

Research and Development

 

All costs incurred to establish the technological feasibility of computer software to be sold, leased or otherwise marketed as research and development are expensed as incurred. Once technological feasibility has been established, the subsequent costs of producing, coding and testing the products should be capitalized. The expensing of computer software costs is discontinued when the product is available for general release for customers. The Company did not achieve technological feasibility in connection with the development of its digital banking business and therefore expensed all computer software purchases and development expenses related to research and development. As previously noted, on September 25, 2015, the Company suspended the development of its digital banking business.

 

Results of Operations

 

Net Interest Income

 

Net interest income is the Company’s primary source of revenue. Net interest income is the difference between interest earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on the Company’s interest-earning assets and the rates paid on its interest-bearing liabilities and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income was $3.2 million for the year ended December 31, 2016, a slight decrease of $1,787, or 0.1%, over net interest income of $3.2 million in 2015. Total interest income decreased by $2,935, or 0.1%, during the year, primarily due to a decrease in interest income on investment securities. Total interest expense decreased by $4,722, or 1.4%, during the year due to decreases in interest expense on deposits and borrowings.

 

Our consolidated net interest margin for the year ended December 31, 2016 was 3.89%, a 27 basis point increase over the net interest margin for the year ended December 31, 2015 of 3.62%. The net interest margin is calculated as net interest income divided by year-to-date average earning assets. Earning assets averaged $83.2 million in 2016, a decrease of $6.4 million, or 7.2%, from $89.6 million in 2015. This decrease in earning assets is due to the $4.4 million decrease in average investment securities available for sale and a decrease in average net loans of $2.6 million, partially offset by an increase in federal funds sold between years of $542,044. Our yield on earning assets increased during the year, moving from 3.99% for the year ended December 31, 2015 to 4.28% for the year ended December 31, 2016. This increase is largely attributable to an increase in yield on loans and investment securities. These increases were accompanied by an increase in the cost of interest-bearing liabilities, which moved from 0.44% for the year ended December 31, 2015 to 0.48% for the year ended December 31, 2016. The increase in this area was a result of several factors, including the repricing of deposits, specifically money market accounts and retail time deposits, which increased to a rate of 0.25% and 0.86%, respectively, for the year ended December 31, 2016 from 0.24% and 0.77%, respectively, for the year ended December 31, 2015. In pricing deposits, we considered our liquidity needs, the direction and levels of interest rates and local market conditions. At times, higher rates are paid initially to attract deposits. Borrowings averaged $135,708 for the year ended December 31, 2016 compared to $553,599 for the year ended December 31, 2015, primarily as a result of the repayment of the note payable. Our net interest spread was 3.81% for 2016 compared to 3.54% in 2015. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities.

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees is amortized into interest income on loans.

 

		For the Year Ended December 31,
		2016												2015
		Average Balance				Income/ Expense				Yield/ Rate				Average Balance				Income/ Expense				Yield/ Rate
Interest-earning assets:
Federal funds sold and other		$	10,013,935			$	73,030				0.76	%		$	9,471,891			$	49,953				0.56	%
Investment securities			9,173,821				219,507				2.31	%			13,575,466				323,979				2.31	%
Loans (1)			64,014,530				3,272,291				5.11	%			66,593,873				3,193,831				4.81	%
Total interest-earning assets			83,202,286				3,564,828				4.28	%			89,641,230				3,567,763				3.99	%
Non-interest-earning assets			10,500,151												9,541,314
Total assets		$	93,702,437											$	99,182,544
Interest-bearing liabilities:
NOW accounts		$	9,101,906			$	10,935				0.12	%		$	8,129,603			$	9,840				0.12	%
Savings & money market			32,082,911				80,458				0.25	%			35,400,117				83,492				0.24	%
Time deposits (excluding brokered time deposits)			27,380,014				234,727				0.86	%			29,021,956				222,152				0.77	%
Total interest-bearing deposits			68,564,831				326,120				0.48	%			72,551,676				315,484				0.44	%
Borrowings			135,708				220				0.16	%			553,599				15,578				2.82	%
Total interest-bearing liabilities			68,700,539				326,340				0.48	%			73,105,275				331,062				0.45	%
Non-interest-bearing liabilities:
Non-interest-bearing deposits			12,419,304												11,742,521
Other non-interest-bearing liabilities			776,104												1,836,190
Shareholders’ equity			11,806,490												12,498,558
Total liabilities and shareholders’ equity		$	93,702,437											$	99,182,544
Net interest spread											3.81	%											3.54	%
Net interest income/margin						$	3,238,488				3.89	%						$	3,236,701				3.62	%

(1)

Nonaccrual loans are included in average balances for yield computations.

		For the Year Ended December 31,
		2014
		Average Balance				Income/ Expense				Yield/ Rate
Interest-earning assets:
Federal funds sold and other		$	5,125,344			$	34,505				0.68	%
Investment securities			19,225,587				495,403				2.58	%
Loans (1)			66,635,561				3,388,060				5.10	%
Total interest-earning assets			90,986,482				3,917,968				4.32	%
Non-interest-earning assets			10,041,726
Total assets		$	101,028,208
Interest-bearing liabilities:
NOW accounts		$	7,112,555			$	9,689				0.14	%
Savings & money market			38,844,285				92,213				0.24	%
Time deposits (excluding brokered time deposits)			28,085,586				184,351				0.66	%
Brokered time deposits			388,688				6,034				1.56	%
Total interest-bearing deposits			74,431,114				292,287				0.39	%
Borrowings			2,596,893				19,737				0.76	%
Total interest-bearing liabilities			77,028,007				312,024				0.41	%
Non-interest-bearing liabilities:
Non-interest-bearing deposits			10,646,556
Other non-interest-bearing liabilities			924,433
Shareholders’ equity			12,429,212
Total liabilities and shareholders’ equity		$	101,028,208
Net interest spread											3.91	%
Net interest income/margin						$	3,605,944				3.97	%

(1)

Nonaccrual loans are included in average balances for yield computations.

Rate/Volume Analysis

 

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

 

		2016 Compared to 2015
		Total Change				Change in Volume				Change in Rate
Interest-earning assets:
Federal funds sold and other		$	22,992			$	3,185			$	19,807
Investment securities			(100,952	)			(101,797	)			846
Loans (1)			69,711				(127,018	)			196,728
Total interest income			(8,249	)			(225,630	)			217,381
Interest-bearing liabilities:
Interest-bearing deposits			9,772				(20,047	)			29,818
Borrowings			(15,401	)			(6,849	)			(8,552	)
Total interest expense			(5,629	)			(26,895	)			21,267
Net Interest Income		$	(2,621	)		$	(198,733	)		$	196,113

 

		2015 Compared to 2014
		Total Change				Change in Volume				Change in Rate
Interest-earning assets:
Federal funds sold and other		$	18,332			$	25,142			$	(6,810	)
Investment securities			(182,755	)			(134,712	)			(48,043	)
Loans (1)			(194,760	)			(2,124	)			(192,636	)
Total interest income			(359,183	)			(111,694	)			(247,489	)
Interest-bearing liabilities:
Interest-bearing deposits			23,261				(3,538	)			26,798
Borrowings			(4,170	)			(25,062	)			20,891
Total interest expense			22,091				(28,600	)			47,689
Net Interest Income		$	(359,183	)		$	(83,094	)		$	(297,178	)

(1)

Nonaccrual loans are included in average balances for yield computations.

 

Provision for Loan Losses

 

We have established an allowance for loan losses through a provision for loan losses charged to expense to our consolidated statement of operations. We review our loan portfolio at least quarterly to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

 

The provision, reversal of provision and allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

We recorded a provision for loan losses of $407,000 for the year ended December 31, 2016, an increase of $257,000, or 171% from a provision for loan losses of $150,000 for the year ended December 31, 2015. The increase in provision for loan losses is primarily due to the recognition of specific reserves during 2016 on six impaired loans. The allowance as a percentage of gross loans increased to 2.21% at December 31, 2016 from 1.68% at December 31, 2015. Specific reserves were approximately $611,000 on impaired loans of $2.2 million as of December 31, 2016 compared to specific reserves of approximately $375,000 on impaired loans of $2.4 million as of December 31, 2015. As of December 31, 2016, the general reserve allocation was 1.22% of gross loans not impaired compared to 1.17% as of December 31, 2015. The provision for loan losses is discussed further below under “Provision and Allowance for Loan Losses.” 

 

Non-interest Income

 

Non-interest income for the year ended December 31, 2016 was $840,100, an increase of 26.0% from non-interest income of $666,907 for the year ended December 31, 2015. Our largest components of non-interest income in 2016 were from residential loan origination fees, which were $231,495 for 2016, or approximately 27.6% of total non-interest income, and from the recognition of gains on sales of investments of $296,723, or approximately 35.3% of total non-interest income. Residential loan origination fees increased by $6,832, or 3.0%, during the year due to the changes in mortgage loan underwriting and compensation regulations as well as increased customer demand. The remaining increase is primarily due to the recognition of income related to the collection of SBA loan fees of $119,306. For the year ended December 31, 2016, service fees on deposit accounts totaled $95,431, an increase of $14,272, or 17.6%, from 2015 due primarily to an increase in NSF/return check fees. Other income includes ATM surcharges, wire fees, and commissions on insurance referrals. Other income was $97,145 for 2016, an increase of $51,310, or 111.9%, compared to $45,835 for the year ended December 31, 2015 due primarily to an increase related to commissions received and income recognized for bank-owned life insurance.

 

The Company recognized a gain on sale of investment securities available for sale of approximately $297,000 during 2016. The Company recognized a loss on sale of investment securities available for sale of approximately $88,000 during 2015.

 

Non-interest Expenses

 

The following table sets forth information related to our non-interest expenses for the years ended December 31, 2016 and 2015.

 

		2016				2015
Compensation and benefits		$	2,557,959			$	2,950,953
Real estate owned activity			512,407				457,173
Occupancy and equipment			639,167				678,404
Insurance			216,295				233,168
Data processing and related costs			471,976				343,107
Professional fees			1,050,062				1,320,505
Product research and development			249,594				2,209,978
Other			562,146				353,759
Total non-interest expenses		$	6,259,606			$	8,547,047

 

Non-interest expenses decreased by approximately $2.3 million, or 26.8%, for the year ended December 31, 2016. This decrease was primarily due to decreases in product research and development expenses, professional fees, and compensation and benefits expenses, partially offset by increases in data processing costs and other expenses. Product research and development expenses decreased $2.0 million due to the suspension of further development of the transaction services segment in September 2015. Product research and development expenses consisted primarily of outside service fees to developers, software licenses, compensation expense, consulting fees and research and development expense. Compensation and benefits decreased $392,994 due to the reduction in staffing related to the suspension of the product development segment as well as by a decrease of $293,703 in expense incurred related to stock option expense. Professional fees decreased $270,443 due to a decrease in consulting fees. These decreases were offset by a $128,869 increase in data processing costs and an increase of $208,387 in other expenses related to marketing and costs related to our consumer lending program.

Income Tax Expense

 

No income tax benefit or expense was recognized for the year ended December 31, 2016. In 2015, we recognized approximately $5,100 in state income taxes due with the Bank’s state tax return.

 

Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighing all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. We will continue to analyze our deferred tax assets and related valuation allowance on a quarterly basis, taking into account performance compared to forecasted earnings as well as current economic or internal information.

 

Balance Sheet Review

 

Investments

 

The purpose of the investment portfolio is to provide liquidity and stable returns through the purchase of high quality investment securities. At December 31, 2016, our investment portfolio of $2.5 million represented approximately 2.8% of total assets. The portfolio decreased from $10.7 million at December 31, 2015, or 11.0% of total assets. Decreases in investment balances during 2016 were due to normal investment maturities and repayments as well as due to the October 2016 sale of the mortgage-backed and municipal security portfolios. At December 31, 2016, we held one US Treasury note as an investment security available for sale. At December 31, 2015, we held government-sponsored mortgage-backed securities, non-taxable and taxable municipal bonds as investment securities available for sale. The amortized costs and the fair value of our investments at December 31, 2016, 2015 and 2014 are shown in the following table.

 

		2016								2015								2014
		Amortized Cost				Fair Value				Amortized Cost				Fair Value				Amortized Cost				Fair Value
Available for Sale
US Treasury Note		$	2,507,861			$	2,499,805			$	—			$	—			$	—			$	—
Government-sponsored mortgage-backed			—				—				4,290,680				4,312,449				7,597,334				7,601,517
Collateralized mortgage-backed			—				—				—				—				2,040,478				1,982,960
Municipals, tax-exempt			—				—				4,916,379				5,039,447				4,658,532				4,696,996
Municipals, taxable			—				—				1,308,298				1,335,955				1,317,433				1,334,053
Total		$	2,507,861			$	2,499,805			$	10,515,357			$	10,687,851			$	15,613,777			$	15,615,526

 

Contractual maturities and yields on our investment securities available for sale at December 31, 2016 are shown in the following table. Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		One year or less								After one year through five years								After five years through ten years								After ten years								Total
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
Available for Sale
US Treasury Note			—				—			$	2,499,805				1.08	%			—				—				—				—			$	2,499,805				1.08	%
Total		$	—				—	%		$	2,499,805				1.08	%		$	—				—	%		$	—				—	%		$	2,499,805				1.08	%

 

At December 31, 2016 and 2015, we also held non-marketable equity securities, which consisted of Federal Reserve Bank stock of $293,050 and $303,500, respectively, and FHLB stock of $87,000 and $89,000, respectively. These investments are carried at cost, which approximates fair market value.

Loans

 

Since loans typically provide higher interest yields than other types of interest-earning assets, a significant percentage of our earning assets are invested in our loan portfolio. Average loans for the year ended December 31, 2016 were $64.0 million, a decrease of $2.6 million, or 3.9%, compared to average loans of $66.6 million for the year ended December 31, 2015. Before allowance for loan losses, gross loans outstanding at December 31, 2016 were $60.5 million, or 66.9% of total assets, compared to $67.5 million, or 69.3% of total assets at December 31, 2015.

 

The principal component of our loan portfolio is loans secured by real estate mortgages. Most of our real estate loans are secured by residential or commercial property. We do not generally originate traditional long term residential mortgages for the Bank’s portfolio, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 80%. The total amount of second lien mortgage collateral and home equity loans as of December 31, 2016, 2015, 2014, 2013 and 2012 were approximately $4.3 million, $5.8 million, $8.3 million, $7.3 million, and $8.6 million, respectively.

 

The largest component of our loan portfolio at year-end was commercial real estate loans, which represented 36.4% of the portfolio. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration of certain types of collateral. Refer to Item 1, “Lending Activities”, for a detailed discussion regarding the risks inherent in each loan category noted above. Due to the short time our portfolio has existed, the current mix may not be indicative of the ongoing portfolio mix.

 

As previously disclosed, although traditionally we have maintained only a small percentage of the Bank’s loan portfolio in consumer loans, we plan to supplement our current lending strategy by expanding our consumer lending program with on-line offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. We are focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of our consumer lending program, which may include purchases of in-market consumer loans that meet the Bank’s underwriting criteria.

The following tables summarize the composition of our loan portfolio as of December 31, 2016, 2015, 2014, 2013 and 2012.

 

		2016								2015
		Amount				% of Total				Amount				% of Total
Real Estate:
Commercial		$	22,033,590				36.4	%		$	25,559,943				37.8	%
Construction and development			7,913,783				13.1				7,286,459				10.8
Single and multifamily residential			13,314,130				22.0				16,434,722				24.3
Total real estate loans			43,261,503				71.5				49,281,124				72.9
Commercial business			15,954,106				26.4				17,027,054				25.2
Consumer — other			1,434,449				2.4				1,369,224				2.1
Deferred origination fees, net			(167,062	)			(0.3	)			(135,647	)			(0.2	)
Gross loans, net of deferred fees			60,482,996				100.0	%			67,541,755				100.0	%
Less allowance for loan losses			(1,338,149	)							(1,139,509	)
Total loans, net		$	59,144,847							$	66,402,246

		2014								2013
		Amount				% of Total				Amount				% of Total
Real Estate:
Commercial		$	25,246,396				36.6	%		$	21,795,047				34.2	%
Construction and development			8,425,453				12.2				10,053,100				15.8
Single and multifamily residential			18,073,429				26.2				18,757,484				29.5
Total real estate loans			51,745,278				75.0				50,605,631				79.5
Commercial business			16,059,082				23.2				12,170,698				19.1
Consumer — other			1,372,906				2.0				999,941				1.6
Deferred origination fees, net			(149,823	)			(0.2	)			(106,134	)			(0.2	)
Gross loans, net of deferred fees			69,027,443				100.0	%			63,670,136				100.0	%
Less allowance for loan losses			(1,032,776	)							(1,301,886	)
Total loans, net		$	67,994,667							$	62,368,250

		2012
		Amount				% of Total
Real Estate:
Commercial		$	24,845,155				35.3	%
Construction and development			12,299,452				17.5
Single and multifamily residential			21,294,926				30.2
Total real estate			58,439,533				83.0
Commercial business			10,915,768				15.5
Consumer — other			1,128,544				1.6
Deferred origination fees, net			(102,099	)			(0.1	)
Gross loans			70,381,746				100.0	%
Less allowance for loan losses			(1,858,416	)
Total loans, net		$	68,523,330

Maturities and Sensitivity of Loans to Changes in Interest Rates

 

The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

 

The following table summarizes the loan maturity distribution by type and related interest rate characteristics at December 31, 2016.

 

		One year or less				After one but within five years				After five years				Total
Real Estate:
Commercial		$	3,144,814			$	16,958,206			$	1,930,570			$	22,033,590
Construction and development			2,987,321				4,829,172				97,290				7,913,783
Single and multifamily residential			1,445,328				6,710,484				5,158,318				13,314,130
Total real estate			7,577,463				28,497,862				7,186,178				43,261,503
Commercial business			6,203,428				8,736,000				1,014,678				15,954,106
Consumer — other			540,500				821,639				72,310				1,434,449
Gross loans		$	14,321,391			$	38,055,501			$	8,273,166			$	60,650,058
Deferred origination fees, net															(167,062	)
Gross loans, net of deferred fees														$	60,482,996
Loans maturing — after one year with
Fixed interest rates														$	16,767,328
Floating interest rates														$	29,561,339

 

Loan Performance and Asset Quality

 

Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest (unless the loan is well-collateralized and in the process of collection), or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when concern no longer exists as to the collectability of principal or interest based on current available information or as evidenced by sufficient payment history, which generally is six months. Foregone interest income related to nonaccrual loans equaled $60,633 and $129,066 for the years ended December 31, 2016 and 2015, respectively. No interest income was recognized on nonaccrual loans during 2016 and 2015. At both December 31, 2016 and 2015, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments.

 

The following tables summarize delinquencies and nonaccruals, by portfolio class, as of December 31, 2016, 2015, 2014, 2013, and 2012.

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2016
30–59 days past due		$	442,295			$	—			$	—			$	617,052			$	—			$	1,059,347
60–89 days past due			—				—				—				409,675				—				409,675
Nonaccrual			108,951				—				195,500				—				—				304,451
Total past due and nonaccrual			551,246				—				195,500				1,026,727				—				1,773,473
Total debt restructurings			—				—				—				—				—				—
Current			12,762,884				7,913,783				21,838,090				14,927,379				1,434,449				58,876,585
Total loans		$	13,314,130			$	7,913,783			$	22,033,590			$	15,954,106			$	1,434,449			$	60,650,058

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2015
30–59 days past due		$	75,890			$	—			$	—			$	—			$	—			$	75,890
60–89 days past due			63,702				250,378				—				—				—				314,080
Nonaccrual			168,879				40,500				1,390,013				65,798				—				1,665,190
Total past due and nonaccrual			308,471				290,878				1,390,013				65,798				—				2,055,160
Total debt restructurings			—				—				—				—				—				—
Current			16,126,251				6,995,581				24,169,930				16,961,256				1,369,224				65,622,242
Total loans		$	16,434,722			$	7,286,459			$	25,559,943			$	17,027,054			$	1,369,224			$	67,677,402

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2014
30–59 days past due		$	188,033			$	39,561			$	—			$	23,938			$	—			$	251,532
60–89 days past due			—				—				—				9,129				—				9,129
Nonaccrual			—				—				534,057				—				—				534,057
Total past due and nonaccrual			188,033				39,561				534,057				33,067				—				794,718
Total debt restructurings			—				—				—				—				—				—
Current			17,885,396				8,385,892				24,712,339				16,026,015				1,372,906				68,382,548
Total loans		$	18,073,429			$	8,425,453			$	25,246,396			$	16,059,082			$	1,372,906			$	69,177,266

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2013
30–59 days past due		$	—			$	42,542			$	524,430			$	—			$	—			$	566,972
60–89 days past due			—				—				—				—				—				—
Nonaccrual			—				1,008,253				347,615				—				—				1,402,715
Total past due and nonaccrual			46,847				1,050,795				872,045				—				—				1,969,687
Total debt restructurings			46,847				—				—				—				—				—
Current			—				9,002,305				20,923,002				12,170,698				999,941				61,806,583
Total loans		$	18,757,484			$	10,053,100			$	21,795,047			$	12,170,698			$	999,941			$	63,776,270

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2012
30–59 days past due		$	46,178			$	—			$	—			$	—			$	9,316			$	55,494
60–89 days past due			—				—				—				—				1,541				1,541
Nonaccrual			719,260				3,710,587				331,000				—				—				4,760,847
Total past due and nonaccrual			765,438				3,710,587				331,000				—				10,857				4,817,882
Total debt restructurings			1,175,843				—				1,314,205				—				—				2,490,048
Current			19,353,645				8,588,865				23,199,950				10,915,768				1,117,687				63,175,915
Total loans		$	21,294,926			$	12,299,452			$	24,845,155			$	10,915,768			$	1,128,544			$	70,483,845

 

Total delinquent and nonaccrual loans decreased from $2,055,160 at December 31, 2015 to $1,773,473 at December 31, 2016, a decrease of $281,687 or 13.7%. This decrease was a result of the movement of three nonaccrual loans transferring to other real estate owned, which decreased by $1.4 million from 2015 to 2016, partially offset by an increase in loans past due 30-59 days of $983,457 and an increase in loans past due 60-89 days of $95,595 as discussed below. Nonaccrual decreases were seen in single and multifamily residential, construction and development, commercial real estate and residential lot real estate loans due to successful

foreclosure of the properties collateralizing these loans and their transfer to other real estate owned. At December 31, 2016, nonaccrual loans represented 0.5% of gross loans. Loans past due 30-89 days are considered potential problem loans and amounted to $1,469,022 and $389,970 at December 31, 2016 and 2015, respectively. The increase in 30-89 delinquent loans is due to seven loans moving into the 30-59 days delinquent category and two loans moving into the 60-89 days delinquent category.

 

Another method used to monitor the loan portfolio is credit grading. As part of the loan review process, loans are given individual credit grades, representing the risk we believe is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. The following tables summarize management’s internal credit risk grades, by portfolio class, as of December 31, 2016 and 2015.

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2016
Pass Loans (Consumer)		$	8,246,567			$	1,462,925			$	—			$	—			$	1,434,449			$	11,143,941
Grade 1 — Prime			—				—				—				—				—				—
Grade 2 — Good			—				—				—				—				—				—
Grade 3 — Acceptable			1,919,685				1,108,334				11,057,550				7,676,592				—				21,762,161
Grade 4 — Acceptable w/Care			2,877,013				5,273,411				9,232,019				7,307,961				—				24,690,404
Grade 5 — Special Mention			—				69,113				766,388				—				—				835,501
Grade 6 — Substandard			270,865				—				977,633				969,553				—				2,218,051
Grade 7 — Doubtful			—				—				—				—				—				—
Total loans		$	13,314,130			$	7,913,783			$	22,033,590			$	15,954,106			$	1,434,449			$	60,650,058

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2015
Pass Loans (Consumer)		$	8,340,816			$	1,350,332			$	—			$	—			$	1,369,224			$	11,060,372
Grade 1 — Prime			—				—				—				—				—				—
Grade 2 — Good			—				—				—				—				—				—
Grade 3 — Acceptable			4,479,116				809,004				8,121,125				7,667,706				—				21,076,951
Grade 4 — Acceptable w/Care			3,382,209				4,759,864				14,724,468				8,199,385				—				31,065,926
Grade 5 — Special Mention			63,702				76,381				611,189				846,106				—				1,597,378
Grade 6 — Substandard			168,879				290,878				2,103,161				313,857				—				2,876,775
Grade 7 — Doubtful			—				—				—				—				—				—
Total loans		$	16,434,722			$	7,286,459			$	25,559,943			$	17,027,054			$	1,369,224			$	67,677,402

 

Loans graded one through four are considered “pass” credits. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. At December 31, 2016, approximately 95% of the loan portfolio had a credit grade of “pass” compared to 93% at December 31, 2015. For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

 

Loans with a credit grade of five are not considered classified; however they are categorized as a special mention or watch list credit, and are considered potential problem loans. This classification is utilized by us when we have an initial concern about the financial health of a borrower. These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information. There are times when we

may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of December 31, 2016, we had loans totaling $835,501 on the watch list compared to $1.6 million as of December 31, 2015. This decrease was primarily related to two loans from 2015 being deemed as acceptable and one loan being repaid in full, partially offset by two loans being deemed special mention during 2016.

 

Loans graded six or greater are considered classified credits. At December 31, 2016 and 2015, classified loans totaled $2.2 million and $2.9 million, respectively, with the vast majority of these loans being collateralized by real estate. The decrease was primarily related to three loans moving to other real estate owned and three loans being repaid in full during 2016. Classified credits are evaluated for impairment on a quarterly basis.

 

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan-by-loan basis by calculating either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The resulting shortfall is charged to provision for loan losses and is classified as a specific reserve. When an impaired loan is ultimately charged-off, the charge-off is taken against the specific reserve.

 

At December 31, 2016, impaired loans totaled $2.2 million, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral. Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower. During 2016, the average recorded investment in impaired loans was $2.1 million compared to $2.4 million during 2015. As of December 31, 2016 and December 31, 2015, we had loans totaling approximately $835,501 and $498,437, respectively that were classified in accordance with our loan rating policies but were not considered impaired. On March 7, 2017, one impaired loan was transferred to other real estate owned for $165,000, net of a specific reserve of $35,000. The specific reserve was included in the December 31, 2016 allowance amounts. The following tables summarize information relative to impaired loans, by portfolio class, at December 31, 2016 and 2015.

 

		Unpaid principal balance				Recorded investment				Related allowance				Average impaired investment				Interest income
December 31, 2016
With no related allowance recorded:
Single and multifamily residential real estate		$	99,794			$	99,794			$	—			$	179,235			$	3,261
Construction and development			—				—				—				109,660				6,130
Commercial real estate — other			782,133				782,133				—				718,589				46,778
Commercial			231,448				231,448				—				96,283				4,744
Consumer			—				—				—				—				—
With related allowance recorded:
Single and multifamily residential real estate			171,071				171,071				93,471				201,000				3,251
Construction and development			—				—				—				98,139				—
Commercial real estate — other			195,500				195,500				30,500				524,283				—
Commercial			738,105				738,105				487,490				191,329				46,315
Consumer			—				—				—				—				—
Total:
Single and multifamily residential real estate			270,865				270,865				93,471				380,235				6,512
Construction and development			—				—				—				207,799				6,130
Commercial real estate — other			977,633				977,633				30,500				1,242,872				46,778
Commercial			969,553				969,553				487,490				287,612				51,059
Consumer			—				—				—				—				—
		$	2,218,051			$	2,218,051			$	611,461			$	2,118,518			$	110,479

		Unpaid principal balance				Recorded investment				Related allowance				Average impaired investment				Interest income
December 31, 2015
With no related allowance recorded:
Single and multifamily residential real estate		$	—			$	—			$	—			$	411,430			$	21,667
Construction and development			—				—				—				177,047				—
Commercial real estate — other			905,968				905,968				—				415,488				29,423
Commercial			—				—				—				62,015				—
Consumer			—				—				—				—				—
With related allowance recorded:
Single and multifamily residential real estate			236,938				236,938				163,138				270,668				—
Construction and development			40,500				40,500				10,500				239,206				727
Commercial real estate — other			1,197,193				1,197,193				201,793				805,654				46,761
Commercial			—				—				—				18,139				2,119
Consumer			—				—				—				—				—
Total:
Single and multifamily residential real estate			236,938				236,938				163,138				682,098				21,667
Construction and development			40,500				40,500				10,500				416,253				727
Commercial real estate — other			2,103,161				2,103,161				201,793				1,221,142				76,184
Commercial			—				—				—				80,154				2,119
Consumer			—				—				—				—				—
		$	2,380,599			$	2,380,599			$	375,431			$	2,399,647			$	100,697

 

Troubled debt restructurings (“TDRs”) are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.

 

At December 31, 2016, the principal balance of TDRs was zero as the one loan previously constituting our sole TDR during the year had been repaid in full at maturity in August 2016. At December 31, 2015, the principal balance of TDRs was zero as the one loan previously constituting our sole TDR had been transferred to other real estate owned. No TDRs went into default during the year ended December 31, 2015 and 2016. A TDR can be removed from “troubled” status once there is sufficient history of demonstrating the borrower can service the credit under market terms. We currently consider sufficient history to be approximately six months.

 

There were no loans modified as TDRs within the previous 12- month period for which there was a payment default during the years ended December 31, 2015 and 2016.

 

Provision and Allowance for Loan Losses

 

We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statements of operations. At December 31, 2016, the allowance for loan losses was $1.3 million, or 2.20% of gross loans, compared to $1.1 million at December 31, 2015, or 1.68% of gross loans. This increase in the allowance for loan losses is due to the recognition of provision for loan losses, partially offset by charge-offs taken against specific reserves, as well as payoffs in our commercial real estate portfolio, which carries a higher historical loss ratio and, consequently, a higher reserve factor within our allowance model.

 

The provision, reversal of provision and allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and

prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. We strive to follow a comprehensive, well-documented, and consistently applied analysis of our loan portfolio in determining an appropriate level for the allowance for loan losses. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on what we believe are all significant factors that impact the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of directors’ oversight, concentrations of credit, and peer group comparisons.

 

Our allowance for loan losses consists of both specific and general reserve components. The specific reserve component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. Loans determined to be impaired are excluded from the general reserve calculation described below and evaluated individually for impairment. Impaired loans totaled $2.2 million at December 31, 2016, with an associated specific reserve of approximately $611,000. See above discussion under “Loan Performance and Asset Quality” for additional information related to impaired loans.

 

The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. The total general reserve is based upon the individual loan categories and their historical loss factors over an eight quarter moving average, adjusted for other risk factors as well. Therefore, the general allocation will move among the categories depending on if some loss factors increased while others decreased. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.

 

The following tables summarize activity related to our allowance for loan losses for the years ended December 31, 2016, 2015, 2014, 2013, and 2012 by portfolio segment.

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2016
Allowance for loan losses:
Balance, beginning of year		$	265,797			$	184,130			$	439,830			$	244,679			$	5,073			$	1,139,509
Provision (reversal of provision) for loan losses			(30,000	)			(100,000	)			100,000				440,000				(3,000	)			407,000
Loan charge-offs			—				(10,500	)			(209,045	)			—				(640	)			(220,185	)
Loan recoveries			—				—				—				—				11,825				11,825
Net loans charged-off			—				(10,500	)			(209,045	)			—				11,185				(208,360	)
Balance, end of year		$	235,797			$	73,630			$	330,785			$	684,679			$	13,258			$	1,338,149
Individually reviewed for impairment		$	93,471			$	—			$	30,500			$	487,490			$	—			$	611,461
Collectively reviewed for impairment			142,326				73,630				300,285				197,189				13,258				726,688
Total allowance for loan losses		$	235,797			$	73,630			$	330,785			$	684,679			$	13,258			$	1,338,149
Gross loans, end of period:
Individually reviewed for impairment		$	171,071			$	—			$	195,500			$	738,105			$	—			$	1,104,676
Collectively reviewed for impairment			13,143,059				7,913,783				21,838,090				15,216,001				1,434,449				59,545,382
Total gross loans		$	13,314,130			$	7,913,783			$	22,033,590			$	15,954,106			$	1,434,449			$	60,650,058

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2015
Allowance for loan losses:
Balance, beginning of year		$	160,797			$	234,130			$	363,097			$	184,679			$	90,073			$	1,032,776
Provision (reversal of provision) for loan losses			105,000				(50,000	)			120,000				60,000				(85,000	)			150,000
Loan charge-offs			—				—				(43,267	)			—				—				(43,267	)
Loan recoveries			—				—				—				—				—				—
Net loans charged-off			—				—				(43,267	)			—				—				(43,267	)
Balance, end of year		$	265,797			$	184,130			$	439,830			$	244,679			$	5,073			$	1,139,509
Individually reviewed for impairment		$	163,138			$	10,500			$	201,793			$	—			$	—			$	375,431
Collectively reviewed for impairment			102,659				173,630				238,037				244,679				5,073				764,078
Total allowance for loan losses		$	265,797			$	184,130			$	439,830			$	244,679			$	5,073			$	1,139,509
Gross loans, end of period:
Individually reviewed for impairment		$	236,938			$	40,500			$	2,103,161			$	—			$	—			$	2,380,599
Collectively reviewed for impairment			16,197,784				7,245,959				23,456,782				17,027,054				1,369,224				65,296,803
Total gross loans		$	16,434,722			$	7,286,459			$	25,559,943			$	17,027,054			$	1,369,224			$	67,677,402

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2014
Allowance for loan losses:
Balance, beginning of year		$	237,230			$	485,010			$	360,564			$	129,009			$	90,073			$	1,301,886
Provision for loan losses			(150,000	)			(295,265	)			100,106				315,159				—				(30,000	)
Loan charge-offs			—				(118,577	)			(101,000	)			(297,889	)			—				(517,466	)
Loan recoveries			73,567				162,962				3,427				38,400				—				278,356
Net loans charged-off			73,567				44,385				(97,573	)			(259,489	)			—				(239,110	)
Balance, end of year		$	160,797			$	234,130			$	363,097			$	184,679			$	90,073			$	1,032,776
Individually reviewed for impairment		$	—			$	—			$	88,712			$	—			$	—			$	88,712
Collectively reviewed for impairment			160,797				234,130				274,385				184,679				90,073				944,064
Total allowance for loan losses		$	160,797			$	234,130			$	363,097			$	184,679			$	90,073			$	1,032,776
Gross loans, end of period:
Individually reviewed for impairment		$	725,090			$	—			$	1,290,503			$	—			$	—			$	2,015,593
Collectively reviewed for impairment			17,348,339				8,425,453				23,955,893				16,059,082				1,372,906				67,161,673
Total gross loans		$	18,073,429			$	8,425,453			$	25,246,396			$	16,059,082			$	1,372,906			$	69,177,266

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2013
Allowance for loan losses:
Balance, beginning of year		$	611,576			$	1,073,110			$	63,747			$	36,683			$	73,300			$	1,858,416
Provision for loan losses			(115,000	)			(586,040	)			703,817				85,827				16,820				105,424
Loan charge-offs			(259,346	)			(97,060	)			(407,000	)			—				(148	)			(763,554	)
Loan recoveries			—				95,000				—				6,499				101				101,600
Net loans charged-off			(259,346	)			(2,060	)			(407,000	)			6,499				(47	)			(661,954	)
Balance, end of year		$	237,230			$	485,010			$	360,564			$	129,009			$	90,073			$	1,301,886
Individually reviewed for impairment		$	7,425			$	101,000			$	83,614			$	—			$	—			$	192,039
Collectively reviewed for impairment			229,805				384,010				276,950				129,009				90,073				1,109,847
Total allowance for loan losses		$	237,230			$	485,010			$	360,564			$	129,009			$	90,073			$	1,301,886
Gross loans, end of period:
Individually reviewed for impairment		$	138,691			$	1,008,253			$	347,969			$	—			$	—			$	1,494,913
Collectively reviewed for impairment			18,618,793				9,044,847				21,447,078				12,170,698				999,941				62,281,357
Total gross loans		$	18,757,484			$	10,053,100			$	21,795,047			$	12,170,698			$	999,941			$	63,776,270

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2012
Allowance for loan losses:
Balance, beginning of year		$	576,669			$	688,847			$	347,061			$	412,808			$	85,138			$	2,110,523
Provision for loan losses			88,351				402,724				(233,315	)			(361,806	)			82,046				(22,000	)
Loan charge-offs			(55,330	)			(18,461	)			(49,999	)			(15,443	)			(93,884	)			(233,117	)
Loan recoveries			1,886				—				—				1,124				—				3,010
Net loans charged-off			(53,444	)			(18,461	)			(49,999	)			(14,320	)			(93,884	)			(230,108	)
Balance, end of year		$	611,576			$	1,073,110			$	63,747			$	36,683			$	73,300			$	1,858,416
Individually reviewed for impairment		$	159,979			$	248,417			$	34,000			$	—			$	—			$	442,396
Collectively reviewed for impairment			451,597				824,693				29,747				36,683				73,300				1,416,020
Total allowance for loan losses		$	611,576			$	1,073,110			$	63,747			$	36,683			$	73,300			$	1,858,416
Gross loans, end of period:
Individually reviewed for impairment		$	2,034,986			$	4,814,002			$	1,645,205			$	—			$	—			$	8,494,193
Collectively reviewed for impairment			19,259,940				7,485,450				23,199,950				10,915,768				1,128,544				61,989,652
Total gross loans		$	21,294,926			$	12,299,452			$	24,845,155			$	10,915,768			$	1,128,544			$	70,483,845

 

Net loan charge-offs increased during 2016 from $43,267 for the year ended December 31, 2015 to $208,360 for the year ended December 31, 2016, an increase of $165,093. Charge-offs in 2016 of approximately $220,000 were partial charge-offs taken on certain collateral-dependent loans within our commercial real estate and construction segments. Charge-offs in 2015 of approximately $43,000 were full charge-offs taken on one loan within our commercial real estate segment. Partial charge-offs were based on recent appraisals and evaluations on commercial real estate loans in the process of foreclosure. Loans with partial charge-offs are typically considered impaired loans and remain on nonaccrual status. In addition, when collateral is obtained in satisfaction of a loan, a charge-off is taken through the allowance at the time of repossession to move the collateral to other real estate owned at fair value less costs to sell.

The allowance as a percentage of gross loans increased from 1.68% at December 31, 2015 to 2.21% at December 31, 2016. The increase in the reserve percentage is due to an increase in allowance for loan losses of $198,640. The increase in allowance is attributed to the recognition of a provision for loan losses of $407,000, net of recoveries and charge-offs taken against specific reserves of $208,360. The general reserve as a percentage of non-impaired loans has increased from 1.17% at December 31, 2015 to 1.22% at December 31, 2016.

 

Portions of the allowance for loan losses may be allocated for specific loans or portfolio segments. However, the entire allowance for loan losses is available for any loan that, in management’s judgment, should be charge-off. While management utilizes the best judgment and information available to it, the ultimate adequacy of the allowance for loan losses depends on a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

 

Other Real Estate Owned and Repossessed Assets

 

As of December 31, 2016, we had $2.2 million in other real estate owned. This compares to $1.9 million in other real estate owned as of December 31, 2015. During 2016, collateral was obtained from three loan relationships that went through the foreclosure process. We also completed the sale of three repossessed properties.

 

During 2016, other real estate owned for the Company decreased due to the sale of real estate owned that were purchased from the Bank for proceeds of approximately $613,000, which resulted in a loss of approximately $18,000 to the Company. Real estate owned for the Bank increased due to three pieces of real estate being moved to other real estate owned for $1.3 million, partially offset by the sale of one piece of real estate held by the Bank for proceeds of approximately $24,000, which resulted in a loss of approximately $6,000. In addition, the Bank recognized writedowns on real estate owned of approximately $284,000 during 2016. On March 7, 2017, one impaired loan was transferred to other real estate owned for $165,000, net of a specific reserve of $35,000. The specific reserve was included in the December 31, 2016 allowance amounts. The following table summarizes changes in the consolidated balance of other real estate owned and repossessed assets during the periods noted:

 

		2016				2015
Balance at beginning of year		$	1,910,220			$	2,557,457
Repossessed property acquired in settlement of loans			1,257,289				300,000
Proceeds from sales of repossessed property			(637,072	)			(582,295	)
Gain (loss) on sale and write-downs of repossessed property, net			(307,770	)			(364,942	)
Balance at end of year		$	2,222,667			$	1,910,220

 

The following table summarizes the composition of other real estate owned and repossessed assets as of the dates noted:

 

		December 31,
		2016				2015
Residential land lots		$	—			$	31,320
Single and multifamily residential real estate			—				—
Commercial office space			1,412,667				1,008,900
Commercial land			810,000				870,000
Equipment			—				—
Total		$	2,222,667			$	1,910,220

 

The remaining assets are being actively marketed with the primary objective of liquidating the collateral at a level which most accurately approximates fair value and allows recovery of as much of the unpaid principal loan balance as possible upon the sale of the asset within a reasonable period of time. Based on currently available valuation information, the carrying value of these assets is believed to be representative of their fair value less estimated costs to sell, although there can be no assurance that the ultimate

proceeds from the sale of these assets will be equal to or greater than their carrying values, particularly in the current real estate environment and the downward, though stabilizing, trends in third party appraised values.

 

Deposits and Other Interest-Bearing Liabilities

 

Our primary source of funds for loans and investments is our deposits and short-term repurchase agreements. Average total deposits for the years ended December 31, 2016 and 2015 were $83.1 million and $85.0 million, respectively. The following table shows the balance outstanding and the weighted-average rates paid on deposits held by us as of December 31, 2016, 2015, and 2014.

 

		2016								2015								2014
		Amount				Rate				Amount				Rate				Amount				Rate
Non-interest bearing demand deposits		$	13,723,902				—	%		$	13,010,209				—	%		$	11,016,882				—	%
Interest bearing demand deposits			8,959,818				0.11				8,894,408				0.12				7,335,360				0.12
Money market accounts			29,620,179				0.28				33,164,973				0.25				35,077,304				0.24
Savings accounts			1,054,314				0.05				1,034,438				0.05				767,668				0.05
Time deposits less than $100,000			5,565,797				0.76				5,756,202				0.71				6,695,936				0.62
Time deposits of $100,000 or more			20,783,638				0.92				21,707,095				0.84				21,981,513				0.76
Brokered time deposits less than $100,000			—				—				—				—				—				—
Total		$	79,707,648				0.45	%		$	83,567,325				0.38	%		$	82,874,663				0.36	%

 

Core deposits, which exclude time deposits of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Core deposits decreased $4.9 million, or 4.7%, from $61.9 million at December 31, 2015 to $58.9 million at December 31, 2016. Total retail, or customer, deposits decreased $1.1 million during 2016, or 4.1%. Our loan-to-deposit ratio was 74.2% and 78.1% at December 31, 2016 and 2015, respectively.

 

All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $100,000 or more, excluding brokered deposits, at December 31, 2016 is as follows:

 

Three months or less		$	4,694,072
Over three through six months			3,153,453
Over six through twelve months			7,249,907
Over twelve months			11,252,003
Total		$	26,349,435

 

Time deposits that meet or exceed the FDIC insurance limit at $250,000 amounted to $8,913,592 and $7,578,706 as of December 31, 2016 and 2015, respectively.

 

Short-Term Borrowings

 

At December 31, 2016, 2015, and 2014, the Bank had sold $113,598, $113,080, and $153,603, respectively, of securities under agreements to repurchase with brokers with a weighted rate of 0.12%, 0.10%, and 0.15%, respectively that mature in less than 90 days. These agreements were secured with approximately $50,000, $107,000, and $130,000 of investment securities, respectively. The securities, under agreements to repurchase, averaged $135,708 during 2016, with $279,628 being the maximum amount outstanding at any month-end. The average rate paid in 2016 was 0.10%. The securities, under agreements to repurchase, averaged $98,636 during 2015, with $354,739 being the maximum amount outstanding at any month-end. The average rate paid in 2015 was 0.10%. The securities, under agreements to repurchase, averaged $110,307 during 2014, with $221,467 being the maximum amount outstanding at any month-end. The average rate paid in 2014 was 0.10%.

 

At December 31, 2016, the Bank had an unused unsecured line of credit to purchase federal funds of $2.0 million. The line of credit is available on a one to fourteen day basis for general corporate purposes of the Bank. The lender has reserved the right to withdraw the line at its option. At December 31, 2016, the Bank had pledged $15.5 million in loans to the FRB’s Borrower-in-Custody of Collateral program. Our available credit under this line was approximately $11.4 million as of December 31, 2016.

Federal Home Loan Bank Advances

 

From time to time, the Bank utilizes FHLB advances as a source of funding. However, at December, 31, 2016 and 2015, the Bank had no advances from the FHLB. In February 2017, an advance of $4,000,000 was obtained from the FHLB with a weighted average rate of 0.89% and a maturity date of November 2017.

 

Capital Resources

 

Total shareholders’ equity was $9.9 million at December 31, 2016, a decrease of $2.7 million, or 21.4%, from $12.6 million at December 31, 2015. Shareholders’ equity decreased during 2016 primarily due to the recognition of a net loss of $2.6 million and a decrease in the unrealized gain on investment securities of $121,902. For 2016, the $2.6 million net loss was primarily the result of $1.1 million in professional fees, $407,000 in provisions for loan losses and $512,407 in expenses related to real estate owned. Our shareholders’ equity is also affected by fluctuations in our other comprehensive income (loss). The highest month end reported unrealized loss in other comprehensive income during calendar 2016 was $288,014 in August 2016 as compared to the highest month end unrealized gain in December 2015 of $113,846.

 

Our Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies. Under the 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 also subject to qualitative judgments by the regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

 

The Basel III capital rules, which were released in July 2013, implement new capital standards and apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. The requirements of the rules began to phase in on January 1, 2015 for the Bank, and the requirements of the rules will be fully phased in by January 1, 2019. Under the rules, the following minimum capital requirements apply to the Bank:

 

•

a new common equity Tier 1 risk-based capital ratio of 4.5%,

•

a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement),

•

a total risk-based capital ratio of 8% (unchanged from the former requirement), and

•

a leverage ratio of 4% (also unchanged from the former requirement).

 

Under the rule, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, common equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital. Accumulated other comprehensive income (AOCI) is presumptively included in common equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

 

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2017, the Bank is required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.

 

Under the regulations adopted by the federal regulatory authorities, the Bank will be categorized as:

•

Well capitalized if the institution (i) has total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage capital ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

 

•

Adequately capitalized if the institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 4.5% or greater, and (iv) has a leverage capital ratio of 4% or greater.

 

•

Undercapitalized if the institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 4.5% or greater, or (iv) has a leverage capital ratio of less than 4%.

 

•

Significantly undercapitalized if the institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 3% or greater, or (iv) has a leverage capital ratio of less than 3%.

 

•

Critically undercapitalized if the institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

 

In addition, the Bank may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. The Bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the Bank’s overall financial condition or prospects for other purposes.

 

See additional discussion above under “Business — Supervision and Regulation.”

 

The following table sets forth the Bank’s and the Company’s various capital ratios at December 31, 2016, 2015, and 2014.

 

		Bank												Holding Company
		2016				2015				2014				2016				2015				2014
Total risk-based capital			13.4	%			14.1	%			15.3	%			15.7	%			12.8	%			14.0	%
Tier 1 risk-based capital			12.1	%			12.8	%			14.0	%			14.4	%			16.7	%			12.7	%
Leverage capital			9.0	%			10.0	%			10.6	%			10.1	%			13.0	%			9.7	%
Common equity to Tier 1 capital			12.1	%			12.8	%			n/a				14.4	%			16.7	%			n/a

 

Since December 31, 2016, no conditions or events have occurred, of which we are aware, that have resulted in a material change in the Company’s or the Bank’s capital category. As of December 31, 2016, there were no commitments outstanding, and there were no new commitments as of March 23, 2017. Under Regulation W, the Bank may not be a source of cash or capital for the Company. As disclosed in “Note 22 — Parent Company Financial Information,” the Company’s cash balances were $1.8 million and it had no real estate held for sale at December 31, 2016.

 

Return on Equity and Assets

 

The following table shows the return on average assets (net income (loss) divided by average total assets), return on average equity (net income (loss) divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2016, 2015 and 2014. Since our inception, we have not paid cash dividends.

 

		2016				2015				2014
Return on average assets			(2.79	)%			(4.94	)%			(6.25	)%
Return on average equity			(27.36	)%			(38.47	)%			(6.24	)%
Equity to assets ratio			10.18	%			12.85	%			12.29	%

Effect of Inflation and Changing Prices

 

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on a historical cost basis in accordance with GAAP.

 

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude.

 

Off-Balance Sheet Risk

 

Commitments to extend credit are agreements to lend to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2016, unfunded commitments to extend credit were $8.6 million, of which approximately $7.9 million is at fixed rates and $677,000 is at variable rates. A significant portion of the unfunded commitments related to commercial lines of credit. Based on historical experience, we anticipate that a significant portion of these lines of credit will not be funded. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

 

We are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements, or other transactions that could result in liquidity needs or other commitments that significantly impact earnings.

 

Market Risk

 

Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.

 

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive.

 

Approximately 67.7% of our loans were variable rate loans at December 31, 2016, an increase from 64.6% at December 31, 2015. As of December 31, 2016, our ratio of cumulative gap to total earning assets after 12 months but within five years was 18.84% because in a rate change scenario, $17.5 million more liabilities would reprice in a 12 month period than assets. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

 

Interest rate risk is the Company’s primary market risk exposure. As part of interest rate risk management, the Company may enter into swap agreements to provide protection from rising rates and the impact on the current gap. There were no swap agreements at December 31, 2016. Currently, the Company’s exposure to market risk is reviewed on a regular basis by management, and at the Bank level, the ALCO.

Liquidity and Interest Rate Sensitivity

 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

The Consolidated Company

 

At December 31, 2016, our liquid assets, consisting of cash and due from banks and federal funds sold, amounted to $10.8 million, or 11.9% of total assets, a decrease from our cash liquidity ratio of 14.2% as of December 31, 2015. During 2016, the decrease in liquidity is due primarily to the decrease in cash and due from bank and fed funds sold.

 

The Company

 

The Company’s cash balances, independent of the Bank, were $1.8 million and its real estate held for sale was zero at December 31, 2016 compared to cash balances of approximately $2.9 million and real estate held for sale of $631,320 at December 31, 2015. The Company’s accrued and other liabilities, independent of the Bank, were $304,346 at December 31, 2016 compared to $905,824 at December 31, 2015. The decrease in liquid assets of approximately $1.1 million was primarily due to the repayment of accrued liabilities, approximately $250,000 in expenses incurred related to the transaction services segment, approximately $147,000 in other real estate owned expenses incurred related to the asset management segment and approximately $913,000 in professional fees and data processing expenses incurred at the Company. The decrease in payables of $601,478 was due primarily to the repayment of accrued liabilities related to the transaction services segment during 2016. See “Note 22 — Parent Company Financial Information” for additional information related to the transaction services segment.

 

Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our ALCO monitors and considers methods of managing exposure to interest rate risk. We have both an internal ALCO consisting of senior management that meets at various times during each month and a board ALCO that meets monthly. The ALCOs are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

 

The Bank

 

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits within our market. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. Our investment securities available for sale at December 31, 2016 amounted to $2.5 million, or 2.8% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. At December 31, 2016, $2.4 million of our investment portfolio was pledged against outstanding debt. Therefore, the related debt would need to be repaid prior to the securities being sold and converted to cash.

 

We are a member of the FHLB, from which applications for borrowings can be made for leverage purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. At December 31, 2016, we had collateral that would support approximately $12.3 million in additional borrowings. Like all banks, we are subject to the FHLB’s credit risk rating policy which assigns member institutions a rating which is reviewed quarterly. The rating system utilizes key factors such as loan quality, capital, liquidity, profitability, etc. Our ability to access our available borrowing capacity from the FHLB in the future is subject to our rating and any subsequent changes based on our financial performance as compared to factors considered by the FHLB in their assignment of our credit risk rating each quarter.

 

At December 31, 2016, the Bank had an unused line of credit to purchase federal funds of $2.0 million. The line of credit is available on a one to fourteen day basis for general corporate purposes of the Bank. The lender has reserved the right to withdraw the line at its option. At December 31, 2016, the Bank had pledged $15.5 million in loans to the FRB’s Borrower-in-Custody of Collateral program. Our available credit under this line was approximately $11.4 million as of December 31, 2016.

 

The following table sets forth information regarding our rate sensitivity, as of December 31, 2016, at each of the time intervals. The information in the table may not be indicative of our rate sensitivity position at other points in time. In addition, the maturity distribution indicated in the table may differ from the contractual maturities of the earning assets and interest-bearing liabilities

presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.

 

		Within three months				After three but within twelve months				After one but within five years				After five years				Total
Interest-earning assets:
Federal funds sold and other		$	6,143,000			$	—			$	—			$	—			$	6,143,000
Investment securities			—				—				2,499,805				—				2,499,805
Interest-bearing deposits in other institutions			1,750,000				4,250,000				4,500,000				—				10,500,000
Loans			2,116,714				12,204,679				13,531,086				32,797,579				60,650,058
Total interest-earning assets		$	10,009,714			$	16,454,679			$	20,530,891			$	32,797,579			$	79,792,863
Interest-bearing liabilities:
Money market and NOW		$	38,579,997			$	—			$	—			$	—			$	38,579,997
Regular savings			1,054,314				—				—				—				1,054,314
Time deposits			4,694,072				10,403,360				9,686,221				1,565,781				26,349,434
Repurchase agreements			113,598				—				—				—				113,598
Total interest-bearing liabilities		$	44,441,981			$	10,403,360			$	9,686,221			$	1,565,781			$	66,097,343
Period gap		$	(34,432,267	)		$	6,051,319			$	10,844,670			$	31,231,798
Cumulative gap			(34,432,267	)			(28,380,948	)			(17,536,278	)			13,695,520
Ratio of cumulative gap to total earning assets			(36.99	)%			(30.49	)%			(18.84	)%			14.71	%

 

Accounting, Reporting, and Regulatory Matters

 

The following is a summary of recent authoritative pronouncements that may affect our accounting, reporting, and disclosure of financial information:

 

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. This topic was amended again in March 2016 to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for annual periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

 

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified

awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

 

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable.

Item 8. Financial Statements and Supplementary Data.

 

INDEX TO FINANCIAL STATEMENTS

 

FOR THE YEARS ENDED DECEMBER 31, 2016 and 2015

 

	Page(s)
Report of Independent Registered Public Accounting Firm	F-2
Consolidated Financial Statements:
Consolidated Balance Sheets	F-3
Consolidated Statements of Operations and Comprehensive Income (Loss)	F-4
Consolidated Statements of Changes in Shareholders’ Equity	F-5
Consolidated Statements of Cash Flows	F-6
Notes to Consolidated Financial Statements	F-7

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders

Independence Bancshares, Inc.

Greenville, South Carolina

 

We have audited the accompanying consolidated balance sheets of Independence Bancshares, Inc. and its subsidiary (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income (loss), changes in shareholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and 2015, and the results of its operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

/s/ Elliott Davis Decosimo, LLC

 

Greenville, South Carolina

March 23, 2017

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS

 

		December 31,
		2016				2015
Assets
Cash and due from banks		$	4,631,727			$	5,453,795
Federal funds sold			6,143,000				8,446,000
Cash and cash equivalents			10,774,727				13,899,795
Interest-bearing deposits in other institutions			10,500,000				1,500,000
Investment securities available for sale			2,499,805				10,687,851
Non-marketable equity securities			380,050				392,500
Loans, net of an allowance for loan losses of $1,338,149 and $1,139,509, respectively			59,144,847				66,402,246
Accrued interest receivable			170,342				232,215
Property,  equipment, and software, net			2,025,774				2,198,796
Other real estate owned and repossessed assets			2,222,667				1,910,220
Bank-owned life insurance			2,542,910				—
Other assets			187,935				243,683
Total assets		$	90,449,057			$	97,467,306
Liabilities
Deposits:
Non-interest bearing		$	13,723,903			$	13,010,209
Interest bearing			65,983,745				70,557,116
Total deposits			79,707,648				83,567,325
Securities sold under agreements to repurchase			113,598				113,080
Accrued interest payable			8,802				7,909
Accounts payable and accrued expenses			674,644				1,134,833
Total liabilities			80,504,692				84,823,147
Commitments and contingencies — notes 13 and 14
Shareholders’ equity
Preferred stock, par value $.01 per share; 10,000,000 shares authorized; 8,425 Series A shares issued and outstanding			84				84
Common stock, par value $.01 per share; 300,000,000 shares authorized; 20,502,760 shares issued and outstanding			205,028				205,028
Additional paid-in capital			43,053,599				43,043,473
Accumulated other comprehensive income			(8,056	)			113,846
Accumulated deficit			(33,306,290	)			(30,718,272	)
Total shareholders’ equity			9,944,365				12,644,159
Total liabilities and shareholders’ equity		$	90,449,057			$	97,467,306

 

See notes to consolidated financial statements that are an integral part of these consolidated statements.

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)

 

		Year Ended December 31,
		2016				2015
Interest income
Loans		$	3,272,291			$	3,193,831
Investment securities			219,507				323,979
Federal funds sold and other			73,030				49,953
Total interest income			3,564,828				3,567,763
Interest expense
Deposits			326,120				315,484
Borrowings			220				15,578
Total interest expense			326,340				331,062
Net interest income			3,238,488				3,236,701
Provision for loan losses			407,000				150,000
Net interest income after provision for loan losses			2,831,488				3,086,701
Non-interest income
Service fees on deposit accounts			95,431				81,159
Residential loan origination fees			231,495				224,663
Forgiveness of debt			—				403,245
SBA loan fees			119,306				—
Gain (loss) on sale of investments			296,723				(87,995	)
Other income			97,739				45,835
Total non-interest income			840,694				666,907
Non-interest expenses
Compensation and benefits			2,557,959				2,950,953
Real estate owned activity			512,407				457,173
Occupancy and equipment			639,167				678,404
Insurance			216,295				233,168
Data processing and related costs			471,976				343,107
Professional fees			1,050,062				1,320,505
Product research and development expense			249,594				2,209,978
Other			562,740				353,759
Total non-interest expenses			6,260,000				8,547,047
Loss before income tax expense			(2,588,018	)			(4,793,439	)
Income tax expense			—				5,080
Net loss		$	(2,588,018	)		$	(4,798,519	)
Other comprehensive income (loss), net of tax
Unrealized (loss) gain on investment securities available for sale, net of tax			174,821				24,697
Reclassification adjustment included in net income, net of tax			(296,723	)			87,995
Other comprehensive (loss) income			(121,902	)			112,692
Total comprehensive loss		$	(2,709,920	)		$	(4,685,827	)
Loss per common share — basic and diluted		$	(0.13	)		$	(0.23	)
Weighted average common shares outstanding — basic and diluted			20,502,760				20,502,760

 

See notes to consolidated financial statements that are an integral part of these consolidated statements.

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

 

																						Accumulated other
		Preferred stock								Common stock								Additional				comprehensive				Accumulated
		Shares				Amount				Shares				Amount				paid-in capital				income (loss)				deficit				Total
December 31, 2014			—			$	—				20,502,760			$	205,028			$	35,124,151			$	1,154			$	(25,919,753	)		$	9,410,580
Compensation expense related to stock options granted			—				—				—				—				303,829				—				—				303,829
Issuance of preferred stock – net of expenses			8,425				84				—				—				7,615,493				—				—				7,615,577
Net loss			—				—				—				—				—				—				(4,798,519	)			(4,798,519	)
Other comprehensive income			—				—				—				—				—				112,692				—				112,692
December 31, 2015			8,425			$	84				20,502,760			$	205,028			$	43,043,473			$	113,846			$	(30,718,272	)		$	12,644,159
Compensation expense related to stock options granted			—				—				—				—				10,126				—				—				10,126
Net loss			—				—				—				—				—				—				(2,588,018	)			(2,588,018	)
Other comprehensive loss			—				—				—				—				—				(121,902	)			—				(121,902	)
December 31, 2016			8,425			$	84				20,502,760			$	205,028			$	43,053,599			$	(8,056	)		$	(33,306,290	)		$	9,944,365

 

See notes to consolidated financial statements that are an integral part of these consolidated statements.

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Year Ended December 31,
		2016				2015
Operating activities
Net loss		$	(2,588,018	)		$	(4,798,519	)
Adjustments to reconcile net loss to cash used in operating activities:
Provision for loan losses			407,000				150,000
Depreciation			206,623				215,471
Amortization of investment securities discounts/premiums, net			134,622				110,134
Stock option expense related to stock options granted			10,126				303,829
(Gain) loss on sale of investment securities			(296,723	)			87,995
Increase in value of bank owned life insurance			(42,910	)			—
Loss on disposal of property, equipment and software			566				—
Net changes in fair value and losses on sale of other real estate owned and repossessed assets			307,770				364,942
Forgiveness of debt			—				(403,245	)
Decrease in other assets, net			117,621				170,697
Decrease in other liabilities, net			(400,648	)			(1,185,202	)
Net cash used in operating activities			(2,143,971	)			(4,983,898	)
Investing activities
Net decrease in loans			5,593,110				1,142,421
Purchases of investment securities available for sale			(7,437,287	)			(336,864	)
Maturities and sales of investment securities available for sale			14,955,233				4,070,789
Repayments of investment securities available for sale			651,651				1,166,366
Net activity in interest bearing deposits in other institutions			(9,000,000	)			(1,500,000	)
Redemption of non-marketable equity securities, net			12,450				217,150
Purchase of bank owned life insurance			(2,500,000	)			—
Purchase of property, equipment, and software			(34,167	)			(30,260	)
Proceeds from sale of other real estate owned and repossessed assets			637,072				582,295
Net cash provided by investing activities			2,878,062				5,311,897
Financing activities
(Decrease) increase in deposits, net			(3,859,677	)			692,662
Repayments on borrowings			—				(5,000,000	)
Increase (decrease) in securities sold under agreements to repurchase			518				(40,523	)
Repayments on note payable			—				(600,000	)
Issuance of preferred stock, net			—				7,615,577
Net cash provided by (used in) financing activities			(3,859,159	)			2,667,716
Net increase (decrease) in cash and cash equivalents			(3,125,068	)			2,995,715
Cash and cash equivalents at beginning of the year			13,899,795				10,904,080
Cash and cash equivalents at end of the year		$	10,774,727			$	13,899,795
Supplemental information
Cash paid for
Interest		$	325,447			$	331,379
Schedule of non-cash transactions
Unrealized gain on securities available for sale, net of tax		$	174,821			$	24,697
Loans transferred to other real estate owned and repossessed assets		$	1,257,289			$	300,000

 

See notes to consolidated financial statements that are an integral part of these consolidated statements.

INDEPENDENCE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

 

Independence Bancshares, Inc. (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Banking and Branching Efficiency Act of 1996, and to own and control all of the capital stock of Independence National Bank (the “Bank”), a national association organized under the laws of the United States. Since opening for business on May 16, 2005, the Bank has operated as a traditional community bank in Greenville, South Carolina, fulfilling the financial needs of individuals and small businesses in its market. The Bank provides traditional checking and savings products insured by the Federal Deposit Insurance Corporation (the “FDIC”) and consumer, commercial and mortgage loans, as well as ATM and online banking, cash management and safe deposit boxes.

 

As previously reported, on September 25, 2015, the Company suspended development of its digital banking, payments and transaction services business and has subsequently been evaluating strategic alternatives for the Company. A key goal of the Company’s digital banking business was to reduce costs for banking activities and operate more efficiently through utilizing mobile and on-line delivery channels. In furtherance of this goal and based in part upon the institutional knowledge acquired in the pursuit of the digital banking strategy, the Company plans to supplement its current lending strategy by expanding its consumer lending program with on-line offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. The Company’s board of directors is focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of its consumer lending program, which may include purchases of in-market consumer loans that meet the Bank’s underwriting criteria.

 

The following is a description of the significant accounting and reporting policies that the Company follows in preparing and presenting consolidated financial statements.

 

Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Independence National Bank. In consolidation, all significant intercompany transactions have been eliminated. The accounting and reporting policies conform to accounting principles generally accepted in the United States and to general practices in the banking industry.

 

Subsequent Events

 

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management performed an evaluation to determine whether or not there have been any subsequent events since the balance sheet date.

 

Reclassifications

 

Certain amounts have been reclassified to state all periods on a comparable basis. Reclassifications had no effect on previously reported shareholders’ equity or net loss.

 

Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and calculation of the provision for income taxes and deferred income tax assets and related valuation allowances. In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate,

management obtains independent appraisals for significant properties and takes into account other current market information. Management must also make estimates in determining the useful lives and methods for depreciating premises and equipment.

 

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance for loan losses and changes to valuation of foreclosed real estate may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and valuation of foreclosed real estate. Such agencies may require the Company to recognize additions to the allowance for loan losses or additional write-downs on foreclosed real estate based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses and valuation of foreclosed real estate may change materially in the near term.

 

Risks and Uncertainties

 

In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default within the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

 

The Company is subject to the regulations of various governmental agencies. These regulations can change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to changes with respect to valuation of assets, amount of required loss allowance and operating restrictions resulting from the regulators’ judgments based on information available to them at the time of their examinations. The Bank makes loans to individuals and businesses in and around “Upstate” South Carolina for various personal and commercial purposes. The Bank has a diversified loan portfolio. Borrowers’ ability to repay their loans is not dependent upon any specific economic sector.

 

Cash and Cash Equivalents

 

For purposes of reporting cash flows, cash and cash equivalents includes cash, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. Due to the short term nature of cash and cash equivalents, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value.

 

At December 31, 2016 and 2015, the Company had restricted cash totaling $2,000 with the Federal Home Loan Bank (“FHLB”) of Atlanta. The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant.

 

Investment Securities

 

Investment securities are accounted for in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 320, “Investments — Debt and Equity Securities.” Management classifies securities at the time of purchase into one of three categories as follows: (1) Securities Held to Maturity: securities which the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost; (2) Trading Securities: securities that are bought and held principally for the purpose of selling them in the near future, which are reported at fair value with unrealized gains and losses included in earnings; and (3) Securities Available for Sale: securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity as accumulated other comprehensive income. The amortization of premiums and accretion of discounts on investment securities are recorded as adjustments to interest income. Gains or losses on sales of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Losses on securities, reflecting a decline in value or impairment judged by the Company to be other-than-temporary, are charged to earnings in the consolidated statements of operations.

 

Non-Marketable Equity Securities

 

The Bank, as a member of the Federal Reserve Bank (“FRB”) and the FHLB, is required to own capital stock in these organizations. The amount of FRB stock owned is based on the Bank’s capital levels and totaled $293,050 and $303,500 at December 31, 2016 and 2015, respectively. The amount of FHLB stock owned is determined based on the Bank’s balances of residential mortgages and advances from the FHLB and totaled $87,000 and $89,000 at December 31, 2016 and 2015, respectively. No ready

market exists for these stocks, and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value.

 

Loans Receivable

 

Loans are stated at their unpaid principal balance net of any charge-offs. Interest income is computed using the simple interest method and is recorded in the period earned. Fees earned and direct costs incurred on loans are amortized using the effective interest method over the life of the loan.

 

When serious doubt exists as to the collectability of a loan or when a loan becomes contractually 90 days past due as to principal or interest, interest income is generally discontinued unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest. When interest accruals are discontinued, income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal. Generally, loans are returned to accrual status when the loan is brought current and ultimate collectability of principal and interest is no longer in doubt.

 

Allowance for Loan Losses

 

An allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent losses in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. In cases where management deems the amount of the reserve for loan losses to be less than previously determined, an adjustment to lower or reverse the provision will be recorded. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, as well as any reversal of provision, if any, are credited to the allowance.

 

The allowance for loan losses or any reversal of provision is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The allowance consists of both a specific and a general component. The specific component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. For such loans, an allowance is established when either the discounted cash flows or collateral value (less estimated selling costs) or observable market price of the impaired loan is lower than the carrying value of that loan. The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.

 

The Company identifies impaired loans through its internal loan review process. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans on the Company’s problem loan watch list are considered potentially impaired loans. Generally, once loans are considered impaired and in the process of the foreclosure process, they are moved to nonaccrual status and recognition of interest income is discontinued. Impairment is measured on a loan-by-loan basis based on the determination of the most probable source of repayment which is usually liquidation of the underlying collateral, but may also include discounted future cash flows, or in rare cases, the market value of the loan itself.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

 

The Company designates loan modifications as troubled debt restructurings (TDRs) when, for economic or legal reasons related to the borrower’s financial difficulties, a concession is granted to the borrower that would not otherwise be considered. Upon initial

restructuring, TDRs are considered classified and impaired and are placed in nonaccrual status if not already categorized. TDRs are returned to accrual status when there is economic substance to the restructuring, any portion of the debt not expected to be repaid has been charged off, the remaining note is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally six months).

 

Property and Equipment and Software

 

Land is reported at cost. Buildings and improvements, furniture and equipment, capitalized software, and automobiles are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method, based on the estimated useful lives of 40 years for buildings and 3 to 15 years for software, furniture, equipment and automobiles. Leasehold improvements are amortized over the life of the lease. The cost of assets sold or otherwise disposed of, and the related allowance for depreciation, are eliminated from the accounts and the resulting gains or losses are reflected in the statement of operations when incurred. Maintenance and repairs are charged to current expense. The costs of major renewals and improvements are capitalized.

 

Other Real Estate Owned and Repossessed Assets

 

Real estate and other property acquired in settlement of loans, is recorded at the lower of cost or fair value less estimated selling costs, establishing a new cost basis at the time of acquisition. Fair value of such property is reviewed regularly and write-downs are recorded when it is determined that the carrying value of the property exceeds the fair value less estimated costs to sell. Write-downs resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are charged against income. Costs relating to the development and improvement of such properties are capitalized.

 

Securities Sold Under Agreements to Repurchase

 

The Bank enters into sales of securities under agreements to repurchase. Repurchase agreements are treated as financing, with the obligation to repurchase securities sold being reflected as a liability and the securities underlying the agreements remaining as assets.

 

Fair Value

 

The Company determines the fair market values of its financial instruments based on the fair value hierarchy established in FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”), which provides a framework for measuring and disclosing fair value under GAAP. ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).

 

ASC Topic 820 defines fair value 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. ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1

—

Valuations are based on quoted prices in active markets for identical assets or liabilities.

 

Level 2

—

Valuations are based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3

—

Valuations include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Residential Loan Origination Fees

 

The Company offers residential loan origination services to its customers. The loans are offered on terms and prices offered by the Company’s correspondents and are closed in the name of the correspondents. The Company receives fees for services it provides in conjunction with these origination services. The fees are recognized at the time the loans are closed by the Company’s correspondent. Residential loan origination fees are included in other income on the Company’s consolidated statements of operations.

Income Taxes

 

The Company accounts for income taxes in accordance with FASB ASC Topic 740, “Income Taxes”. Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized.

 

Net Loss per Common Share

 

Basic loss per common share represents net loss divided by the weighted-average number of common shares outstanding during the period. Diluted loss per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and warrants, and are determined using the treasury stock method. For the years ended December 31, 2016 and 2015 as a result of the Company’s net loss, all of the potential common shares (3,089,755 and 3,097,255 stock options, respectively, and zero warrants, as the warrants were not exercised and were deemed expired in May 2015) were considered anti-dilutive.

 

Research and Development

 

All costs incurred to establish the technological feasibility of computer software to be sold, leased or otherwise marketed as research and development are expensed as incurred. Once technological feasibility has been established, the subsequent costs of producing, coding and testing the products should be capitalized. The expensing of computer software costs is discontinued when the product is available for general release for customers. The Company did not achieve technological feasibility in connection with its digital banking business and therefore expensed all computer software purchases and development expenses related to research and development. On September 25, 2015 the Company suspended the development of its digital banking business.

 

Recently Issued Accounting Pronouncements

 

The following is a summary of recent authoritative pronouncements that may affect our accounting, reporting, and disclosure of financial information:

 

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. This topic was amended again in March 2016 to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for annual periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

 

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

NOTE 2 — INVESTMENT SECURITIES

 

The amortized costs and fair values of investment securities available for sale are as follows:

 

		December 31, 2016
						Gross Unrealized
		Amortized Cost				Gains				Losses				Fair Value
US treasury note		$	2,507,861			$	—			$	(8,056	)		$	2,499,805
Total investment securities available for sale		$	2,507,861			$	—			$	(8,056	)		$	2,499,805

 

		December 31, 2015
						Gross Unrealized
		Amortized Cost				Gains				Losses				Fair Value
Government-sponsored mortgage-backed		$	4,290,680			$	66,350			$	(44,581	)		$	4,312,449
Municipals, tax-exempt			4,916,379				140,335				(17,267	)			5,039,447
Municipals, taxable			1,308,298				27,657				—				1,335,955
Total investment securities available for sale		$	10,515,357			$	234,342			$	(61,848	)		$	10,687,851

The following table presents information regarding securities with unrealized losses at December 31, 2016:

 

		Securities in an Unrealized Loss Position for Less than 12 Months								Securities in an Unrealized Loss Position for More than 12 Months								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
US treasury note		$	2,499,805			$	8,056			$	—			$	—			$	2,499,805			$	8,056
Total temporarily impaired securities		$	2,499,805			$	8,056			$	—			$	—			$	2,499,805			$	8,056

 

The following table presents information regarding securities with unrealized losses at December 31, 2015:

 

		Securities in an Unrealized Loss Position for Less than 12 Months								Securities in an Unrealized Loss Position for More than 12 Months								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Government-sponsored mortgage-backed		$	627,542			$	5,569			$	764,462			$	39,012			$	1,392,004			$	44,581
Municipals, tax-exempt			323,796				6,249				1,074,440				11,018				1,398,236				17,267
Total temporarily impaired securities		$	951,338			$	11,818			$	1,838,902			$	50,030			$	2,790,240			$	61,848

 

At December 31, 2016, there were investment securities with a fair value of approximately $ 2.5 million which had been in a continuous loss position for less than twelve months. At December 31, 2016, there were no investment securities which had been in a continuous loss position for more than one year. The Company believes, based on industry analyst reports and credit ratings that the deterioration in the fair value of these investment securities available for sale is attributed to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company has the ability and intent to hold these securities until such time as the values recover or the securities mature. At December 31, 2015, there were investment securities with a fair value of approximately $ 951,000 which had been in a continuous loss position for less than twelve months. At December 31, 2015, investment securities with a fair value of approximately $1.8 million and unrealized losses of $50,030 had been in a continuous loss position for more than one year. All remaining investment securities were in an unrealized gain position.

 

The amortized costs and fair values of investment securities available for sale at December 31, 2016, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers have the right to prepay the obligations.

 

		December 31, 2016
		Amortized Cost				Fair Value
Due within one year		$	—			$	—
Due after one through three years			—				—
Due after three through five years			2,507,861				2,499,805
Due after five through ten years			—				—
Due after ten years			—				—
Total investment securities		$	2,507,861			$	2,499,805

 

During 2016, the Company received proceeds from maturities and sales of securities of $15.0 million for a total gain of $296,723. During 2015, the Company received proceeds from sales of securities of $4.1 million for a total loss of $87,995. At December 31, 2016 and 2015, $2.4 million and $2.7 million, respectively, in securities were pledged as collateral for repurchase agreements, a credit line and public deposits.

 

The Company’s investment portfolio consists principally of obligations of the United States of America, its agencies or enterprises it sponsors. In the opinion of management, there is no concentration of credit risk in its investment portfolio.

NOTE 3 — LOANS

 

The composition of net loans by major category is as follows:

 

		December 31,
		2016				2015
Real estate:
Commercial		$	22,033,590			$	25,559,943
Construction and development			7,913,783				7,286,459
Single and multifamily residential			13,314,130				16,434,722
Total real estate loans			43,261,503				49,281,124
Commercial business			15,954,106				17,027,054
Consumer			1,434,449				1,369,224
Deferred origination fees, net			(167,062	)			(135,647	)
Gross loans, net of deferred fees			60,482,996				67,541,755
Less allowance for loan losses			(1,338,149	)			(1,139,509	)
Loans, net		$	59,144,847			$	66,402,246

 

The Company, through the Bank, makes loans to individuals and small- to mid-sized businesses for various personal and commercial purposes primarily in Greenville County, South Carolina. Credit concentrations can exist in relation to individual borrowers or groups of borrowers, certain types of collateral, certain types of industries, certain loan products, or certain regions of the country. Credit risk associated with these concentrations could arise when a significant amount of loans, related by similar characteristics, are simultaneously impacted by changes in economic or other conditions that cause their probability of repayment to be adversely affected. The Company regularly monitors its credit concentrations. The Company does not have a significant concentration to any individual client. The major concentrations of credit arise by collateral type. As of December 31, 2016, management has determined that the Company has a concentration in commercial real estate and construction and development loans, including construction and development loans. At December 31, 2016, the Company had $29.9 million in commercial real estate loans, representing 49.4% of gross loans. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its commercial real estate portfolio.

 

As noted above, the Company plans to supplement its current lending strategy by expanding its consumer lending program with on-line offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. The Company’s board of directors is focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of its consumer lending program, which may include purchases of in-market consumer loans that meet the Bank’s underwriting criteria.

 

In addition to monitoring potential concentrations of loans to a particular borrower or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk that could arise from potential concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.) and loans with high loan-to-value ratios. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans). These loans are underwritten and monitored to manage the associated risks. Management has determined that there is no concentration of credit risk associated with its lending policies or practices.

 

The composition of gross loans, before the deduction for deferred origination fees, by rate type is as follows:

 

		December 31, 2016
Variable rate loans		$	41,077,648
Fixed rate loans			19,572,410
		$	60,650,058

Directors, executive officers and associates of such persons are customers of and have transactions with the Bank in the ordinary course of business. Included in such transactions are outstanding loans and commitments, all of which were made under substantially the same credit terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectability. The aggregate dollar amount of these outstanding loans was $1.7 million and $2.8 million at December 31, 2016 and 2015, respectively. During 2016, there were approximately $95,000 in new loans and advances on these lines of credit and repayments were approximately $738,000. During 2015, there were $266,000 new loans and advances on these lines of credit and repayments were approximately $557,000. At December 31, 2015, there were commitments to extend additional credit to related parties in the amount of approximately $140,000. There were no commitments to extend additional credit to related parties at December 31, 2016. The Bank has a line of credit with the FHLB to borrow funds, subject to the pledge of qualified collateral. Acceptable collateral includes certain types of commercial real estate, consumer residential and home equity loans. At December 31, 2016, approximately $34.9 million of first and second mortgage loans, commercial loans and home equity lines of credit were specifically pledged to the FHLB, resulting in $12.3 million in lendable collateral. At December 31, 2016, the Bank had also pledged $15.5 million of commercial loans to the FRB’s Borrower-in-Custody of Collateral program, resulting in $11.4 million in lendable collateral.

 

Credit Quality

 

The following table summarizes delinquencies and nonaccruals, by portfolio class, as of December 31, 2016 and 2015.

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2016
30–59 days past due		$	442,295			$	—			$	—			$	617,052			$	—			$	1,059,347
60–89 days past due			—				—				—				409,675				—				409,675
Nonaccrual			108,951				—				195,500				—				—				304,451
Total past due and nonaccrual			551,246				—				195,500				—				—				1,773,473
Current			12,762,884				7,913,783				21,838,090				14,927,379				1,434,449				58,876,585
Total loans		$	13,314,130			$	7,913,783			$	22,033,590			$	15,954,106			$	1,434,449			$	60,650,058
December 31, 2015
30–59 days past due		$	75,890			$	—			$	—			$	—			$	—			$	75,890
60–89 days past due			63,702				250,378				—				—				—				314,080
Nonaccrual			168,879				40,500				1,390,013				65,798				—				1,665,190
Total past due and nonaccrual			308,471				290,878				1,390,013				65,798				—				2,055,160
Current			16,126,251				6,995,581				24,169,930				16,961,256				1,369,224				65,622,242
Total loans		$	16,434,722			$	7,286,459			$	25,559,943			$	17,027,054			$	1,369,224			$	67,677,402

 

At December 31, 2016 and 2015, there were nonaccrual loans of $304,451 and $1.7 million, respectively, included in the above loan balances. Foregone interest income related to nonaccrual loans equaled $60,633 and $129,066 for the years ended December 31, 2016 and 2015, respectively. No interest income was recognized on nonaccrual loans during 2016 and 2015. At both December 31, 2016 and 2015, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments.

 

As part of the loan review process, loans are given individual credit grades, representing the risk the Company believes is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade.

The following table summarizes management’s internal credit risk grades, by portfolio class, as of December 31, 2016 and 2015.

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2016
Pass Loans (Consumer)		$	8,246,567			$	1,462,925			$	—			$	—			$	1,434,449			$	11,143,941
Grade 1 — Prime			—				—				—				—				—				—
Grade 2 — Good			—				—				—				—				—				—
Grade 3 — Acceptable			1,919,685				1,108,334				11,057,550				7,676,592				—				21,762,161
Grade 4 — Acceptable w/Care			2,877,013				5,273,411				9,232,019				7,307,961				—				24,690,404
Grade 5 — Special Mention			—				69,113				766,388				—				—				835,501
Grade 6 — Substandard			270,865				—				977,633				969,553				—				2,218,051
Grade 7 — Doubtful			—				—				—				—				—				—
Total loans		$	13,314,130			$	7,913,783			$	22,033,590			$	15,954,106			$	1,434,449			$	60,650,058

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2015
Pass Loans (Consumer)		$	8,340,816			$	1,350,332			$	—			$	—			$	1,369,224			$	11,060,372
Grade 1 — Prime			—				—				—				—				—				—
Grade 2 — Good			—				—				—				—				—				—
Grade 3 — Acceptable			4,479,116				809,004				8,121,125				7,667,706				—				21,076,951
Grade 4 — Acceptable w/Care			3,382,209				4,759,864				14,724,468				8,199,385				—				31,065,926
Grade 5 — Special Mention			63,702				76,381				611,189				846,106				—				1,597,378
Grade 6 — Substandard			168,879				290,878				2,103,161				313,857				—				2,876,775
Grade 7 — Doubtful			—				—				—				—				—				—
Total loans		$	16,434,722			$	7,286,459			$	25,559,943			$	17,027,054			$	1,369,224			$	67,677,402

 

Loans graded one through four are considered “pass” credits. At December 31, 2016, approximately 95% of the loan portfolio had a credit grade of “pass” compared to 93% at December 31, 2015. For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment. Loans totaling $835,501 and $1.6 million, respectively, were classified as special mention at December 31, 2016 and 2015. This classification is utilized when an initial concern is identified about the financial health of a borrower. Loans are designated as such in order to be monitored more closely than other credits in the loan portfolio. At December 31, 2016 and 2015, substandard loans totaled $2.2 million and $2.9 million, respectively, with the vast majority of these loans being collateralized by real estate. Substandard credits are evaluated for impairment on a quarterly basis.

The following table summarizes information relative to impaired loans, by portfolio class, at December 31, 2016 and 2015.

 

		Unpaid principal balance				Recorded investment				Related allowance				Average impaired investment				Interest income
December 31, 2016
With no related allowance recorded:
Single and multifamily residential real estate		$	99,794			$	99,794			$	—			$	179,235			$	3,261
Construction and development			—				—				—				109,660				6,130
Commercial real estate — other			782,133				782,133				—				718,589				46,778
Commercial business			231,448				231,448				—				96,283				4,744
Consumer			—				—				—				—				—
With related allowance recorded:
Single and multifamily residential real estate			171,071				171,071				93,471				201,000				3,251
Construction and development			—				—				—				98,139				—
Commercial real estate — other			195,500				195,500				30,500				524,283				—
Commercial business			738,105				738,105				487,490				191,329				46,315
Consumer			—				—				—				—				—
Total:
Single and multifamily residential real estate			270,865				270,865				93,471				380,235				6,512
Construction and development			—				—				—				207,799				6,130
Commercial real estate — other			977,633				977,633				30,500				1,242,872				46,778
Commercial business			969,553				969,553				487,490				287,612				51,059
Consumer			—				—				—				—				—
		$	2,218,051			$	2,218,051			$	611,461			$	2,118,518			$	110,479

 

		Unpaid principal balance				Recorded investment				Related allowance				Average impaired investment				Interest income
December 31, 2015
With no related allowance recorded:
Single and multifamily residential real estate		$	—			$	—			$	—			$	411,430			$	21,667
Construction and development			—				—				—				177,047				—
Commercial real estate — other			905,968				905,968				—				415,488				29,423
Commercial business			—				—				—				62,015				—
Consumer			—				—				—				—				—
With related allowance recorded:
Single and multifamily residential real estate			236,938				236,938				163,138				270,668				—
Construction and development			40,500				40,500				10,500				239,206				727
Commercial real estate — other			1,197,193				1,197,193				201,793				805,654				46,761
Commercial business			—				—				—				18,139				2,119
Consumer			—				—				—				—				—
Total:
Single and multifamily residential real estate			236,938				236,938				163,138				682,098				21,667
Construction and development			40,500				40,500				10,500				416,253				727
Commercial real estate — other			2,103,161				2,103,161				201,793				1,221,142				76,184
Commercial business			—				—				—				80,154				2,119
Consumer			—				—				—				—				—
		$	2,380,599			$	2,380,599			$	375,431			$	2,399,647			$	100,697

TDRs are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.

 

At December 31, 2016, the principal balance of TDRs was zero as the one loan previously constituting our sole TDR during the year had been repaid in full at maturity in August 2016. At December 31, 2015, the principal balance of TDRs was zero as the one loan constituting our sole TDR had been transferred to other real estate owned. No TDRs went into default during the years ended December 31, 2016 and 2015. A TDR can be removed from “troubled” status once there is sufficient history of demonstrating the borrower can service the credit under market terms. We currently consider sufficient history to be approximately six months.

 

Provision and Allowance for Loan Losses

 

The provision, reversal of provision and allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

The following table summarizes activity related to our allowance for loan losses for the years ended December 31, 2016 and 2015, by portfolio segment.

 

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2016
Allowance for loan losses:
Balance, beginning of year		$	265,797			$	184,130			$	439,830			$	244,679			$	5,073			$	1,139,509
Provision (reversal of provision) for loan losses			(30,000	)			(100,000	)			100,000				440,000				(3,000	)			407,000
Loan charge-offs			—				(10,500	)			(209,045	)			—				(640	)			(220,185	)
Loan recoveries			—				—				—				—				11,825				11,825
Net loans charged-off			—				(10,500	)			(209,045	)			—				11,185				(208,360	)
Balance, end of year		$	235,797			$	73,630			$	330,785			$	684,679			$	13,258			$	1,338,149
Individually reviewed for impairment		$	93,471			$	—			$	30,500			$	487,490			$	—			$	611,461
Collectively reviewed for impairment			142,326				73,630				300,285				197,189				13,258				726,688
Total allowance for loan losses		$	235,797			$	73,630			$	330,785			$	684,679			$	13,258			$	1,338,149
Gross loans, end of period:
Individually reviewed for impairment		$	171,071			$	—			$	195,500			$	738,105			$	—			$	1,104,676
Collectively reviewed for impairment			13,143,059				7,913,783				21,838,090				15,216,001				1,434,449				59,545,382
Total gross loans		$	13,314,130			$	7,913,783			$	22,033,590			$	15,954,106			$	1,434,449			$	60,650,058

		Single and multifamily residential real estate				Construction and development				Commercial real estate — other				Commercial business				Consumer				Total
December 31, 2015
Allowance for loan losses:
Balance, beginning of year		$	160,797			$	234,130			$	363,097			$	184,679			$	90,073			$	1,032,776
Provision (reversal of provision) for loan losses			105,000				(50,000	)			120,000				60,000				(85,000	)			150,000
Loan charge-offs			—				—				(43,267	)			—				—				(43,267	)
Loan recoveries			—				—				—				—				—				—
Net loans charged-off			—				—				(43,267	)			—				—				(43,267	)
Balance, end of year		$	265,797			$	184,130			$	439,830			$	244,679			$	5,073			$	1,139,509
Individually reviewed for impairment		$	163,138			$	10,500			$	201,793			$	—			$	—			$	375,431
Collectively reviewed for impairment			102,659				173,630				238,037				244,679				5,073				764,078
Total allowance for loan losses		$	265,797			$	184,130			$	439,830			$	244,679			$	5,073			$	1,139,509
Gross loans, end of period:
Individually reviewed for impairment		$	236,938			$	40,500			$	2,103,161			$	—			$	—			$	2,380,599
Collectively reviewed for impairment			16,197,784				7,245,959				23,456,782				17,027,054				1,369,224				65,296,803
Total gross loans		$	16,434,722			$	7,286,959			$	25,559,943			$	17,027,054			$	1,369,224			$	67,677,402

 

NOTE 4 — PROPERTY, EQUIPMENT AND SOFTWARE

 

Property, equipment and software are stated at cost less accumulated depreciation. Components of property, equipment and software included in the consolidated balance sheets are as follows:

 

		December 31,
		2016				2015
Land and land improvements		$	1,108,064			$	1,108,064
Building			784,845				784,845
Leasehold improvements			257,159				257,159
Software			24,039				374,039
Furniture and equipment			1,464,847				1,432,378
			3,638,954				3,956,485
Accumulated depreciation			(1,613,180	)			(1,757,689	)
Total property, equipment and software		$	2,025,774			$	2,198,796

 

Depreciation expense for the years ended December 31, 2016 and 2015 was $206,623 and $215,471, respectively. There were asset purchases of $34,167 and two disposals totaling $351,698 during 2016. There were asset purchases of $30,260 and no disposals during 2015.

NOTE 5 — OTHER REAL ESTATE OWNED AND REPOSSESSED ASSETS

 

The following table summarizes the composition of other real estate owned and repossessed assets as of the dates noted.

 

		December 31,
		2016				2015
Residential land lots		$	—			$	31,320
Single and multifamily residential real estate			—				—
Commercial office space			1,412,667				1,008,900
Commercial land			810,000				870,000
		$	2,222,667			$	1,910,220

 

Changes in other real estate owned and repossessed assets are presented below:

 

		2016				2015
Balance at beginning of year		$	1,910,220			$	2,557,457
Repossessed property acquired in settlement of loans			1,257,289				300,000
Proceeds from sales of repossessed property			(637,072	)			(582,295	)
Loss on sale and write-downs of repossessed property, net			(307,770	)			(364,942	)
Balance at end of year		$	2,222,667			$	1,910,220

 

During 2015, other real estate owned for the Company increased due to three pieces of real estate being moved to other real estate owned for $1.3 million, partially offset by the sale of one piece of real estate held by the Bank for proceeds of approximately $24,000, which resulted in a loss of approximately $6,000 and another sale of real estate owned that was purchased from the Bank for proceeds of approximately $613,000, which resulted in a loss of approximately $18,000 to the Company. In addition, the Bank recognized writedowns on real estate owned of approximately $284,000 during 2016. On March 7, 2017, one impaired loan was transferred to other real estate owned for $165,000, net of a specific reserve of $35,000.

 

NOTE 6 — DEPOSITS

 

Deposits at December 31, 2016 and 2015 are summarized as follows:

 

		2016				2015
Non-interest bearing		$	13,723,902			$	13,010,209
Interest bearing:
NOW accounts			8,959,818				8,894,408
Money market accounts			29,620,179				33,164,973
Savings			1,054,314				1,034,438
Time, less than $100,000			5,565,797				5,756,202
Time, $100,000 and over			20,783,638				21,707,095
Total deposits		$	79,707,648			$	83,567,325

 

Interest expense on time deposits greater than $100,000 was $192,160 and $182,041 for the years ended December 31, 2016 and 2015 respectively.

 

Time deposits that meet or exceed the FDIC insurance limit at $250,000 amounted to $9,163,592 and $7,578,706 as of December 31, 2016 and 2015, respectively.

At December 31, 2016 the scheduled maturities of certificates of deposit (including brokered time deposits) are as follows:

 

2017		$	15,097,432
2018			5,217,537
2019			4,468,684
2020			784,291
2021			781,490
		$	26,349,434

 

At December 31, 2016, $2.3 million in securities were pledged as collateral for public deposits and approximately $50,000 in securities were pledged as collateral for business deposits.

 

NOTE 7 — SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

 

At December 31, 2016 and 2015, the Bank had sold $113,598 and $113,080, respectively, of securities under agreements to repurchase with brokers with a weighted rate of 0.10% for the comparable periods that mature in less than 90 days. These agreements were secured with approximately $50,000 and $107,000 of investment securities, respectively. The securities, under agreements to repurchase, averaged $135,708 during 2016, with $279,628 being the maximum amount outstanding at any month-end. The average rate paid in 2016 was 0.10%. The securities, under agreements to repurchase, averaged $98,636 during 2015, with $354,739 being the maximum amount outstanding at any month-end. The average rate paid in 2015 was 0.10%.

 

NOTE 8 — FEDERAL HOME LOAN BANK ADVANCES

 

At December 31, 2014, the Bank had $5.0 million of advances from the FHLB, with a weighted average rate of 0.25%. The advance was obtained in July 2014 with a maturity date of January 2015. The FHLB advance from 2014 was repaid in full in January 2015 upon maturity. There were no advances from the FHLB for the years ended December 31, 2016 and 2015. In February 2017, an advance of $4,000,000 was obtained from the FHLB with a weighted average rate of 0.89% and a maturity date of November 2017.

 

NOTE 9 — NOTE PAYABLE - RELATED PARTY

 

In September 2014, the Company closed a $600,000 one-year borrowing. The loan was provided by a board member of the Bank and as a result needed to comply with Regulation O. Proceeds of the loan were used primarily to fund the research and development effort in the transaction services business segment. The loan was collateralized by a first perfected security interest in certain real estate assets of the Company. The loan was fully drawn at closing, and carried an annual interest rate of 7% per annum for the first six months on any outstanding borrowings and then stepped up to 8% per annum for the remaining 6 months of the term. On March 18, 2015, one of the parcels of real estate was sold and a payment was made on the loan so that the outstanding balance of the loan was $149,774, which was equal to the balance on June 30, 2015. The outstanding balance of $149,774 plus accrued interest was repaid in its entirety on September 3, 2015.

 

NOTE 10 — UNUSED LINES OF CREDIT

 

At December 31, 2016 and 2015, the Bank had an unused unsecured line of credit to purchase federal funds of $2.0 million that has not been utilized. The line of credit is available on a one to fourteen day basis for general corporate purposes of the Bank. The lender has reserved the right to withdraw the line at its option.

 

The Bank has a line of credit with the FHLB to borrow funds, subject to the pledge of qualified collateral. At December 31, 2016, approximately $34.9 million of first and second mortgage loans, commercial loans and home equity lines of credit were specifically pledged to the FHLB, resulting in $12.3 million in lendable collateral. At December 31, 2015, approximately $39.9 million of first and second mortgage loans, commercial loans and home equity lines of credit were specifically pledged to the FHLB, resulting in $13.0 million in lendable collateral.

 

The Bank is subject to the FHLB’s credit risk rating policy which assigns member institutions a rating which is reviewed quarterly. The rating system utilizes key factors such as loan quality, capital, liquidity, profitability, etc. During the fourth quarter of 2010, the Bank’s credit risk rating was downgraded by the FHLB, which resulted in decreased borrowing availability (total line reduced to 15% of total assets from 20% of total assets) and increased collateral requirements (moved to 125% of borrowings from 115%). During the third quarter of 2013, the FHLB upgraded our credit risk rating, which resulted in increased borrowing availability

(total line increased from 15% of total assets to 20% of total assets) and decreased collateral requirements (moved to 115% of borrowings from 125%). The Bank’s ability to access available borrowing capacity from the FHLB in the future is subject to its rating and any subsequent changes based on financial performance as compared to factors considered by the FHLB in their assignment of our credit risk rating each quarter.

 

At December 31, 2016, the Bank had pledged $15.5 million in loans to the FRB’s Borrower-in-Custody of Collateral program resulting in $12.3 million in lendable collateral. Our available credit under this line was approximately $11.4 million and $10.5 million as of December 31, 2016 and 2015, respectively. The Bank had no outstanding borrowings from the FRB as of December 31, 2016 and 2015.

 

NOTE 11 — INCOME TAXES

 

The components of income tax expense were as follows:

 

		Year Ended December 31,
		2016				2015
Current income tax expense (benefit)		$	—			$	5,080
Deferred income tax expense (benefit)			(944,814	)			(2,404,737	)
			(944,814	)			(2,409,817	)
Change in valuation allowance			944,814				2,404,737
Income tax expense		$	—			$	5,080

 

The following is a summary of the items that caused recorded income taxes to differ from taxes computed using the Company’s statutory federal income tax rate of 34%:

 

		Year Ended December 31,
		2016				2015
Income tax benefit at federal statutory rate		$	(879,926	)		$	(1,629,769	)
Change in valuation allowance			944,814				(2,404,737	)
IRC Section 382 limitation to net operating loss carry-forward			—				4,020,027
Other			(64,888	)			19,559
Income tax expense		$	—			$	5,080

The components of the net deferred tax asset are as follows:

 

		December 31,
		2016				2015
Deferred tax assets (liabilities):
Allowance for loan losses		$	278,511			$	140,131
Lost interest on nonaccrual loans			19,047				44,348
Real estate acquired in settlement of loans			187,707				250,453
Net operating loss carry-forward			2,757,843				1,987,292
Deferred operational and start-up costs			43,471				56,513
Other-than-temporary impairment on non-marketable equity securities.			—				—
Unrealized loss (gain) on investment securities available for sale			(2,978	)			(58,648	)
Internally developed software			3,864,656				3,771,558
Other			229,187				185,313
			7,377,444				6,376,960
Valuation allowance			(7,377,444	)			(6,376,960	)
Net deferred tax asset		$	—			$	—

 

The valuation allowance for deferred tax assets as of December 31, 2016 and 2015 was $7.4 million and $6.4 million, respectively. Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not that the Company will not recognize the entire deferred tax asset. The determination of whether a deferred tax asset is realizable is based on the weighting all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. As of December 31, 2016 and 2015, the Company determined that it is not more likely than not that deferred tax assets will be recognized in future years.

 

The Company will continue to analyze deferred tax assets and the related valuation allowance on a quarterly basis, taking into account performance compared to forecasted earnings as well as current economic and internal information.

 

At December 31, 2016, the Company has federal operating loss carry-forwards of approximately $8.0 million that may be used to offset future taxable income and expire beginning in 2026. At December 31, 2016, the Company has state operating loss carry-forwards of approximately $1.2 million that may be used to offset future taxable income and expire beginning in 2035.

 

The Company has analyzed the tax positions taken or expected to be taken on its tax returns and concluded it has no liability related to uncertain tax positions in accordance with FIN 48. With limited exceptions, income tax returns for 2013 and subsequent years are subject to examination by the taxing authorities.

 

We have generated significant net operating losses, or NOLs, as a result of our operating results. We are generally able to carry NOLs forward to reduce taxable income in future years. However, the ability to utilize the NOLs is subject to the rules of Section 382 of the Internal Revenue Code. Section 382 generally restricts the use of NOLs after an “ownership change.” An ownership change occurs if, among other things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more of a corporation’s common stock or are otherwise treated as 5% shareholders under Section 382 and U.S. Treasury regulations promulgated thereunder because of an increase of their aggregate percentage ownership of that corporation’s stock by more than 50 percentage points over the lowest percentage of the stock owned by these shareholders over a rolling three-year period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carryforwards. This annual limitation is generally equal to the product of the value of the corporation’s stock on the date of the ownership change, multiplied by the long-term tax-exempt rate published monthly by the Internal Revenue Service. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carryforwards.

 

NOTE 12 — RELATED PARTY TRANSACTIONS

 

On December 31, 2016 and 2015, the Bank had various loans outstanding to directors and officers. All of these loans were made under normal credit terms and did not involve more than normal risk of collection. See Note 3 for further details.

In September 2014, the Company closed a $600,000 one-year borrowing. The loan was provided by a board member of the Bank and as a result needed to comply with Regulation O. Proceeds of the loan were used primarily to fund the research and development effort in the Transaction Services business segment. The loan was collateralized by a first perfected security interest in certain real estate assets of the Company. The loan was fully drawn at closing, and carried an annual interest rate of 7% per annum for the first six months on any outstanding borrowings and then stepped up to 8% per annum for the remaining 6 months of the term. On March 18, 2015, one of the parcels of real estate was sold and a payment was made on the loan so that the outstanding balance of the loan was $149,774, which was equal to the balance on June 30, 2015. The outstanding balance of $149,774 plus accrued interest was repaid in its entirety on September 3, 2015.

 

On May 14, 2015, the Company entered into a license agreement with MPIB pursuant to which it received a non-exclusive, non-transferable, non-licensable, worldwide license to use certain intellectual property of MPIB related to mobile payments and digital transactions. On January 4, 2016, the parties amended and restated the license agreement (the “Amended and Restated License Agreement”) pursuant to which MPIB agreed to make the license perpetual, subject to termination rights of the parties set forth in the Amended and Restated License Agreement, in exchange for the Company’s payment of an additional license fee of $275,000. In addition, as previously disclosed, on April 27, 2015, the Company submitted a proposed asset purchase agreement between the Company and MPIB to the Federal Reserve Bank of Richmond. The Company subsequently withdrew this application to the agency and no longer intends to enter into the asset purchase agreement or consummate the transaction contemplated therein.

 

NOTE 13 — FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK

 

In the ordinary course of business, and to meet the financing needs of its customers, the Company is a party to various financial instruments with off balance sheet risk. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheets. The contract amount of those instruments reflects the extent of involvement the Company has in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2016, unfunded commitments to extend credit were $8.6 million, of which approximately $7.9 million is at fixed rates and $677,000 is at variable rates. The Company evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. The fair value of these off-balance sheet financial instruments is considered immaterial.

 

The Company does not have any commitments to lend additional funds to borrowers whose loans have been modified as a TDR.

 

NOTE 14 — COMMITMENTS AND CONTINGENCIES

 

The Bank has a two-year operating lease on its main office facility which began in October 2008. The Bank exercised its remaining two-year renewal options in September 2012. The Bank renegotiated on terms similar to the current lease and amended the current lease in October 2014 for a term of five years. The monthly rent under the lease amendment is $10,370 from October 1, 2012 through September 30, 2014, $10,789 from October 1, 2014 through September 30, 2015, $11,005 from October 1, 2015 through September 30, 2016 and $11,225 from October 1, 2016 through September 30, 2017. The Bank has a ten-year operating lease on a branch facility which began in August 2007. The monthly rent under the lease is $9,229 from August 1, 2012 through July 31, 2017. The Company is currently in negotiations regarding the terms of renewing the lease. The Company had a 21- month operating lease on its New York office which began in May 2013. The monthly rent under the lease agreement allowed for one month free rent from May 23, 2013 through June 22, 2013, an installment of $2,680 for June 23, 2013 through June 30, 2013, and fixed monthly installments of $9,450 from July 1, 2013 through February 27, 2015. The New York office lease was not renewed in February 2015. At that time, the Company moved to a month to month lease for the New York office at a rate of $2,189 per month. The New York office month to month lease was terminated during 2015. Rent expense of $268,988 and $314,117 was recorded for the years ended December 31, 2016 and 2015, respectively.

Future minimum lease payments under these operating leases are summarized as follows:

 

For the year ended December 31,
2017		$	199,975
2018			138,080
2019			105,105
2020			—
Thereafter			—
		$	443,160

 

As of December 31, 2016, there were no other commitments outstanding, and there were no new commitments as of March 23, 2017.

 

The board of directors has approved employment agreements with the president and chief executive officer of the Bank, the chief financial officer of the Company and Bank and the Bank’s chief operating officer. The agreements include provisions regarding term, compensation, benefits, annual bonus, incentive program, stock option plan and severance and non-compete upon early termination.

 

The Bank may become party to litigation and claims in the normal course of business. As of December 31, 2016, management believes there is no material litigation pending.

 

NOTE 15— STOCK COMPENSATION PLANS

 

On July 26, 2005, the Company adopted the Independence Bancshares, Inc. 2005 Stock Incentive Plan (the “2005 Incentive Plan”) for the benefit of the directors, officers and employees. The 2005 Incentive Plan initially reserved up to 260,626 shares of the Company’s common stock for the issuance of stock options and contained evergreen provision, which provided that the maximum number of shares to be issued under the 2005 Incentive Plan would automatically increase each time the Company issues additional shares of common stock such that the total number of shares issuable under the 2005 Incentive Plan would at all times equal 12.5% of the then outstanding shares of common stock.

 

In February 2013, our board of directors amended the 2005 Incentive Plan to cap the number of shares issuable thereunder at 2,466,720 and adopted the Independence Bancshares, Inc. 2013 Equity Incentive Plan (the “2013 Incentive Plan”) which was subsequently approved by the Company’s shareholders at the 2013 annual shareholders’ meeting. The 2013 Incentive Plan is an omnibus equity incentive plan which provides for the granting of various types of equity compensation awards, including stock options, restricted stock, and stock appreciation rights, to the Company’s employees and directors.

 

As of December 31, 2016 and 2015, 3,089,755 total options were outstanding at a weighted average price of $1.11. Of the 3,097,255 options outstanding, 3,067,255 options were vested.

 

A summary of the status of the plans and changes for the years ended December 31, 2016 and 2015 are presented below:

 

		2016												2015
		Shares				Weighted average exercise price				Average Intrinsic Value				Shares				Weighted average exercise price
Outstanding at beginning of year			3,089,755			$	1.11								3,102,255			$	1.08
Granted			—				—								115,000				1.59
Exercised			—				—								—				—
Forfeited or expired			—				—								(127,500	)			0.80
Outstanding at end of year			3,089,755				1.11			$	0.00				3,089,755				1.11
Options exercisable at year-end			3,022,255							$	0.00				3,022,255
Shares available for grant			2,030,935												2,030,935

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of 2016 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2016. This amount changes based on the fair market value of the Company’s stock. Fair market value is based on the most recent trade of common stock reported through the OTC Bulletin Board. As of December 31, 2016, the Company’s closing stock price was $0.15 resulting in no intrinsic value.

 

Compensation expense related to stock options granted was $10,126 and $303,829 for the years ended December 31, 2016 and 2015, respectively. Compensation expense is based on the fair value of the option estimated at the date of grant using the Black-Scholes option-pricing model. Compensation expense is recognized on a straight line basis over the vesting period of the option.

 

In 2005, the Company issued warrants to each of its organizers to purchase up to an additional 312,500 shares of common stock at $10.00 per share. These warrants vested six-months from the date the Bank opened for business, or May 16, 2005, and they were exercisable in whole or in part until May 16, 2015. No warrants were exercised by May 16, 2015, at which time the warrants were deemed expired.

 

NOTE 16 — EMPLOYEE BENEFIT PLAN

 

The Bank maintains an employee benefit plan for all eligible employees of the Bank under the provisions of Internal Revenue Code Section 401(k). The Independence National Bank 401(k) Profit Sharing Plan (the “Plan”), adopted in 2005, allows for employee contributions. Upon annual approval of the board of directors, the Company also matches 50% of employee contributions up to a maximum of 6% of annual compensation. For the year ended December 31, 2016 and 2015, $14,043 and $15,859, respectively, was charged to operations for the Company’s matching contribution. Employees are immediately vested in their contributions to the Plan and become fully vested in the employer matching contribution after six years of service.

 

NOTE 17 — REGULATORY MATTERS

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Total capital includes Tier 1 and Tier 2 capital. Tier 2 capital consists of the allowance for loan losses subject to certain limitations.

 

In July 2013, the FDIC approved a final rule to implement the Basel III regulatory capital reforms among other changes required by the Dodd-Frank Act. The framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, taking into account the impact of risk. The approved rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% as well as a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking institutions. For the largest, most internationally active banking organizations, the rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures. In terms of quality of capital, the final rule emphasized common equity Tier 1 capital and implemented strict eligibility criteria for regulatory capital instruments. It also changed the methodology for calculating risk-weighted assets to enhance risk sensitivity. The changes began to take effect for the Bank on January 1, 2015.

The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at December 31, 2016 and 2015.

 

										For capital adequacy purposes								To be well capitalized under prompt corrective action provisions
		Actual								Minimum								Minimum
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of December 31, 2016
Total Capital (to risk weighted assets)		$	9,251,000				13.4	%		$	5,525,000				8.0	%		$	6,906,000				10.0	%
Tier 1 Capital (to risk weighted assets)			8,382,000				12.1				2,762,000				4.0				4,144,000				6.0
Tier 1 Capital (to average assets)			8,382,000				9.0				3,724,000				4.0				4,655,000				5.0
Common Equity Tier 1 Capital (to risk weighted assets)			8,382,000				12.1				3,108,000				4.5				3,108,000				4.5
As of December 31, 2015
Total Capital (to risk weighted assets)		$	10,598,000				14.1	%		$	6,029,000				8.0	%		$	7,536,000				10.0	%
Tier 1 Capital (to risk weighted assets)			9,653,000				12.8				3,014,000				4.0				4,521,000				6.0
Tier 1 Capital (to average assets)			9,653,000				10.0				3,875,000				4.0				4,844,000				5.0
Common Equity Tier 1 Capital (to risk weighted assets)			9,653,000				12.8				3,391,000				4.5				3,391,000				4.5

 

The Federal Reserve has similar requirements for bank holding companies. The Company is currently not subject to these requirements because the Federal Reserve guidelines contain an exemption for bank holding companies of less than $1 billion in consolidated assets, subject to certain limitations.

 

Since December 31, 2016, no conditions or events have occurred, of which we are aware, that have resulted in a material change in the Company’s or the Bank’s category, other than as reported in this Annual Report on Form 10-K.

 

NOTE 18 — RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS, OR ADVANCES

 

The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. However, certain restrictions exist regarding the ability of the subsidiary to transfer funds to Independence Bancshares, Inc. in the form of cash dividends, loans, or advances. The approval of the OCC is required to pay dividends in excess of the Bank’s net profits (as defined) for the current year plus retained net profits (as defined) for the preceding two years, less any required transfers to surplus. The Company also has to obtain the prior written approval of the Federal Reserve Bank of Richmond before declaring or paying any dividends.

 

NOTE 19— BUSINESS SEGMENTS

 

The Company reports its activities as four business segments — community banking, transaction services, asset management and parent only — as defined in “Item 1. Business”. In determining proper segment definition, the Company considers the materiality of a potential segment and components of the business about which financial information is available and regularly evaluated, relative to a resource allocation and performance assessment.

The following table presents selected financial information for the Company’s reportable business segments for the year ended December 31, 2016 and 2015. See Note 22 for parent company condensed financial information.

 

						Parent Company
		Community Banking				Transaction Services				Asset Management				Parent Only				Total
For the year ended December 31, 2016
Interest income		$	3,564,828			$	—			$	—			$	—			$	3,564,828
Interest expense			326,340								—				—				326,340
Net interest income			3,238,488				—				—				—				3,238,488
Provision for loan losses			407,000				—				—				—				407,000
Noninterest income			840,694				—				—				—				840,694
Noninterest expense			4,951,094				249,594				146,512				913,000				6,260,200
Loss before income taxes			(1,278,912	)			(249,594	)			(146,512	)			(913,000	)			(2,588,018	)
Income taxes			—				—				—				—				—
Net loss		$	(1,278,912	)		$	(249,594	)		$	(146,512	)		$	(913,000	)		$	(2,588,018	)
As of December 31, 2016		Community Banking				Holding Company (1)				Eliminations				Total
Cash and due from banks		$	4,632,515			$	1,847,837			$	(1,848,625	)		$	4,631,727
Interest bearing deposits in other institutions			10,500,000				—				—				10,500,000
Federal funds sold			6,143,000				—				—				6,143,000
Investment securities			2,499,805				—				—				2,499,805
Loans receivable, net			59,144,847				—				—				59,144,847
Other real estate owned			2,222,667				—				—				2,222,667
Property, equipment, and software, net			2,005,226				20,548				—				2,025,774
Bank owned life insurance			2,542,910				—				—				2,542,910
Other assets			731,838				6,489				—				738,328
Total Assets		$	90,422,808			$	1,874,874			$	(1,848,625	)		$	90,449,057
Deposits		$	81,556,273			$	—			$	(1,848,625	)		$	79,707,648
Securities sold under agreement to repurchase			113,598				—				—				113,598
Accrued and other liabilities			379,100				304,346				—				683,446
Shareholders’ equity			8,373,837				1,570,528				—				9,944,365
Total liabilities and shareholders’ equity		$	90,422,808			$	1,874,874			$	(1,848,625	)		$	90,449,057

 

(1)	Excludes investment in wholly-owned Bank subsidiary

						Parent Company
		Community Banking				Transaction Services				Asset Management				Parent Only				Total
For the year ended December 31, 2015
Interest income		$	3,567,763			$	—			$	—			$	—			$	3,567,763
Interest expense			316,358								—				14,704				331,062
Net interest income			3,251,405				—				—				(14,704	)			3,236,071
Reversal of provision for loan losses			150,000				—				—				—				150,000
Noninterest income			262,521				383,312				—				21,074				666,907
Noninterest expense			4,271,806				2,214,478				140,782				1,919,981				8,547,047
Income (loss) before income taxes			(907,580	)			(1,831,166	)			(140,782	)			(1,913,611	)			(4,793,439	)
Income taxes			5,080				—				—				—				5,080
Net income (loss)		$	(912,960	)		$	(1,831,166	)		$	(140,782	)		$	(1,913,611	)		$	(4,798,519	)
As of December 31, 2015		Community Banking				Holding Company (1)				Eliminations				Total
Cash and due from banks		$	5,458,252			$	2,909,255			$	(2,913,712	)		$	5,453,795
Interest bearing deposits in other institutions			1,500,000				—				—				1,500,000
Federal funds sold			8,446,000				—				—				8,446,000
Investment securities			10,687,851				—				—				10,687,851
Loans receivable, net			66,402.246				—				—				66,402,246
Other real estate owned			1,278,900				631,320				—				1,910,220
Property, equipment, and software, net			2,053,575				145,221				—				2,198,796
Other assets			771,437				96,961				—				868,398
Total Assets		$	96,598,261			$	3,782,757			$	(2,913,712	)		$	97,467,306
Deposits		$	86,481,037			$	—			$	(2,913,712	)		$	83,567,325
Securities sold under agreement to repurchase			113,080				—				—				113,080
Accrued and other liabilities			236,918				905,824				—				1,142,742
Shareholders’ equity (deficit)			9,767,226				2,876,933				—				12,644,159
Total liabilities and shareholders’ equity		$	96,598,261			$	3,782,757			$	(2,913,712	)		$	97,467,306

 

(1)	Excludes investment in wholly-owned Bank subsidiary

 

The sole activity conducted within our asset management business segment is the resolution of assets purchased by the Company in the second quarter of 2013 from the Bank. All assets have been sold and resolved as of December 31, 2016.

 

The activities conducted within our transaction services business segment relate to the Company’s research and development efforts to enhance existing and develop new digital banking, payments and transaction services. The Company incurred approximately $250,000 and $2.2 million in research and development expenses during 2016 and 2015, respectively. The expenses paid since the suspension of the development of the transaction services segment in September 2015 relate to remaining monthly contract costs which have since been completed. The Company recognized approximately $383,000 in noninterest income during 2015 within the transaction services business segment and approximately $21,000 representing forgiveness of debt as a result of settling certain outstanding liabilities for the Company. As previously noted, on September 25, 2015, the Company suspended development of its digital banking business.

NOTE 20 — FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Assets and Liabilities Measured at Fair Value

 

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 determines the fair values of its financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are detailed in Note 1.

 

Available-for-sale investment securities ($2,499,805 and $10,687,851 at December 31, 2016 and 2015, respectively) are carried at fair value and measured on a recurring basis using Level 2 inputs (other observable inputs). Fair values are estimated by using bid prices and quoted prices of pools or tranches of securities with similar characteristics.

 

We do not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and a specific reserve within the allowance for loan losses is established or the loan is charged down to the fair value less costs to sell. At December 31, 2016, all impaired loans were evaluated on a nonrecurring basis based on the market value of the underlying collateral. Market values are generally obtained using independent appraisals or other market data, which the Company considers to be Level 3 inputs. The aggregate carrying amount, net of specific reserves, of impaired loans carried at fair value at December 31, 2016 and 2015 was $1.6 million and $2.0 million, respectively.

 

Other real estate owned and repossessed assets, generally consisting of properties or other collateral obtained through foreclosure or in satisfaction of loans, are carried at the lower or market value and measured on a non-recurring basis. Market values are generally obtained using independent appraisals which are generally prepared using the income or market valuation approach, adjusted for estimated selling costs which the Company considers to be Level 3 inputs. The carrying amount of other real estate owned and repossessed assets carried at fair value at December 31, 2016 and 2015 was $2,222,667 and $1,910,220, respectively. The Company utilizes two methods to determine carrying values, either appraised value, or if lower, current net listing price.

 

The Company has no assets whose fair values are measured using Level 1 inputs. The Company also has no liabilities carried at fair value or measured at fair value.

 

For Level 3 assets measured at fair value on a non-recurring basis as of December 31, 2016, the significant observable inputs used in the fair value measurements were as follows:

 

Description	Fair Value at December 31, 2016	Valuation Technique	Significant Unobservable Inputs
Other real estate owned and repossessed assets	$2,222,667	Appraised value	Discounts to reflect current market conditions, abbreviated holding period, and estimated costs to sell
Impaired loans	$1,606,590	Internal assessment of appraised value	Adjustments to estimated value based on recent sales of comparable collateral

 

For Level 3 assets measured at fair value on a non-recurring basis as of December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

 

Description	Fair Value at December 31, 2015	Valuation Technique	Significant Unobservable Inputs
Other real estate owned and repossessed assets	$1,910,220	Appraised value	Discounts to reflect current market conditions and estimated costs to sell
Impaired loans	$2,005,168	Internal assessment of appraised value	Adjustments to estimated value based on recent sales of comparable collateral

 

Disclosures about Fair Value of Financial Instruments

 

FASB ASC Topic 825, “Financial Instruments” requires disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. FASB ASC Topic 825 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or other financial

instruments. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, property, equipment, and software and other assets and liabilities.

 

Fair value approximates carrying value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, federal funds sold, and securities sold under agreements to repurchase. Investment securities are valued using quoted market prices. No ready market exists for non-marketable equity securities, and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value. Fair value of loans is based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality.

 

The carrying value of loans held for sale as of December 31, 2016 approximates fair value as these loans were discounted to their liquidation value which is equal to the minimum acceptable bid price established by the Company in connection with the Company’s intent to sell these loans to unaffiliated third party investors.

 

Fair value for demand deposit accounts and interest bearing accounts with no fixed maturity date is equal to the carrying value. The fair value of certificate of deposit accounts are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for FHLB Advances is based on discounted cash flows using the Company’s current incremental borrowing rate.

 

The Company has used management’s best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts that could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair value presented. The estimated fair values of the Company’s financial instruments at December 31, 2016 and 2015 are as follows:

 

December 31, 2016		Carrying Amount				Fair Value				Level 1				Level 2				Level 3
Financial Assets:
Cash and due from banks		$	4,631,727			$	4,631,727			$	4,631,727			$	—			$	—
Interest bearing deposits in other institutions			10,500,000				10,500,000				—				10,500,000				—
Federal funds sold			6,143,000				6,143,000				6,143,000				—				—
Investment securities available for sale			2,499,805				2,499,805				—				2,499,805				—
Non-marketable equity securities			380,050				380,050				—				380,050				—
Loans, net			59,144,847				59,084,364				—				—				59,084,364
Bank owned life insurance			2,542,910				2,542,910				—				2,542,910				—
Financial Liabilities:
Deposits			79,707,648				79,598,034				—				79,598,034				—
Securities sold under agreements to repurchase			113,598				113,598				—				113,598				—

December 31, 2015		Carrying Amount				Fair Value				Level 1				Level 2				Level 3
Financial Assets:
Cash and due from banks		$	5,453,795			$	5,453,795			$	5,453,795			$	—			$	—
Interest bearing deposits in other institutions			1,500,000				1,500,000				—				1,500,000				—
Federal funds sold			8,446,000				8,446,000				8,446,000				—				—
Investment securities available for sale			10,687,851				10,687,851				—				10,687,851				—
Non-marketable equity securities			392,500				392,500				—				392,500				—
Loans, net			66,602,246				66,873,213				—				—				66,873,213
Financial Liabilities:
Deposits			83,567,325				83,538,827				—				83,538,827				—
Securities sold under agreements to repurchase			113,080				113,080				—				113,080				—

NOTE 21 — BANK OWNED LIFE INSURANCE AND PRE-RETIREMENT BENEFIT PLAN

 

In June 2016, the Bank purchased two bank owned life insurance policies with aggregate death benefits of $2,500,000 for investment purposes. The Bank is responsible for paying all premiums and is the owner and beneficiary of the policies. At December 31, 2016, the cash surrender value of these policies was $2,542,910, and as a result $42, 910 in income recognized during the period.

 

In connection with the purchase of the bank owned life insurance policies, the Bank offered pre-retirement death benefits to selected employees of the Bank. The policies are not transferrable to the employees and are not impacted by a change in control. The pre-retirement death benefits are indirectly funded by the bank owned life insurance.

 

NOTE 22 — PARENT COMPANY FINANCIAL INFORMATION

 

Following is condensed financial information of Independence Bancshares, Inc. (includes transaction service, asset management and holding company segments — for further detail, see “Note 19 — Business segments”):

 

Condensed Balance Sheets

 

		December 31,
		2016				2015
Cash and cash equivalents		$	1,847,837			$	2,909,255
Investment in subsidiary			8,373,837				9,767,226
Premises and equipment, net			20,548				145,221
Other real estate owned			—				631,320
Other assets			6,489				96,961
		$	10,248,711			$	13,549,983
Liabilities and Shareholders’ Equity
Accrued and other liabilities		$	304,346			$	905,824
Shareholders’ equity			9,944,365				12,644,159
Total liabilities and shareholders’ equity		$	10,248,711			$	13,549,983

 

Condensed Statements of Operations

 

		Year Ended December 31,
		2016				2015
Equity in undistributed net loss of subsidiary		$	(1,278,912	)		$	(912,960	)
Product research and development — Transaction Services			(249,594	)			(2,209,978	)
Forgiveness of debt			—				403,245
Loan interest and other income			—				1,141
Interest expense on note payable			—				(14,704	)
Property tax expense			(1,139	)			(23,504	)
Consulting and miscellaneous fees			(222,056	)			(378,825	)
Real estate owned activity			(145,373	)			(117,278	)
General and administrative expenses			(529,432	)			(852,012	)
Legal expense			(158,811	)			(404,672	)
Stock compensation expense			(2,701	)			(288,972	)
Net loss		$	(2,588,018	)		$	(4,798,519	)

Condensed Statements of Cash Flows

 

		Year Ended December 31,
		2016				2015
Operating activities
Net loss		$	(2,588,018	)		$	(4,798,519	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock compensation expense			2,701				288,973
Equity in undistributed net loss of subsidiary			1,278,912				912,960
Net changes in fair value and losses on other real estate owned			18,222				105,603
Depreciation expense			124,107				128,549
Loss on disposal of property, equipment and software			566				—
Change in other assets			90,472				153,329
Change in accrued items			(601,478	)			(1,633,526	)
Net cash used in operating activities			(1,674,516	)			(4,842,631	)
Investing activities
Purchase of premises and equipment			—				(7,408	)
Proceeds from sale of other real estate owned			613,098				455,277
Net cash provided by investing activities			613,098				447,869
Financing activities
Issuance of preferred stock, net of closing costs			—				7,615,577
(Repayments of) proceeds from note payable from affiliate			—				(600,000	)
Net cash provided by financing activities			—				7,015,577
Net increase (decrease) in cash and cash equivalents			(1,061,418	)			2,620,815
Cash and cash equivalents, beginning of year			2,909,255				288,440
Cash and cash equivalents, end of year		$	1,847,837			$	2,909,255
Schedule of non-cash transactions
Loans transferred to other real estate owned		$	—			$	—

 

NOTE 23 — SUBSEQUENT EVENTS

 

As part of our strategy to identify growth and sources of new operating revenues, including increasing net interest income, the Company purchased approximately $4.8 million in consumer loans during the first quarter of 2017. These loans are all personal unsecured loans with terms within 36 to 60 months and have a weighted interest rate of 10.42%. While the Company holds the loans, the servicing is retained by the seller for a 1% monthly fee.

PART II

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.  Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Based on our management’s evaluation (with participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer as appropriate to allow timely decisions regarding required disclosure.

 

Management’s Annual Report on Internal Controls over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the 1934 Act. Management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2015 based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As a result of this assessment, management concluded that, as of December 31, 2016, our internal control over financial reporting was effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

The effectiveness of the internal control over financial reporting as of December 31, 2016 was not required to be, and has not been, audited by Elliott Davis Decosimo, LLC, the Company’s independent registered public accounting firm.

 

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting during our fourth quarter of fiscal 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B.  Other Information.

 

None.

PART III

 

Item 10.  Directors, Executive Officers, and Corporate Governance.

 

Directors and Executive Officers

 

The following table sets forth information about our directors, executive officers, and other officers. Our directors are elected by a plurality of the votes cast at our annual shareholders’ meetings and serve for one-year terms, which expire at the next annual shareholders’ meeting.

 

Name	Age	Year First Appointed or Elected to the Company’s Board	Year First Appointed or Elected to the Bank’s Board	Position(s) Held
Directors of the Company
H. Neel Hipp, Jr.	65	2004	2005	Director, Chairman of the Bank’s Board
Keith Stock	64	2013	—	Director
Robert B. Willumstad	71	2013	—	Director, Chairman of the Company’s Board
Russell Echlov	41	2015	—	Director
Adam G. Hurwich	55	2015	—	Director
Lawrence R. Miller	70	2015	2005	Director
Non-Director Executive Officers and Other Officers of the Company
Martha L. Long	58	—	—	Chief Financial Officer of the Company and the Bank
E. Fred Moore	58	—	—	Executive Vice President, Chief Credit Officer of the Company and the Bank

 

Set forth below is certain information about our directors, executive officers, and proposed executive officer, including their age, their business experience for at least the past five years, the names of other publicly-held companies where they currently serve as a director or served as a director during the past five years, and additional information about the specific experience, qualifications, attributes, or skills that led to the board’s conclusion that such person should serve as a director for the Company.

 

H. Neel Hipp, Jr., director and the chairman of the board of directors of the Bank, is the former vice president of Liberty Corporation and former chairman of Liberty Life Insurance Company with over 29 years of experience with the Liberty companies. He is the current owner of Hipp Investments, LLC, which he founded in 1998. Mr. Hipp was a founder and a director of Greenville Financial Corporation and Greenville National Bank. He received his B.A. in economics from Furman University, his M.B.A. from the University of North Carolina, Chapel Hill, and he also attended the Harvard Business School Program for Management Development. Mr. Hipp is actively involved in the community. He currently serves as a trustee of Wofford College, on the board of the Aircraft Owners and Pilots Association of Frederick, Maryland. Mr. Hipp was appointed chairman of the South Carolina Aeronautics Commission in 2006 by Governor Sanford. He has served as a member of the South Carolina Chamber of Commerce, the Greenville Downtown Airport Commission (chair), the Greenville County United Way, the board of the South Carolina Historical Society and the Furman University board of trustees. Mr. Hipp’s extensive business experience in a regulated industry, his past experience in the banking industry, including service as a bank director, as well as his ties to the Greenville community led the board to conclude that he should serve as a director.

 

Keith Stock, director, has served since 2011 as the chairman and chief executive officer of First Financial Investors, Inc. and senior executive advisor with The Brookside Group family-owned investment offices. Since 2014, Mr. Stock has served as chairman, and was previously a member of the executive office, of Clarien Bank Limited. He also served as chairman and chief executive officer of Clarien Group Limited, the bank holding company. Since 2014, he has been a director of Sun Bancorp, Inc. and Sun National Bank. Mr. Stock is a registered securities professional with Sword Securities, LLC. Since 2016, Mr. Stock has served as president, chief executive officer, treasurer and director of National Property REIT Corp. as well as executive officer of certain of its subsidiaries. From 2009 until 2011, Mr. Stock served as chief strategy officer and member of the Office of the CEO at TIAA-CREF. From 2004 until May 2008, he served as president of MasterCard Advisors, LLC and as a member of the MasterCard Worldwide Operating Committee and Management Council. Prior to that, Mr. Stock served as chairman and chief executive officer of St. Louis Bank, FSB,

chairman and president of Treasury Bank Ltd., and as a director of Severn Bancorp, Inc. He has held global management roles with AT Kearney, Capgemini, Ernst & Young and McKinsey & Company after beginning his career with BNY Mellon. He is a director of the Foreign Policy Association, a member of the Economic Club of New York, a member of the Governing Council of the Bermuda Stock Exchange and the Advisory Board of the Institute for Ethical Leadership at Rutgers University Business School. He is a graduate of Princeton University and received his MBA from The University of Pennsylvania Wharton School. Mr. Stock’s prior service as an executive officer and director of other banks, as well as his extensive payments services experience with MasterCard, led the board to conclude that he should serve as a director as the Company implements the expansion of its business model.

 

Robert B. Willumstad, director, has over 35 years of experience in the banking and financial services industry, and he presently serves as a partner with Brysam Global Partners, a specialty private equity firm that focuses in financial services, which he co-founded in 2005. Mr. Willumstad also previously served as the chairman, and briefly as chief executive officer, of American International Group until 2008. Prior to that, he held positions as president and chief operating officer, as well as a director, at Citigroup. Mr. Willumstad also served for over 20 years with Chemical Bank in various capacities of operations, retail banking and computer systems. Mr. Willumstad’s extensive banking and financial services experience led the board to conclude that he should serve as a director and as chairman of the board of directors.

 

Russell Echlov, director, was appointed to the board as a representative of RMB Capital Management, LLC, the investment adviser to certain private funds whose strategy focuses on the banking and financial services sectors (“Mendon Capital Strategy”) and which invested in the Company’s 2015 private offering of Series A preferred stock. Mr. Echlov has served as an assistant portfolio manager with RMB Capital Management, LLC focused on Mendon Capital Strategy since April 2014. Prior to that time, he was employed as an investment advisor for Spring Hill Capital, LLC from 2010 until January 2014. He is an experienced institutional investor with knowledge of banking and financial services and is a graduate of Dartmouth College. Mr. Echlov’s extensive experience as an institutional investor in banks and other financial institutions led the board to conclude that he should serve as a director of the Company.

 

Adam G. Hurwich, director, was appointed to the board as a representative of Ulysses Management LLC, the investment manager for Ulysses Partners, L.P. and Ulysses Offshore Fund, Ltd., which together invested in the Company’s 2015 private offering of Series A preferred stock. Mr. Hurwich has served as a portfolio manager at Ulysses Management LLC since January 2010. He has also served as a director of First Security Group, Inc. and FSGBank, National Association, from June 2013 to October 2015, when First Security Group merged with and into Atlantic Capital Bancshares, Inc. Mr. Hurwich has served as a director of Atlantic Capital Bancshares, Inc. and Atlantic Capital Bank since November 2015. Mr. Hurwich has worked over a period spanning almost a decade in various advisory committees to the Financial Accounting Standards Board – the last of which, the Financial Accounting Standards Advisory Council, he completed in December 2015. He is an experienced institutional investor with knowledge of banking and financial services. Mr. Hurwich received his A.B. from Harvard College in 1987 and his M.B.A. from Yale University in 1989. Mr. Hurwich’s extensive experience as an institutional investor, as well as a director of another financial institution, led the board to conclude that he should serve as a director of the Company.

 

Lawrence R. Miller, serves as the Company’s interim chief executive officer and the Bank’s president and chief executive officer. He has also served as a director of the Bank since its organization in 2005. Mr. Miller served as the Company’s and the Bank’s chief executive officer from organization until December 31, 2012, when he stepped down as the Company’s chief executive officer but continued to serve as the Bank’s chief executive officer. In October 2015, the Company’s board of directors appointed him as the Company’s interim chief executive officer. Mr. Miller has over 45 years of banking experience, having held various positions in the banking industry since November 1971. From 1995 until March 2004, he served as market chief executive officer for SouthTrust Bank, where he successfully opened seven offices in 10 years. He has lived in Upstate South Carolina for over 45 years and has been actively involved in the community and its future planning. He has served as a trustee for the College of Charleston for thirteen years for which he chaired both the Audit and Finance Committees; and is past board chairman of Christ School, Arden, North Carolina for which he served as a trustee for ten years. Mr. Miller is a member of the South Carolina Bankers Association Council and a former board member of the South Carolina Bankers Association. He has served on both the economic development board of the Greenville Chamber of Commerce and the board of directors of the Greer Chamber of Commerce. Mr. Miller graduated from Newberry College, from the School of Banking of the South at Louisiana State University, and from the National Commercial Lending Graduate School at the University of Oklahoma. Mr. Miller’s extensive knowledge of the Bank and the Company as well as his ties to the Greenville community led the board to conclude that he should serve as a director of the Company.

 

Additional information is set forth below regarding certain other executive officers of our Company and our Bank:

 

Martha L. Long, serves as the Company’s and the Bank’s chief financial officer. Ms. Long began assisting the Bank with financial accounting matters as an independent contractor beginning in June 2011, and in August 2012, she was appointed as chief financial officer of the Bank. She was appointed as chief financial officer of the Company in December 2013. Ms. Long has over 32 years of experience in various senior financial officer roles. Prior to her work with the Bank, Ms. Long served in various accounting capacities,

including most recently working for her own CPA firm from 2009 through 2012. Prior to that, she served as Senior Vice President for AIMCO, a publicly held real estate investment trust from 1998 to 2009 in various financial capacities. She has also served as Senior Vice President and Controller for two SEC-registered companies, The First Savings Bank and Insignia Financial Group, Inc., an owner and operator of multi-family housing facilities. Ms. Long is a graduate of Bob Jones University with a degree in Accounting and is a certified public accountant in South Carolina.

 

E. Fred Moore, serves as the executive vice president and chief credit officer of the Company and the Bank, and he has held these positions since 2006. He previously served as a senior vice president of risk management for First National Bank of the South in Spartanburg, South Carolina. He has over 32 years of experience in administrative banking and finance, including credit administration and internal audit. Mr. Moore was previously employed with American Federal as a senior credit analyst until November 2000, when he resigned to join First National Bank of the South. He graduated from University of South Carolina in 1982 where he received his B.A. in business economics.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act requires the Company’s officers and directors and persons who own more than 10% of the Company’s common stock to file reports of ownership and changes in ownership with the SEC. Based solely on the Company’s review of these forms and written representations from the officers and directors, the Company believes that all Section 16(a) filing requirements were met during fiscal 2016.

 

Code of Ethics

 

We expect all of our directors, executive officers, and other employees to conduct themselves honestly and ethically, particularly in handling actual and apparent conflicts of interest and providing full, accurate, and timely disclosure to the public.

 

We have adopted a Code of Ethics that is applicable to our directors, executive officers, principal shareholders, and other employees, including our principal executive officer and our principal financial officer. A copy of this Code of Ethics is available without charge to shareholders upon request to the secretary of the Company, at Independence Bancshares, Inc., 500 East Washington St., Greenville, South Carolina 29601.

 

Audit Committee and Audit Committee Financial Expert

 

Our audit committee is currently composed of Messrs. Stock and Hipp. Each of these members is considered “independent” under NASDAQ Rule 5605(c)(2). The board of directors has determined that Mr. Stock is an “audit committee financial expert” as defined in Item 407(d)(5) of the SEC’s Regulation S-K. The audit committee met four times in 2016. The audit committee functions are set forth in its charter, which was adopted on May 5, 2005 and was revised and approved by the board of directors on October 29, 2015. The audit committee has the responsibility of reviewing financial statements, evaluating internal accounting controls, reviewing reports of regulatory authorities, and determining that all audits and examinations required by law are performed. The committee recommends to the board the appointment of the independent auditors for the next fiscal year, reviews and approves the auditor’s audit plans, and reviews with the independent auditors the results of the audit and management’s responses. The audit committee is responsible for overseeing the entire audit function and appraising the effectiveness of internal and external audit efforts. The audit committee reports its findings to the board of directors.

 

Item 11.  Executive Compensation.

 

Summary Compensation Table

 

The following table summarizes the compensation paid to or earned by each of the named executive officers for the year ended December 31, 2016:

Name and Position		Year				Salary				Bonus				Option Awards				All Other Compensation				Total
Lawrence R. Miller(1)			2016			$	179,655			$	—			$	—			$	21,870(2)(3)			$	201,525
Interim Chief Executive Officer of the Company and President and Chief Executive Officer of the Bank; Director			2015			$	179,655			$	—			$	—			$	21,250(2)(3)			$	200,905
Martha L. Long			2016			$	205,800			$	—			$	—			$	8,203(2)			$	214,003
Chief Financial Officer of the Company and the Bank			2015			$	205,800			$	—			$	—			$	7,266(2)			$	213,066
E. Fred Moore			2016			$	135,518			$	—			$	—			$	7,382(2)			$	142,900
Executive Vice President, Chief Credit Officer of the Company and the Bank			2015			$	130,935			$	—			$	—			$	6,567(2)			$	137,502

 

 

(1)

Mr. Miller was appointed as the Company’s interim chief executive officer on October 4, 2015.

(2)

Includes 401(k) matching contributions, excess premiums for life insurance at two times salary and premiums for long-term and short-term disability insurance policies. All of these benefits are provided to all full-time Bank employees on a non-discriminatory basis.

(3)

Includes membership dues paid to country clubs, vehicle expenses, and premiums paid on additional life insurance.

 

Employment Agreements

 

Lawrence R. Miller

 

We entered into an employment agreement with Lawrence R. Miller on December 10, 2008, for an initial one-year term, annually renewing thereafter, pursuant to which he served as the president and the chief executive officer of the Company and the Bank. On December 31, 2012, the Company, the Bank, and Mr. Miller entered into an amendment to his employment agreement solely to remove references to his position as the Company’s president and chief executive officer. On December 15, 2016, the Company, the Bank and Mr. Miller entered into a second amendment to his employment agreement to eliminate the Employer’s (as defined therein) obligations to continue the medical, life, disability, or benefits to Mr. Miller, his dependents, and beneficiaries for a period of two years following a change in control, in favor or a provision allowing Mr. Miller to continue participation, in accordance with the terms of the applicable benefits plans, in the Employer’s group health plan pursuant to plan continuation rules under COBRA. The second amendment also requires that Mr. Miller terminate his membership in the Thornblade Club upon termination of employment following a change in control, and in connection therewith, the Employer shall pay to Mr. Miller, within 15 days of the date of his termination, a lump sum amount equal to the twelve required monthly payments relating to such membership termination. As of March 23, 2017, Mr. Miller receives an annual salary of $177,000, plus a portion of his yearly medical insurance premium. He is eligible to receive an annual increase in his salary as determined by the board of directors. He is eligible to receive an annual bonus of up to 50% of his annual salary if the Bank achieves certain performance levels to be determined from time to time by the board of directors. He is also eligible to participate in any management incentive program of the Bank or any long-term equity incentive program and is eligible for grants of stock options and other awards thereunder. As of March 2017, Mr. Miller has been granted options to purchase a total of 92,885 shares of common stock. These options were granted in 2005, 2007, 2008 and 2013 under our 2005 Incentive Plan, with each grant vesting over a three-year period beginning on the date of grant. All options have a term of 10 years. Additionally, Mr. Miller participates in the Bank’s retirement, welfare, and other benefit programs and is entitled to a life insurance policy and an accident liability policy and reimbursement for automobile expenses, club dues, and travel and business expenses.

 

Mr. Miller's employment agreement also provides that during his employment and for a period of 12 months following termination, he may not (a) compete with the Company, the Bank, or any of its affiliates by, directly or indirectly, forming, serving as an organizer, director or officer of, or consultant to, or acquiring or maintaining more than 1% passive investment in, a depository financial institution or holding company thereof if such depository institution or holding company has one or more offices or branches within a radius of 30 miles from the main office of the Company or any branch office of the Company, (b) solicit customers of the Bank with which he has had material contact for the purpose of providing financial services, or (c) solicit employees of the Bank for employment. If we terminate the employment agreement for Mr. Miller without cause, he will be entitled to severance in an amount equal to his then current monthly base salary multiplied by 12, excluding any bonus. If, following a change in control of the Company, Mr. Miller terminates his employment for good cause as that term is defined in the employment agreement, he will be entitled to

severance compensation of his then current monthly salary multiplied by 24, plus accrued bonus, all outstanding options and incentives will vest immediately. In addition, Mr. Miller and his covered dependents may continue participation, in accordance with the terms of the applicable benefits plans, in the Employer's group health plan pursuant to plan continuation rules COBRA. If Mr. Miller elects COBRA coverage for group health coverage, then for the first twelve months of COBRA coverage he will only be obligated to pay the portion of the full COBRA cost of the coverage equal to an active employee's share of premiums for coverage for the respective plan year of coverage and the Company's share of such premiums shall be treated as taxable income to the Executive, and thereafter he will be required the full COBRA of the full COBRA cost of the coverage.

 

Martha L. Long

 

We entered into a change in control agreement with Martha L. Long on December 19, 2014, for an initial one-year term, which was renewed on December 19, 2015 and annually renewing thereafter unless the Company delivers a notice of termination at least thirty days prior to the beginning of the renewal period. Upon the termination of Ms. Long’s employment by (i) the Executive for Good Reason upon delivery of a Notice of Termination to the Employer, or (ii) the Employer other than for Cause, in each case simultaneously with or within one year after the occurrence of a Change in Control, the Employer shall pay the Ms. Long (or in the event of her death during the term of this Agreement, her estate) in cash within 60 days of the date of termination, severance compensation in an amount equal to her then current monthly base salary multiplied by twelve, plus any bonus earned through the date of termination but unpaid as of the date of termination. In addition, Ms. Long and her covered dependents may continue participation, in accordance with the terms of the applicable benefits plans, in the Employer’s group health plan pursuant to plan continuation rules COBRA. If Ms. Long elects COBRA coverage for group health coverage, then for the first twelve months of COBRA coverage she will only be obligated to pay the portion of the full COBRA cost of the coverage equal to an active employee’s share of premiums for coverage for the respective plan year of coverage and the Company’s share of such premiums shall be treated as taxable income to the Executive, and thereafter she will be required the full COBRA of the full COBRA cost of the coverage.

 

E. Fred Moore

 

Neither the Company nor the Bank have entered into an employment agreement with Mr. Moore.

 

Outstanding Equity Awards at Fiscal Year-End

 

The following table sets forth information concerning equity awards that were outstanding to our named executive officers at December 31, 2016.

 

		Option Awards
		Number of Securities Underlying Unexercised Options								Option Exercise Price				Option Expiration Date		Grant-date Fair Value
		Exercisable				Unexercisable				(per share)
Martha L. Long			16,000				—			$	0.80			07/16/2023		$	32,000
			7,500				—			$	1.59			02/05/2014		$	11,925
Lawrence R. Miller			15,000				—			$	10.00			07/26/2015		$	61,650
			13,500				—			$	10.00			04/11/2017		$	57,375
			14,385				—			$	10.50			01/23/2018		$	57,396
			35,000				15,000			$	0.80			07/16/2023		$	40,000
E. Fred Moore			21,000				9,000			$	0.80			07/16/2023		$	24,000

 

Ten percent of the options granted to each of Ms. Long and Mr. Miller on July 16, 2013 were to immediately vest on the grant date, with the remaining 90% subject to incremental vesting over a 3-year period (30% to vest annually on the first three anniversaries of the grant date) provided, in each case, that the Bank’s previously disclosed consent order with the OCC had been removed. The consent order was removed on June 5, 2014, and since then, all of the options have now vested for both executives.

 

The options previously granted to Mr. Miller, vested at a rate of 33% each year on the first three anniversaries of the date of grant.

 

Director Compensation

 

In 2015, we paid Mr. Willumstad an annual retainer of $130,000 as the chairman of the board. Mr. Willumstad agreed to defer $40,000 for 2015 and $120,000 for the year ended 2016 as a result of the Company suspending further development of its digital

banking, payments and transaction services business. This deferral is included in the payables of the Company. No other directors received any form of compensation.

 

Potential Payments upon Termination or Change in Control

 

For information regarding the potential payments that would be due upon Termination or Change in Control, see “Employment Agreements” in this Part III, Item 11 “Executive Compensation” included in this Annual Report on Form 10-K.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.

 

Equity Based Compensation Plan Information

 

The following table sets forth equity-based compensation plan information at December 31, 2016:

 

Plan Category		Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)				Weighted-average exercise price of outstanding options, warrants and rights (b)				Number of securities remaining available for future issuance under equity compensation plans (c) (excluding securities reflected in column(a))
Equity compensation plans approved by security holders
2005 Incentive Plan (1)			2,323,505			$	1.11				143,215
2013 Incentive Plan (2)			778,750				1.11				2,542,720
Equity compensation plans not approved by security holders (2)			—				—				—
Total			3,102,255			$	1.11				2,685,935

	(1)	At our annual meeting of shareholders held on May 16, 2006, our shareholders approved the 2005 Incentive Plan. The 260,626 of shares of common stock initially available for issuance under the 2005 Incentive Plan automatically increased to 2,466,720 shares on December 31, 2012, such that the number of shares available for issuance continued to equal 12.5% of our total outstanding shares. In February 2013, the board of directors adopted Amendment No. 2 to the 2005 Incentive Plan to provide that the maximum number of shares that may be issued thereunder shall be 2,466,720 and to eliminate the evergreen provision.

 

(2)

At our annual meeting of shareholders held on May 15, 2013, our shareholders approved the 2013 Incentive Plan. The 2,466,720 shares of common stock initially available for issuance under the 2013 Incentive Plan automatically increased to 2,658,970 shares on August 1, 2013, such that the number of shares available for issuance (plus the 2,466,720 shares reserved for issuance under the 2005 Incentive Plan) continued to equal 20% of our total outstanding shares on an as-diluted basis.

 

See Item 8. Financial Statements and Supplementary Data, Note 1, Summary of Significant Accounting Policies, and Note 15, Equity-Based Compensation, for a discussion regarding matters related to our equity-based compensation.

 

Security Ownership of Certain Beneficial Owners and Management

 

The following tables set forth information known to the Company with respect to beneficial ownership of the Company’s common stock as of March 23, 2017 for (i) each current director of the Company, (ii) each of the Company’s named executive officers, (iii) each holder of 5.0% or greater of the Company’s common stock, and (iv) all of the Company’s directors and executive officers as a group. Unless otherwise indicated, the mailing address for each beneficial owner is care of Independence Bancshares, Inc., 500 East Washington St., Greenville, South Carolina 29601.

Name		Common Shares Beneficially Owned(1)				Options for Common Shares Exercisable within 60 Days of March 23, 2017				Shares of Common Stock Issuable Upon Conversion of Series A Preferred Shares Beneficially Owned(2)				Total				Percentage of Beneficial Ownership(3)
Directors of the Company
Russell Echlov			—				—				3,062,000	(5)			3,062,000				9.87	%
H. Neel Hipp, Jr.			331,500				20,000				—				351,500				1.13	%
Adam G. Hurwich			—				—				3,062,500	(7)			3,062,500				9.87	%
Lawrence R. Miller			93,750				80,385				—				174,135				0.56	%
Keith Stock			125,000	(8)			20,000				125,000	(9)			270,000				0.87	%
Robert B. Willumstad			1,250,000				762,500				312,500				2,325,000				7.49	%
Named Executive Officers (Non-Directors)
Martha L. Long			62,500				47,500				—				110,000				0.35	%
E. Fred Moore			4,125								—				4,125				0.01	%
Other Holders of 5% or Greater of the Company’s Common Stock
Aequitas Capital Opportunities Fund, LP 5300 Meadows Road, Suite 400 Lake Oswego, OR 97035			—				—				3,062,500	(10)			3,062,500				9.87	%
Huntington Partners, LLLP 10 S. Wacker Drive, Suite 2675 Chicago, IL 60606			1,875,000				—				—				1,875,000				6.04	%
Iron Road Multi-Strategy Fund LP 115 S. LaSalle, 34th Floor Chicago, IL 60603			—				—				312,500	(11)			312,500				1.01	%
Mendon Capital Master Fund Ltd. 115 S. LaSalle, 34th Floor Chicago, IL 60603			—				—				2,387,500	(12)			2,387,500				7.69	%
Mendon Capital QP LP 115 S. LaSalle, 34th Floor Chicago, IL 60603			—				—				362,500	(13)			362,500				1.17	%
Ulysses Offshore Fund, Ltd. c/o Ulysses Management LLC One Rockefeller Plaza New York, New York 10020			—				—				375,000	(14)			375,000				1.21	%
Ulysses Partners, L.P. c/o Ulysses Management LLC One Rockefeller Plaza New York, New York 10020			—				—				2,687,500	(14)			2,687,500				8.66	%
Steven D. Hovde 968 Williamsburg Park Barrington, IL 60010			1,250,000				—				—				1,250,000				4.03	%
Gordon A. Baird			1,072,250	(4)			1,500,000				—				2,572,250				7.91	%
Alvin G. Hageman			1,390,250	(6)			37,500				156,250				1,584,000				9.48	%
All directors and executive officers of the Company as a group (9 persons)			1,862,750				930,385				6,250,000				9,043,135				30.14	%

(1)	Includes shares for which the named person has sole voting and investment power, has shared voting and investment power with a spouse, or holds in an IRA or other retirement plan program, unless otherwise indicated in these footnotes.

 

(2)

Each share of Series A preferred stock is convertible, at the holder’s option, into 1,250 shares of our common stock. The Series A preferred stock is also automatically converted upon the satisfaction of certain conditions.

 

(3)

For each individual, this percentage is determined by assuming the named person converts all shares of Series A preferred stock which he or she beneficially owns and exercises all options and warrants which he or she has the right to acquire within 60 days, but that no other persons convert any shares of Series A preferred stock or exercise any options or warrants. For the directors and executive officers as a group, this percentage is determined by assuming that each director and executive officer converts all shares of Series A preferred stock which he or she beneficially owns and exercises all options and warrants which he or she has the right to acquire within 60 days, but that no other persons convert any shares of Series A preferred stock or exercise any options or warrants. The calculations are based on 20,502,760 shares of common stock outstanding on March 23, 2017.

(4)

Based on a Schedule 13D/A filing made on July 14, 2015, consists of 900,000 shares of common stock held by Baird Hageman & Co. Series 1, LLC and 172,250 shares of common stock individually owned by Gordon A. Baird. Mr. Baird and Alvin G. Hageman are the members of the board of managers of Baird Hageman & Co., LLC and therefore share voting and investment power over the shares. The foregoing is not an admission by Mr. Baird that he is the beneficial owner of the shares held by Baird Hageman & Co., LLC. The address of Baird Hageman & Co., LLC is c/o Baird Hageman & Co., LLC, 33 Christie Hill Road, Darien, CT 06820.

 

(5)

Consists of 1,910 shares of Series A preferred stock, which are convertible into 2,387,500 shares of common stock, held by Mendon Capital Master Fund Ltd. and 290 shares of Series A preferred stock, which are convertible into 362,500 shares of common stock, owned by Mendon Capital QP LP. Mr. Echlov is an assistant portfolio manager with RMB Capital Management, LLC, an affiliate of Mendon Capital Master Fund Ltd. and Mendon Capital QP LP. Accordingly, Mr. Echlov may be deemed to be the beneficial owner of shares of Series A preferred stock held by Mendon Capital Master Fund Ltd. and Mendon Capital QP LP.

 

(6)

Based on a Schedule 13D/A filing made on July 14, 2015, consists of 900,000 shares of common stock held by Baird Hageman & Co. Series 1, LLC and 490,250 shares of common stock individually owned by The Hageman 2013 Grantor Trust. Mr. Hageman and Gordon A. Baird are the members of the board of managers of Baird Hageman & Co., LLC and therefore share voting and investment power over the shares. The foregoing is not an admission by Mr. Hageman that he is the beneficial owner of the shares held by Baird Hageman & Co., LLC. The address of Baird Hageman & Co., LLC is c/o Baird Hageman & Co., LLC, 33 Christie Hill Road, Darien, CT 06820.

 

(7)

Consists of 300 shares of Series A preferred stock, which are convertible into 375,000 shares of common stock, held by Ulysses Offshore Fund, Ltd. and 2,150 shares of Series A preferred stock, which are convertible into 2,687,500 shares of common stock, owned by Ulysses Partners, L.P. Mr. Hurwich is a portfolio manager with Ulysses Management LLC, the investment manager of Ulysses Offshore Fund, Ltd. and Ulysses Partners, L.P. Accordingly, Mr. Hurwich may be deemed to be the beneficial owner of shares of Series A preferred stock held by Ulysses Offshore Fund, Ltd. and Ulysses Partners, L.P.

 

(8)

Consists of 125,000 shares of common stock held by First Financial Partners Fund II, LP. Mr. Stock serves as general partner for FFP Affiliates II, LP, which in turn serves as the general partner of First Financial Partners Fund II, LP. Its address is One Stamford Forum, 201 Tresser Blvd., Stamford, CT 06901.

 

(9)

Consists of 100 shares of Series A preferred stock, which are convertible into 125,000 shares of common stock, held by First Financial Partners Fund II, LP. As noted above, Mr. Stock serves as general partner for FFP Affiliates II, LP, which in turn serves as the general partner of First Financial Partners Fund II, LP.

 

(10)

The general partner of Aequitas Capital Opportunities Fund, LP, is Aequitas Capital Opportunities GP, LLC (“ACOF GP”), and its investment advisor is Aequitas Investment Management, LLC (“AIM”). Both ACOF GP and AIM are subsidiaries of Aequitas Capital Management, Inc. (“ACM”). Each of ACOF GP, AIM and ACM may be deemed to be beneficial owners of the 2,450 shares of Series A preferred stock, which are convertible into 3,062,500 shares of common stock, held directly by Aequitas Capital Opportunities Fund, LP. The principal address of each of the above entities is 5300 Meadows Road, Suite 400, Lake Oswego, Oregon 97035.

 

(11)

The general partner of Iron Road Multi-Strategy Fund LP is Iron Road Capital Partners LLC and its investment adviser is RMB Capital Management LLC (“RMB Capital Management”). Iron Road Capital Partners LLC is owned by RMB Capital Management. RMB Capital Management is wholly-owned by RMB Capital Holdings LLC (“RMB Holdings”). Each of the foregoing may be deemed to be beneficial owners of the 250 shares of Series A preferred stock, which are convertible into 312,500 shares of common stock, held directly by Iron Road Multi-Strategy Fund LP. The principal address of each of the above entities is 115 S. LaSalle, 34th Floor, Chicago, IL 60603.

 

(12)

Mendon Capital Master Fund Ltd. is owned by Mendon Capital LLC and Mendon Capital Ltd., and is managed by RMB Mendon Managers LLC and subadvised by RMB Capital Management. RMB Mendon Managers LLC is owned by Mendon Capital Advisers Corp. (“MCA”) and RMB Capital Management. RMB Capital Management is wholly-owned by RMB Capital Holdings LLC. Each of the foregoing may be deemed to be beneficial owners of the 1,910 shares of Series A preferred stock, which are convertible into 2,387,500 shares of common stock, held directly by Mendon Capital Master Fund Ltd. The principal address of each of the above entities is 115 S. LaSalle, 34th Floor, Chicago, IL 60603, except that MCA is located at 150 Allens Creek Road, Rochester, NY 14618.

 

(13)

Mendon Capital QP LP (“MCQP”) is owned by Mendon Capital QP Ltd., and is managed by RMB Mendon Managers LLC and subadvised by RMB Capital Management. RMB Mendon Managers LLC is owned by MCA and RMB Capital Management. RMB Capital Management is wholly-owned by RMB Capital Holdings LLC. Each of the foregoing may be deemed to be beneficial owners of the 290 shares of Series A preferred stock, which are convertible into 362,500 shares of common stock, held directly by MCQP. The principal address of each of the above entities is 115 S. LaSalle, 34th Floor, Chicago, IL 60603, except that MCA is located at 150 Allens Creek Road, Rochester, NY 14618.

 

(14)

Ulysses Management LLC, a Delaware limited liability company (“Ulysses Management”), in its capacity as investment manager, may be deemed to share voting and investment power over the shares beneficially owned by Ulysses Partners, L.P., a Delaware limited partnership (“Ulysses Partners”) and Ulysses Offshore Fund, Ltd., an exempted company incorporated and existing under the laws of the Cayman Islands (“Ulysses Offshore,” and collectively with Ulysses Partners, the “Ulysses Purchasers”). Joshua Nash LLC, a Delaware limited liability company (“Nash LLC”), as the managing general partner of Ulysses Partners, may be deemed to share voting and investment power over the shares beneficially owned by Ulysses Partners; and Joshua Nash, who is a United States citizen (“Mr. Nash”), as an executive of Ulysses Management, the sole member of Nash LLC and the President of Ulysses Offshore, may be deemed to share voting and investment power over the shares beneficially owned by each of Ulysses Management, Ulysses Partners and Ulysses Offshore. The address of each Ulysses Management affiliate is c/o Ulysses Management LLC, One Rockefeller Plaza, New York, New York 10020.

Item 13.  Certain Relationships and Related Transactions, and Director Independence.

 

Transactions with Related Persons

 

The Bank has had, and expects to have in the future, loans and other banking transactions in the ordinary course of business with directors (including our independent directors) and executive officers of the Company and its subsidiaries, including members of their families or corporations, partnerships or other organizations in which such officers or directors have a controlling interest. These loans are made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with unrelated parties. Such loans do not involve more than the normal risks of repayment nor present other unfavorable features.

 

Loans to individual directors and officers must also comply with our Bank’s lending policies and statutory lending limits, and directors with a personal interest in any loan application are excluded from the consideration of the loan application.

 

In July 2011, Gordon A. Baird formed MPIB Holdings, LLC (“MPIB”), a Delaware limited liability company, for the purpose of developing the business and regulatory plans for a digital transaction services business. Alvin G. Hageman also invested in MPIB in December 2011. On December 31, 2012, Mr. Baird was appointed Chief Executive Officer and director of the Company and Mr. Hageman became a director of the Company in April 23, 2013. As previously disclosed, on May 14, 2015, the Company entered into a license agreement with MPIB, pursuant to which the Company received a non-exclusive, non-transferable, non-sublicensable, worldwide license to use certain intellectual property of MPIB related to mobile payments and digital transactions. On January 4, 2016, the parties amended and restated the license agreement (the “Amended and Restated License Agreement”) pursuant to which MPIB agreed to make the license perpetual, subject to termination rights of the parties set forth in the Amended and Restated License Agreement, in exchange for the Company’s payment of an additional license fee of $275,000. In addition, as previously disclosed, on April 27, 2015, the Company submitted a proposed asset purchase agreement between the Company and MPIB to the Federal Reserve Bank of Richmond. The Company subsequently withdrew this application to the agency and no longer intends to enter into the asset purchase agreement or consummate the transaction contemplated therein.

 

Director Independence

 

We apply the definition of independent director as defined by NASDAQ Rule 5605(a)(2). In accordance with this guidance, Messrs. Hipp, Stock and Willumstad are considered independent.

 

Item 14.  Principal Accounting Fees and Services.

 

Elliott Davis Decosimo, LLC was our auditor during the fiscal year ended December 31, 2016. A representative of Elliott Davis Decosimo, LLC will be present at the 2017 annual shareholders’ meeting and will be available to respond to appropriate questions and will have the opportunity to make a statement if he or she desires to do so. The following table shows the fees that we paid for services performed in fiscal years ended December 31, 2016 and 2015.

 

		Years Ended December 31,
		2016				2015
Audit Fees		$	84,450			$	90,140
Audit-Related Fees			—				21,400
Tax Fees			10,800				11,330
All Other Fees			—				—
Total		$	95,250			$	122,870

 

Audit Fees

 

This category includes the aggregate fees billed for professional services rendered by the independent auditors during the Company’s 2016 and 2015 fiscal years for the audit of the Company’s consolidated annual financial statements and quarterly reports on Form 10-Q.

Audit-Related Fees

 

This category includes the aggregate fees billed for non-audit services, exclusive of the fees disclosed relating to audit fees, during the fiscal years ended December 31, 2016 and 2015. These services principally include the assistance for various filings with the SEC and consultations regarding accounting and disclosure matters.

 

Tax Fees

 

This category includes the aggregate fees billed for tax services rendered in the preparation of federal and state income tax returns for the Company and its subsidiaries and consultations regarding tax and disclosure matters.

 

Oversight of Accountants; Pre-Approval of Accounting Fees

 

Under the provisions of its charter, the audit committee is responsible for the retention, compensation, and oversight of the work of the independent auditors. The charter provides that the audit committee must pre-approve the fees paid for the audit. The audit committee may delegate approval of non-audit services and fees to one or more designated audit committee members. The designated committee member is required to report such pre-approval decisions to the full audit committee at the next scheduled meeting. The policy specifically prohibits certain non-audit services that are prohibited by securities laws from being provided by an independent auditor. All of the accounting services and fees reflected in the table above were reviewed and approved by the audit committee, and none of the services were performed by individuals who were not employees of the independent auditor.

 

Item 15.  Exhibits, Financial Statement Schedules.

 

(a)(1)

Financial Statements

 

The following consolidated financial statements are included in Item 8 of this report:

 

•

Report of Independent Registered Public Accounting Firm

 

•

Consolidated Balance Sheets as of December 31, 2016 and 2015

 

•

Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years Ended December 31, 2016 and 2015

 

•

Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2016 and 2015

 

•

Consolidated Statements of Cash Flows for the Years Ended December 31, 2016 and 2015

 

•

Notes to Consolidated Financial Statements

 

(2)

Financial Statement Schedules

 

These schedules have been omitted because they are not required, are not applicable or have been included in our consolidated financial statements.

 

(3)

Exhibits

 

See the “Exhibit Index” immediate following the signature page to this report, which is incorporated by reference herein.

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	INDEPENDENCE BANCSHARES, INC.
Dated: March 23, 2017	By: /s/ Lawrence R. Miller
	Lawrence R. Miller Interim Chief Executive Officer

 

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Lawrence R. Miller, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

 

Signature		Title		Date
/s/Lawrence R. Miller		Interim Chief Executive Officer
		(Principal Executive Officer) Director		March 23, 2017
Lawrence R. Miller
/s/Martha L. Long		Chief Financial Officer
		(Principal Financial and Accounting Officer)
Martha L. Long
/s/H. Neel Hipp, Jr.		Director
H. Neel Hipp, Jr.
/s/Robert Willumstad		Chairman
Robert Willumstad
/s/Russell Echlov		Director
Russell Echlov
/s/Adam G. Hurwich		Director
Adam G. Hurwich
/s/Keith Stock		Director
Keith Stock

EXHIBIT INDEX

 

3.1	Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form SB-2, File No. 333-121485).
3.2	Articles of Amendment to the Articles of Incorporation (incorporated by reference to Appendix A of the Company’s Proxy Statement on Schedule 14A filed on May 2, 2011).
3.3	Articles of Amendment to the Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on July 22, 2013).
3.4	Articles of Amendment to the Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on May 15, 2015).
3.5	Amended and Restated Bylaws as of March 5, 2012 (incorporated by reference to Exhibit 3.2 of the Company’s Form 10-K for the fiscal year ended December 31, 2011).
4.1	See Exhibits 3.1 — 3.4 for provisions in Independence Bancshares, Inc.’s Articles of Incorporation and Bylaws defining the rights of holders of the common stock.
4.2	Form of certificate of common stock (incorporated by reference to Exhibit 4.2 of the Company’s Form SB-2, File No. 333-121485).
4.3	Certificate of Designations of Preferred Stock, Series of the Company (incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K filed on May 15, 2015).
10.1	Amended and Restated Employment Agreement between Independence Bancshares, Inc. and Lawrence R. Miller dated December 10, 2008 (incorporated by reference to Exhibit 10.11 of the Company’s Form 10-K for the fiscal year ended December 31, 2008).*
10.2	Independence Bancshares, Inc. 2005 Stock Incentive Plan and Form of Option Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Form 10-QSB for the period ended June 30, 2005). *
10.3	Amendment No. 1 to the Independence Bancshares, Inc. 2005 Stock Incentive Plan (incorporated by reference to the Company’s Form 10-Q for the period ended September 30, 2008).*
10.4	Amendment to the Amended and Restated Employment Agreement by and among Independence Bancshares, Inc. and Lawrence R. Miller. (incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed on January 7, 2013).*
10.5	Amendment No. 2 to the Independence Bancshares, Inc. 2005 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on March 5, 2013).*
10.6	Independence Bancshares, Inc. 2013 Equity Incentive Plan (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on March 5, 2013).*
10.7	Form of Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed on March 5, 2013).*
10.8	Form of Stock Option Award Agreement (incorporated by reference to Exhibit 10.4 of the Company’s Form 8-K filed on March 5, 2013).*
10.9	Change in Control Agreement by and between Independence Bancshares, Inc. and Martha L. Long dated December 19, 2014 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on December 29, 2014). *
10.10	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on May 15, 2015).
10.11	Form of Registration Rights Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on May 15, 2015).
10.12	License Agreement between the Company and MPIB Holdings, LLC (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on May 15, 2015).

10.13	Form of Asset Purchase Agreement between the Company and MPIB Holdings, LLC (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on May 15, 2015).
10.14	Amended and Restated License Agreement between the Company and MPIB Holdings, LLC (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on January 5, 2016).
10.15	Severance and Release Agreement between the Company and Gordon A. Baird (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed on January 5, 2016). *
10.16	Second Amendment to the Amended and Restated Employment Agreement between Independence Bancshares, Inc., Independence National Bank, and Lawrence R. Miller, dated December 15, 2016 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on December 17, 2016).*
21.1	Subsidiaries of the Company.
23.1	Consent of Elliott Davis Decosimo, LLC.
24.1	Power of Attorney (filed as part of the signature page herewith).
31.1	Rule 13a-14(a) Certification of the Principal Executive Officer.
31.2	Rule 13a-14(a) Certification of the Principal Financial Officer.
32	Section 1350 Certifications of the Principal Executive Officer and Principal Financial Officer.
101	The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, formatted in eXtensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at December 31, 2016 and December 31, 2015, (ii) Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 2016 and 2015, (iii) Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2016 and 2015, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2015, and (iv) Notes to Consolidated Financial Statements.

 

* Management contract of compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K.