UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
Commission File Number 000-22787
FOUR OAKS FINCORP, INC.
(Exact name of registrant as specified in its charter)
North Carolina | 56-2028446 |
(State or other jurisdiction of | (IRS Employer Identification |
incorporation or organization) | Number) |
6114 U.S. 301 South | |
Four Oaks, North Carolina | 27524 |
(Address of principal executive offices) | (Zip Code) |
Registrant's telephone number, including area code: | (919) 963-2177 |
Securities registered under Section 12(b) of the Act: NONE
Securities registered under Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES o 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 o 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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES x NO o
Indicate by check mark whether disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
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Large accelerated filer o | Accelerated filer o |
Non-accelerated filer o (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): oYES xNO
$21,152,342
(Aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant
based on the price at which the registrant’s Common Stock, par value $1.00 per share
was sold on June 30, 2011)
7,684,740
(Number of shares of Common Stock, par value $1.00 per share, outstanding as of March 21, 2012)
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Forward Looking Information
Information set forth in this Annual Report on Form 10-K under the caption “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains various “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which statements represent our judgment concerning the future and are subject to business, economic and other risks and uncertainties, both known and unknown, that could cause our actual operating results and financial position to differ materially. Such forward looking statements can be identified by the use of forward looking terminology, such as “may,” “will,” “expect,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereof or comparable terminology.
We caution that any such forward looking statements are further qualified by important factors that could cause our actual operating results to differ materially from those in the forward looking statements, including, without limitation, our ability to comply with the Written Agreement (the “Written Agreement”) we entered with the Federal Reserve Bank of Richmond (the “FRB”) and the North Carolina Office of the Commissioner of Banks (the “NCCOB”) in May 2011, the effects of future economic conditions, governmental fiscal and monetary policies, legislative and regulatory changes, the risks of changes in interest rates on the level and composition of deposits, the effects of competition from other financial institutions, our ability to raise capital and continue as a going concern, the failure of assumptions underlying the establishment of the allowance for possible loan losses, our ability to maintain an effective internal control environment, the low trading volume of our common stock and the risks discussed in Item 1A. Risk Factors below.
Any forward looking statements contained in this Annual Report on Form 10-K are as of the date hereof and we undertake no duty to update them if our view changes later, except as required by law. These forward looking statements should not be relied upon as representing our view as of any date subsequent to the date hereof.
PART I
Item 1 - Business.
Four Oaks Bank & Trust Company (referred to herein as the “bank”) was incorporated under the laws of the State of North Carolina in 1912. On February 5, 1997, the bank formed Four Oaks Fincorp, Inc. (referred to herein as the “Company”; references herein to “we,” “us” and “our” refer to the Company and its consolidated subsidiaries, unless the context otherwise requires) for the purpose of serving as a holding company for the bank. Our corporate offices and banking offices are located in eastern and central North Carolina. We have no significant assets other than cash, the capital stock of the bank and its membership interest in Four Oaks Mortgage Services, L.L.C., as well as $1,241,000 in securities available for sale.
In addition, we have an interest in Four Oaks Statutory Trust I, a wholly owned Delaware statutory business trust (the “Trust”), for the sole purpose of issuing trust preferred securities. The Trust is not included in the consolidated financial statements of the Company.
The bank continues to remain a community-focused bank engaging in general commercial banking business to the communities we serve. The bank provides a full range of banking services, including such services as:
• | checking accounts; |
• | savings accounts; |
• | individual retirement accounts; |
• | NOW accounts; |
• | money market accounts; |
• | certificates of deposit; |
• | a student checking and savings program; |
• | e-statements; |
• | loans for businesses, agriculture, real estate, personal uses, home improvement and automobiles; |
• | consumer loans; |
• | overdraft privileges; |
• | Christmas club accounts; |
• | mortgage loans; |
• | equity lines of credit; |
• | credit cards; |
• | safe deposit boxes; |
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• | night depository; |
• | electronic funds transfer services, including wire transfers; |
• | Internet banking, bill pay services and mobile banking; |
• | telephone banking; |
• | gift cards; |
• | cashier’s checks; |
• | traveler’s check cards; |
• | merchant services |
◦ | ACH origination |
◦ | remote deposit capture |
◦ | ATM and VISA debit cards; |
• | financial services |
◦ | investment services |
◦ | wealth management |
◦ | financial planning |
◦ | insurance-life/long term care/annuities |
• | free notary services to all bank customers. |
We maintain a website at www.fouroaksbank.com where our periodic reports on Form 10-Q and 10-K and our current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available under “Investor Relations.” We are registered as a bank holding company with the Federal Reserve System. We are a state-chartered member of the Federal Reserve System and the FDIC insures the bank’s deposits up to applicable limits. Our corporate offices are located at 6114 US 301 South, Four Oaks, North Carolina, 27524. Our common stock is traded on the OTC Bulletin Board under the symbol “FOFN”.
Our market area is concentrated in eastern and central North Carolina. From its headquarters located in Four Oaks and its seventeen locations in Four Oaks, Clayton, Smithfield, Garner, Benson, Fuquay-Varina, Wallace, Holly Springs, Harrells, Sanford, Zebulon, Dunn, Rockingham, Southern Pines, and Raleigh, the bank serves a major portion of Johnston County, and parts of Wake, Harnett, Duplin, Sampson, Lee, Moore and Richmond counties. Johnston County is contiguous to Wake, Wayne, Wilson, Harnett, Sampson, and Nash counties. Wake County is contiguous to Johnston, Durham, Harnett, Nash, Franklin, Granville and Chatham counties. Sampson County is contiguous to Duplin, Pender, Bladen, Harnett, Cumberland, Johnston, and Wayne counties. Lee County is contiguous to Chatham, Moore and Harnett counties. Duplin County is contiguous to Pender, Sampson, Wayne, Lenoir, Jones and Onslow counties. Harnett County is contiguous to Cumberland, Moore, Lee, Chatham, Wake, Johnston and Sampson counties. Moore County is contiguous to Harnett, Lee, Chatham, Randolph, Montgomery, Richmond, Hoke, Cumberland and Scotland counties. Richmond County is contiguous to Anson, Stanley, Montgomery, Moore, Hoke and Scotland counties. We plan to close our Sanford office in Lee County on May 25, 2012.
Johnston County has a diverse economy and is not dependent on any one particular industry. The leading industries in the area include retail trade, manufacturing, pharmaceuticals, government, services, construction, wholesale trade and agriculture. The population for Johnston County in 2010 was estimated in excess of 170,000. As of June 2011, the bank ranked first in deposit market share for Johnston County at 33.70%.
In Four Oaks, the main office is located at 6144 US 301 South and an additional branch is located at 111 North Main Street. The bank also operates a branch office in Clayton at 102 East Main Street, two in Smithfield at 128 North Second Street, and 403 South Brightleaf Boulevard, one in Garner at 200 Glen Road, one in Raleigh at 1408 Garner Station Boulevard, one in Benson at 200 East Church Street, one in Fuquay-Varina at 325 North Judd Parkway Northeast, one in Wallace at 406 East Main Street, one in Holly Springs at 201 West Center Street, one in Harrells at 590 Tomahawk Highway, one in Sanford at 830 Spring Lane, one in Zebulon at 805 North Arendell Avenue, one in Dunn at 604-A Erwin Road, one in Rockingham at 1401 Fayetteville Road and one in Southern Pines at 105 Commerce Avenue.
The majority of the bank’s customers are individuals and small to medium-size businesses. The deposits and loans are well diversified with no material concentration in a single industry or group of related industries. There are no seasonal factors that would have any material adverse effect on the bank’s business, and the bank does not rely on foreign sources of funds or income.
On August 17, 2009, we entered into a joint venture with PrimeLending to provide mortgage lending services. Through this partnership, Four Oaks Mortgage Services, L.L.C., offers a competitive product line of secondary marketing-type mortgages.
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Amounts spent on research activities relating to the development or improvement of services has been immaterial over the past two years. At December 31, 2011, the bank employed 194 full time equivalent employees. Our employees are extremely important to our continued success and the bank considers its relationship with its employees to be good. Management continually seeks ways to improve upon their benefits and well being.
The following table sets forth certain of our financial data and ratios for the years ended December 31, 2011 and 2010 derived from our audited financial statements and notes. This information should be read in conjunction with and is qualified in its entirety by reference to the more detailed audited financial statements and notes thereto included in this report:
2011 | 2010 | |||||||
(In thousands, except ratios) | ||||||||
Net loss | $ | (9,090 | ) | $ | (28,291 | ) | ||
Average equity capital accounts | $ | 35,964 | $ | 66,050 | ||||
Ratio of net loss to average equity capital accounts | (25.28 | )% | (42.83 | )% | ||||
Average daily total deposits | $ | 762,575 | $ | 747,417 | ||||
Ratio of net loss to average daily total deposits | (1.19 | )% | (3.79 | )% | ||||
Average daily loans | $ | 651,944 | $ | 708,094 | ||||
Ratio of average daily loans to average daily total deposits | 85.49 | % | 94.74 | % |
Competition
Commercial banking in North Carolina is extremely competitive due in large part to North Carolina’s early adoption of statewide branching. As a result, many commercial banks have branches located in several communities. The bank competes in its market area with some of the largest banking organizations in the state and the country and other financial institutions, such as federally and state-chartered savings and loan institutions. At June 2011 we operated branches in Johnston, Wake, Sampson, Duplin, Lee, Harnett, Moore and Richmond counties, North Carolina. At that time in Johnston County, North Carolina, the bank’s primary market, there were a total of approximately $1.5 billion in deposits and 43 branches represented by the top thirteen financial institutions in the county based on deposit share, all commercial banks. The bank operated seven of the 43 branches with deposits of $498.0 million. The bank ranks first among the thirteen banks based on deposit share. Many of the bank’s competitors have broader geographic markets and higher lending limits than those of the bank and are also able to provide more services and make greater use of media advertising. Therefore, in our market area, the bank has significant competition for deposits and loans from other depository institutions. Other financial institutions such as credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit with varying degrees of regulatory restrictions also compete in our market area. Additionally, credit unions have been permitted to expand their membership criteria and expand their loan services to include traditional bank services such as commercial lending creating a greater competitive disadvantage to tax-paying financial institutions.
The enactment of legislation authorizing interstate banking has caused great increases in the size and financial resources of some of the bank’s competitors. See “Holding Company Regulation” below for a description of this legislation. In addition, as a result of interstate banking, out-of-state commercial banks may acquire North Carolina banks and heighten the competition among banks in North Carolina.
Although the competition in its market areas is expected to continue to be significant, the bank believes that it has certain competitive advantages that distinguish it from its competition. The bank believes that its primary competitive advantages are its strong local identity, its affiliation with the community and its emphasis on providing specialized services to small and medium-sized business enterprises, as well as professional and upper-income individuals. The bank offers customers modern, high-tech banking without forsaking community values such as prompt, personal service and friendliness. The bank offers many personalized services and attracts and retains customers by being responsive and sensitive to their individualized needs. The bank also relies on goodwill and referrals from our shareholders and the bank’s satisfied customers, as well as traditional media, to attract new customers. To enhance a positive image in the community, the bank supports and participates in local events and its officers and directors serve on boards of local civic and charitable organizations.
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Governmental Regulation
Holding companies, banks and many of their non-bank affiliates are extensively regulated under both federal and state law. The following is a brief summary of certain statutes, rules, and regulations affecting us and the bank. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and are not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company or bank. Supervision, regulation and examination of the Company and the bank by bank regulatory agencies is intended primarily for the protection of the bank’s depositors rather than the Company’s shareholders.
Holding Company Regulation
General. Four Oaks Fincorp, Inc. is a holding company registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (the “BHCA”). As such, we are subject to the supervision, examination and reporting requirements contained in the BHCA and the regulation of the Federal Reserve. The bank is also subject to the BHCA. The BHCA requires that a bank holding company obtain the prior approval of the Federal Reserve before (i) acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank, (ii) taking any action that causes a bank to become a subsidiary of the bank holding company, (iii) acquiring all or substantially all of the assets of any bank or (iv) merging or consolidating with any other bank holding company.
The BHCA generally prohibits a bank holding company, with certain exceptions, from engaging in activities other than banking, or managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be closely related to banking, or managing or controlling banks, as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. For example, banking, operating a thrift institution, extending credit or servicing loans, leasing real or personal property, providing securities brokerage services, providing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance underwriting activities have all been determined by regulations of the Federal Reserve to be permissible activities.
Pursuant to delegated authority, the FRB has authority to approve certain activities of holding companies within its district, including us, provided the nature of the activity has been approved by the Federal Reserve. Despite prior approval, the Federal Reserve has the power to order a holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it believes that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company.
Effective December 2, 2009, we have elected to become a bank holding company, and therefore we are not subject to the financial holding company regulatory framework under the Gramm-Leach-Bliley Act (“GLBA”). However, the additional customer privacy protections introduced by the GLBA do apply to us and the bank. The GLBA’s privacy provisions require financial institutions to, among other things: (i) establish and annually disclose a privacy policy, (ii) give consumers the right to opt out of disclosures to nonaffiliated third parties, with certain exceptions, (iii) refuse to disclose consumer account information to third-party marketers and (iv) follow regulatory standards to protect the security and confidentiality of consumer information.
Pursuant to the GLBA’s rulemaking provisions, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the FDIC, and the Office of Thrift Supervision adopted regulations, establishing standards for safeguarding customer information. Such regulations provide financial institutions guidance in establishing and implementing administrative, technical, and physical safeguards to protect the security, confidentiality, and integrity of customer information.
Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “IBBEA”) permits interstate acquisitions of banks and bank holding companies without geographic limitation, subject to any state requirement that the bank has been organized for a minimum period of time, not to exceed five years, and the requirement that the bank holding company, prior to or following the proposed acquisition, controls no more than 10% of the total amount of deposits of insured depository institutions in the U.S. and no more than 30% of such deposits in any state (or such lesser or greater amount set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another state as long as neither of the states has opted out of the IBBEA prior to May 31, 1997. In 1995, the State of North Carolina “opted in” to such legislation. In addition, a bank may establish and operate a de novo branch in a state in which the bank does not maintain a branch if that state expressly permits de
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novo interstate branching. As a result of North Carolina having opted-in, unrestricted interstate de novo branching is permitted in North Carolina.
Additional Restrictions and Oversight. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve on any extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or securities thereof and the acceptance of such stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. An example of a prohibited tie-in would be any arrangement that would condition the provision or cost of services on a customer obtaining additional services from the bank holding company or any of its other subsidiaries.
The Federal Reserve may issue cease and desist orders against bank holding companies and non-bank subsidiaries to stop actions believed to present a serious threat to a subsidiary bank. The Federal Reserve also regulates certain debt obligations, changes in control of bank holding companies and capital requirements.
Under the provisions of North Carolina law, we are registered with and subject to supervision by the North Carolina Commissioner of Banks.
Capital Requirements. The Federal Reserve has established risk-based capital guidelines for bank holding companies and state member banks. The minimum standard for the ratio of capital to risk-weighted assets (including certain off balance sheet obligations, such as standby letters of credit) is 8%. At least half of this capital must consist of common equity, retained earnings and a limited amount of perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill items and certain other items (“Tier 1 capital”). The remainder (“Tier 2 capital”) may consist of mandatory convertible debt securities and a limited amount of other preferred stock, subordinated debt and loan loss reserves.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets less certain amounts (“Leverage Ratio”) equal to three percent for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a Leverage Ratio of between four percent and five percent.
The guidelines also provide that bank holding companies experiencing significant growth, whether through internal expansion or acquisitions, will be expected to maintain strong capital ratios well above the minimum supervisory levels without significant reliance on intangible assets. The same heightened requirements apply to bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as to other banking institutions if warranted by particular circumstances or the institution's risk profile. Furthermore, the guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 Leverage Ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve has not advised us of any specific minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable to us.
As of December 31, 2011, we had Tier 1 risk-adjusted, total regulatory capital and leverage capital of approximately 7.0%, 10.3% and 4.4%, respectively.
Dividends. During 2011, we paid no cash dividends on our common stock. Under the terms of the Written Agreement, neither the Company nor the bank may pay cash dividends on common stock without the prior approval of the FRB. In general, our ability to pay cash dividends is dependent in part upon the amount of dividends paid to us by the bank. No dividends were paid to us by the bank during 2011. The ability of the bank to pay dividends to us is subject to statutory and regulatory restrictions on the payment of cash dividends, including the requirement under the North Carolina banking laws that cash dividends be paid only out of undivided profits and only if the bank has surplus of a specified level. In the past, we have received cash dividends from our bank and may continue to do so from time to time in the future as necessary for cash flow purposes. Also, applicable federal banking law contains additional limitations and restrictions on the payment of dividends by a bank holding company. Accordingly, shareholders receive dividends from us only to the extent that funds are available from our operations or the bank. In addition, the Federal Reserve generally prohibits bank holding companies from paying dividends except out of operating earnings, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. At present, the Company does not have a sufficient level of retained earnings to pay cash dividends on its common stock.
USA Patriot Act of 2001. Title III of the USA Patriot Act of 2001 contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “IMLAFA”). The anti-money laundering provisions of IMLAFA impose affirmative obligations on a broad range of financial institutions, including banks, brokers, and dealers. Among other requirements, IMLAFA
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requires all financial institutions to establish anti-money laundering programs that include, at minimum, internal policies, procedures, and controls; specific designation of an anti-money laundering compliance officer; ongoing employee training programs; and an independent audit function to test the anti-money laundering program. IMLAFA requires financial institutions that establish, maintain, administer, or manage private banking accounts for non-United States persons or their representatives to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering. Additionally, IMLAFA provides for the Department of Treasury to issue minimum standards with respect to customer identification at the time new accounts are opened. As of the date of this filing, we believe that IMLAFA has not had a material impact on the bank’s operations. The bank has established policies and procedures to ensure compliance with the IMLAFA, which are overseen by an Anti-Money Laundering Officer who was appointed by our Board of Directors.
Dodd-Frank Act. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was intended primarily to overhaul the financial regulatory framework following the global financial crisis and impacts all financial institutions including our holding company and the bank. The Dodd-Frank Act contains significant regulatory and compliance changes, including, among other things.
• | enhanced authority over troubled and failing banks and their holding companies; |
• | increased capital and liquidity requirements; |
• | increased regulatory examination fees; and |
• | specific provisions designed to improve supervision and safety and soundness by imposing restrictions and limitations |
on the scope and type of banking and financial activities.
In addition, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system that will be enforced by new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the FRB, the Office of Comptroller of the Currency, the FDIC, and the Consumer Financial Protection Bureau. The Dodd-Frank Act requires the various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act are not yet known and may not be known for many months or years. However, a few changes pursuant to the Dodd-Frank Act that may have an impact on us include, but are not limited to,
• | elimination of the federal law prohibition on the payment of interest on commercial demand deposit accounts; |
• | expansion of the assessment base for determining deposit insurance premiums to include liabilities other than just deposits; |
• | new regulations regarding debit card fees; |
• | potentially heightened capital standards; |
• | increased requirements and limitations with respect to transactions with affiliates and insiders; and |
• | enhanced corporate governance and executive compensation requirements. |
Bank Regulation
The bank is subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and is supervised and examined by the North Carolina Commissioner of Banks and the Federal Reserve. The Federal Reserve and the North Carolina Commissioner of Banks regularly examine the operations of banks over which they exercise jurisdiction. They have the authority to approve or disapprove the establishment of branches, mergers, consolidations, and other similar corporate actions, and to prevent the continuance or development of unsafe or unsound banking practices and other violations of law. The Federal Reserve and the North Carolina Commissioner of Banks regulate and monitor all areas of the operations of banks and their subsidiaries, including loans, mortgages, issuances of securities, capital adequacy, loss reserves, and compliance with the Community Reinvestment Act of 1977 (the “CRA”), as well as other laws and regulations. Interest and certain other charges collected and contracted for by banks are also subject to state usury laws and certain federal laws concerning interest rates.
The deposit accounts of the bank are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to a maximum of $250,000 per insured depositor, with the exception of non-interest bearing accounts, which are 100% FDIC insured from December 31, 2010 through December 31, 2012. Any insured bank that is not operated in accordance with or does not conform to FDIC regulations, policies, and directives may be sanctioned for noncompliance. Civil and criminal proceedings may be instituted against any insured bank or any director, officer or employee of such bank for the violation of applicable laws and regulations, breaches of fiduciary duties or engaging in any unsafe or unsound practice. The FDIC has the authority to terminate insurance of accounts pursuant to procedures established for that purpose.
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Under the North Carolina Business Corporation Act, the bank may not pay a dividend or distribution, if after giving it, the effect would be that the bank would not be able to pay its debts as they become due in the usual course of business or its total assets would be less than its liabilities. North Carolina banking law requires that cash dividends be paid out of undivided profits determined pursuant to North Carolina General Statutes Section 53-87.The Federal Reserve also imposes limits on the bank's payment of dividends. All dividends paid by the bank are paid to us, the sole shareholder of the bank. The amount of future dividends paid to us by the bank will in general be a function of the profitability of the bank, which cannot be accurately estimated or assured. Under the terms of the Written Agreement, the bank is prohibited from paying dividends to us without the prior written approval of the FRB and the NCCOB. The bank did not pay dividends to us during 2011, and until the Written Agreement is terminated, the bank’s ability to pay dividends to us will be restricted.
The bank is subject to insurance assessments imposed by the FDIC. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 and further amended by the Dodd-Frank Act.
Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. Effective April 1, 2011, the FDIC implemented a revised assessment rate calculator, which is based on a number of elements to measure the risk each institution poses to the DIF. The new assessment rate is applied to average consolidated total assets minus average tangible equity, as defined under the Dodd-Frank Act. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. The Dodd-Frank Act also changed the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) provides for, among other things, (i) publicly available annual financial condition and management reports for certain financial institutions, including audits by independent accountants, (ii) the establishment of uniform accounting standards by federal banking agencies, (iii) the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with greater scrutiny and restrictions placed on depository institutions with lower levels of capital, (iv) additional grounds for the appointment of a conservator or receiver and (v) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements. FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity. Institutions that fail to comply with capital or other standards are restricted in the scope of permissible activities and are subject to enforcement action by the federal banking agencies.
At December 31, 2011, the bank had Tier 1 risk-adjusted, total regulatory capital and leverage capital of approximately 8.5%, 9.8% and 5.4%, respectively, in excess of the minimum requirements to be considered adequately capitalized under prompt corrective action provisions. Since the bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on interest rates paid on deposits of comparable size and maturity in the bank’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 the bank’s normal market area. With respect to non-brokered deposits, as an adequately capitalized institution, the bank cannot offer interest rates that are significantly higher than the prevailing rates in its normal market area. Moreover, if the bank becomes less than adequately capitalized, it will be subject to additional interest restrictions and must adopt a capital restoration plan acceptable to the FDIC. The bank also would become subject to increased regulatory oversight and enforcement action and would be increasingly restricted in the scope of its permissible activities. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution.
Banks are also subject to the CRA, which requires the appropriate federal bank regulatory agency, in connection with its examination of a bank, to assess such bank's record in meeting the credit needs of the community served by that bank, including low and moderate-income neighborhoods. Each institution is assigned one of the following four ratings of its record in meeting community credit needs: “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank which has applied to (i) charter a national bank, (ii) obtain deposit insurance coverage for a newly chartered institution, (iii) establish a new branch
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office that will accept deposits, (iv) relocate an office or (v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application.
In addition, the GLBA’s “CRA Sunshine Requirements” call for financial institutions to disclose publicly certain written agreements made in fulfillment of the CRA. Banks that are parties to such agreements also must report to federal regulators the amount and use of any funds expended under such agreements on an annual basis, along with such other information as regulators may require. This annual reporting requirement is effective for any agreements made after May 12, 2000.
Written Agreement
In late May 2011, the Company and the bank entered into the Written Agreement with the FRB and the NCCOB. Under the terms of the Written Agreement, the Bank developed and submitted for approval, within the time periods specified, plans to:
• | revise lending and credit administration policies and procedures at the Bank and provide relevant training; |
• | enhance the Bank's real estate appraisal policies and procedures; |
• | enhance the Bank's loan grading and independent loan review programs; |
• | improve the Bank's position with respect to loans, relationships, or other assets in excess of $750,000, which are now or in the future become past due more than 90 days, are on the Bank's problem loan list, or adversely classified in any report of examination of the Bank; and |
• | review and revise the Bank's current policy regarding the Bank's allowance for loan and lease losses and maintain a program for the maintenance of an adequate allowance. |
In addition, the Bank has agreed that it will:
• | refrain from extending, renewing, or restructuring any credit to or for the benefit of any borrower, or related interest, whose loans or other extensions of credit have been criticized in any report of examination of the Bank absent prior approval by the Bank's board of directors or a designated committee of the board in accordance with the restrictions in the Written Agreement; |
• | eliminate from its books, by charge-off or collection, all assets or portions of assets classified as “loss” in any report of examination of the Bank, unless otherwise approved by the FRB and the NCCOB; and |
• | take all necessary steps to correct all violations of law or regulation cited by the FRB and the NCCOB. |
In addition, the Company has agreed that it will:
• | refrain from taking any form of payment representing a reduction in capital from the Bank or make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities absent prior regulatory approval; |
• | refrain from incurring, increasing, or guaranteeing any debt without the prior written approval of the FRB; and |
• | refrain from purchasing or redeeming any shares of its stock without the prior written consent of the FRB. |
Under the terms of the Written Agreement, both the Company and the Bank have agreed to:
• | submit for approval a joint plan to maintain sufficient capital at the Company on a consolidated basis and at the Bank on a stand-alone basis; |
• | notify the FRB and the NCCOB if the Company's or the Bank's capital ratios fall below the approved capital plan's minimum ratios; |
• | refrain from declaring or paying any dividends absent prior regulatory approval; |
• | comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers of the Company and the Bank and legal and regulatory limitations on indemnification and severance payments; and |
• | submit annual business plans and budgets and quarterly joint written progress reports regarding compliance with the Written Agreement. |
The Company is committed to expeditiously addressing and resolving the issues raised in the Written Agreement. As such, the Board of Directors has established an Enforcement Action Committee that meets regularly to monitor the Bank's progress on compliance with the Written Agreement. The Bank has made progress on multiple provisions included in the Written Agreement and continues to aggressively work to implement any necessary changes to policies and procedures. Several control changes have
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been implemented to address the financial reporting material weaknesses, identified as of December 31, 2010, of identification and valuation of impaired loans, the support and validation of the allowance for loan losses, and the valuation of foreclosed assets. Additionally, the Bank has implemented additional controls around obtaining updated collateral valuations as required by regulation and has established new policies to further reduce Commercial Real Estate concentrations, ensure current financial information is evaluated, and control interest only loans. Other areas also being addressed are the adequacy of credit resources, portfolio risk management and reporting,and consistency and compliance when dealing with loan workouts. A material failure to comply with the terms of the Written Agreement could subject the Company to additional regulatory actions and further restrictions on its business. These regulatory actions and resulting restrictions on the Company's business may have a material adverse effect on its future results of operations and financial condition.
Since the Company and the bank entered the Written Agreement, management has had frequent and regular communication with the FRB and NCCOB. This communication has involved:
• | Updates on the progress involving each of the actions outlined in the Written Agreement: |
• | Specific steps taken by the Company to remain in compliance with the Written Agreement: and |
• | Communications, verbally and via interim internal reports, regarding the financial status of the Company including, but not limited to, the Company's key capital ratios. |
To date, the Company has not received any disagreement from the regulatory authorities regarding actions taken or contemplated. Nor has the Company received any indication that additional measures are required beyond those contained in the Written Agreement. Despite the actions taken thus far, there is no assurance that additional measures or actions will not be required by the regulatory authorities in the future.
Monetary Policy and Economic Controls
Both the Company and the bank are directly affected by governmental policies and regulatory measures affecting the banking industry in general. Of primary importance is the Federal Reserve Board, whose actions directly affect the money supply which, in turn, affects banks’ lending abilities by increasing or decreasing the cost and availability of funds to banks. The Federal Reserve Board regulates the availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in United States government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against bank deposits, and limitations on interest rates that banks may pay on time and savings deposits.
Deregulation of interest rates paid by banks on deposits and the types of deposits that may be offered by banks have eliminated minimum balance requirements and rate ceilings on various types of time deposit accounts. The effect of these specific actions and, in general, the deregulation of deposit interest rates has generally increased banks’ cost of funds and made them more sensitive to fluctuations in money market rates. In view of the changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, or loan demand on our business and earnings or those of the bank. As a result, banks, including the bank, face a significant challenge to maintain acceptable net interest margins.
Item 1A. Risk Factors
Our results are impacted by the economic conditions of our principal operating regions.
The majority of our customers are individuals and small to medium-size businesses located in North Carolina’s Johnston, Wake, Duplin, Sampson, Harnett, Lee, Moore and Richmond counties and surrounding areas. As a result of this geographic concentration, our results may correlate to the economic conditions in these areas. Declines in these markets’ economic conditions may adversely affect the quality of our loan portfolio and the demand for our products and services, and accordingly, our results of operations.
We are exposed to risks in connection with the loans we make.
A significant source of risk for us arises from the possibility that loan losses will be sustained because borrowers, guarantors, and related parties fail to perform in accordance with the terms of their loans. Our policy dictates that we maintain an allowance for loan losses. The amount of the allowance is based on management’s evaluation of our loan portfolio, the financial condition of the borrowers, current economic conditions, past and expected loan loss experience, and other factors management
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deems appropriate. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations.
If the value of real estate in our core market areas were to decline materially, a significant portion of our loan portfolio could become undercollateralized, which could have a material adverse effect on us. With most of our loans concentrated in the Coastal Plain region of North Carolina, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. In addition to the financial strength and cash flow characteristics of the borrower in each case, the bank often secures loans with real estate collateral. At December 31, 2011, approximately 91.0% of the bank's 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. 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.
Our real estate and land acquisition and development loans are based upon estimates of costs and the value of the complete project.
We extend real estate land loans, construction loans, and acquisition and development loans to builders and developers, primarily for the construction/development of properties. We originate these loans on a presold and speculative basis and they include loans for both residential and commercial purposes. At December 31, 2011, our loan portfolio was comprised of $548.2 million of real estate loans, including land acquisition and development loans, or 91.0% of total loans.
In general, construction and land lending involves additional risks because of the inherent difficulty in estimating a property’s value both before and at completion of the project. Construction costs may exceed original estimates as a result of increased materials, labor, or other costs. In addition, because of current uncertainties in the residential and commercial real estate markets, property values have become more difficult to determine than they have been historically. Construction and land acquisition and development loans often involve the repayment dependent, in part, on the ability of the borrower to sell or lease the property. These loans also require ongoing monitoring. In addition, speculative construction loans to a residential builder are often associated with homes that are not presold, and thus pose a greater potential risk than construction loans to individuals on their personal residences. At December 31, 2011, $27.5 million of our residential construction loans were for speculative construction loans. Slowing housing sales have been a contributing factor to an increase in nonperforming loans as well as an increase in delinquencies. Residential construction loans and commercial construction loans represented 2.4% and 49.1%, respectively, of our nonperforming assets at December 31, 2011.
Our non-owner occupied commercial real estate loans may be dependent on factors outside the control of our borrowers.
We originate non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. This may be adversely affected by changes in the economy or local market conditions. Non-owner occupied commercial real estate loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. If we foreclose on a non-owner occupied commercial real estate loan, our holding period for the collateral typically is longer than a 1-4 family residential property because there are fewer potential purchasers of the collateral. Additionally, non-owner occupied commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on non-owner occupied commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
As of December 31, 2011, our non-owner occupied commercial real estate loans totaled $99.2 million, or 15.2% of our total loan portfolio.
A portion of our commercial real estate loan portfolio utilizes interest reserves which may not accurately portray the financial condition of the project and the borrower’s ability to repay the loan.
Some of our commercial real estate loans utilize interest reserves to fund the interest payments and are funded from loan proceeds. Our decision to establish a loan-funded interest reserve upon origination of a loan is based on the feasibility of the project, the creditworthiness of the borrower and guarantors and the protection provided by the real estate and other collateral. When applied appropriately, an interest reserve can benefit both the lender and the borrower. For the lender, an interest reserve provides an effective means for addressing the cash flow characteristics of a properly underwritten acquisition, development and construction (“ADC”) loan. Similarly, for the borrower, interest reserves provide the funds to service the debt until the property
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is developed, and cash flow is generated from the sale or lease of the developed property.
Although potentially beneficial to the lender and the borrower, our use of interest reserves carries certain risks. Of particular concern is the possibility that an interest reserve may not accurately reflect problems with a borrower’s willingness or ability to repay the debt consistent with the terms and conditions of the loan obligation. For example, a project that is not completed in a timely manner or falters once completed may appear to perform if the interest reserve keeps the loan current.
In some cases, we may extend, renew, or restructure the term of certain loans, providing additional interest reserves to keep the loan current. As a result, the financial condition of the project may not be apparent and developing problems may not be addressed in a timely manner. Consequently, we may end up with a matured loan where the interest reserve has been fully advanced, and the borrower’s financial condition has deteriorated. In addition, the project may not be complete, its sale or lease-up may not be sufficient to ensure timely repayment of the debt or the value of the collateral may have declined, exposing us to increasing credit losses. As of December 31, 2011, our commercial real estate loans with interest reserves totaled $13.9 million or 2.3% of our total loan portfolio.
We compete with larger companies for business.
Commercial banking in North Carolina is extremely competitive due in large part to North Carolina’s early adoption of statewide branching. The bank competes in the North Carolina market area with some of the largest banking organizations in the state and the country and other financial institutions, such as federally and state-chartered savings and loan institutions and credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of these competitors have broader geographic markets, higher lending limits, more services, and more media advertising. We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition.
We are exposed to certain market risks.
Like most financial institutions, our most significant market risk exposure is the risk of economic loss resulting from adverse changes in market prices and interest rates. Our market risk stems primarily from interest rate risk inherent in our lending and deposit-taking activities. Our policy allows that we may maintain derivative financial instruments, such as interest rate swap agreements, to manage such risk.
U.S. and international credit markets and economic conditions could affect the Company’s liquidity and financial condition.
Global market and economic conditions continue to be disruptive and volatile and the disruption has particularly had a negative impact on the financial sector. The duration and severity of the continued effects of the recent financial crisis are still unknown. The cost and availability of funds to the Company has been adversely affected by illiquid credit markets. Continued turbulence in U.S. and international markets and economies may continue to adversely affect the Company’s liquidity, financial condition, and profitability.
We may not be able to continue without additional capital to fund our operations, and an inability to improve our regulatory capital position could adversely affect our operations.
Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. During 2011, we experienced continued loan losses, increases to our reserves and declining capital levels. However, management believes that our current operations and cash availability are sufficient for us to discharge our liabilities and meet our commitments in the normal course of business. While management does not anticipate further deterioration in the bank’s loan portfolio and has performed stress tests and financial modeling under various potential scenarios in determining that we and the bank will maintain at least adequate capitalization under federal regulatory guidelines, no assurances regarding these expectations can be made. If we are unable to become profitable and cannot generate cash flow from our operating activities, we may be required to raise additional capital or debt to fund our operations. Such financing may be unavailable when needed or may not be available on acceptable terms.
At December 31, 2011, the bank was classified as “adequately capitalized” for regulatory capital purposes. Until the bank becomes “well capitalized” for regulatory capital purposes, we cannot renew or accept brokered deposits without prior regulatory approval and we may not offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area. As a result, it may be more difficult for us to attract new deposits, as our existing brokered deposits mature and do not rollover, and to retain or increase non-brokered deposits. If we are not able to attract new deposits, our ability to fund our growth may be adversely affected.
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In order for the Company and the Bank to become “well capitalized” under federal banking agencies’ guidelines, management believes that we will need to raise additional capital to absorb the potential future credit losses associated with the disposition of our nonperforming assets. Management is in the process of evaluating various alternatives to increase tangible common equity and regulatory capital through the issuance of additional equity in public or private offerings. We are also working to reduce our balance sheet to improve capital ratios and actively evaluating a number of capital sources, asset reductions and other balance sheet management strategies to ensure that the projected level of regulatory capital can support our balance sheet long-term. There can be no assurance as to whether these efforts will be successful, either on a short-term or long-term basis. Should these efforts be unsuccessful, we may be unable to discharge our liabilities in the normal course of business. There can be no assurance that we will be successful in any efforts to raise additional capital during 2012.
Technological advances impact our business.
The banking industry undergoes frequent technological changes with introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors, however, have substantially greater resources to invest in technological improvements.
Legislative and regulatory actions taken now or in the future to address the liquidity and credit crisis in the financial industry may significantly affect our liquidity and financial condition.
The Federal Reserve, U.S. Congress, the U.S. Treasury Department, the FDIC and others have taken numerous actions to address the liquidity and credit situation in the financial markets. These measures include actions to encourage loan restructuring and modification for homeowners, the establishment of significant liquidity and credit facilities for financial institutions and investment banks, and coordinated efforts to address liquidity and other weaknesses in the banking sector.
On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which was intended primarily to overhaul the financial regulatory framework following the global financial crisis and impacts all financial institutions including our holding company and the bank. The Dodd-Frank Act contains significant regulatory and compliance changes, including, among other things,
• | enhanced authority over troubled and failing banks and their holding companies; |
• | increased capital and liquidity requirements; |
• | increased regulatory examination fees; and |
• | specific provisions designed to improve supervision and safety and soundness by imposing restrictions and limitations on the scope and type of banking and financial activities. |
The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act are not yet known and may not be known for many months or years. While many of the provisions in the Dodd-Frank Act are aimed at financial institutions significantly larger than us, it will likely increase our regulatory compliance burden and may have a material adverse effect on us, including by increasing the costs associated with our regulatory examinations and compliance measures. However, it is too early for us to fully assess the impact of the Dodd-Frank Act and subsequent regulatory rulemaking processes on our business, financial condition, or results of operations.
Further, the U.S. Congress and state legislatures and federal and state regulatory authorities continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including interpretation and implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer or increasing the ability of non-banks to offer competing financial services and products. While we cannot predict the regulatory changes that may be borne out of the recent economic crisis, and we cannot predict the extent to which we will become subject to increased regulatory scrutiny by any of these regulatory agencies, any regulatory changes or scrutiny could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations, and other institutions. We cannot predict whether additional legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
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We are subject to examination and scrutiny by a number of regulatory authorities, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations, or financial position pursuant to the terms of formal or informal regulatory orders, including our current Written Agreement with the Federal Reserve Bank of Richmond and the North Carolina Office of the Commissioner of Banks.
We are subject to examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions, and requirements on us and our banking subsidiaries if they determine, upon conclusion of their examination or otherwise, violations of laws with which we or our subsidiaries must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, cease and desist orders, civil money penalties and termination of deposit insurance and bank closures. Enforcement actions may be taken regardless of the capital levels of the institutions, and regardless of prior examination findings.
In late May 2011, the Company and the bank entered into the Written Agreement with the FRB and the NCCOB. The Written Agreement requires the Company and the bank to take certain actions, including, among other things, strengthening credit risk management practices at the bank; enhancing the bank’s policies and procedures related to lending, credit administration, real estate appraisals, loan review, and allowance for loan and lease losses; improving the bank’s position with respect to past due loans, classified loans, and foreclosed assets; and improving capital at the Company on a consolidated basis and at the bank on a stand-alone basis. The Company and the bank are also restricted from taking certain actions, including the payment of dividends as discussed below. Compliance with the Written Agreement’s provisions has caused the Company and the bank to incur higher expenses in connection with such compliance.
We are committed to expeditiously addressing and resolving the issues raised in the Written Agreement. As such, the Board of Directors has established an Enforcement Action Committee that meets regularly to monitor the Bank's progress on compliance with the Written Agreement. The Bank has made progress on multiple provisions included in the Written Agreement and continues to aggressively work to implement any necessary changes to policies and procedures. Several control changes have been implemented to address the financial reporting material weaknesses, identified as of December 31, 2010. of identification and valuation of impaired loans, the support and validation of the allowance for loan losses, and the valuation of foreclosed assets. Additionally, the Bank has implemented additional controls around obtaining updated collateral valuations as required by regulation and has established new policies to further reduce Commercial Real Estate concentrations, ensure current financial information is evaluated, and control interest only loans. Other areas also being addressed are the adequacy of credit resources, portfolio risk management and reporting,and consistency and compliance when dealing with loan workouts. There can be no assurance that the terms and conditions of the Written Agreement will be met or that the impact or effect of such terms and conditions will not have a material adverse effect on our financial condition, results of operations and future prospects. A material failure to comply with the terms of the Written Agreement could subject the Company and the bank to additional regulatory actions and further restrictions on our business. The Company and the bank cannot determine whether or when the Written Agreement will be terminated. Even if the Written Agreement is terminated, in whole or in part, the Company and the bank may remain subject to supervisory enforcement actions that restrict their activities.
Our ability to pay dividends and interest on our outstanding securities is currently restricted.
We have not paid any cash dividends on our common stock since we suspended dividends in the fourth quarter of 2010, and we do not expect to resume paying cash dividends on our common stock for the foreseeable future. In order to preserve capital, in January 2011, we also exercised our right to defer regularly scheduled interest payments on our outstanding subordinated debentures issued in connection with our Trust Preferred Securities. Pursuant to the terms of the indenture governing the subordinated debentures, we may not pay any cash dividends on our common stock until we are current on interest payments on such subordinated debentures. In addition, under the terms of the Written Agreement, we may not pay cash dividends on our common stock or interest on our subordinated debentures or subordinated promissory notes without the prior approval of the FRB. Accordingly, our ability to pay dividends to our shareholders and interest on our subordinated debentures and subordinated promissory notes will be restricted until the Written Agreement is terminated. As a bank holding company, our ability to declare and pay dividends also depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.
We depend on dividends from the bank to meet our cash obligations, but the Written Agreement prohibits payment of
such dividends without prior regulatory approval, which may affect our ability to pay our obligations and dividends.
We are a separate legal entity from the bank, and we do not have significant operations of our own. We have historically depended on the bank’s cash and liquidity as well as dividends to pay our operating expenses. However, the Written Agreement
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prohibits the bank from paying dividends to us without the prior written approval of the FRB and the NCCOB. Accordingly, our ability to receive dividends from the bank will be restricted until the Written Agreement is terminated. In addition, various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. The bank is also subject to limitations under state law regarding the payment of dividends, including the requirement that dividends may be paid only out of undivided profits and only if the bank has surplus of a specified level. In addition to these explicit limitations, it is possible, depending upon the financial condition of the bank and other factors, that the federal and state regulatory agencies could take the position that payment of dividends by the bank would constitute an unsafe or unsound banking practice. Without the payment of dividends from the bank, we may not be able to service our obligations as they become due or to pay dividends on our common stock. Consequently, the inability to receive dividends from the bank could adversely affect our financial condition, results of operations, cash flows and prospects.
Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely
affect our operations.
Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. We are subject to supervision and a periodic examination by the Federal Reserve Bank and the North Carolina State Banking Commission. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to you, our investors, by restricting certain of our activities, such as:
• | payment of dividends to our shareholders; |
• | possible mergers with or acquisitions of or by other institutions; |
• | our desired investments; |
• | loans and interest rates on loans; |
• | payment of interest, interest rates on deposits; |
• | the possible expansion of branch offices; and/or |
• | our ability to make other financial services available. |
We also are subject to capitalization guidelines set forth in federal regulations, and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized. Because our business is highly regulated, the laws and applicable regulations are subject to frequent change. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. The cost of compliance with regulatory requirements including those imposed by the Securities and Exchange Commission (the “SEC”) may adversely affect our ability to operate profitably.
We depend heavily on our key management personnel.
Our success depends in part on our ability to retain key executives and to attract and retain additional qualified management personnel who have experience both in sophisticated banking matters and in operating a small to mid-size bank. Competition for such personnel is strong in the banking industry and we may not be successful in attracting or retaining the personnel we require. We expect to compete effectively in this area by offering competitive financial packages that include incentive-based compensation.
If we fail to evaluate, implement, and integrate strategic opportunities or maximize potential capital raising opportunities successfully, our business may suffer.
From time to time we evaluate strategic opportunities available to us for product, technology, or business acquisitions or dispositions and possible capital raising opportunities. If we choose to make acquisitions or dispositions or raise significant capital that may result in a change in control, we face certain risks, such as failure of an acquired business to meet our performance expectations, diversion of management attention, retention of existing customers of our current and acquired business, and difficulty in integrating or separating a business’s operations, personnel, and financial and operating systems. We may not be able to successfully address these risks or any other problems that arise from future acquisitions, dispositions, or change in control investments. Any failure to successfully evaluate strategic or capital raising opportunities and address risks or other problems that may arise from such transactions could adversely affect our business, results of operations and financial condition.
Our allowance for probable loan losses may be insufficient.
We maintain an allowance for probable loan losses, which is a reserve established through a provision for probable loan losses charged to expense. This allowance represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry
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concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for probable loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates and assumptions regarding current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside our control, may require an increase in the allowance for probable loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for probable 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 probable loan losses; we will need additional provisions to increase the allowance for probable loan losses. Any increases in the allowance for probable 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. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes A and C to our consolidated financial statements presented under Item 8 of Part II of this Form 10-K, for further discussion related to our process for determining the appropriate level of the allowance for probable loan losses.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.
Our controls and procedures may fail or be circumvented.
Management regularly reviews and updates 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.
The holders of our subordinated debentures and subordinated promissory notes have rights that are senior to those of our shareholders.
We have issued $12.0 million of subordinated debentures in connection with a trust preferred securities (“Trust Preferred Securities”) issuance by our subsidiary, the Trust and $12.0 million aggregate principal amount of subordinated promissory notes. We unconditionally guarantee payments of the principal and interest on the trust preferred securities. Our subordinated debentures and subordinated promissory notes are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures (and the related trust preferred securities) and subordinated promissory notes before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution or liquidation, the holders of the debentures and promissory notes must be satisfied before any distributions can be made to the holders of common stock.
We have the right to defer payment of interest on our subordinated debentures at any time and from time to time for a period not exceeding five years, provided that no deferral period extends beyond the stated maturities of the subordinated debentures. In January 2011, we elected to defer the regularly scheduled interest payments on the subordinated debentures. Such deferral of interest payments by us will result in a deferral of distribution payments on the related trust preferred securities. We may not pay any cash dividends on our common stock until we are current on payments on the Trust Preferred Securities. In addition, we are currently prohibited by the Written Agreement from paying interest on our subordinated debentures in connection with our Trust Preferred Securities and on our subordinated promissory notes without prior approval of the supervisory authorities. We obtained approval to pay the interest on our subordinated promissory notes for the second, third and fourth quarters of 2011. We cannot predict whether or when the Written Agreement will be terminated or when we will cease deferring interest payments on the subordinated debentures.
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Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business. The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have 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 we can prevent any such failures, interruptions or security breaches 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 financial condition and results of operations.
An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.
Our common stock is thinly traded.
Our common stock is traded on the OTC Bulletin Board. There can be no assurance, however, that an active trading market for our common stock will develop or be sustained in the future. Our common stock is thinly traded and has substantially less liquidity than the average trading market for many other publicly traded companies. Thinly traded stocks can be more volatile than stock trading in an active public market. Our stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to changes in analysts’ recommendations or projections, our announcement of developments related to our business, operations, and stock performance of other companies deemed to be peers, news reports of trends, concerns, irrational exuberance on the part of investors and other issues related to the financial services industry. Recently, the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies, including those in the financial services sector, have experienced wide price fluctuations that have not necessarily been related to operating performance. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector of the economy, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Therefore, our shareholders may not be able to sell their shares at the volume, prices, or times that they desire.
As part of our capital raising efforts, we may issue additional shares of common stock or convertible securities that would dilute the percentage ownership interest of existing shareholders and may dilute the book value per share of common stock and adversely affect the terms on which we may obtain additional capital.
Our authorized capital includes 20,000,000 shares of common stock. As of December 31, 2011, we had 7,663,387 shares of common stock outstanding and had 337,106 shares of underlying options that are or may become exercisable at a weighted average exercise price of $10.11 per share. In addition, as of December 31, 2011, we had the ability to issue 250,298 shares of common stock pursuant to options that may be granted in the future under our existing equity compensation plans, 261,516 shares of common stock under the Employee Stock Purchase and Bonus Plan, and 368,544 shares of common stock under the Dividend Reinvestment and Stock Purchase Plan. Subject to applicable law, our Board of Directors generally has the authority, without action by or vote of the shareholders, to issue all or part of any authorized but unissued shares of common stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. Any issuance of additional shares of common stock or convertible securities will dilute the percentage ownership interest of our shareholders, may dilute the book value per share of our common stock, and could adversely affect the terms on which we may obtain additional capital.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that historically would have been held as bank deposits in brokerage accounts or mutual funds. 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 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
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these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Item 1B – Unresolved Staff Comments.
Not applicable.
Item 2 - Properties.
The bank owns its main office, which is located at 6144 US 301 South, Four Oaks, North Carolina. The main office, which was constructed by the bank in 1985, is a 12,000 square foot facility on 1.64 acres of land. The bank leases a limited-service facility in downtown Four Oaks located at 111 North Main Street from M.S. Canaday, who is a former director of the company as well as a former director of the bank. Under the terms of the lease, which the bank believes to be arms-length, the bank paid $1,081 per month in rent in 2011. The lease is month-to-month and we review its terms on an annual basis. The bank also leases a branch office located at 201 West Center Street, Holly Springs, North Carolina. Under the terms of the lease, the bank will pay $3,072 per month for a period of two years ending April 1, 2013, with a 3% increase per year for the next two years until March 31, 2013. The bank’s Harrells office located at 590 Tomahawk Highway, Harrells, North Carolina is under a lease with terms specifying the bank will pay $600 each month for periods of one year duration until the lease is terminated by one of the parties. In addition, the bank has entered into a ten year lease, commencing on June 12, 2006, on its Sanford office located at 830 Spring Lane, Sanford, North Carolina. Under the terms of the lease, the bank will pay $7,987 each month with an annual rate increase not to exceed 2.5% over a 10 year period. On September 17, 2011, the bank entered into a two year lease on its Dunn office located at 604-A Erwin Road, Dunn, North Carolina. Under the terms of the lease, the bank will pay $1,600 each month for the period beginning September 17, 2011 and ending August 31, 2013. In addition, the bank has leased additional space for its Dunn location for a renewable one year term beginning September 8, 2010 at $450 per month. On February 25, 2008, the bank entered into a five year lease on its Garner Village office, located at 574 Village Court, Garner, North Carolina. Under the terms of the lease, the bank will pay $3,300 each month with an annual rate increase not to exceed 3% over a five year period. The Bank also has a lease on the building at 1408 Garner Station Boulevard, Raleigh, North Carolina which expires on June 30, 2022. The bank paid $12,327 each month until September 2011, with a 3% increase each consecutive year thereafter, until expiration in June 30, 2022.
The bank owns a 5,000 square foot facility renovated in 1992 on 1.15 acres of land located at 5987 US 301 South, Four Oaks, North Carolina, which houses its training center. The bank also owns a 15,000 square foot facility built in 2000 located at 6114 US 301 South, Four Oaks, North Carolina, which houses its administrative offices, data operations, loan operations, and wide area network central link. In addition, the bank owns the following:
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Location | Year Built | Present Function | Square Feet | ||||
102 East Main Street Clayton, North Carolina | 1986 | Branch Office | 4,900 | ||||
200 East Church Street Benson, North Carolina | 1987 | Branch Office | 2,300 | ||||
128 North Second Street Smithfield, North Carolina | 1991 | Branch Office | 5,500 | ||||
403 South Brightleaf Boulevard Smithfield, North Carolina | 1995 | Limited-Service Facility | 860 | ||||
200 Glen Road Garner, North Carolina | 1996 | Branch Office | 3,500 | ||||
325 North Judd Parkway Northeast Fuquay-Varina, North Carolina | 2002 | Branch Office | 8,900 | ||||
406 East Main Street Wallace, North Carolina | 2006 | Branch Office | 9,300 | ||||
805 N. Arendell Avenue Zebulon, North Carolina | 2007 | Branch Office | 6,100 | ||||
1401 Fayetteville Road Rockingham, North Carolina | 2005 | Branch Office | 10,200 | ||||
105 Commerce Avenue Southern Pines, North Carolina | 2005 | Branch Office | 4,100 |
On September 1, 2008, the bank leased three offices of its Fuquay-Varina branch office to PrimeLending. Under the terms of the agreement, the bank receives $1,200 per month in rent from PrimeLending, renewable each month.
Management believes each of the properties referenced above is adequately covered by insurance. The net book value for our properties, including land, buildings, and furniture and equipment was $16.0 million at December 31, 2011. Additional information is disclosed in Note D “Bank Premises and Equipment” to our consolidated financial statements presented under Item 8 of Part II of this Form 10-K.
Item 3 - Legal Proceedings.
On July 16, 2010, Thomas Caffrey and Eddie Alvarez, former officers and employees of Nuestro Banco, filed a lawsuit against the Company in the General Court of Justice, Superior Court Division, in Wake County, North Carolina. The Company removed the case to the United States District Court for the Eastern District of North Carolina. The complaint alleged that Mr. Caffrey and Mr. Alvarez were entitled to severance under the terms of offer letters that they received from Immigrant Financial Services, the predecessor to Nuestro Banco, and under the terms of unexecuted draft severance agreements that were negotiated before the consummation of the Company’s acquisition of Nuestro Banco. In addition to severance, Mr. Caffrey and Mr. Alvarez sought double damages and attorneys’ fees. The Company denied that any severance was owed to Mr. Caffrey or Mr. Alvarez, both of whom were discharged by Nuestro Banco prior to the consummation of the Company’s acquisition. On June 29, 2011, the federal court dismissed with prejudice all claims based on the offer letters, while remanding to state court the remaining claims that were based on the unexecuted draft severance agreements. The plaintiffs appealed this decision to the United States Court of Appeals for the Fourth Circuit. On July 5, 2011, Four Oaks filed a motion for judgment on the pleadings in state court, seeking judgment on all remaining claims. Four Oaks also filed a motion to stay discovery. In November 2011, the parties reached an agreement to settle the lawsuit, the United States Court of Appeals for the Fourth Circuit dismissed the appeal, and a Stipulation of Dismissal was filed in the United States District Court for the Eastern District of North Carolina. The settlement is reflected in the results
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of operations for the year ended December 31, 2011.
We are party to certain other legal actions in the ordinary course of our business. We believe these other actions are routine in nature and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition, results of operations, cash flows or prospects. If, however, our assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, our business, financial condition, results of operations, cash flows and prospects could be adversely affected.
Item 4 - Mine Safety Disclosures
Not Applicable.
PART II
Item 5 - Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock trades on the OTC Bulletin Board under the symbol “FOFN.” The range of high and low bid prices of our common stock for each quarter during the two most recent fiscal years, as published by the OTC Bulletin Board, adjusted for stock splits, is as follows (prices reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions):
Fiscal Year Ended December 31, | ||||||||||||||||
2010 | 2011 | |||||||||||||||
High | Low | High | Low | |||||||||||||
First quarter | $ | 5.75 | $ | 5.15 | $ | 4.80 | $ | 2.60 | ||||||||
Second quarter | 5.50 | 3.96 | 2.80 | 1.50 | ||||||||||||
Third quarter | 4.65 | 3.00 | 2.80 | 1.45 | ||||||||||||
Fourth quarter | 4.00 | 2.50 | 1.65 | 0.85 |
As of March 21, 2012, the approximate number of holders of record of our common stock was 2,347. We have no other issued class of equity securities. The bank’s ability to declare a dividend to us and the Company’s ability to pay dividends are subject to the restrictions of the North Carolina Business Corporation Act. There also are state banking laws that require a surplus of at least 50% of paid-in capital stock be maintained in order for the bank to declare a dividend to the Company. No dividends were paid to us by the bank during 2011. Our written agreement requires us to obtain prior regulatory approval for the payment of dividends from the bank to the Company and from the Company to its shareholders. Subject to the legal availability of funds to pay dividends, total quarterly cash dividends paid by us in 2011 and 2010 were $.00 and $.03 per share., respectively.
We have currently suspended payment of our quarterly cash dividend. In addition, the Company exercised its right to defer regularly scheduled interest payments on the subordinated debentures related to its Trust Preferred Securities. The Company cannot pay any cash dividends on its common stock until it is current on its interest payments on the subordinated debentures. Actual declaration of any future dividends and the establishment of the record dates related thereto remain subject to further action by our board of directors as well as the limitations discussed above.
We did not sell any securities in 2011 that were not registered under the Securities Act of 1933 as amended. During 2011, we repurchased no shares of our equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended. We made no purchases on behalf of the Company or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Exchange Act) of the Company's common stock during the three months ended December 31, 2011.
Item 6 - Selected Financial Data
Not applicable.
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Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis provides information about the major components of our results of operations and financial condition, liquidity and capital resources and should be read in conjunction with our audited consolidated financial statements and notes thereto which are contained in this report. Additional discussion and analysis related to fiscal year 2011 is contained in our Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2011, June 30, 2011 and September 30, 2011, respectively.
Impact of Recent Developments on the Banking Industry
The banking industry, including the Company, continues to operate in a challenging and volatile economic environment. The effects of the downturn in the housing market have adversely impacted credit markets, consumer confidence, and the broader economy. Along with other financial institutions, the Company’s stock price has suffered as a result. Management cannot predict when these market difficulties will subside. While the current economic downturn and the difficulties it presents for the Company and others in the banking industry are unprecedented, management believes that the business is cyclical and must be viewed and measured over time. The Company’s primary focus at this time is to manage the business safely during the economic downturn, including taking actions to reduce our non-performing loans and other real estate owned (“OREO”) and to preserve our capital.
Overview
As a community-focused commercial bank, our primary business consists of providing a full range of banking services to our customers with an emphasis on quality personal service. Our core products consist of loans secured by real estate, commercial and consumer loans, as well as various deposit products to meet our customers’ needs. Our primary source of income is generated from net interest income, the difference between interest income received on our loans and securities and interest expense paid on deposits and borrowings. Our income is also affected by our ability to price our products competitively and maximize the interest rate spread between the interest yield on loans and securities and the interest rate paid on deposits and borrowings. Our products also generate other income through product related fees and commissions. We incur operating expenses consisting primarily of salaries and benefits, occupancy and equipment and other professional and miscellaneous expenses.
Our assets have decreased from $947.6 million at December 31, 2010 to $916.6 million at December 31, 2011, primarily due to a reduction in loans which have decreased from $682.3 million to $602.2 million over that same period offset by the increase in cash deposits held at the Federal Reserve Bank of Richmond of $49.8 million. In addition, prior to 2010, for 73 consecutive years, we have paid dividends (prior to 1997 when we reorganized into a holding company, it was our wholly owned subsidiary, Four Oaks Bank & Trust Company, which paid dividends). We suspended dividends in the fourth quarter of 2010 due to losses for the year and will continue to monitor our ability to pay dividends based on our financial soundness and the terms of the Written Agreement.
We set interest rates on deposits and loans at competitive rates. We have maintained spreads of 2.63% and 3.18% in 2011 and 2010, respectively, between interest earned on average loans and investments and interest paid on average interest-bearing deposits and borrowings. Our gross loans have decreased from $682.3 million at December 31, 2010 to $602.2 million at December 31, 2011 an 11.7% decrease from 2010; while our average net annual charge-offs over the same period were approximately $7.6 million lower than 2010.
Our total investments (including interest-earning deposits and FHLB stock) increased in 2011 over 2010, due to the increased investment in marketable securities, cash, assets, and higher interest-earning cash balances at the Federal Reserve Bank. We closely monitor changes in the financial markets in order to maximize the yield on our assets. Losses moderated in 2011, ending the year with net loss of $9.1 million, an improvement of 67.9% from 2010’s net loss of $28.3 million, as a result of a challenging economic environment.
Due to the net loss reported for the year ended December 31, 2011, the bank remains adequately capitalized. Since the bank is not well capitalized it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on interest rates paid on deposits of comparable size and maturity in the bank’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 the bank’s normal market area. With respect to non-brokered deposits, as an adequately capitalized institution, the bank cannot offer interest rates that are significantly higher than the prevailing rates in its normal market area.
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We are committed to improving our financial position and capital levels. Management is in the process of evaluating various alternatives to increase tangible common equity and regulatory capital through the issuance of additional equity in public or private offerings. The Company is also working to reduce its balance sheet to improve capital ratios and actively evaluating a number of capital sources, asset reductions and other balance sheet management strategies to ensure that the projected level of regulatory capital can support its balance sheet long-term. Specific efforts made during 2011, include the consolidation of our two Garner locations and staff reductions. However, there can be no assurance that the Company will be successful in any efforts to raise additional capital during 2012.
Results of Operations
Comparison of Financial Condition at December 31, 2011 and 2010
During 2011, our total assets decreased by $30.9 million, or 3.3% from $947.6 million at December 31, 2010, to $916.6 million at December 31, 2011. The decrease in our total assets was primarily due to contraction in our loan portfolio which decreased from $682.3 million at December 31, 2010 to $602.2 million at December 31, 2011, a decrease of $80.0 million, or 11.7%. Loans secured by residential real estate at December 31, 2011 decreased by $21.5 million or 8.93% while commercial real estate loans decreased by $50.2 million or 13.25%. Net loans declined by $79.1 million or 11.98% during 2011, primarily due to a lack of demand by qualified borrowers and our heightened standards for lending due to our need to preserve capital. Our securities portfolio decreased $39.4 million to $92.8 million at December 31, 2011 from $132.2 million at December 31, 2010. During 2010, we sold all the tax-free municipals and increased our taxable municipals and GNMA mortgage backed securities in order to position the portfolio for our best capital and tax positions. Deposits decreased by $23.3 million, or 3.0%, during 2011 to $745.9 million at December 31, 2011 compared to $769.2 million at December 31, 2010. Noninterest bearing demand deposits increased by 53.1% or $47.9 million during 2011, and interest bearing deposits decreased 10.5% or $71.2 million. Wholesale deposits decreased 23.2% or $44.3 million to $146.3 million at December 31, 2011 as compared to $190.6 million at December 31, 2010.
Shareholders’ equity declined 16.3% to $29.7 million at December 31, 2011, as compared to $35.5 million at December 31, 2010. The decline resulted primarily from a net operating loss of $9.1 million for 2011 partially offset by other comprehensive income of $3.0 million comprised of unrealized gains on securities available for sale.
Net Loss
During 2011, we had a net loss of $9.1 million or $1.20 basic net loss per share, which represents a 67.9% decrease from the 2010 net loss of $28.3 million, or $3.78 basic net loss per share. Loan charge-offs totaled $14.9 million in 2011 as compared to $28.4 million in 2010. Recoveries of loan charge-offs totaled $2.5 million in 2011 as compared to $3.1 million in 2010. Increases to the provision for loan loss expense totaled $11.4 million in 2011 as compared to $31.7 million in 2010, resulting in an ending allowance for loan losses of $21.1 million at December 31, 2011, as compared to $22.1 million at December 31, 2010. Pre-tax pre-provision earnings totaled $2.4 million in 2011 as compared to $9.5 million in 2010. The primary reason for this decline was a reduction in interest income of $6.0 million from the decreased loan portfolio. In addition to expenses related to deterioration of loans and foreclosed properties, we recognized a deferred tax valuation allowance of $3.4 million, for the year ended December 31, 2011 and $15.2 million for the year ended December 31, 2010 due to the losses recognized in each of these years as well as the uncertainty of when positive earnings will be realized in the future.
Net Interest Income
The primary component of earnings for the bank is net interest income, which is the difference between interest income, principally from loan and investment securities, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and capital.
Net interest income decreased by $4.8 million to $25.9 million in 2011, with a net yield of 2.87% compared to $30.7 million and a net yield of 3.41% in 2010. Our loans repriced to the floor rate when they renewed or were modified and deposits repriced to lower levels as the low rate environment continued throughout 2011. The decrease in yield and net interest income was a result of a 67bp decline in the yield on interest earning assets, which was only marginally offset by a 12bp decline in yield of interest-bearing liabilities since time deposits greater than $100,000, borrowings and subordinated debentures were not re-priced during 2011. The national prime rate remained at 3.25% at December 31, 2011. Nonaccrual loans averaged $58.6 million
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in 2011 compared to $24.3 million in 2010, which accounted for a significant portion of the decline in loan yields.
On average, our interest-earning assets grew $885,000 during 2011 over 2010. A substantial portion of the increase in interest-earning assets was funded through interest-bearing deposits including cash reserves. Average loans decreased by $56.2 million during 2011 to $651.9 million. The volume of interest-bearing liabilities increased $12.9 million.
Provision for Loan Losses
The provision for loan losses is charged to bring the allowance for loan losses to the level deemed appropriate by management after adjusting for recoveries of amounts previously charged off. Loans are charged against the allowance for loan losses when management believes that the uncollectibility of a loan balance is confirmed. The allowance for loan losses is maintained at a level deemed adequate to absorb probable losses inherent in the loan portfolio and results from management’s consideration of such factors as the financial condition of borrowers, past and expected loss experience, current economic conditions, and other factors management feels deserve recognition in establishing an appropriate reserve. Although management attempts to maintain the allowance at a level deemed adequate, future additions to the allowance may be necessary based upon changes in market conditions or the status of the loans included in the loan portfolio. In addition, various regulatory agencies periodically review our allowance for loan losses. These agencies may require us to make adjustments based upon their judgments about information available to them at the time of their examination. See “Allowance for Loan Losses and Summary of Loan Loss Experience” below and Notes A and C to our consolidated financial statements presented under Item 8 of Part II of this Form 10-K, for further discussion related to our process for determining the appropriate level of the allowance for probable loan losses.
Our non-performing assets, which consist of loans past due 90 days or more, real estate acquired in the settlement of loans, and loans in nonaccrual status, increased to $72.4 million at December 31, 2011 from $61.2 million at December 31, 2010. This increase was primarily due to the contraction of the housing market and subsequent slowdown of real estate construction, resulting from the current economic environment. Our provision for loan losses was $11.4 million during 2011 compared to $31.7 million during 2010, a decrease of 64.0%. Net charge-offs in 2011 decreased to $12.4 million compared to $25.3 million in 2010. As a percent of average loans, net charge-offs were 1.90%, a decrease of 31.99% from 2010. Our allowance for loan losses, expressed as a percentage of gross loans, was 3.51% and 3.24% at December 31, 2011 and 2010, respectively. At December 31, 2011, the allowance for loan losses amounted to $21.1 million which management believes is adequate to absorb losses inherent in our loan portfolio.
Non-interest Income
Non-interest income before gains and losses on sales of securities, and impairment losses on investments decreased$301,000 or 5.7%, from $5.3 million during 2010 to $5.0 million in 2011. Our non-interest income is comprised primarily of service charges on deposit accounts, financial services commissions, merchant fees, changes in the value of bank-owned life insurance and various other sources of miscellaneous operating income.
Non-interest Expense
Our non-interest expense decreased from $29.7 million in 2010 to $28.9 million in 2011, a decrease of $739,000, primarily the result of decreases in various operating expenses.
Income Taxes
Due to the losses in 2011 and 2010 as well as the uncertainty of when positive earnings will be realized in the future, the Company has recorded deferred tax assets in each of the years which have been been fully reserved through establishment of a valuation allowance of $18.6 million as of December 31, 2011 and $15.2 million as December 31, 2010, an increase of $3.4 million.
Liquidity and Capital Resources
Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources. The term "liquidity" refers to our ability to generate adequate amounts of cash to meet our needs for funding loan originations, deposit withdrawals, maturities of borrowings and operating expenses. Management measures our liquidity position by giving consideration to both on and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.
Sources of liquidity include cash and cash equivalents, (net of federal requirements to maintain reserves against deposit
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liabilities), investment securities eligible for pledging to secure borrowings, investments available for sale, loan repayments, loan sales, deposits and borrowings from the Federal Home Loan Bank secured with pledged loans and securities, and from correspondent banks under overnight federal funds credit lines. In addition to interest rate sensitive deposits, the Company's primary demand for liquidity is anticipated funding under credit commitments to customers.
We have maintained a sufficient level of liquidity in the form of cash, federal funds sold, and investment securities. These aggregated $257.8 million at December 31, 2011, compared to $230.6 million at December 31, 2010. The increase resulted from declines in loans outstanding.
Supplementing customer deposits as a source of funding, we have available lines of credit from various correspondent banks to purchase federal funds on a short-term basis of approximately $16.0 million. As of December 31, 2011, the bank has the credit capacity to borrow up to $183.3 million, from the Federal Home Loan Bank of Atlanta (“FHLB”), with $112.0 million outstanding as of that date. At December 31, 2010 we had FHLB borrowings outstanding of $112.3 million. Outstanding borrowing capacity from correspondent banks and the FHLB would have to be secured for advances to be permitted.
At December 31, 2011, our outstanding commitments to extend credit consisted of loan commitments of $43.1 million, undisbursed lines of credit of $19.9 million, unused credit card lines of $13.7 million, financial stand-by letters of credit of $378,000 and performance stand-by letters of credit of $1.7 million. We believe that our combined aggregate liquidity position from all sources is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.
At December 31, 2010, our outstanding commitments to extend credit consisted of loan commitments of $53.5 million, undisbursed lines of credit of $27.8 million, unused credit card lines of $12.6 million, financial stand-by letters of credit of $403,000 and performance stand-by letters of credit of $2.1 million.
Certificates of deposits represented 61.4% of our total deposits at December 31, 2011, a decrease from 68.7% at December 31, 2010. Brokered and out-of-market certificates of deposit totaled $157.4 million at year-end 2011 and $183.3 million at year-end 2010, which comprised 21.1% and 23.8% of total deposits, respectively. Certificates of deposit of $100,000 or more, inclusive of brokered and out-of-market certificates, represented 42.6% of our total deposits at December 31, 2011 and 49.6% at December 31, 2010. Large certificates of deposits are generally considered rate sensitive. While we will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. In addition, until the bank becomes “well capitalized” for regulatory capital purposes, we cannot renew or accept brokered deposits without prior regulatory approval and we may not offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area.
The Company sold $12.0 million aggregate principal amount of subordinated promissory notes to certain accredited investors between May and August 2009. These notes are due ten years after the date of issuance, beginning May 15, 2019, and the Company is obligated to pay interest at an annualized rate of 8.5% payable in quarterly installments beginning on the third month anniversary of the date of issuance. The Company may prepay the notes at any time after the fifth anniversary of the date of issuance, subject to compliance with applicable law.
The Company is currently prohibited by the Written Agreement, described in Note K to the Consolidated Financial Statements presented under Item 8 of Part II of this Form 10-K , from paying interest on its subordinated promissory notes and on its subordinated debentures in connection with its trust preferred securities without prior approval of the supervisory authorities. The Company and the Bank are prohibited from declaring or paying dividends without prior approval of the supervisory authorities. The Company obtained approval to pay the interest on its subordinated promissory notes for the second, third and fourth quarters of 2011. The Company exercised its right to defer regularly scheduled interest payments on its outstanding subordinated debentures and as of December 31, 2011, $269,000 of interest payments have been accrued for and deferred pursuant to the terms of the indenture governing the subordinated debentures. The Company may not pay any cash dividends on its Common Stock until it is current on interest payments on such subordinated debentures. The Company has not paid any cash dividends on its Common Stock since it suspended dividends in the fourth quarter of 2010. As a bank holding company, the Company's ability to declare and pay dividends also depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.
Off-Balance Sheet Arrangements
As part of its normal course of business to meet the financing needs of its customers, the bank is at times a party to financial instruments with off-balance sheet credit risk. Such instruments include commitments to extend credit and standby letters of credit. At December 31, 2011, the bank’s outstanding commitments to extend credit consisted of undisbursed lines of credit, other commitments to extend, undisbursed portion of construction loans and stand-by letters of credit of $78.7 million. Additional
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detail regarding the bank’s off-balance sheet risk exposure is presented in Note L to the accompanying consolidated financial statements.
Inflation
The effect of inflation on financial institutions differs somewhat from the effect it has on other businesses. The performances of banks, with assets and liabilities that are primarily monetary in nature, are affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits. Also, general increases in the price of goods and services will generally result in increased operating expenses.
Distribution of Assets, Liabilities, and Shareholders’ Equity; Interest Rates and Interest Differential
The following schedule presents average balance sheet information for the years 2011, 2010, and 2009, along with related interest earned and average yields for interest-earning assets and the interest paid and average rates for interest-bearing liabilities. Nonaccrual notes are included in loan amounts.
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Average Daily Balances, Interest Income/Expense, Average Yield/Rate For the Years Ended December 31, | ||||||||||||||||||||||||||||||||
2011 | 2010 | 2009 | ||||||||||||||||||||||||||||||
Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | ||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||||||||||
Loans | $ | 651,944 | $ | 36,550 | 5.61 | % | $ | 708,095 | $ | 41,489 | 5.86 | % | $ | 710,919 | $ | 40,887 | 5.75 | % | ||||||||||||||
Investment securities - taxable | 112,327 | 2,753 | 2.50 | % | 87,352 | 2,704 | 3.10 | % | 88,578 | 3,604 | 4.07 | % | ||||||||||||||||||||
Investment securities - tax exempt | — | — | — | % | 32,393 | 1,271 | 3.92 | % | 58,719 | 2,403 | 4.09 | % | ||||||||||||||||||||
Other investments and FHLB stock | 8,103 | 258 | 2.53 | % | 9,822 | 357 | 3.63 | % | 10,944 | 414 | 3.78 | % | ||||||||||||||||||||
Interest earning deposits in banks | 129,982 | 443 | 0.34 | % | 63,809 | 157 | 0.25 | % | 27,825 | 41 | 0.15 | % | ||||||||||||||||||||
Total interest-earning assets | 902,356 | 40,004 | 4.43 | % | 901,471 | 45,978 | 5.10 | % | 896,985 | 47,349 | 5.28 | % | ||||||||||||||||||||
Other assets | 35,979 | 53,518 | 41,662 | |||||||||||||||||||||||||||||
Total assets | $ | 938,335 | $ | 954,989 | $ | 938,647 | ||||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||||||||||
NOW and money market deposits | $ | 118,243 | $ | 503 | 0.43 | % | $ | 123,458 | $ | 766 | 0.62 | % | $ | 139,379 | $ | 1,443 | 1.04 | % | ||||||||||||||
Savings deposits | 31,190 | 89 | 0.29 | % | 30,385 | 121 | 0.40 | % | 28,652 | 170 | 0.59 | % | ||||||||||||||||||||
Time deposits, $100,000 and over | 354,370 | 5,524 | 1.56 | % | 320,751 | 5,618 | 1.75 | % | 285,270 | 6,475 | 2.27 | % | ||||||||||||||||||||
Other time deposits | 141,281 | 2,665 | 1.89 | % | 183,135 | 3,449 | 1.88 | % | 200,484 | 5,187 | 2.59 | % | ||||||||||||||||||||
Borrowed funds | 112,170 | 4,072 | 3.63 | % | 112,442 | 4,082 | 3.63 | % | 114,422 | 4,125 | 3.61 | % | ||||||||||||||||||||
Subordinated debentures | 24,372 | 1,243 | 5.10 | % | 24,372 | 1,246 | 5.11 | % | 18,575 | 839 | 4.52 | % | ||||||||||||||||||||
Total interest-bearing liabilities | 781,626 | 14,096 | 1.80 | % | 794,543 | 15,282 | 1.92 | % | 786,782 | 18,239 | 2.32 | % | ||||||||||||||||||||
Noninterest-bearing deposits | 117,491 | 89,688 | 80,541 | |||||||||||||||||||||||||||||
Other liabilities | 3,254 | 4,740 | 3,433 | |||||||||||||||||||||||||||||
Stockholders' equity | 35,964 | 66,018 | 67,891 | |||||||||||||||||||||||||||||
Total liabilities and shareholders' equity | $ | 938,335 | $ | 954,989 | $ | 938,647 | ||||||||||||||||||||||||||
Net interest income and interest rate spread | $ | 25,908 | 2.63 | % | $ | 30,696 | 3.18 | % | $ | 29,110 | 2.96 | % | ||||||||||||||||||||
Net yield on average interest-earning assets | 2.87 | % | 3.41 | % | 3.25 | % | ||||||||||||||||||||||||||
Ratio of average interest- | ||||||||||||||||||||||||||||||||
earning assets to average | ||||||||||||||||||||||||||||||||
interest-bearing liabilities | 115.45 | % | 113.46 | % | 114.01 | % |
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The following table shows changes in interest income and expense by category and rate/volume variances for the years ended December 31, 2011, 2010 and 2009. The changes due to rate and volume were allocated on their absolute values:
Year Ended December 31, 2011 vs. 2010 | Year Ended December 31, 2010 vs. 2009 | |||||||||||||||||||||||
Increase (Decrease) Due to | Increase (Decrease) Due to | |||||||||||||||||||||||
Volume | Rate | Total | Volume | Rate | Total | |||||||||||||||||||
(In thousands) | (In thousands) | |||||||||||||||||||||||
Interest income: | ||||||||||||||||||||||||
Loans | $ | (3,218 | ) | $ | (1,720 | ) | $ | (4,938 | ) | $ | (164 | ) | $ | 766 | $ | 602 | ||||||||
Investment securities - taxable | 698 | (595 | ) | 103 | (45 | ) | (855 | ) | (900 | ) | ||||||||||||||
Investment securities - tax exempt | (1,272 | ) | — | (1,272 | ) | (1,055 | ) | (77 | ) | (1,132 | ) | |||||||||||||
Other investments | (53 | ) | (99 | ) | (152 | ) | (42 | ) | (15 | ) | (57 | ) | ||||||||||||
Other interest-earning assets | 193 | 92 | 285 | 71 | 45 | 116 | ||||||||||||||||||
Total interest income | (3,652 | ) | (2,322 | ) | (5,974 | ) | (1,235 | ) | (136 | ) | (1,371 | ) | ||||||||||||
Interest expense: | ||||||||||||||||||||||||
Deposits | ||||||||||||||||||||||||
NOW and money market deposits | (27 | ) | (236 | ) | (263 | ) | (132 | ) | (545 | ) | (677 | ) | ||||||||||||
Savings deposits | 3 | (35 | ) | (32 | ) | 9 | (58 | ) | (49 | ) | ||||||||||||||
Time deposits over $100,000 | 77 | (171 | ) | (94 | ) | 713 | (1,568 | ) | (855 | ) | ||||||||||||||
Other time deposits | (220 | ) | (565 | ) | (785 | ) | (389 | ) | (1,350 | ) | (1,739 | ) | ||||||||||||
Borrowed funds | (10 | ) | — | (10 | ) | (72 | ) | 29 | (43 | ) | ||||||||||||||
Subordinated Debentures | — | (2 | ) | (2 | ) | 279 | 128 | 407 | ||||||||||||||||
Total interest expense | (177 | ) | (1,009 | ) | (1,186 | ) | 408 | (3,364 | ) | (2,956 | ) | |||||||||||||
Net interest income increase (decrease) | $ | (3,475 | ) | $ | (1,313 | ) | $ | (4,788 | ) | $ | (1,643 | ) | $ | 3,228 | 1,104,000 | $ | 1,585 |
Investment Portfolio
The valuations of investment securities, available for sale, at December 31, 2011, 2010, and 2009 respectively, were as follows (in thousands):
Available for Sale | |||||||||||||||||||||||
2011 | 2010 | 2009 | |||||||||||||||||||||
Amortized cost | Estimated fair value | Amortized cost | Estimated fair value | Amortized cost | Estimated fair value | ||||||||||||||||||
State and municipal securities | $ | — | $ | — | $ | — | $ | — | $ | 36,976 | $ | 37,389 | |||||||||||
Taxable Municipals | 17,046 | 17,919 | 31,285 | 30,021 | 12,397 | 12,045 | |||||||||||||||||
Mortgage-backed securities | |||||||||||||||||||||||
GNMA | 72,839 | 73,629 | 102,046 | 100,447 | 64,800 | 66,336 | |||||||||||||||||
FHLMC | — | — | — | — | 2,641 | 2,641 | |||||||||||||||||
FNMA | — | — | — | — | 5,317 | 5,317 | |||||||||||||||||
Trust preferred securities | 1,175 | 1,085 | 1,750 | 1,299 | 1,750 | 1,294 | |||||||||||||||||
Equity securities | 170 | 157 | 310 | 403 | 1,152 | 738 | |||||||||||||||||
Total securities | $ | 91,230 | $ | 92,790 | $ | 135,391 | $ | 132,170 | $ | 125,033 | $ | 125,760 | |||||||||||
Pledged securities | $ | 91,549 | $ | 87,529 | $ | 100,944 |
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The valuations of investment securities, held to maturity, at December 31, 2011, 2010, and 2009 were as follows (in thousands):
Held to Maturity | |||||||||||||||||||||
2011 | 2010 | 2009 | |||||||||||||||||||
Amortized cost | Estimated fair value | Amortized cost | Estimated fair value | Amortized cost | Estimated fair value | ||||||||||||||||
U.S. Government and agency securities | |||||||||||||||||||||
GNMA | $ | 20,445 | $ | 20,456 | $ | — | $ | — | — | — | |||||||||||
Total securities | $ | 20,445 | $ | 20,456 | $ | — | $ | — | — | — | |||||||||||
Pledged securities | $ | 20,456 |
The following table sets forth the carrying value of our available for sale investment portfolio at December 31, 2011 (in thousands):
Carrying Value | |||||||||||||||||||
Within 1 year | After 1 year through 5 years | After 5 years through 10 years | After 10 years | Total | |||||||||||||||
Taxable Municipals | $ | — | $ | 369 | $ | 12,035 | $ | 5,515 | $ | 17,919 | |||||||||
Mortgage-backed securities | — | ||||||||||||||||||
GNMA | 1,434 | 29,332 | 42,863 | — | 73,629 | ||||||||||||||
Trust preferred securities | — | — | — | 1,078 | 1,078 | ||||||||||||||
Equity securities | — | — | — | 164 | 164 | ||||||||||||||
Total | $ | 1,434 | $ | 29,701 | $ | 54,898 | $ | 6,757 | $ | 92,790 |
The following table sets forth the carrying value of our held to maturity investment portfolio at December 31, 2011 (in thousands):
Carrying Value | |||||||||||||||||||
Within 1 year | After 1 year through 5 years | After 5 years through 10 years | After 10 years | Total | |||||||||||||||
Mortgage-backed securities | |||||||||||||||||||
GNMA | $ | — | $ | 16,510 | $ | 3,946 | $ | — | $ | 20,456 | |||||||||
Total | $ | — | $ | 16,510 | $ | 3,946 | $ | — | $ | 20,456 | |||||||||
The following table sets forth the weighted average yield by maturity of our available for sale investment portfolio at December 31, 2011 amortized cost:
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Weighted Average Yields | ||||||||||||||
Within 1 year | After 1 year through 5 years | After 5 years through 10 years | After 10 years | Total | ||||||||||
Taxable Municipals | — | 2.74 | % | 2.52 | % | 2.88 | % | 2.64 | % | |||||
Mortgage-backed securities | ||||||||||||||
GNMA | 0.78 | % | 1.63 | % | 1.63 | % | — | % | 1.61 | % | ||||
Trust preferred securities | — | — | — | 5.90 | % | 0.59 | % | |||||||
Equity securities | — | — | — | 0.37 | % | 0.37 | % | |||||||
Total weighted average yields | 0.78 | % | 1.64 | % | 1.82 | % | 3.86 | % | 1.89 | % |
The following table sets forth the weighted average yield by maturity of our held to maturity investment portfolio at December 31, 2011 amortized cost:
Weighted Average Yields | ||||||||||||||
Within 1 year | After 1 year through 5 years | After 5 years through 10 years | After 10 years | Total | ||||||||||
Mortgage-backed securities | ||||||||||||||
GNMA | — | % | 1.36 | % | 2.99 | % | — | % | 1.68 | % | ||||
Total weighted average yields | — | % | 1.36 | % | 2.99 | % | — | % | 1.68 | % |
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Loan Portfolio
The following loan table describes our loan portfolio composition by category based on new loan classifications discussed in Note C to the financial statements for December 31, 2011, 2010, 2009, 2008, and 2007 (in thousands):
2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Loans receivable: | |||||||||||||||||||
Commercial and Industrial | |||||||||||||||||||
Commercial and industrial loans | $ | 34,224 | $ | 39,437 | $ | 54,982 | $ | 53,336 | $ | 44,742 | |||||||||
Municipal | 3,079 | 4,270 | 7,396 | 883 | 744 | ||||||||||||||
Agriculture | 2,026 | 1,837 | 2,582 | 3,060 | 3,119 | ||||||||||||||
Business credit cards | 1,016 | 1,109 | 1,037 | 919 | 407 | ||||||||||||||
Total commercial and industrial | 40,345 | 46,653 | 65,997 | 58,198 | 49,012 | ||||||||||||||
Commercial real estate | |||||||||||||||||||
Commercial construction and land development | 113,762 | 133,171 | 176,160 | 187,329 | 172,414 | ||||||||||||||
Commercial non-owner occupied | 91,714 | 126,032 | 110,105 | 80,369 | 56,151 | ||||||||||||||
Commercial owner occupied | 99,191 | 94,965 | 80,509 | 70,836 | 54,618 | ||||||||||||||
Farmland | 23,835 | 24,487 | 19,577 | 15,918 | 12,700 | ||||||||||||||
Total commercial real estate | 328,502 | 378,655 | 386,351 | 354,452 | 295,883 | ||||||||||||||
Residential real estate | |||||||||||||||||||
Residential construction | 26,707 | 45,296 | 49,141 | 87,852 | 80,037 | ||||||||||||||
Residential mortgage | |||||||||||||||||||
First lien, closed-end | 118,391 | 117,892 | 130,552 | 107,647 | 73,645 | ||||||||||||||
Junior lien, closed-end | 6,228 | 6,449 | 6,986 | 6,736 | 3,131 | ||||||||||||||
Home equity loans | 39,264 | 40,719 | 38,054 | 37,078 | 24,579 | ||||||||||||||
Multifamily | 29,089 | 30,870 | 18,189 | 8,033 | 5,123 | ||||||||||||||
Total residential mortgage | 219,679 | 241,226 | 242,922 | 247,346 | 186,515 | ||||||||||||||
Consumer loans | |||||||||||||||||||
Consumer loans | 9,359 | 11,711 | 14,288 | 13,906 | 10,771 | ||||||||||||||
Consumer credit cards | 2,092 | 2,048 | 2,128 | 2,060 | 2,304 | ||||||||||||||
Total consumer loans | 11,451 | 13,759 | 16,416 | 15,966 | 13,075 | ||||||||||||||
Other | |||||||||||||||||||
Other loans | 2,330 | 2,262 | 3,858 | 5,723 | 1,023 | ||||||||||||||
Lease financing receivables | — | — | — | 4 | 5 | ||||||||||||||
Deferred cost (unearned income) and fees | (75 | ) | (301 | ) | (411 | ) | (189 | ) | (243 | ) | |||||||||
Total Loans | 602,232 | 682,254 | 715,133 | 681,500 | 545,270 | ||||||||||||||
Allowance for loan losses | (21,141 | ) | (22,100 | ) | (15,676 | ) | (9,542 | ) | (6,653 | ) | |||||||||
Net Loans | $ | 581,091 | $ | 660,154 | $ | 699,457 | $ | 671,958 | $ | 538,617 | |||||||||
Commitments and contingencies: | |||||||||||||||||||
Commitments to make loans | 78,683 | 93,878 | 70,669 | 119,958 | 141,511 | ||||||||||||||
Standby letters of credit | 1,940 | 2,537 | 2,189 | 2,940 | 2,611 |
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Certain Loan Maturities
The maturities and carrying amounts of certain loans as of December 31, 2011 are summarized as follows (in thousands):
Commercial and Industrial | Commercial Real Estate | Residential Construction | Total | ||||||||||||
Due within one year | |||||||||||||||
Fixed rate | $ | 22,148 | $ | 104,539 | $ | 26,708 | $ | 153,395 | |||||||
Variable rate | 2,173 | 18,082 | — | 20,255 | |||||||||||
Due after one year through five years: | |||||||||||||||
Fixed rate | 13,079 | 199,846 | — | 212,925 | |||||||||||
Variable rate | — | — | — | — | |||||||||||
Due after five years: | |||||||||||||||
Fixed rate | 2,944 | 6,035 | — | 8,979 | |||||||||||
Variable rate | — | — | — | — | |||||||||||
Total | $ | 40,344 | $ | 328,502 | $ | 26,708 | $ | 395,554 |
Loan Policy
We have a loan policy in place that is amended and approved from time to time as needed to reflect current economic conditions and product offerings in our markets. This policy relates to loan administration, documentation, approval, and reporting requirements for various types of loans. The policy is designed to comply with all applicable federal and state regulatory requirements and establishes minimum standards for the extension of credit. The lending policy also establishes pre-determined lending authorities for loan officers commensurate with their abilities and experience. In addition, the policy establishes committees to review for approval or denial of credit requests at various lending amounts. These committees are the Credit Department Loan Committee, the Executive Loan Committee, comprised of the Chief Executive Officer and four independent directors, and the Board Loan Committee that reviews the larger requests and requests that fall under Regulation O. Approval authorities are under regular review and are subject to adjustment. Loan requests outside of standard policy or guidelines may be made on a case by case basis when justified, documented, and approved by the appropriate authority.
Loan Underwriting
Underwriting criteria for all types of loans are prescribed within the lending policy.
Residential Real Estate. Owner occupied 1-4 family residential comprises approximately 6% of our total loan portfolio. The outstanding balances have generally been very stable. These loans are held within the bank’s portfolio. Terms may range up to 85 months with amortizations of 20 years. Home equity loans with a revolving line of credit feature comprise approximately 7% of the portfolio. Underwriting criteria and procedures for residential real estate mortgage loans generally include:
• | Monthly debt payments of the borrower to gross monthly income should not exceed 42% with stable employment of two years. |
• | Loan to value ratio limits of up to 90% of the appraised value. |
• | A credit investigation, which includes an Equifax credit report with a Beacon score of at least 620. |
• | Verification of income by various methods. (From January 1, 2005 through June 1, 2008, the bank waived income verification and used stated income for residential lot applications in the Wallace branch office when applicants had a Beacon score of at least 679.) |
• | Appropriate insurance to protect the bank, typically in the amount of the loan. |
• | Flood certifications are procured. |
• | Collateral is investigated using current appraisals and is supplemented by the loan officer’s knowledge of the local |
32
market. Outside appraisals are completed by appraisers on the bank’s approved list. The appraisals on loans greater than $250,000 are reviewed by an outside source that certifies it is compliant with Uniform Standards of Professional Appraisal Practice.
Commercial Real Estate. Commercial real estate and real estate construction makes up the largest segment of our loan portfolio. This segment is closely monitored at the staff and Board level. Our Board of Directors receives reports on a monthly basis detailing trends. Underwriting criteria and procedures for commercial real estate loans generally include:
• | Procurement of federal income tax returns and financial statements, preferably for the past three years if available, and related supplemental information deemed relevant. The bank has a policy of requiring audited financial statements on certain loan requests based on size and complexity. |
• | Rent rolls, tenant listings, and other similar documents are requested as needed. |
• | Detailed financial and credit analysis related to cash flow, collateral, the borrower’s capital and character, and the operational environment is performed and presented to the appropriate officer or committee for approval. |
• | Cash flows from the project financed and aggregate cash flows of the principals and their entities must produce a minimum debt service coverage ratio of 1.25:1. |
• | Cash or collateral equity injection by the applicant, ranging from 15% to 35% based on regulatory loan to value ratio limits, in order to meet minimum federal guidelines for each loan category. |
• | Past experience of the investor in commercial real estate. |
• | Past experience of the customer with the bank. |
• | Tangible net worth analysis of the borrower and any guarantors. |
• | General and local commercial real estate conditions are monitored and considered in the decision-making process. |
• | Alternative uses of the security are considered in the event of default. |
• | Credit enhancements are utilized when necessary and desirable, such as the use of guarantors and take out commitments. |
• | Non-construction real estate loans typically have a 15-year amortization with a five-year balloon payment. If appropriate, a loan may be set up as an interest only single payment if repayment coincides with the maturity. |
• | Commercial construction projects require that an engineer or architect review the applicant’s cost figures for accuracy. In addition, all draw requests must be approved by either the engineer or architect for accuracy before payment is made. |
• | On-site progress inspections are completed to protect the bank. |
• | Requests for residential construction loans are closely monitored at the contractor level and subdivision level for concentrations. A request is denied if either the predetermined builder’s concentration or bank’s concentration limit has been attained. |
• | Real estate construction loans are made for terms not to exceed 12 months for residential construction and 18 to 24 months for commercial construction. |
Commercial, Financial, Agricultural, and Installment Loans.
Financial. Financial loans are secured by stocks, bonds, and mutual funds. Underwriting procedures and criteria for financial loans generally include:
• | Stock loans should be structured to coincide with the identified source of repayment. |
• | The maximum loan to value ratio for stock listed for sale on the NYSE, AMEX, or NASDAQ is 60% of its market value. |
• | Generally, stock loans should not exceed 60 months. |
Agricultural. Crop production lending presents many risks to the lender because of weather uncertainty and fluctuations in commodity prices. Underwriting procedures and criteria for agricultural loans generally include:
• | The farmer should have the financial capacity to withstand at least one bad crop year. |
• | The farmer must possess sufficient equity in equipment or farmland for the bank to term, within acceptable collateral margins (ranging from 50% to 70%) and cash flow debt service coverage requirements (generally 1.25:1), any line outstanding after the sale of crops. |
• | Farmers should meet certain qualitative criteria with respect to the farmer’s knowledge and experience. |
• | For new customers, documentation on where the farmer previously banked and the circumstances underlying the new loan request. |
Commercial Inventory and Accounts Receivable. Underwriting procedures and loan to value ratios for commercial inventory loans and accounts receivable loans generally include:
• | Up to 75% of eligible accounts receivable. |
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• | Up to 80% of the individually assigned accounts receivable. The customer assigns individual invoices, sometimes with shipping documents attached. These may be stamped or marked to show that they have been assigned to the bank. The customer brings payments to the bank for processing against individual invoices. |
• | 50% or less of the cost or market on materials and qualified finished goods, depending on their quality and stability. |
• | 0% on work-in-progress. |
Installment Loans. These loans are predominantly direct loans to established customers of the bank and primarily include the financing of automobiles, boats, and other consumer goods. The character, capacity, collateral, and conditions are evaluated using policy limitations. Installment loans are typically made for terms that do not exceed 60 months with any exceptions being documented. Installment loan underwriting criteria and procedures for such financing generally include:
• | Financial statements are required on all consumer loans secured by a primary residence, all unsecured loans of $10,000 or more, and all secured transactions of $50,000 or more. |
• | Income verification is required on all consumer loans secured by a primary residence, all unsecured loans greater than $20,000, and all secured loans of $50,000 or more at origination. |
• | Past experience of the customer with the bank. |
• | A debt to income ratio that does not exceed 38%. |
• | Stable employment record of two years. |
• | Stable residency record of two years. |
• | A Beacon score of at least 620. |
• | Terms to match the usefulness or life of the security. |
• | If unsecured, the total unsecured loans of the applicant should not exceed 15% of adjusted net worth or 20% of the applicant’s gross annual income. |
Interest Only Loans. Interest only loans are generally limited to construction lending, properties recently completed and undergoing occupancy stabilization period, and revolving lines of credit. Any other loans made as interest only should have a well documented reason and proper approval.
Bank policy generally prohibits underwriting negative amortization loans or hybrid loans.
Nonperforming Assets
Our financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan in nonaccrual status. We account for loans on a nonaccrual basis when we have serious doubts about the collectability of principal or interest. Generally, our policy is to place a loan on nonaccrual status when the loan becomes past due 90 days. We also place loans on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. We accrue interest on restructured loans at the restructured rates when we anticipate that no loss of original principal will occur.
Our non-performing assets, which consist of loans past due 90 days or more, real estate acquired in the settlement of loans, and loans in nonaccrual status, increased to $72.4 million at December 31, 2011 from $61.2 million at December 31, 2010. This increase was primarily due to the contraction of the housing market and subsequent slowdown of real estate construction, resulting from the current economic environment.
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The following past due, nonaccrual and restructured loan table describes our loan portfolio composition by category based on the loan classifications discussed in Note C to the financial statements for December 31, 2011, 2010, 2009, 2008, and 2007 (in thousands):
2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Nonaccrual loans: | |||||||||||||||||||
Commercial and industrial | $ | 779 | $ | 3,501 | $ | 387 | $ | 607 | $ | 176 | |||||||||
Commercial construction and land development | 29,538 | 22,969 | 8,921 | 5,808 | 279 | ||||||||||||||
Commercial real estate | 14,830 | 10,718 | 2,751 | 2,115 | 111 | ||||||||||||||
Residential construction | 1,469 | 4,773 | 3,822 | 6,072 | 365 | ||||||||||||||
Residential mortgage | 13,466 | 9,482 | 4,134 | 6,169 | 283 | ||||||||||||||
Consumer | 59 | 49 | 90 | 33 | 40 | ||||||||||||||
Total nonaccrual loans | $ | 60,141 | $ | 51,492 | $ | 20,105 | $ | 20,804 | $ | 1,254 | |||||||||
Other real estate owned: | |||||||||||||||||||
Commercial construction and land development | $ | 6,863 | $ | 3,954 | $ | 3,068 | $ | 409 | $ | 201 | |||||||||
Commercial real estate | 2,183 | 1,749 | 1,775 | 574 | 624 | ||||||||||||||
Residential construction | 837 | 1,469 | 3,896 | — | 644 | ||||||||||||||
Residential mortgage | 2,276 | 1,633 | 1,969 | 208 | 219 | ||||||||||||||
Total other real estate owned | $ | 12,159 | $ | 8,805 | $ | 10,708 | $ | 1,191 | $ | 1,688 | |||||||||
Past due 90 days or more and still accruing: | |||||||||||||||||||
Commercial and Industrial | $ | — | $ | 109 | $ | 20 | $ | 18 | $ | — | |||||||||
Commercial construction and land development | — | — | 441 | 456 | — | ||||||||||||||
Commercial real estate | — | — | 425 | 112 | — | ||||||||||||||
Residential construction | — | — | — | — | — | ||||||||||||||
Residential mortgage | — | 797 | 287 | 400 | 30 | ||||||||||||||
Consumer | — | 6 | 32 | 60 | 22 | ||||||||||||||
Credit cards | 60 | 34 | — | — | — | ||||||||||||||
Total past due 90 days and still accruing | $ | 60 | $ | 946 | $ | 1,205 | $ | 1,046 | $ | 52 | |||||||||
Total nonperforming assets | $ | 72,360 | $ | 61,243 | $ | 32,018 | $ | 23,041 | $ | 2,994 | |||||||||
Nonperforming loans to gross loans | 10.00 | % | 7.55 | % | 2.98 | % | 6.21 | % | 0.24 | % | |||||||||
Nonperforming assets to total assets | 7.89 | % | 6.37 | % | 3.28 | % | 2.49 | % | 0.42 | % | |||||||||
Allowance coverage of nonperforming loans | 35.12 | % | 42.92 | % | 73.56 | % | 43.67 | % | 509.42 | % |
Troubled Debt Restructurings
Loans are classified as a troubled debt restructuring (“TDR”) when, for economic or legal reasons related to the debtor's financial difficulties, the bank grants a concession to the debtor that would not otherwise be considered. Generally, these loans are restructured due to a borrower's inability to repay or meet the contractual obligations under the loan, which predominantly occurs, because of cash flow problems. The Bank only restructures loans for borrowers in financial difficulty that demonstrate the willingness and capacity to repay the loan under reasonable terms and where the Bank has sufficient protection provided by the cash flow potential of the underlying collateral or business. We may grant concessions by (1) forgiving principal or interest,
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(2) reducing the stated interest rate to a below market rate, (3) deferring principal payments, (4) changing repayment terms from amortizing to interest only, (5) extending the repayment period, or (6) accepting a change in terms based on a bankruptcy plan.
Loans being renewed or modified are reviewed by the Bank to determine if the risk grade assigned is accurate based on updated information. All loans graded a “5” or worse at or prior to renewal or modification are also reviewed to determine if the loan should be classified as a TDR. The Bank's knowledge of the borrower's situation and any updated financial information obtained is first used to determine whether the borrower is experiencing financial difficulty. Once this is determined, the Bank reviews the modification terms to determine if a concession has been made. If the Bank determines the answer to both of the above questions is yes, the loan will be classified as a TDR. If the Bank determines the answer to either of these questions is no, the loan is not classified as a TDR. Documentation to support this review and determination of classification is maintained with the credit file.
The Bank's policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. If a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If the borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual until such time as continued performance has been demonstrated, which is typically a period of at least six consecutive payments. If the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status. We will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured terms. However, all TDRs are considered to be impaired and are evaluated as such in the quarterly allowance calculation.
All TDRs are considered to be impaired and are evaluated as such in the quarterly allowance calculation. As of December 31, 2011, allowance for loan losses allocated to performing TDRs totaled $2.8 million. Outstanding nonperforming TDRs and their related allowance for loan losses totaled $33.9 million and $3.8 million respectively, as of December 31, 2011.
2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Performing TDRs: | |||||||||||||||||||
Commercial and industrial | $ | 360 | $ | 873 | $ | 668 | $ | — | $ | — | |||||||||
Commercial construction and land development | 1,631 | 9,130 | 908 | — | — | ||||||||||||||
Commercial real estate | 4,910 | 5,962 | 2,028 | — | — | ||||||||||||||
Residential construction | 165 | 314 | 627 | — | — | ||||||||||||||
Residential mortgage | 3,728 | 4,286 | 5,015 | — | — | ||||||||||||||
Consumer | 15 | 18 | 28 | — | — | ||||||||||||||
Total performing TDRs | $ | 10,809 | $ | 20,583 | $ | 9,274 | $ | — | $ | — |
2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Non-Performing TDRs: | |||||||||||||||||||
Commercial and industrial | $ | 315 | $ | 516 | $ | 37 | $ | — | $ | — | |||||||||
Commercial construction and land development | 18,357 | 16,525 | 273 | — | — | ||||||||||||||
Commercial real estate | 7,395 | 6,897 | — | — | — | ||||||||||||||
Residential construction | 345 | 2,078 | — | — | — | ||||||||||||||
Residential mortgage | 7,470 | 4,908 | — | — | — | ||||||||||||||
Consumer | 8 | 14 | — | — | — | ||||||||||||||
Total non-performing TDRs | $ | 33,890 | $ | 30,938 | $ | 310 | $ | — | $ | — |
At December 31, 2011 and 2010, there were 205 foreclosed properties valued at $12.2 million and 357 nonaccrual loans totaling $60.1 million and 153 foreclosed properties valued at $8.8 million and 332 nonaccrual loans totaling $51.5 million, respectively.
At December 31, 2011 and 2010 there were 52 restructured notes in accrual status totaling $10.8 million and 82 restructured notes in accrual status totaling $20.6 million, respectively.
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The gross interest income that would have been recorded for loans accounted for on a nonaccrual basis at December 31, 2011 and 2010 was approximately $4.5 million and $2.3 million, respectively. These amounts represent interest income that would have been recorded if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination, if held for part of the period. The amount of interest recognized on nonaccrual loans and TDRs during 2011 was approximately $488,000 and $684,000, respectively. In addition, the Company has $29.7 million in loans in the coastal North Carolina region which are collateralized by properties that have seen significant declines in value. The Company has evaluated these loans in determining its allowance for loan losses as of December 31, 2011, and has determined that its exposure to loss on these loans is either mitigated by the values of the underlying collateral or reflected in our increased provision.
Allowance for Loan Losses and Summary of Loan Loss Experience
The allowance for loan losses is established through periodic charges to earnings in the form of a provision for loan losses. Increases to the allowance for loan losses occur as a result of provisions charged to operations and recoveries of amounts previously charged-off, and decreases to the allowance occur when loans are charged-off because management believes that the uncollectibility of a loan balance is confirmed. Management evaluates the adequacy of our allowance for loan losses on a quarterly basis. The evaluation of the adequacy of the allowance for loan losses involves the consideration of loan growth, loan portfolio composition and industry diversification, historical loan loss experience, current delinquency levels, adverse conditions that might affect a borrower’s ability to repay the loan, estimated value of underlying collateral, prevailing economic conditions and all other relevant factors derived from our history of operations. Additionally, regulatory agencies review our allowance for loan losses and may require additional provisions for estimated losses based on judgments that differ from those of management.
Management has developed a model for evaluating the adequacy of the allowance for loan losses. The model uses the Company’s internal grading system to assess which loans need to be assessed for impairment. The grade is initially assigned by the lending officer and reviewed by the loan administration function. The internal grading system is reviewed and tested periodically by an independent third party credit review firm. The testing process involves the evaluation of a sample of new loans, loans having been identified as possessing potential weakness in credit quality, past due loans and nonaccrual loans to determine the ongoing effectiveness of the internal grading system.
The grading system is comprised of seven risk categories. Grades 1 through 4 demonstrate various degrees of risk, but each is considered to have the capacity to perform in accordance with the terms of the loan. Loans possessing a grade of 5 exhibit characteristics which indicate higher risk that the loan may not be able to perform in accordance with the terms of the loan. Grade 6 loans are considered sub-standard and are generally impaired, however, certain of these loans continue to accrue interest and are not TDRs and are not considered impaired. All loans that are on nonaccrual status or TDRs are evaluated for specific reserves. Grade 7 loans are considered doubtful and would be included in nonaccrual loans.
Those loans that are identified through the Company’s internal loan grading system as impaired are evaluated individually under FASB ASC 310-10. Management orders a new appraisal based on where the loan is in the collection process and the age of the existing appraisal. Each loan is analyzed to determine the net value of collateral and an estimate of potential loss. The net value of collateral per our analysis is determined using various subjective discounts, selling expenses and a review of the assumptions used to generate the current appraisal. Appraised values on real estate collateral are subject to constant change and management makes certain assumptions about how the age of an appraisal impacts current value. TDRs and nonaccrual loans are re-evaluated periodically to determine the adequacy of specific reserves and prior charge-offs
Loans that are not assessed for specific reserves under FASB ASC 310-10 are reserved for under FASB ASC 450. The loans analyzed under FASB ASC 450 are first assigned a quantitative factor based on historical charge-off levels for the call report category using either the three year historical charge-offs, the two year historical charge-offs, or the last twelve months historical charge-offs. Depending on the economic cycle and where we are in the cycle, one of these methods will be chosen as most representative of the expectations for losses that are in the portfolio which are unidentified. Adding to the quantitative factor are qualitative factors which are more of a reflection of current economic conditions and trends. Together these two components comprise the reserve. Loans that are assessed for specific reserves are identified by being in nonaccrual, troubled debt restructuring, or other impaired loan status. For each of these loans the collateral value less collection costs and distressed sale discounts is determined and any deficiency is identified. If collection is deemed to be collateral dependent the deficiency is charged off and if not collateral dependent a specific reserve is established for the deficiency.
Using the data gathered during the quarterly evaluation process, the model calculates an acceptable level for the allowance for loan losses. Management and the Board of Directors are responsible for determining the appropriate level of the allowance for loan losses based on the model results.
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The provision for 2011 was primarily the result of credit quality deterioration due to the current economic conditions in our markets. The sectors of the loan portfolio being impacted most by the economic climate are residential construction, land acquisition and development. Other factors influencing the provision include net loan charge-offs. For the year ended December 31, 2011, net loan charge-offs were $12.4 million compared with $25.3 million for the prior year period and non-accrual loans were $60.1 million and $51.5 million at December 31, 2011 and 2010, respectively. The allowance for loan losses at December 31, 2011 was $21.1 million, which represents 3.51% of total loans outstanding compared to $22.1 million or 3.24% as of December 31, 2010.
The allowance for loan losses represents management’s estimate of an appropriate amount to provide for known and inherent losses in the loan portfolio in the normal course of business. While management believes the methodology used to establish the allowance for loan losses incorporates the best information available at the time, future adjustments to the level of the allowance may be necessary and the results of operations could be adversely affected should circumstances differ substantially from the assumptions initially used. We believe that the allowance for loan losses was established in conformity with generally accepted accounting principles; however, there can be no assurances that the regulatory agencies, after reviewing the loan portfolio, will not require management to increase the level of the allowance. Likewise, there can be no assurance that the existing allowance for loan losses is adequate should there be deterioration in the quality of any loans or changes in any of the factors discussed above. Any increases in the provision for loan losses resulting from such deterioration or change in condition could adversely affect our financial condition and results of operations.
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The following table summarizes the bank’s loan loss experience for the years ending December 31, 2011, 2010, 2009, 2008, and 2007 (in thousands, except ratios):
2011 | 2010 | 2009 | 2008 | 2007 | |||||||||||||||
Balance at beginning of period | $ | 22,100 | $ | 15,676 | $ | 9,542 | $ | 6,653 | $ | 5,566 | |||||||||
Charge-offs: | |||||||||||||||||||
Commercial and industrial | 2,181 | 6,137 | 1,496 | 260 | 104 | ||||||||||||||
Commercial construction and land development | 7,735 | 12,593 | 2,502 | 141 | 25 | ||||||||||||||
Commercial real estate | 1,802 | 2,499 | 593 | 544 | 36 | ||||||||||||||
Residential construction | 588 | 1,634 | 1,876 | — | 20 | ||||||||||||||
Residential mortgage | 2,126 | 4,842 | 2,657 | 582 | 63 | ||||||||||||||
Consumer | 375 | 569 | 349 | 309 | 217 | ||||||||||||||
Consumer credit cards | 102 | 163 | 122 | 159 | 39 | ||||||||||||||
14,909 | 28,437 | 9,595 | 1,995 | 504 | |||||||||||||||
Recoveries: | |||||||||||||||||||
Commercial and industrial | 419 | 820 | 35 | 51 | 26 | ||||||||||||||
Commercial construction and land development | 404 | 865 | 19 | 12 | — | ||||||||||||||
Commercial real estate | 485 | 210 | — | — | — | ||||||||||||||
Residential construction | 291 | 229 | 22 | — | — | ||||||||||||||
Residential mortgage | 771 | 736 | 95 | 7 | 71 | ||||||||||||||
Consumer | 127 | 249 | 70 | 78 | 95 | ||||||||||||||
Consumer credit cards | 13 | 8 | 18 | 10 | 37 | ||||||||||||||
2,510 | 3,117 | 259 | 158 | 229 | |||||||||||||||
Net charge-offs | 12,399 | 25,320 | 9,336 | 1,837 | 275 | ||||||||||||||
Additions charged to operations | 11,440 | 31,744 | 15,470 | 3,336 | 1,362 | ||||||||||||||
Adjustments due to Merger with Longleaf Community Bank | — | — | — | 1,390 | — | ||||||||||||||
Balance at end of year | $ | 21,141 | $ | 22,100 | $ | 15,676 | $ | 9,542 | $ | 6,653 | |||||||||
Ratio of net charge-offs during the year to average gross loans outstanding during the year | 1.90 | % | 3.58 | % | 1.31 | % | 0.29 | % | 0.06 | % |
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The following table summarizes the bank’s allocation of allowance for loan losses at December 31, 2011, 2010, 2009, 2008, and 2007 (in thousands, except ratios):
At December 31, | ||||||||||||||||||||
2011 | 2010 | 2009 | ||||||||||||||||||
Amount | % of Total Loans (1) | Amount | % of Total Loans (1) | Amount | % of Total Loans (1) | |||||||||||||||
Commercial and industrial | $ | 2,730 | 13 | % | $ | 2,049 | 9 | % | $ | 1,737 | 11 | % | ||||||||
Commercial construction and land development | 8,799 | 41 | % | 8,375 | 39 | % | 5,441 | 35 | % | |||||||||||
Commercial real estate | 3,800 | 18 | % | 4,038 | 18 | % | 1,418 | 9 | % | |||||||||||
Residential construction | 740 | 4 | % | 2,848 | 13 | % | 1,814 | 12 | % | |||||||||||
Residential mortgage | 4,630 | 22 | % | 4,291 | 19 | % | 4,655 | 29 | % | |||||||||||
Consumer | 413 | 2 | % | 415 | 2 | % | 446 | 3 | % | |||||||||||
Other | 29 | — | % | 84 | — | % | 165 | 1 | % | |||||||||||
Total | $ | 21,141 | 100 | % | $ | 22,100 | 100 | % | $ | 15,676 | 100 | % |
At December 31, | |||||||||||||
2008 | 2007 | ||||||||||||
Amount | % of Total Loans (1) | Amount | % of Total Loans (1) | ||||||||||
Commercial and industrial | $ | 686 | 7 | % | $ | 223 | 3 | % | |||||
Commercial construction and land development | 2,535 | 27 | % | 1,732 | 26 | % | |||||||
Commercial real estate | 1,929 | 20 | % | 1,208 | 18 | % | |||||||
Residential construction | 845 | 9 | % | 577 | 9 | % | |||||||
Residential mortgage | 2,721 | 28 | % | 966 | 15 | % | |||||||
Consumer | 728 | 8 | % | 1,902 | 28 | % | |||||||
Other | 98 | 1 | % | 45 | 1 | % | |||||||
Total | $ | 9,542 | 100 | % | $ | 6,653 | 100 | % |
(1) Represents total of all outstanding loans in each category as a percentage of total loans outstanding.
Deposits
Time certificates in amounts of $100,000 or more outstanding at December 31, 2011, 2010, and 2009, by maturity were as follows (in thousands):
2011 | 2010 | 2009 | |||||||||
Three months or less | $ | 37,829 | $ | 26,589 | $ | 64,526 | |||||
Over three months through six months | 33,808 | 85,088 | 56,805 | ||||||||
Over six months through twelve months | 74,976 | 97,933 | 93,433 | ||||||||
Over twelve months through three years | 144,493 | 126,780 | 89,103 | ||||||||
Over three years | 26,524 | 45,235 | 1,800 | ||||||||
Total | $ | 317,630 | $ | 381,625 | $ | 305,667 |
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Borrowings
The bank borrows funds principally from the FHLB. Information regarding such borrowings at December 31, 2011, 2010, and 2009, are as follows (in thousands, except rates):
2011 | 2010 | 2009 | |||||||||
Balance outstanding at December 31 | $ | 112,000 | $ | 112,271 | $ | 112,543 | |||||
Weighted average rate at December 31 | 3.58 | % | 3.58 | % | 3.58 | % | |||||
Maximum borrowings during the year | $ | 112,271 | $ | 112,543 | $ | 114,314 | |||||
Average amounts outstanding during year | $ | 112,170 | $ | 112,441 | $ | 112,906 | |||||
Weighted average rate during year | 3.63 | % | 3.63 | % | 3.66 | % |
There were no short-term advances outstanding from the FHLB at December 31, 2011, 2010 and 2009.
In addition, the bank may purchase federal funds through secured federal funds lines of credit with various banks aggregating $16.0 million. These lines are intended for short-term borrowings and are payable on demand and bear interest based upon the daily federal funds rate. For 2011, 2010, and 2009, average federal funds purchased were $0, $0, and $1.5 million, respectively. At December 31, 2011 and December 31, 2010, the bank had no federal funds borrowings outstanding under these lines.
The Company completed a $12 million offering of Subordinated Promissory Notes on August 12, 2009.
Return on Equity and Assets
The following table indicates the ratios for return on average assets and average equity, dividend payout, and average equity to average assets for 2011, 2010, and 2009:
As of and for the Year Ended December 31, | ||||||||
2011 | 2010 | 2009 | ||||||
Selected Performance Ratios | ||||||||
Return of average assets | (0.97 | )% | (2.96 | )% | (0.22 | )% | ||
Return of average equity | (25.28 | )% | (42.83 | )% | (3.07 | )% | ||
Dividend payout ratio | 0.00 | % | (0.79 | )% | (84.01 | )% | ||
Average equity to average assets | 3.84 | % | 6.92 | % | 7.20 | % |
Critical Accounting Estimates and Policies
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Critical accounting estimates and policies are those we believe are both most important to the portrayal of our financial condition and results, and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We believe that the allowance for loan losses, other than temporary impairment of investments available for sale, valuation of foreclosed assets and income taxes represent particularly sensitive accounting estimates.
Allowance for Loan Losses and Valuation of Impaired Loans
The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the maturity of the loan portfolio, credit concentration, trends in historical loss experience, specific impaired loans and general economic conditions. See Notes A and C to the consolidated financial statements for a comprehensive discussion of our accounting
41
policy for the allowance for loan losses.
Other Than Temporary Impairment
The Company also reviews its investment portfolio for other than temporary impairments. On a quarterly basis, management reviews the investment portfolio for any investments that are in a loss position and have shown a loss greater than twelve months. In determining whether or not the investment is other than temporarily impaired, management reviews the current market for the investment and events that could have an impact on the investment’s performance in the future. If the impairment is considered other than temporary, the investment is written down to the current value.
Valuation of Foreclosed Assets
Assets acquired as a result of foreclosure are valued at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations of the property are periodically performed by management and the assets are carried at the lower of cost or fair value minus estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of debt are treated as credit losses. Routine holding costs, subsequent declines in value, and gains or losses on disposition are included in other income and expense.
Income Taxes
Accrued taxes represent the estimated amount payable to or receivable from taxing jurisdictions, either currently or in the future, and are reported, on a net basis, as a component of “other assets” in the consolidated balance sheets. The calculation of the Company’s income tax expense is complex and requires the use of many estimates and judgments in its determination.
Management’s determination of the realization of the net deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income and the implementation of various tax plans to maximize realization of the deferred tax asset. As of December 31, 2011, an $18.6 million valuation allowance has been established primarily due to the possibility that all of the deferred tax asset associated with the allowance for loan losses may not be realized. See Note J Income Taxes in the footnotes to the audited consolidated financial statements for further disclosure on this matter.
From time to time, management bases the estimates of related tax liabilities on its belief that future events will validate management’s current assumptions regarding the ultimate outcome of tax-related exposures. While the Company has obtained the opinion of advisors that the anticipated tax treatment of these transactions should prevail and has assessed the relative merits and risks of the appropriate tax treatment, examination of the Company’s income tax returns, changes in tax law and regulatory guidance may impact the treatment of these transactions and resulting provisions for income taxes.
Item 7A - Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
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Item 8 - Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Four Oaks Fincorp, Inc.
Four Oaks, North Carolina
We have audited the accompanying consolidated balance sheets of Four Oaks Fincorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, comprehensive loss, shareholders’ equity and cash flows for each of 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 Four Oaks Fincorp, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Dixon Hughes Goodman LLP
Raleigh, North Carolina
March 30, 2012
43
Four Oaks Fincorp, Inc.
Consolidated Balance Sheets
As of December 31, 2011 and 2010
2011 | 2010 | ||||||
(Amounts in thousands, except share data) | |||||||
ASSETS | |||||||
Cash and due from banks | $ | 13,969 | $ | 10,093 | |||
Interest-earning deposits | 150,997 | 88,301 | |||||
Investment securities available for sale, at fair value | 92,790 | 132,170 | |||||
Investment securities held to maturity, at amortized cost | 20,445 | — | |||||
Loans | 602,232 | 682,254 | |||||
Allowance for loan losses | (21,141 | ) | (22,100 | ) | |||
Net loans | 581,091 | 660,154 | |||||
Accrued interest receivable | 1,985 | 2,621 | |||||
Bank premises and equipment, net | 16,024 | 16,708 | |||||
FHLB stock | 6,553 | 6,747 | |||||
Investment in life insurance | 13,827 | 11,550 | |||||
Foreclosed assets | 12,159 | 8,805 | |||||
Other assets | 6,796 | 10,423 | |||||
Total assets | $ | 916,636 | $ | 947,572 | |||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||
Deposits: | |||||||
Noninterest-bearing demand | 138,123 | $ | 90,230 | ||||
Money market, NOW accounts and savings accounts | 150,185 | 150,389 | |||||
Time deposits, $100,000 and over | 317,630 | 381,625 | |||||
Other time deposits | 139,951 | 146,972 | |||||
Total deposits | 745,889 | 769,216 | |||||
Borrowings | 112,000 | 112,271 | |||||
Subordinated debentures | 12,372 | 12,372 | |||||
Subordinated promissory notes | 12,000 | 12,000 | |||||
Accrued interest payable | 1,437 | 1,612 | |||||
Other liabilities | 3,246 | 4,646 | |||||
Total liabilities | 886,944 | 912,117 | |||||
Commitments and Contingencies (Notes C, L, O and P) | |||||||
Shareholders’ equity: | |||||||
Common stock, $1.00 par value, 20,000,000 shares authorized; | |||||||
7,663,387 and 7,542,601 issued and outstanding | 7,663 | 7,543 | |||||
Additional paid-in capital | 34,048 | 33,815 | |||||
Accumulated deficit | (13,071 | ) | (3,981 | ) | |||
Accumulated other comprehensive income (loss) | 1,052 | (1,922 | ) | ||||
Total shareholders' equity | 29,692 | 35,455 | |||||
Total liabilities and shareholders' equity | $ | 916,636 | $ | 947,572 |
See notes to consolidated financial statements.
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Four Oaks Fincorp, Inc.
Consolidated Statements of Operations
For the Years Ended December 31, 2011 and 2010
2011 | 2010 | ||||||
(Amounts in thousands, except per share data) | |||||||
Interest and dividend income: | |||||||
Loans, including fees | $ | 36,550 | $ | 41,489 | |||
Investment securities: | |||||||
Taxable | 2,753 | 2,704 | |||||
Tax-exempt | — | 1,271 | |||||
Dividends | 258 | 357 | |||||
Interest-earning deposits | 443 | 157 | |||||
Total interest and dividend income | 40,004 | 45,978 | |||||
Interest expense: | |||||||
Deposits | 8,781 | 9,954 | |||||
Borrowings | 4,072 | 4,082 | |||||
Subordinated debt | 208 | 212 | |||||
Subordinated promissory notes | 1,035 | 1,034 | |||||
Total interest expense | 14,096 | 15,282 | |||||
Net interest income | 25,908 | 30,696 | |||||
Provision for loan losses | 11,440 | 31,744 | |||||
Net interest income (loss) after provision for loan losses | 14,468 | (1,048 | ) | ||||
Non-interest income: | |||||||
Service charges on deposit accounts | 2,017 | 2,035 | |||||
Other service charges, commissions and fees | 2,503 | 2,714 | |||||
Gains on sale of investment securities, net | 958 | 3,411 | |||||
Total other-than-temporary impairment loss | (656 | ) | (211 | ) | |||
Portion of loss recognized in other comprehensive income | 71 | — | |||||
Net impairment loss recognized in earnings | (585 | ) | (211 | ) | |||
Income from investment in life insurance | 379 | 481 | |||||
Other non-interest income | 97 | 67 | |||||
Total non-interest income | 5,369 | 8,497 | |||||
Non-interest expenses: | |||||||
Salaries | 10,514 | 10,634 | |||||
Employee benefits | 1,885 | 1,977 | |||||
Occupancy expenses | 1,332 | 1,364 | |||||
Equipment expenses | 1,645 | 1,677 | |||||
Professional and consulting fees | 2,242 | 2,513 | |||||
FDIC assessments | 2,381 | 2,201 | |||||
Loss on sale or write-down of foreclosed assets | 3,166 | 3,974 | |||||
Collection expenses | 1,059 | 783 | |||||
Other operating expenses | 4,703 | 4,543 | |||||
Total non-interest expenses | 28,927 | 29,666 | |||||
Loss before income taxes | (9,090 | ) | (22,217 | ) |
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Provision for income taxes | — | 6,074 | |||||
Net loss | $ | (9,090 | ) | $ | (28,291 | ) | |
Basic net loss per common share | $ | (1.20 | ) | $ | (3.78 | ) | |
Diluted net loss per common share | $ | (1.20 | ) | $ | (3.78 | ) |
See notes to consolidated financial statements.
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Four Oaks Fincorp, Inc.
Consolidated Statements of Comprehensive Loss
For the Years Ended December 31, 2011 and 2010
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Net loss | $ | (9,090 | ) | $ | (28,291 | ) | |
Other comprehensive loss: | |||||||
Securities available for sale: | |||||||
Unrealized holding gains (losses) on available for sale securities | 5,225 | (748 | ) | ||||
Tax effect | (1,977 | ) | 303 | ||||
Reclassification of gains recognized in net loss | (958 | ) | (3,411 | ) | |||
Tax effect | 369 | 1,364 | |||||
Reclassification of impairment loss recognized in net loss | 585 | 211 | |||||
Tax effect | (226 | ) | (84 | ) | |||
Portion of other-than-temporary impairment loss recognized in other comprehensive income | (71 | ) | — | ||||
Tax effect | 27 | — | |||||
Net of tax amount | 2,974 | (2,365 | ) | ||||
Comprehensive loss | $ | (6,116 | ) | $ | (30,656 | ) |
See notes to consolidated financial statements.
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Four Oaks Fincorp, Inc.
Consolidated Statements of Shareholders’ Equity
For the Years Ended December 31, 2011 and 2010
Common stock | Additional paid-in capital | Retained earnings (Accumulated) deficit | Accumulated other comprehensive income (loss) | Total shareholders' equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
(Amounts in thousands, except share data) | ||||||||||||||||||||||
BALANCE, DECEMBER 31, 2009 | 7,440,268 | $ | 7,440 | $ | 33,346 | $ | 24,625 | $ | 443 | $ | 65,854 | |||||||||||
Change in estimate of the fair value of assets acquired from Nuestro Banco | — | — | — | (91 | ) | — | (91 | ) | ||||||||||||||
Net loss | — | — | — | (28,291 | ) | — | (28,291 | ) | ||||||||||||||
Other comprehensive loss | — | — | — | — | (2,365 | ) | (2,365 | ) | ||||||||||||||
Issuance of common stock | 102,333 | 103 | 350 | — | — | 453 | ||||||||||||||||
Stock based compensation | — | — | 119 | — | — | 119 | ||||||||||||||||
Cash dividends of $ .03 per share | — | — | — | (224 | ) | — | (224 | ) | ||||||||||||||
BALANCE, DECEMBER 31, 2010 | 7,542,601 | 7,543 | 33,815 | (3,981 | ) | (1,922 | ) | 35,455 | ||||||||||||||
Net loss | — | — | — | (9,090 | ) | — | (9,090 | ) | ||||||||||||||
Other comprehensive income | — | — | — | — | 2,974 | 2,974 | ||||||||||||||||
Issuance of common stock | 120,786 | 120 | 138 | — | — | 258 | ||||||||||||||||
Stock based compensation | — | — | 95 | — | — | 95 | ||||||||||||||||
BALANCE, DECEMBER 31, 2011 | 7,663,387 | $ | 7,663 | $ | 34,048 | $ | (13,071 | ) | $ | 1,052 | $ | 29,692 |
See notes to consolidated financial statements.
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Four Oaks Fincorp, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2011 and 2010
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Cash flows from operating activities: | |||||||
Net loss | $ | (9,090 | ) | $ | (28,291 | ) | |
Adjustments to reconcile net loss to net cash provided by operations: | |||||||
Provision for loan losses | 11,440 | 31,744 | |||||
Provision for depreciation and amortization | 1,243 | 1,245 | |||||
Net amortization of bond premiums and discounts | 1,415 | 877 | |||||
Deferred income taxes | — | 6,837 | |||||
Stock based compensation | 95 | 119 | |||||
Gain on sale of investment securities | (958 | ) | (3,411 | ) | |||
Loss on sale of foreclosed assets, net | 390 | 792 | |||||
Write-downs of foreclosed assets | 2,776 | 3,164 | |||||
Income from investment in life insurance | (379 | ) | (481 | ) | |||
Impairment loss on investment securities available for sale | 585 | 211 | |||||
Changes in assets and liabilities: | |||||||
Other assets | (233 | ) | (99 | ) | |||
FDIC prepaid insurance premium | 2,052 | 2,043 | |||||
Interest receivable | 636 | 979 | |||||
Other liabilities | (1,400 | ) | (1,031 | ) | |||
Interest payable | (175 | ) | (671 | ) | |||
Net cash provided by operating activities | 8,397 | 14,027 | |||||
Cash flows from investing activities: | |||||||
Proceeds from sales and calls of investment securities available for sale | 85,929 | 124,799 | |||||
Proceeds from paydowns of investment securities available for sale | 12,314 | 21,800 | |||||
Proceeds from paydowns of investment securities held to maturity | 925 | — | |||||
Purchase of investment securities available for sale | (55,007 | ) | (154,634 | ) | |||
Purchase of investment securities held to maturity | (21,486 | ) | — | ||||
Proceeds from sale of loans | 5,133 | — | |||||
Proceeds from loan participation sale | 4,989 | — | |||||
Purchase of bank owned life insurance | (1,898 | ) | — | ||||
Redemption of FHLB stock | 194 | 55 | |||||
Net decrease (increase) in loans | 46,183 | (2,301 | ) | ||||
Purchases of bank premises and equipment | (559 | ) | (472 | ) | |||
Proceeds from sale of foreclosed assets | 4,872 | 8,164 | |||||
Capitalized expenditures on foreclosed assets | (74 | ) | (357 | ) | |||
Net cash provided by (used in) investing activities | 81,515 | (2,946 | ) | ||||
Cash flows from financing activities: | |||||||
Net decrease from borrowings | (271 | ) | (272 | ) | |||
Net (decrease) increase in deposit accounts | (23,327 | ) | 3,194 |
49
Proceeds from issuance of common stock | 258 | 453 | |||||
Cash dividends paid | — | (224 | ) | ||||
Net cash (used in) provided by financing activities | (23,340 | ) | 3,151 | ||||
Net increase in cash and cash equivalents | 66,572 | 14,232 | |||||
Cash and cash equivalents at beginning of year | 98,394 | 84,162 | |||||
Cash and cash equivalents at end of year | $ | 164,966 | $ | 98,394 | |||
Schedule of noncash investing and financing activities: | |||||||
Unrealized gains on investment securities available for sale, net | 2,974 | 3,947 | |||||
Transfers of loans to foreclosed assets | 11,318 | 9,860 | |||||
See notes to consolidated financial statements.
50
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2011 and 2010
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts and transactions of Four Oaks Fincorp, Inc. (the “Company”), a bank holding company incorporated under the laws of the State of North Carolina, and its wholly owned subsidiaries, Four Oaks Bank & Trust Company, Inc. (the “Bank”) and Four Oaks Mortgage Services, L.L.C., the Company’s mortgage origination subsidiary. All significant intercompany transactions have been eliminated. In March 2006, the Company formed Four Oaks Statutory Trust I, a wholly owned Delaware statutory business trust (the “Trust”), for the sole purpose of issuing Trust Preferred Securities (as defined in Note H below). The Trust is not included in the consolidated financial statements of the Company.
Going Concern Considerations
The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. During 2010, the Company experienced significant losses, rapidly escalating impaired loans and declining capital levels. Further deterioration and some subsequent improvements were experienced in 2011. Notwithstanding these negative factors, management believes that its current operations and its cash availability are sufficient for the Company to discharge its liabilities and meet its commitments in the normal course of business. While management does not anticipate further significant deterioration in the Bank's loan portfolio and has performed stress tests and financial modeling under various potential scenarios in determining that the Company and the Bank will maintain at least adequate capitalization under federal regulatory guidelines, no assurances regarding these expectations can be made. These consolidated financial statements do not include any adjustments relating to the recoverability or classification of assets or the amounts and classification of liabilities that may be necessary should the Company be unable to continue as a going concern.
The banking industry continues to operate in a challenging and volatile economic environment, which has adversely impacted the Company's and the Bank's results of operations and capital levels. Continued losses in 2011, primarily related to the elevated provision for loan losses, continue to reduce the Company's and the Bank's capital levels. The loan loss provision for 2011 was $11.4 million compared to $31.7 million for 2010, net charge offs for the year 2011 were $12.4 million compared to $25.3 million for the comparable period in 2010. At December 31, 2011 the Company's total capital to risk weighted assets, Tier 1 capital to risk weighted assets and Tier 1 capital to average assets were 10.31%, 6.97%, and 4.41%, respectively, compared to 10.42%, 7.36% and 5.17%, respectively, at December 31, 2010. At December 31, 2011, the Bank's total capital to risk weighted assets, Tier 1 capital to risk weighted assets and Tier 1 capital to average assets were 9.75%, 8.47% and 5.40%, respectively, compared to 9.77%, 8.50%, and 5.88%, respectively, at December 31, 2010.
The Company and the Bank entered into a formal written agreement (the “Written Agreement”) with the Federal Reserve Bank of Richmond (“FRB”) and the North Carolina Office of the Commissioner of Banks (“NCCOB”) that imposes certain restrictions on the Company and the Bank, as described in Notes H and K. A material failure to comply with the Written Agreement's terms could subject the Company to additional regulatory actions and further restrictions on its business, which may have a material adverse effect on the Company's future results of operations and financial condition.
In order for the Company and the Bank to be well capitalized under federal banking agencies' guidelines, management believes that the Company will need to raise additional capital to absorb the potential future credit losses associated with the disposition of its nonperforming assets. Management is in the process of evaluating various alternatives to increase tangible common equity and regulatory capital through the issuance of additional equity. The Company is also working to reduce its balance sheet to improve capital ratios and actively evaluating a number of capital sources, asset reductions and other balance sheet management strategies to ensure that the projected level of regulatory capital can support its balance sheet long-term. There can be no assurance as to whether these efforts will be successful, either on a short-term or long-term basis. Should these efforts be unsuccessful, the Company may be unable to discharge its liabilities in the normal course of business. There can be no assurance that the Company will be successful in any efforts to raise additional capital during 2012 or 2013.
Cash and cash equivalents at December 31, 2011 were approximately $165.0 million, of which approximately $27.0 million has been earmarked for scheduled broker deposit maturities during 2012. Based on our liquidity analysis, management does not anticipate that the Company will be unable to meet its obligations as they become due. If unanticipated market factors emerge, or if the Company is not successful in its efforts to comply with the requirements set forth in the Written Agreement, the FRB and/or the NCCOB may take further enforcement or other actions. These actions might include greater restrictions on the Company's
51
operations, a revocation of its charter and the placement of the Bank into receivership if the situation materially deteriorates.
Nature of Operations
The Company was incorporated under the laws of the State of North Carolina on February 5, 1997. The Company’s primary function is to serve as the holding company for its wholly owned subsidiaries, the Bank and Four Oaks Mortgage Services, L.L.C. The Bank operates seventeen offices in eastern and central North Carolina, and its primary source of revenue is derived from loans to customers and from its securities portfolio. The loan portfolio is comprised mainly of real estate, commercial, and consumer loans. These loans are primarily collateralized by residential and commercial properties, commercial equipment, and personal property.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
Preparing 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 the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. 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, fair value of impaired loans, fair value of foreclosed assets, other than temporary impairment of investment securities available for sale and held to maturity, and the valuation allowance against deferred tax assets.
Cash and Cash Equivalents
For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions cash and due from banks, and interest-earning deposits.
Federal regulations require institutions to set aside specified amounts of cash as reserves against transactions and time deposits. As of December 31, 2011, the daily average gross reserve requirement was $3.4 million.
Investment Securities
Investment securities are classified into three categories:
(1) Held to Maturity - Debt securities that the Company has the positive intent and the ability to hold to maturity are classified as held to maturity and reported at amortized cost. The Company began using this category in 2011.
(2) Trading - Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. The Company does not use this category.
(3) Available for Sale - Debt and equity securities not classified as either securities held to maturity or trading securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of income taxes, as other comprehensive income, a separate component of shareholders' equity. The Company has historically classified all securities as available for sale until 2011. Gains and losses on sales of securities, computed based on specific identification of adjusted cost of each security, are included in income at the time of the sale. Premiums and discounts are amortized into interest income using a method that approximates the interest method over the period to maturity.
Loans
Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on all loan classifications is calculated by using the simple interest method on daily balances of the principal amount outstanding.
Loan origination fees are deferred, as well as certain direct loan origination costs. Such costs and fees are recognized as an adjustment to yield over the contractual lives of the related loans utilizing the interest method.
Purchased loans acquired in a business combination, which include loans purchased in the Nuestro Banco (“Nuestro”) acquisition, are recorded at estimated fair value on their purchase date; the purchaser cannot carry over the related allowance for loan losses
52
for acquisitions subsequent to January 1, 2009. Purchased loans are accounted for under Financial Accounting Standards Board Accounting Standard Codification (“FASB ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (formerly American Institute of Certified Public Accountants (“AICPA”) Statement of Position 03-3), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the purchase date may include statistics such as past due and nonaccrual status. Generally, acquired loans that meet the Company’s definition for nonaccrual status fall within the scope of FASB ASC 310-30. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. For all other acquired loans that do not fall under the definition of ASC 310-30, the Company will account for these loans as described in the previous paragraphs.
For all classes of loans, a loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate or the loan’s observable market price, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. If the recorded investment in the loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged-off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms.
While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loans are charged against the allowance for loan losses when management believes that the uncollectibility of a loan balance is confirmed. Increases to the allowance for loan losses occur as a result of provisions charged to operations and recoveries of amounts previously charged-off, and decreases to the allowance occur when loans are charged-off. Management evaluates the adequacy of our allowance for loan losses on a quarterly basis. The evaluation of the adequacy of the allowance for loan losses involves the consideration of loan growth, loan portfolio composition and industry diversification, historical loan loss experience, current delinquency levels, adverse conditions that might affect a borrower’s ability to repay the loan, estimated value of underlying collateral, prevailing economic conditions and all other relevant factors derived from our history of operations. Additionally, regulatory agencies review our allowance for loan losses and may require additional provisions for estimated losses based on judgments that differ from those of management.
Management has developed a model for evaluating the adequacy of the allowance for loan losses. The model uses the Company’s internal grading system to assess which loans need to be assessed for impairment. The Bank uses an internal grading system to assign the degree of inherent risk on each individual loan. The grade is initially assigned by the lending officer and reviewed by the loan administration function. The internal grading system is reviewed and tested periodically by an independent third party
53
credit review firm. The testing process involves the evaluation of a sample of new loans, loans having been identified as possessing potential weakness in credit quality, past due loans and nonaccrual loans to determine the ongoing effectiveness of the internal grading system.
The grading system is comprised of seven risk categories. Grades 1 through 4 demonstrate various degrees of risk, but each is considered to have the capacity to perform in accordance with the terms of the loan. Loans possessing a grade of 5 exhibit characteristics which indicate higher risk that the loan may not be able to perform in accordance with the terms of the loan. Grade 6 loans are considered substandard and are generally impaired, however, certain of these loans continue to accrue interest and are not TDRs and are not considered impaired. Grade 7 loans are considered doubtful and would be included in nonaccrual loans.
Those loans that are identified through the Company’s internal loan grading system as impaired are evaluated individually under FASB ASC 310-10. Management orders a new appraisal based on where the loan is in the collection process and the age of the existing appraisal. Each loan is analyzed to determine the net value of collateral and an estimate of potential loss. The net value of collateral per our analysis is determined using various subjective discounts, selling expenses and a review of the assumptions used to generate the current appraisal. Appraised values on real estate collateral are subject to constant change and management makes certain assumptions about how the age of an appraisal impacts current value. Deficiencies identified are charged off when collection of the loan is deemed to be collateral dependent and if not collateral dependent, a specific reserve is established for the deficiency. Impaired loans are re-evaluated periodically to determine the adequacy of specific reserves and prior charge-offs.
Loans that are not assessed for specific reserves under FASB ASC 310 are reserved for under FASB ASC 450. The loans analyzed under FASB ASC 450 are first assigned a quantitative factor based on historical charge-off levels for the call report category using either the three year historical charge-offs, the two year historical charge-offs, or the last twelve months historical chargeoffs. Depending on the economic cycle and where we are in the cycle, one of these methods will be chosen as most representative of the expectations for losses that are in the portfolio which are unidentified. Adding to the quantitative factor are qualitative factors which are more of a reflection of current economic conditions and trends. Together these two components comprise the reserve. Loans that are assessed for specific reserves are identified by being in nonaccrual, troubled debt restructuring or other impaired status. For each of these loans the collateral value less collection costs and distressed sale discounts is determined and any deficiency is identified. If collection is deemed to be collateral dependent the deficiency is charged off and if not collateral dependent a specific reserve is established for the deficiency.
Using the data gathered during the quarterly evaluation process, the model calculates an acceptable level for the allowance for loan losses. Management and the Board of Directors are responsible for determining the appropriate level of the allowance for loan losses based on the model results.
Foreclosed Assets
Assets acquired as a result of foreclosure are valued at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations of the property are periodically performed by management and the assets are carried at the lower of cost or fair value minus estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of debt are treated as credit losses. Routine holding costs, subsequent declines in value, and gains or losses on disposition are included in other income and expense.
Bank Premises and Equipment
Land is carried at cost. Buildings, furniture, and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on the estimated useful lives of assets. Useful lives range from 5 to 10 years for furniture and equipment and 40 years for buildings. Expenditures for repairs and maintenance are charged to expense as incurred.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. These temporary differences consist primarily of the allowance for loan losses, differences in the financial statement and income tax basis in premises and equipment and differences in financial statement and income tax basis in accrued liabilities. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be fully realized.
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Stock in Federal Home Loan Bank of Atlanta
The Company owned Federal Home Loan Bank of Atlanta (“FHLB”) stock totaling $6.6 million at December 31, 2011 and $6.7 million at December 31, 2010. On October 27, 2011, FHLB announced that it would pay an annualized dividend rate of 0.80 percent for the third quarter of 2011. Based on the continued payment of dividends and that redemption of this stock has historically been at par, management believes that its investment in FHLB stock was not other-than-temporarily impaired as of December 31, 2011 or December 31, 2010. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not cause a decrease in the value of the FHLB stock held by the Company.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the change in equity during a period for non-owner transactions and is divided into net income and other comprehensive income. Other comprehensive income (loss) includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. Components of other comprehensive income (loss) for the Company consist of the unrealized gains and losses, net of taxes, in the Company’s available for sale securities portfolio.
Accumulated other comprehensive income (loss) at December 31, 2011 and 2010 consists of the following:
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Unrealized holding gains (loss) - investment securities available for sale | $ | 1,560 | $ | (3,220 | ) | ||
Deferred income taxes | (508 | ) | 1,298 | ||||
Net unrealized holding gains (loss) - investment | |||||||
securities available for sale | 1,052 | (1,922 | ) | ||||
Total accumulated other comprehensive income (loss) | $ | 1,052 | $ | (1,922 | ) |
Stock Compensation Plans
The Company accounts for stock based awards granted to employees using the fair value method. The cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). The cost of employee services received in exchange for an award is based on the grant-date fair value of the award. Excess tax benefits are reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.
Net Loss Per Common Share and Common Shares Outstanding
Basic earnings per share represents income (loss) available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options.
Basic and diluted net loss per common share have been computed based upon net loss as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:
2011 | 2010 | ||||
Weighted average number of common shares used in computing basic net loss per share | 7,599,666 | 7,490,313 | |||
Effect of dilutive stock options | — | — | |||
Weighted average number of commons shares and dilutive potential common shares used in computing diluted net loss per share | 7,599,666 | 7,490,313 |
Stock options that have exercise prices greater than the average market price of the common shares or stock options outstanding do not have a dilutive effect and are considered antidilutive. Outstanding antidilutive options of 337,106 and 329,756 in 2011 and 2010, respectively, had no dilutive effect because the Company reported a net loss for these years.
55
New Accounting Standards
Receivables
In July 2010, the FASB issued Accounting Standards Update (ASU) No 2010-20, Receivables (ASC Topic 310-30) – “Disclosure about the Credit Quality of Financing Receivables and Allowance for Credit Losses.” The objective of this ASU is for an entity to provide disclosures that facilitate finance statement users’ evaluation of the following:
• | The nature of credit risk inherent in the entity’s portfolio of financial receivables; |
• | How that risk is analyzed and assessed in arriving at the allowance for credit losses; and |
• | The changes and reasons for those changes in the allowance for credit losses. |
To achieve these objectives, an entity should provide disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financial receivable. The ASU makes changes to existing disclosure requirements and includes additional disclosure requirements about financial receivables, including:
• | Credit quality indicators of financial receivables at the end of the reporting period by class of financing receivables; |
• | The aging of past due financing receivables at the end of the reporting period by class of financing receivables; and |
• | The nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses. |
For public entities, the disclosures as of the end of the reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurred during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The Company has included the required disclosures within the consolidated financial statements.
On April 5, 2011, FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, which amends Subtopic 310-40, Receivables: Troubled Debt Restructurings by Creditors. The objective of this ASU is to provide greater clarity and guidance to assist creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.
The ASU also states that as a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies: Loss Contingencies. An entity should disclose certain information required by and previously deferred by ASU 2011-01, for interim and annual periods beginning on or after June 15, 2011. The Company has fully adopted all of the provisions within this ASU and has provided all required disclosures.
On May 12, 2011, FASB issued ASU 2011-04 (Topic 220): Fair Value Measurement. The new guidance creates a uniform framework for applying fair value measurement principles. It eliminates differences between GAAP and International Financial Reporting Standards issued by the International Accounting Standards Board. New disclosures required by the guidance include: quantitative information about the significant unobservable inputs used for Level 3 measurements; a qualitative discussion about the sensitivity of recurring Level 3 measurements to changes in the unobservable inputs disclosed, including the interrelationship between inputs; and a description of the company's valuation processes. This guidance is effective for interim and annual periods beginning after December 15, 2011, and all amendments will be applied prospectively with any changes in measurements recognized in income in the period of adoption. The Company is currently evaluating the impact of this standard on the financial statements and related disclosures.
On June 17, 2011, FASB issued ASU 2011-05 (Topic 820): Comprehensive Income. The new guidance amends disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (“OCI”) as part of the statement of changes in shareholders' equity. All changes in OCI will be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The guidance does not change the items that must be reported in OCI. This guidance is effective for fiscal years and interim
56
reporting periods within those years beginning after December 15, 2011 with early adoption permitted. The adoption of this guidance will not impact the Company's consolidated financial position, results of operations or cash flows and will only impact the presentation of OCI in the consolidated financial statements.
Other accounting standards that have been issued 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 and cash flows.
From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.
NOTE B - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities available for sale as of December 31, 2011 and 2010 are as follows:
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Securities Available for Sale | (Amounts in thousands) | ||||||||||||||
2011: | |||||||||||||||
Taxable municipal securities | $ | 17,046 | $ | 873 | $ | — | $ | 17,919 | |||||||
Mortgage-backed securities | |||||||||||||||
GNMA | 72,839 | 841 | 51 | 73,629 | |||||||||||
Trust preferred securities | 1,175 | — | 90 | 1,085 | |||||||||||
Equity securities | 170 | 2 | 15 | 157 | |||||||||||
$ | 91,230 | $ | 1,716 | $ | 156 | $ | 92,790 |
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Securities Available for Sale | (Amounts in thousands) | ||||||||||||||
2010: | |||||||||||||||
Taxable municipal securities | $ | 31,285 | $ | 11 | $ | 1,275 | $ | 30,021 | |||||||
Mortgage-backed securities | |||||||||||||||
GNMA | 102,046 | 352 | 1,951 | 100,447 | |||||||||||
Trust preferred securities | 1,750 | — | 451 | 1,299 | |||||||||||
Equity securities | 310 | 93 | — | 403 | |||||||||||
$ | 135,391 | $ | 456 | $ | 3,677 | $ | 132,170 |
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities held to maturity as of December 31, 2011 are as follows:
Securities Held to Maturity | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
(Amounts in thousands) | |||||||||||||||
2011: | |||||||||||||||
Mortgage-backed securities | |||||||||||||||
GNMA | $ | 20,445 | $ | 48 | $ | 37 | $ | 20,456 | |||||||
$ | 20,445 | $ | 48 | $ | 37 | $ | 20,456 |
The Company did not hold any investments considered to be held-to maturity at December 31, 2010.
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Management evaluates each quarter whether unrealized losses on securities represent impairment that is other than temporary. For debt securities, the Company considers its intent to sell the securities or if it is more likely than not that the Company will be required to sell the securities. If such impairment is identified, based upon the intent to sell or the more likely than not threshold, the carrying amount of the security is reduced to fair value with a charge to earnings. Upon the result of the aforementioned review, management then reviews for potential other than temporary impairment based upon other qualitative factors. In making this evaluation, management considers changes in market rates relative to those available when the security was acquired, changes in market expectations about the timing of cash flows from securities that can be prepaid, performance of the debt security, and changes in the market's perception of the issuer's financial health and the security's credit quality. If determined that a debt security has incurred other than temporary impairment, then the amount of the credit related impairment is determined. If a credit loss is evident, the amount of the credit loss is charged to earnings and the non-credit related impairment is recognized through other comprehensive income.
The unrealized gains and losses on debt securities at December 31, 2011 resulted from changing market interest rates over the yields available at the time the underlying securities were purchased. Six of eighteen GNMA collateralized mortgage obligations, three of eight GNMA adjustable rate mortgage securities, and two trust preferred securities contained unrealized losses at December 31, 2011. Management identified no impairment related to credit quality. At December 31, 2011, management had the intent and ability to hold impaired securities and no impairment was evaluated as other than temporary. As a result, no other than temporary impairment losses were recognized during the twelve months ended December 31, 2011.
For the year ended December 31, 2011, the Company determined four marketable equity securities and two trust preferred securities were other than temporarily impaired resulting in a cumulative impairment loss of $585,000. One of the trust preferred securities represented $500,000 of the total impairment loss and another represented $75,000. The $500,000 impairment loss was driven by the issuer's deferral of dividend payments, mandated by its regulators, on its TARP obligations and its junior subordinated debenture, which is held by the Company, as well as the issuer's agreement to formally enter into a Consent Order with its regulators. All of these events contributed to a severe decline of market values and warranted the recognition of complete impairment loss on this security. At December 31, 2011, the aggregate unrealized loss on the second trust preferred security totaled $146,000 before recognition of any other-than-temporary impairment charges. In its determination of the credit loss related to this investment, including the probability of repayment of principal and interest, management considered and evaluated the deteriorating credit profile/rating for this issuer over a prolonged period of time consisting of six quarters. The deteriorating creditworthiness was deemed to be a result of continued elevated levels of nonperforming assets and loan concentrations, declining regulatory capital levels, high levels of brokered deposits, and runoff in core deposits greater than 10% quarter over quarter. Of the other-than-temporary impairment losses relating to this security totaling $146,000, management determined that the portion related to credit losses amount to $75,000, which was charged against earnings. The difference between total unrealized losses and estimated credit losses on this security was charged against accumulated other comprehensive income, net of deferred taxes. The fair value of the investment at December 31, 2011 is $604,000. Four equity securities were evaluated for other than temporary impairment due to significant length of time in which the securities remain in an unrealized position and as a result of continued decline in market value. Impairment loss on these equity securities represented $10,000 of the total impairment loss. At December 31, 2011, these four equity securities have a total carrying value of $15,000.
The following tables reflect the gross unrealized losses and fair values of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates presented:
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2011 | |||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | ||||||||||||||||||
(Amounts in thousands) | |||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||
Taxable municipal securities | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||
Mortgage-backed securities | |||||||||||||||||||||||
GNMA | 12,100 | 51 | — | — | 12,100 | 51 | |||||||||||||||||
Trust preferred securities | — | — | 481 | 19 | 481 | 19 | |||||||||||||||||
Equity securities | 170 | 15 | — | — | 170 | 15 | |||||||||||||||||
Total temporarily impaired securities | $ | 12,270 | $ | 66 | $ | 481 | $ | 19 | $ | 12,751 | $ | 85 | |||||||||||
Other than temporary impairment | |||||||||||||||||||||||
Trust preferred securities | $ | — | $ | — | 604 | 71 | 604 | 71 | |||||||||||||||
Total other than temporarily impaired securities | $ | — | $ | — | $ | 604 | $ | 71 | $ | 604 | $ | 71 |
2011 | |||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | ||||||||||||||||||
(Amounts in thousands) | |||||||||||||||||||||||
Securities held to maturity: | |||||||||||||||||||||||
Mortgage-backed securities | |||||||||||||||||||||||
GNMA | $ | 8,043 | $ | 37 | $ | — | $ | — | $ | 8,043 | $ | 37 | |||||||||||
Total temporarily impaired securities | $ | 8,043 | $ | 37 | $ | — | $ | — | $ | 8,043 | $ | 37 | |||||||||||
2010 | |||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | ||||||||||||||||||
(Amounts in thousands) | |||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||
Taxable municipal securities | $ | 25,114 | $ | 1,275 | $ | — | $ | — | $ | 25,114 | $ | 1,275 | |||||||||||
Mortgage-backed securities | |||||||||||||||||||||||
GNMA | 75,585 | 1,951 | — | — | 75,585 | 1,951 | |||||||||||||||||
Trust preferred securities | 1,299 | 451 | — | — | 1,299 | 451 | |||||||||||||||||
Total temporarily impaired securities | $ | 101,998 | $ | 3,677 | $ | — | $ | — | $ | 101,998 | $ | 3,677 | |||||||||||
59
The following table shows a roll forward of the amount related to credit losses recognized on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.
2011 | |||
Balance of credit losses on debt securities at the beginning of the period | $ | — | |
Additional increase related to the credit loss for which an other-than-temporary impairment was previously recognized | 75 | ||
Balance of credit losses on debt securities at the end of the period | $ | 75 |
The amortized cost and fair value of available for sale, and held to maturity securities at December 31, 2011 by contractual maturities are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available for Sale | |||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
(Amounts in thousands) | |||||||||||||||
Taxable municipal securities | Mortgage-backed securities -GNMA | ||||||||||||||
Due within one year | $ | — | $ | — | $ | 1,450 | $ | 1,434 | |||||||
Due after one year through five years | 353 | 369 | 28,908 | 29,332 | |||||||||||
Due after five years through ten years | 11,452 | 12,035 | 42,481 | 42,863 | |||||||||||
Due after ten years | 5,241 | 5,515 | — | — | |||||||||||
Total debt securities | 17,046 | 17,919 | 72,839 | 73,629 | |||||||||||
Trust preferred securities | 1,175 | 1,085 | |||||||||||||
Equity securities | 170 | 157 | |||||||||||||
Total securities | $ | 91,230 | $ | 92,790 | |||||||||||
Held to Maturity | |||||||||||||||
Amortized Cost | Fair Value | ||||||||||||||
(Amounts in thousands) | |||||||||||||||
Mortgage-backed securities -GNMA | |||||||||||||||
Due within one year | $ | — | $ | — | |||||||||||
Due after one year through five years | 16,483 | $ | 16,510 | ||||||||||||
Due after five years through ten years | 3,962 | $ | 3,946 | ||||||||||||
Due after ten years | — | $ | — | ||||||||||||
$ | 20,445 | $ | 20,456 | ||||||||||||
Securities with a carrying value of approximately $112.0 million and $87.5 million at December 31, 2011 and 2010, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
Sales and calls of securities available for sale during 2011 and 2010 of $85.9 million and $124.8 million generated gross realized gains of $1.1 million and $3.7 million , respectively, and gross realized losses of $157,000 and $343,000, respectively.
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES
The classification of loan segments as of December 31, 2011 and 2010 are summarized as follows:
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2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Commercial and industrial | $ | 40,345 | $ | 46,653 | |||
Commercial construction and land development | 113,762 | 133,171 | |||||
Commercial real estate | 214,740 | 245,484 | |||||
Residential construction | 26,707 | 45,296 | |||||
Residential mortgage | 192,972 | 195,930 | |||||
Consumer including credit cards | 11,451 | 13,759 | |||||
Other | 2,330 | 2,262 | |||||
602,307 | 682,555 | ||||||
Less: | |||||||
Net deferred loan fees and costs | (75 | ) | (301 | ) | |||
Allowance for loan losses | (21,141 | ) | (22,100 | ) | |||
$ | 581,091 | $ | 660,154 |
Nonperforming assets at December 31, 2011 and 2010 consist of the following:
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Loans past due ninety days or more and still accruing | $ | 60 | $ | 946 | |||
Nonaccrual loans | 60,141 | 51,492 | |||||
Foreclosed assets | 12,159 | 8,805 | |||||
$ | 72,360 | $ | 61,243 |
There was no credit deterioration of the purchased performing loans upon initial estimate at the date of acquisition or that occurred subsequent to acquisition and therefore, no additional loan loss reserve was recorded at December 31, 2011. The following table presents the purchased performing loans receivable at the acquisition date and at December 31, 2011.
Contractual Amounts Receivable | Accretable Yield | Nonaccretable Difference | Carrying Amount | ||||||||||||
(in thousands) | |||||||||||||||
Balance at December 31, 2010 | $ | 5,421 | $ | (937 | ) | $ | — | $ | 4,484 | ||||||
Change due to pay-downs received | (1,420 | ) | $ | 313 | — | (1,107 | ) | ||||||||
Balance at December 31, 2011 | $ | 4,001 | $ | (624 | ) | $ | — | $ | 3,377 |
The population of purchased impaired loans includes certain loans for which no further credit deterioration was noted. Therefore no additional allowance for loan loss reserves has been established because the originally determined credit discounts for such purchased impaired loans were deemed sufficient. The following table presents information regarding the change in all purchased impaired loans from the Company's acquisition of Nuestro Banco on December 31, 2009, from December 31, 2010 through December 31, 2011.
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Contractual Amounts Receivable | Accretable Yield | Nonaccretable Difference | Carrying Amount | ||||||||||||
(in thousands) | |||||||||||||||
As of December 31, 2010 | $ | 2,068 | $ | (954 | ) | $ | (383 | ) | $ | 731 | |||||
Transfer from nonaccretable to accretable | — | (118 | ) | 118 | — | ||||||||||
Change due to charge-offs recognized | (151 | ) | — | 151 | — | ||||||||||
Change due to paydowns received | (1,487 | ) | 942 | — | (545 | ) | |||||||||
Balance at December 31, 2011 | 430 | (130 | ) | (114 | ) | 186 |
The Company had loan and deposit relationships with most of its directors and executive officers and with companies with which certain directors and executive officers are associated. The following is a reconciliation of loans directly outstanding to executive officers, directors, and their affiliates (amounts in thousands):
Balance at December 31, 2010 | $ | 7,048 | |
New loans | — | ||
Principal repayments | (857 | ) | |
Balance at December 31, 2011 | $ | 6,191 |
As a matter of policy, these loans and credit lines are approved by the Company’s Board of Directors and are made with interest rates, terms, and collateral requirements comparable to those required of other borrowers. In the opinion of management, these loans do not involve more than the normal risk of collectibility. At December 31, 2011 the Company had pre-approved but unused lines of credit totaling $1.1 million to executive officers, directors and their affiliates.
We use an internal grading system to assign the degree of inherent risk on each individual loan. The grade is initially assigned by the lending officer and reviewed by the loan administration function throughout the life of the loan. The credit grades have been defined as follows:
• | Grade 1 - Lowest Risk |
Loans secured by properly margined liquid collateral such as certificates of deposit, government securities, cash value of life insurance, stock actively traded on one of the major stock exchanges, etc. Repayment is definite and being handled as agreed. Maintains a strong, liquid financial condition as evidenced by a current financial statement in the Bank. Repayment agreement is definite, realistic, and being handled as agreed.
• | Grade 2 - Satisfactory Quality |
Loans secured by properly margined collateral with a definite repayment agreement in effect. Unsecured loans with repayment agreements that are definite, realistic, and are being handled as agreed. Repayment source well defined by proven income, cash flow, trade asset turn, etc. Multiple repayment sources exist. Individual and businesses will typically have a sound financial condition.
• | Grade 3 – Satisfactory - Merits Attention |
Loans being repaid as agreed that require close following because of complexity, information or underwriting deficiencies, emerging signs of weakness or non-standard terms. Secured loans repaying as agreed where collateral value or marketability are questionable but do not materially affect risk. Repayment sources well defined by proven income, cash flow, trade asset turn, etc., but may be weaker than Grade 2. Loans to weak individuals or business borrowers with a strong endorser or guarantor. Fully collectible, unsecured loans or loans secured by other than approved collateral for which an acceptable repayment agreement has not been established.
• | Grade 4 - Low Satisfactory |
New Loans - Applicants with excessive minor exceptions as defined by the Risk Grade forms. Applicants with major credit history or BEACON score issues as defined by the Risk Grade forms. Applicants with two or more major exceptions WITH mitigating factors identified on the Fair Lending form.
Existing Loans - Borrower’s ability to repay from primary (intended) repayment sources is not clearly sufficient to ensure
62
performance as contracted; BUT the loan is performing as contracted, and secondary repayment sources are clearly sufficient to protect against the risk of principal or income loss; AND it is reasonable to expect that the circumstances causing repayment capacity to be uncertain will be resolved within six months. Access to alternative financing sources exists but may be limited to institutions specializing in higher risk financing.
• | Grade 5 - Special Mention |
Special Mention is an additional risk grade not available on the Grading Form. Loans are not typically made if the grade is Special Mention at inception, without management approval. Special Mention risk loans include the following characteristics: Loans currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the bank’s position at some future date. Potential weaknesses exist, generally the result of deviations from prudent lending practices, such as over advances on collateral or unproven primary repayment sources. Loans where adverse economic conditions that develop subsequent to the loan origination that do not jeopardize liquidation of the debt but do increase the level of risk may also warrant this rating. Such trends may be in the borrower’s options, credit quality or financial strength. New loans with exceptions where no mitigating factors are justified.
• | Grade 6 -8 - Substandard or Worse |
Substandard, Doubtful, and Loss are additional risk grades not available on the Grading Form. Loans are not typically made if graded Substandard or worse at inception, without management's approval. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be affected in the future.
The following tables illustrate the classes of loans by grade:
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Class
As of December 31, 2011 and 2010 (amounts in thousands)
December 31, 2011 | |||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate- Other | |||||||||
1 - Lowest Risk | $ | 2,421 | $ | — | $ | — | |||||
2 - Satisfactory Quality | 483 | 974 | 2,942 | ||||||||
3 - Satisfactory Quality - Merits Attention | 10,696 | 26,907 | 63,887 | ||||||||
4 - Low Satisfactory | 20,070 | 36,852 | 98,007 | ||||||||
5 - Special Mention | 2,593 | 8,673 | 22,311 | ||||||||
6 - Substandard or worse | 3,066 | 40,356 | 27,593 | ||||||||
$ | 39,329 | $ | 113,762 | $ | 214,740 |
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December 31, 2010 | |||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate- Other | |||||||||
1 - Lowest Risk | $ | 2,618 | $ | — | $ | — | |||||
2 - Satisfactory Quality | 1,241 | 1,602 | 6,005 | ||||||||
3 - Satisfactory Quality - Merits Attention | 16,058 | 36,766 | 87,935 | ||||||||
4 - Low Satisfactory | 18,451 | 35,328 | 96,466 | ||||||||
5 - Special Mention | 3,371 | 22,312 | 32,399 | ||||||||
6 - Substandard or worse | 3,805 | 37,163 | 22,679 | ||||||||
$ | 45,544 | $ | 133,171 | $ | 245,484 |
Consumer Credit Exposure
Credit Risk Profile by Creditworthiness Class (amounts in thousands)
December 31, 2011 | |||||||||||||||
Residential - Construction | Residential - Mortgage | Consumer - Other | Other - Loans | ||||||||||||
1 - Lowest Risk | $ | — | $ | 136 | $ | 1,952 | $ | 40 | |||||||
2 - Satisfactory Quality | 497 | 12,720 | 288 | 6 | |||||||||||
3 - Satisfactory Quality - Merits Attention | 1,971 | 68,172 | 5,183 | 298 | |||||||||||
4 - Low Satisfactory | 20,756 | 68,668 | 1,515 | 1,984 | |||||||||||
5 - Special Mention | 1,849 | 15,226 | 165 | 2 | |||||||||||
6 - Substandard or worse | 1,634 | 28,050 | 256 | — | |||||||||||
$ | 26,707 | $ | 192,972 | $ | 9,359 | $ | 2,330 |
December 31, 2010 | |||||||||||||||
Residential - Construction | Residential - Mortgage | Consumer - Other | Other - Loans | ||||||||||||
1 - Lowest Risk | $ | — | $ | 442 | $ | 2,147 | $ | — | |||||||
2 - Satisfactory Quality | 743 | 14,560 | 639 | 158 | |||||||||||
3 - Satisfactory Quality - Merits Attention | 8,550 | 75,936 | 6,389 | 46 | |||||||||||
4 - Low Satisfactory | 24,737 | 59,762 | 2,005 | 2,058 | |||||||||||
5 - Special Mention | 4,321 | 21,952 | 250 | — | |||||||||||
6 - Substandard or worse | 6,945 | 23,278 | 281 | — | |||||||||||
$ | 45,296 | $ | 195,930 | $ | 11,711 | $ | 2,262 |
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Credit Card Portfolio Exposure (amounts in thousands)
December 31, 2011 | December 31, 2010 | ||||||||||||||
Consumer - Credit Card | Business- Credit Card | Consumer - Credit Card | Business- Credit Card | ||||||||||||
Performing | $ | 2,082 | $ | 991 | $ | 2,014 | $ | 1,089 | |||||||
Non Performing | 10 | 25 | 34 | 20 | |||||||||||
$ | 2,092 | $ | 1,016 | $ | 2,048 | $ | 1,109 |
The following table illustrates the aging of loans in relation to the portfolio by loan class:
Age Analysis of Past Due Loans
As of December 31, 2011 and 2010 (amounts in thousands)
December 31, 2011 | |||||||||||||||||||||||
30-89 Days Past Due | Nonaccruals and Greater than 90 Days Past Due (1) | Total Past Due | Current | Total Loans | Recorded Investment > 90 Days and Accruing | ||||||||||||||||||
Commercial & Industrial | $ | 129 | $ | 779 | $ | 908 | $ | 38,421 | $ | 39,329 | $ | — | |||||||||||
Commercial Construction and Land Development | 1,221 | 29,538 | 30,759 | 83,003 | 113,762 | — | |||||||||||||||||
Commercial real estate | 1,647 | 14,830 | 16,477 | 198,263 | 214,740 | — | |||||||||||||||||
Residential construction | 180 | 1,469 | 1,649 | 25,058 | 26,707 | — | |||||||||||||||||
Residential mortgage | 3,479 | 13,466 | 16,945 | 176,027 | 192,972 | — | |||||||||||||||||
Consumer | 103 | 59 | 162 | 9,197 | 9,359 | — | |||||||||||||||||
Consumer credit cards | 62 | 35 | 97 | 1,995 | 2,092 | 35 | |||||||||||||||||
Business credit cards | 15 | 25 | 40 | 976 | 1,016 | 25 | |||||||||||||||||
Other | — | — | — | 2,330 | 2,330 | — | |||||||||||||||||
Total | $ | 6,836 | $ | 60,201 | $ | 67,037 | $ | 535,270 | $ | 602,307 | $ | 60 |
(1) | Nonaccruals and Greater than 90 Days Past Due is comprised of $60,000 of loans that were past due more than 90 days and still accruing interest, as well as $60.1 million of loans in nonaccrual status. |
65
December 31, 2010 | |||||||||||||||||||||||
30-89 Days Past Due | Nonaccruals and Greater than 90 Days Past Due (1) | Total Past Due | Current | Total Loans | Recorded Investment > 90 Days and Accruing | ||||||||||||||||||
Commercial & Industrial | $ | 491 | $ | 3,610 | $ | 4,101 | $ | 41,443 | $ | 45,544 | $ | 109 | |||||||||||
Commercial Construction and Land Development | 1,766 | 22,969 | 24,735 | 108,436 | 133,171 | — | |||||||||||||||||
Commercial real estate | 2,291 | 10,718 | 13,009 | 232,475 | 245,484 | — | |||||||||||||||||
Residential construction | — | 4,773 | 4,773 | 40,523 | 45,296 | — | |||||||||||||||||
Residential mortgage | 3,095 | 10,279 | 13,374 | 182,556 | 195,930 | 797 | |||||||||||||||||
Consumer | 218 | 55 | 273 | 11,438 | 11,711 | 6 | |||||||||||||||||
Consumer credit cards | 103 | 25 | 128 | 1,920 | 2,048 | 25 | |||||||||||||||||
Business credit cards | 56 | 9 | 65 | 1,044 | 1,109 | 9 | |||||||||||||||||
Other | 6 | — | 6 | 2,256 | 2,262 | — | |||||||||||||||||
Total | $ | 8,026 | $ | 52,438 | $ | 60,464 | $ | 622,091 | $ | 682,555 | $ | 946 |
(1) Nonaccruals and Greater than 90 Days Past Due is comprised of $946,000 of loans that were past due more than 90 days and still accruing interest, as well as $51.5 million of loans in nonaccrual status.
The following table represents the loans on nonaccrual status as of December 31, 2011 and 2010 by loan class:
2011 | 2010 | ||||||
Commercial & Industrial | $ | 779 | $ | 3,501 | |||
Commercial Construction and Land Development | 29,538 | 22,969 | |||||
Commercial real estate | 14,830 | 10,718 | |||||
Residential construction | 1,469 | 4,773 | |||||
Residential mortgage | 13,466 | 9,482 | |||||
Consumer | 59 | 49 | |||||
Other | — | — | |||||
Total | $ | 60,141 | $ | 51,492 |
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The following table illustrates the impaired loans by loan class:
Impaired Loans
For the Year Ended December 31, 2011 and 2010 (amounts in thousands)
December 31, 2011 | |||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | YTD Average Recorded Investment | Interest Income Recognized | |||||||||||||||
With no related allowance recorded: | |||||||||||||||||||
Commercial and industrial | $ | 992 | $ | 1,459 | $ | — | $ | 1,262 | $ | 11 | |||||||||
Commercial construction and land development | 23,049 | 28,958 | — | 22,315 | 167 | ||||||||||||||
Commercial real estate other | 18,325 | 20,601 | — | 14,128 | 157 | ||||||||||||||
Residential construction | 98 | 98 | — | 98 | — | ||||||||||||||
Residential mortgage | 16,152 | 18,528 | — | 12,681 | 167 | ||||||||||||||
Consumer | 77 | 132 | — | 90 | — | ||||||||||||||
Other | — | — | — | — | — | ||||||||||||||
Subtotal: | 58,693 | 69,776 | — | 50,574 | 502 | ||||||||||||||
With an allowance recorded: | |||||||||||||||||||
Commercial and industrial | 1,427 | 1,597 | 1,237 | 967 | 18 | ||||||||||||||
Commercial construction and land development | 14,873 | 20,999 | 2,942 | 18,136 | 45 | ||||||||||||||
Commercial real estate other | 7,750 | 9,289 | 1,448 | 6,805 | 72 | ||||||||||||||
Residential construction | 1,144 | 1,363 | 114 | 1,363 | — | ||||||||||||||
Residential mortgage | 9,175 | 10,366 | 1,617 | 7,493 | 76 | ||||||||||||||
Consumer | 9 | 16 | 1 | 4 | — | ||||||||||||||
Other | — | — | — | — | — | ||||||||||||||
Subtotal: | 34,378 | 43,630 | 7,359 | 34,768 | 211 | ||||||||||||||
Totals: | |||||||||||||||||||
Commercial | 66,416 | 82,903 | 5,627 | 63,613 | 470 | ||||||||||||||
Consumer | 86 | 148 | 1 | 94 | — | ||||||||||||||
Residential | 26,569 | 30,355 | 1,731 | 21,635 | 243 | ||||||||||||||
Grand Total: | $ | 93,071 | $ | 113,406 | $ | 7,359 | $ | 85,342 | $ | 713 |
At December 31, 2011, the recorded investment in loans considered impaired totaled $93.1 million. Of the total investment in loans considered impaired, $34.4 million were found to show specific impairment for which $7.4 million in valuation allowance was recorded; the remaining $58.7 million in impaired loans required no specific valuation allowance because either previously established valuation allowances had been absorbed by partial charge-offs or loan evaluations had no indication of impairment. For the year ended December 31, 2011, the average recorded investment in impaired loans was approximately $85.3 million. The amount of interest recognized on impaired loans during the portion of the year that they were considered impaired was approximately $713,000.
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December 31, 2010 | |||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | YTD Average Recorded Investment | Interest Income Recognized | |||||||||||||||
With no related allowance recorded: | |||||||||||||||||||
Commercial and industrial | $ | 1,157 | $ | 2,567 | $ | — | $ | 1,313 | $ | 67 | |||||||||
Commercial construction and land development | 14,731 | 17,019 | — | 5,612 | 230 | ||||||||||||||
Commercial real estate other | 9,989 | 10,858 | — | 5,097 | 219 | ||||||||||||||
Residential construction | 2,923 | 3,179 | — | 1,053 | 55 | ||||||||||||||
Residential mortgage | 8,983 | 11,095 | — | 3,448 | 127 | ||||||||||||||
Consumer | 50 | 96 | — | 57 | 1 | ||||||||||||||
Other | — | — | — | — | — | ||||||||||||||
Subtotal: | 37,833 | 44,814 | — | 16,580 | 699 | ||||||||||||||
With an allowance recorded: | |||||||||||||||||||
Commercial and industrial | 1,203 | 1,203 | 748 | 355 | 21 | ||||||||||||||
Commercial construction and land development | 18,934 | 26,699 | 5,020 | 11,367 | 321 | ||||||||||||||
Commercial real estate other | 7,201 | 8,231 | 1,624 | 3,068 | 103 | ||||||||||||||
Residential construction | 2,264 | 2,953 | 327 | 1,410 | 41 | ||||||||||||||
Residential mortgage | 4,622 | 5,611 | 676 | 2,172 | 85 | ||||||||||||||
Consumer | 18 | 16 | 4 | 5 | — | ||||||||||||||
Other | — | — | — | — | — | ||||||||||||||
Subtotal: | 34,242 | 44,713 | 8,399 | 18,377 | 571 | ||||||||||||||
Totals: | |||||||||||||||||||
Commercial | 53,215 | 66,577 | 7,392 | 26,812 | 961 | ||||||||||||||
Consumer | 68,000 | 112 | 4 | 62 | 1 | ||||||||||||||
Residential | 18,792 | 22,838 | 1,003 | 8,083 | 308 | ||||||||||||||
Grand Total: | $ | 72,075 | $ | 89,527 | $ | 8,399 | $ | 34,957 | $ | 1,270 |
At December 31, 2010, the recorded investment in loans considered impaired totaled $72.1 million. Of the total investment in loans considered impaired, $34.2 million were found to show specific impairment for which $ 8.4 million in valuation allowance was recorded; no valuation allowance for the other impaired loans was considered necessary. For the year ended December 31, 2010, the average recorded investment in impaired loans was approximately $35.0 million. The amount of interest recognized on impaired loans during the portion of the year that they were considered impaired was approximately $1.3 million.
Troubled Debt Restructurings
Loans are classified as a troubled debt restructuring (“TDR”) when, for economic or legal reasons related to the debtor's financial difficulties, the bank grants a concession to the debtor that would not otherwise be considered. Generally, these loans are restructured due to a borrower's inability to repay or meet the contractual obligations under the loan, which predominantly occurs, because of cash flow problems. The Bank only restructures loans for borrowers in financial difficulty that demonstrate the willingness and capacity to repay the loan under reasonable terms and where the Bank has sufficient protection provided by the cash flow potential of the underlying collateral or business. We may grant concessions by (1) forgiving principal or interest, (2) reducing the stated interest rate to a below market rate, (3) deferring principal payments, (4) changing repayment terms from amortizing to interest only, (5) extending the repayment period, or (6) accepting a change in terms based on a bankruptcy plan.
Loans being renewed or modified are reviewed by the Bank to determine if the risk grade assigned is accurate based on updated information. All loans graded a “5” or worse at or prior to renewal or modification are also reviewed to determine if the loan should be classified as a TDR. The Bank's knowledge of the borrower's situation and any updated financial information obtained is first used to determine whether the borrower is experiencing financial difficulty. Once this is determined, the Bank reviews the modification terms to determine if a concession has been made. If the Bank determines the answer to both of the above questions is yes, the loan will be classified as a TDR. If the Bank determines the answer to either of these questions is no, the loan is not classified as a TDR. Documentation to support this review and determination of classification is maintained with the credit file.
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The Bank's policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. If a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If the borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual until such time as continued performance has been demonstrated, which is typically a period of at least six consecutive payments. If the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status. We will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured terms. However, all TDRs are considered to be impaired and are evaluated as such in the quarterly allowance calculation.
For the year ended December 31, 2011, the Bank modified 53 loans totaling $12.5 million which were deemed TDRs. The following table presents a breakdown of these TDRs by loan class and the type of concession made to the borrower.
For the Year Ended | |||||||||
December 31, 2011 | |||||||||
(Dollars in thousands) | |||||||||
Number of loans | Pre-Classification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | |||||||
Below market interest rate | |||||||||
Commercial real estate | 12 | $ | 2,920 | $ | 2,870 | ||||
Residential mortgage | 2 | 310 | 310 | ||||||
Subtotal | 14 | 3,230 | 3,180 | ||||||
Extended payment terms: | |||||||||
Commercial & industrial | 5 | 485 | 485 | ||||||
Commercial real estate | 14 | 5,727 | 5,727 | ||||||
Residential construction | 1 | 165 | 165 | ||||||
Residential mortgage | 11 | 1,526 | 1,531 | ||||||
Subtotal | 31 | 7,903 | 7,908 | ||||||
Other: | |||||||||
Commercial & industrial | 2 | 146 | 146 | ||||||
Commercial real estate | 2 | 290 | 290 | ||||||
Consumer | 2 | 235 | 235 | ||||||
Residential mortgage | 2 | 735 | 735 | ||||||
Subtotal | 8 | 1,406 | 1,406 | ||||||
Total | 53 | $ | 12,539 | $ | 12,494 | ||||
Current Bank policy considers a loan to be in payment default at the time that the loan is placed on nonaccrual. For the year ended December 31, 2011, payment defaults occurred on 23 loans totaling $4.9 million which were modified during the previous 12 months. The following table presents loans that were modified as troubled debt restructurings within the previous 12 months and for which there was a payment default for the year ended December 31, 2011, (dollars in thousands).
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Year Ended | |||||||
December 31, 2011 | |||||||
Number of loans | Recorded Investment | ||||||
Below market interest rate | |||||||
Commercial real estate | 1 | $ | 19 | ||||
Residential mortgage | 2 | 271 | |||||
Subtotal | 3 | 290 | |||||
Extended payment terms | |||||||
Commercial & industrial | 3 | $ | 52 | ||||
Commercial real estate | 8 | 4,033 | |||||
Residential mortgage | 5 | 528 | |||||
Subtotal | 16 | 4,613 | |||||
Other | |||||||
Commercial & industrial | 4 | $ | — | ||||
Subtotal | 4 | — | |||||
Total | 23 | $ | 4,903 | ||||
The table below details successes and failures of troubled debt restructurings that we have entered into during the previous 12 months. There have been 53 TDRs executed during the previous 12 months, 5 of which have resulted in default by the borrower and the current recorded investment in these notes is $0, 30 notes totaling $5.8 million are paying as agreed in the restructure and 23 notes totaling $4.9 million are on non-accrual. (dollars in thousands)
December 31, 2011 | |||||||||||||||||||||||
Paid in full | Paying as restructured | Converted to non-accrual | Foreclosure/Default | ||||||||||||||||||||
Number of loans | Recorded Investment | Number of loans | Recorded Investment | Number of loans | Recorded Investment | Number of loans | Recorded Investment | ||||||||||||||||
Below market interest rate | — | $ | 11 | $ | 2,389 | 3 | $ | 290 | — | $ | — | ||||||||||||
Extended payment terms | — | — | 15 | 2,493 | 15 | 4,613 | 1 | — | |||||||||||||||
Forgiveness of principal | — | — | — | — | — | — | — | — | |||||||||||||||
Other | — | — | 4 | 868 | — | — | 4 | — | |||||||||||||||
Total | — | $ | — | 30 | $ | 5,750 | 18 | $ | 4,903 | 5 | $ | — |
Allowance for Loan Losses and Recorded Investment in Loans
For the Year Ended December 31, 2011 (amounts in thousands)
The allowance for loan losses represents management’s estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. Management evaluates the adequacy of this allowance on a monthly basis during which time those loans that are identified as impaired are evaluated individually.
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A summary of the allowance for the year ended December 31, 2011 and 2010 is as follows:
Year ended December 31, | |||||||
2011 | 2010 | ||||||
Balance, beginning of period | $ | 22,100 | $ | 15,676 | |||
Provision for loan losses | 11,440 | 31,744 | |||||
Loans charged-off | (14,909 | ) | (28,437 | ) | |||
Recoveries | 2,510 | 3,117 | |||||
Net (charge-offs) recoveries | (12,399 | ) | (25,320 | ) | |||
Balance, end of period | $ | 21,141 | $ | 22,100 |
To provide greater transparency on non-performing assets, additional disclosures required by ASU 2010-20 have been included below. Allowance for loan losses is reported by portfolio segment and further detail of credit quality indicators are provided by class of loans.
Following is an analysis of the allowance for loan losses by loan segment for the years ended December 31, 2011 and 2010:
December 31, 2011 | Real Estate | ||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial construction and land development | Commercial real estate | Residential construction | Residential mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
(in thousands) | |||||||||||||||||||||||||||||||
Balance, beginning of period | $ | 2,049 | $ | 8,375 | $ | 4,038 | $ | 2,848 | $ | 4,291 | $ | 415 | $ | 84 | $ | 22,100 | |||||||||||||||
Provision for loan losses | 2,443 | 7,755 | 1,079 | (1,811 | ) | 1,694 | 335 | (55 | ) | 11,440 | |||||||||||||||||||||
Loans charged-off | (2,181 | ) | (7,735 | ) | (1,802 | ) | (588 | ) | (2,126 | ) | (477 | ) | — | (14,909 | ) | ||||||||||||||||
Recoveries | 419 | 404 | 485 | 291 | 771 | 140 | — | 2,510 | |||||||||||||||||||||||
Net (charge-offs) recoveries | (1,762 | ) | (7,331 | ) | (1,317 | ) | (297 | ) | (1,355 | ) | (337 | ) | — | (12,399 | ) | ||||||||||||||||
Balance, end of period | $ | 2,730 | $ | 8,799 | $ | 3,800 | $ | 740 | $ | 4,630 | $ | 413 | $ | 29 | $ | 21,141 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 1,237 | $ | 2,942 | $ | 1,448 | $ | 114 | $ | 1,618 | $ | — | $ | — | $ | 7,359 | |||||||||||||||
Ending balance: collectively evaluated for impairment | 1,493 | 5,857 | 2,352 | 626 | 3,012 | 413 | 29 | 13,782 | |||||||||||||||||||||||
Financing Receivables: | |||||||||||||||||||||||||||||||
Ending Balance | $ | 40,345 | $ | 113,762 | $ | 214,740 | $ | 26,707 | $ | 192,972 | $ | 11,451 | $ | 2,330 | $ | 602,307 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 2,419 | $ | 37,922 | $ | 26,075 | $ | 1,242 | $ | 25,327 | $ | 86 | $ | — | $ | 93,071 | |||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 37,926 | $ | 75,840 | $ | 188,665 | $ | 25,465 | $ | 167,645 | $ | 11,365 | $ | 2,330 | $ | 509,236 |
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December 31, 2010 | Real Estate | ||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial construction and land development | Commercial real estate | Residential construction | Residential mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
(in thousands) | |||||||||||||||||||||||||||||||
Balance, beginning of period | $ | 1,737 | $ | 5,674 | $ | 1,417 | $ | 1,582 | $ | 4,655 | $ | 446 | $ | 165 | $ | 15,676 | |||||||||||||||
Provision for loan losses | 5,629 | 14,429 | 4,910 | 2,671 | 3,742 | 289 | 74 | 31,744 | |||||||||||||||||||||||
Loans charged-off | (6,137 | ) | (12,593 | ) | (2,499 | ) | (1,634 | ) | (4,842 | ) | (569 | ) | (163 | ) | (28,437 | ) | |||||||||||||||
Recoveries | 820 | 865 | 210 | 229 | 736 | 249 | 8 | 3,117 | |||||||||||||||||||||||
Net (charge-offs) recoveries | (5,317 | ) | (11,728 | ) | (2,289 | ) | (1,405 | ) | (4,106 | ) | (320 | ) | (155 | ) | (25,320 | ) | |||||||||||||||
Balance, end of period | $ | 2,049 | $ | 8,375 | $ | 4,038 | $ | 2,848 | $ | 4,291 | $ | 415 | $ | 84 | $ | 22,100 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 748 | $ | 3,990 | $ | 1,625 | $ | 1,356 | $ | 676 | $ | 4 | $ | — | $ | 8,399 | |||||||||||||||
Ending balance: collectively evaluated for impairment | 1,301 | 4,385 | 2,413 | 1,492 | 3,615 | 411 | 84 | 13,701 | |||||||||||||||||||||||
Financing Receivables: | |||||||||||||||||||||||||||||||
Ending Balance | $ | 46,653 | $ | 133,171 | $ | 245,484 | $ | 45,296 | $ | 195,930 | $ | 13,759 | $ | 2,262 | $ | 682,555 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 2,292 | $ | 28,969 | $ | 17,189 | $ | 9,853 | $ | 13,607 | $ | 97 | $ | 68 | $ | 72,075 | |||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 44,361 | $ | 104,202 | $ | 228,295 | $ | 35,443 | $ | 182,323 | $ | 13,662 | $ | 2,194 | $ | 610,480 |
NOTE D - BANK PREMISES AND EQUIPMENT
Company premises and equipment at December 31, 2011 and 2010 are as follows:
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Land | $ | 4,520 | $ | 4,520 | |||
Buildings and leasehold improvements | 13,508 | 13,127 | |||||
Furniture and equipment | 11,628 | 11,450 | |||||
29,656 | 29,097 | ||||||
Less accumulated depreciation | (13,632 | ) | (12,389 | ) | |||
$ | 16,024 | $ | 16,708 |
Depreciation expense was $1.2 million and $1.3 million for the years ended December 31, 2011 and 2010, respectively.
NOTE E - OTHER INTANGIBLES
The following is a summary of other intangible assets at December 31, 2011 and 2010:
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2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Other intangibles – gross | $ | 494 | $ | 494 | |||
Less accumulated amortization | 187 | 134 | |||||
Other intangibles – net | $ | 307 | $ | 360 |
The other intangibles acquired in connection with the LongLeaf and Nuestro acquisitions had estimated lives of 120 and 60 months, respectively. Other intangibles amortization expense for the years ended December 31, 2011 and 2010 amounted to $53,000 and $55,000, respectively. Estimated amortization expense for other intangibles for future years are as follows:
2011 | |||
(Amounts in thousands) | |||
2012 | $ | 51 | |
2013 | 50 | ||
2014 | 49 | ||
2015 | 47 | ||
2016 | 47 | ||
2017 & BEYOND | 63 | ||
Total estimated amortization expense | $ | 307 |
NOTE F - DEPOSITS
At December 31, 2011, the scheduled maturities of time deposits are as follows (amounts in thousands):
Less than $100,000 | $100,000 or more | Total | |||||||||
Within one year | $ | 24,823 | $ | 37,829 | $ | 62,652 | |||||
Over one year through three years | 110,218 | 253,277 | 363,495 | ||||||||
Over three years | 4,910 | 26,524 | 31,434 | ||||||||
Total time deposits | $ | 139,951 | $ | 317,630 | $ | 457,581 |
NOTE G - BORROWINGS
At December 31, 2011 and 2010, borrowed funds included the following FHLB advances (amounts in thousands):
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Maturity | Interest Rate | 2011 | 2010 | ||||||||||
May 25, 2016 | 4.46 | % | Fixed | $ | 5,000 | $ | 5,000 | ||||||
November 17, 2016 | 4.11 | % | Fixed | 5,000 | 5,000 | ||||||||
November 30, 2016 | 4.09 | % | Fixed | 7,000 | 7,000 | ||||||||
June 5, 2017 | 4.35 | % | Fixed | 10,000 | 10,000 | ||||||||
July 3, 2017 | 4.36 | % | Fixed | 13,000 | 13,000 | ||||||||
July 24, 2017 | 4.34 | % | Fixed | 5,000 | 5,000 | ||||||||
July 31, 2017 | 4.35 | % | Fixed | 5,000 | 5,000 | ||||||||
August 14, 2017 | 4.08 | % | Fixed | 5,000 | 5,000 | ||||||||
August 14, 2017 | 3.94 | % | Fixed | 5,000 | 5,000 | ||||||||
October 4, 2017 | 3.95 | % | Fixed | 7,000 | 7,000 | ||||||||
February 5, 2018 | 2.06 | % | Fixed | 10,000 | 10,000 | ||||||||
June 5, 2018 | 2.25 | % | Fixed | 5,000 | 5,000 | ||||||||
June 5, 2018 | 2.55 | % | Fixed | 5,000 | 5,000 | ||||||||
June 5, 2018 | 3.03 | % | Fixed | 5,000 | 5,000 | ||||||||
September 10, 2018 | 3.14 | % | Fixed | 10,000 | 10,000 | ||||||||
September 18, 2018 | 2.71 | % | Fixed | 10,000 | 10,000 | ||||||||
November 17, 2011 | 4.15 | % | Fixed | — | 271 | ||||||||
$ | 112,000 | $ | 112,271 |
The above advances are secured by a floating lien covering the Company’s loan portfolio of qualifying residential (1-4 units) first mortgage loans. At December 31, 2011, the Company has available lines of credit totaling $71.3 million with the FHLB for borrowing dependent on adequate collateralization. The weighted average rates for the above borrowings at December 31, 2011 and 2010 were 3.58%.
In addition to the above advances, the Company has lines of credit of $16.0 million from various financial institutions to purchase federal funds on a short-term basis. The Company has no federal fund purchases outstanding as of December 31, 2011.
NOTE H - TRUST PREFERRED SECURITIES
On March 30, 2006, $12.0 million of trust preferred securities (“Trust Preferred Securities”) were placed through the Four Oaks Statutory Trust I, a wholly owned Delaware statutory business trust (“the Trust”). The Trust has invested the net proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Debentures”) issued by the Company and recorded in borrowings on the accompanying consolidated balance sheets. The Trust Preferred Securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to three month LIBOR plus 1.35%. The dividends paid to holders of the Trust Preferred Securities, which will be recorded as interest expense, are deductible for income tax purposes. The Trust Preferred Securities are redeemable on June 15, 2011 or afterwards in whole or in part, on any June 15, September 15, December 15, or March 15. Redemption is mandatory by June15, 2036. The Company has fully and unconditionally guaranteed the Trust Preferred Securities through the combined operation of the Debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company. The Trust Preferred Securities qualify as Tier I capital for regulatory capital purposes subject to certain limitations. We have the right to defer payment of interest on the Debentures at any time and from time to time for a period not exceeding five years, provided that no deferral period extends beyond the stated maturities of the Debentures. Such deferral of interest payments by the Company will result in a deferral of distribution payments on the related Trust Preferred Securities. Whenever we defer the payment of interest on the Debentures, the Company will be precluded from the payment of cash dividends to shareholders. In January 2011, the Company elected to defer the regularly scheduled interest payments on the Debentures related to our outstanding Trust Preferred Securities.
The Company is currently prohibited by the Written Agreement, described in Note K of these Notes to Consolidated Financial Statements, from paying interest on its Debentures without prior approval of the supervisory authorities. The Company and the Bank are prohibited from declaring or paying dividends without prior approval of the supervisory authorities. The Company exercised its right to defer regularly scheduled interest payments on the Debentures and as of December 31, 2011, $269,000 of interest payments have been accrued for and deferred pursuant to the terms of the indenture governing the Debentures.
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NOTE I – SUBORDINATED PROMISSORY NOTES
The Company sold $12.0 million aggregate principal amount of subordinated promissory notes to certain accredited investors between May and August 2009. These notes are due ten years after the date of issuance, beginning May 15, 2019, and the Company is obligated to pay interest at an annualized rate of 8.5% payable in quarterly installments beginning on the third month anniversary of the date of issuance. The Company may prepay the notes at any time after the fifth anniversary of the date of issuance, subject to compliance with applicable law. The Company is currently prohibited by the Written Agreement, described in Note K of these Notes to Consolidated Financial Statements, from paying interest on its subordinated promissory notes without prior approval of the supervisory authorities. The Company obtained approval to pay the interest on its subordinated promissory notes for the second, third and fourth quarters of 2011.
NOTE J - INCOME TAXES
Allocation of income tax expense between current and deferred portions is as follows:
Years Ended December 31, | |||||||
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Current tax expense: | |||||||
Federal | $ | — | $ | (763 | ) | ||
State | — | — | |||||
— | (763 | ) | |||||
Deferred tax expense: | |||||||
Federal | (2,876 | ) | (6,803 | ) | |||
State | (531 | ) | (1,561 | ) | |||
(3,407 | ) | (8,364 | ) | ||||
Provision for income tax expense before adjustment to deferred tax asset | (3,407 | ) | (9,127 | ) | |||
Valuation allowance | 3,407 | 15,201 | |||||
$ | — | $ | 6,074 |
The reconciliation of expected income tax at the statutory federal rate of 34% with income tax expense is as follows:
Years Ended December 31, | |||||||
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Expense computed at statutory rate of 34% | $ | (2,915 | ) | $ | (7,554 | ) | |
Effect of state income taxes, net of federal benefit | (351 | ) | (1,030 | ) | |||
Tax exempt income | (55 | ) | (363 | ) | |||
Bank owned life insurance income | (129 | ) | (164 | ) | |||
Valuation allowance | 3,407 | 15,201 | |||||
Merger expense | — | 27 | |||||
Other, net | 43 | (43 | ) | ||||
$ | — | $ | 6,074 |
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Deferred income taxes consist of the following:
Years Ended December 31, | |||||||
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Deferred tax assets: | |||||||
Allowance for loan losses | $ | 8,106 | $ | 8,476 | |||
Non-qualified stock options | 341 | 305 | |||||
OTTI | 623 | 399 | |||||
Net deferred loan fees | 29 | 116 | |||||
Net operating loss | 7,591 | 4,533 | |||||
FMV adjustment on purchased assets | 99 | 212 | |||||
Deductible merger expenses | — | 15 | |||||
Unrealized loss on securities | — | 1,298 | |||||
SERP accrual | 141 | 122 | |||||
Other | 2,608 | 1,992 | |||||
Total deferred tax assets | 19,538 | 17,468 | |||||
Less valuation allowance | (18,608 | ) | (15,201 | ) | |||
Net deferred tax assets | 930 | 2,267 | |||||
Deferred tax liabilities: | |||||||
Property and equipment | $ | 628 | $ | 705 | |||
Unrealized gain on securities | 507 | — | |||||
Prepaid expense | 282 | 253 | |||||
Other | 20 | 11 | |||||
Total deferred tax liabilities | 1,437 | 969 | |||||
Net deferred tax (liability)/asset, included in (other liabilities)/other assets | $ | (507 | ) | $ | 1,298 |
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely to be realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. For the years ended December 31, 2011 and 2010, there were no uncertain tax positions taken by the Company. The Company classifies interest and penalties related to income tax assessments, if any, in income tax expense in the consolidated statements of operations. Fiscal years ending December 31, 2007 and thereafter are subject to IRS examination.
We calculate income taxes in accordance with accounting principles generally accepted in the United States (“US GAAP”), which requires the use of the asset and liability method. The largest component of our net deferred tax asset at December 31, 2011 was related to the activity in our allowance for loan losses. In accordance with US GAAP, we regularly assess available positive and negative evidence to determine whether it is more likely than not that our deferred tax asset balances will be recovered. Based upon our analysis of our tax position, including taxes paid in prior years available through carryback and the use of tax planning strategies, at December 31, 2011 and 2010 we recognized a valuation allowance of $18.6 million and $15.2 million, respectively, to properly state our ability to realize this deferred tax asset. The total valuation allowance as of December 31, 2011 was $18.6 million resulting in a net deferred tax liability of $507 thousand. Our analysis of our tax position did not include future taxable earnings. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it may require the future occurrence of circumstances that cannot be predicted with certainty.
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As a result of the net operating loss carry forward expiring in 2030 of $11.7 million at December 31, 2011 and the $18.6 million deferred tax asset valuation allowance, the Company will not record tax expense or tax benefit until positive operating earnings utilizing existing tax loss carry forwards result in exhibited positive performance which would support the partial or full reinstatement of deferred tax assets.
NOTE K - REGULATORY RESTRICTIONS
The Bank, as a North Carolina banking corporation, may pay dividends to the Company only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure the financial soundness of the bank. No dividends were paid to the Company by the Bank during 2011.
Current federal regulations require that the Bank maintain a minimum ratio of total capital to risk weighted assets of 8%, with at least 4% being in the form of Tier 1 capital, as defined in the regulations. In addition, the Bank must maintain a leverage ratio of 4%. To be categorized as well capitalized, the Bank must maintain minimum amounts and ratios as set forth in the table below. At December 31, 2011 the Bank was classified as adequately capitalized for regulatory capital purposes since it met the minimum capital requirements but not the well capitalized requirements.
Since the Bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on interest rates paid on deposits of comparable size and maturity in the Bank’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 the Bank’s normal market area. With respect to non-brokered deposits, as an adequately capitalized institution, the Bank cannot offer interest rates that are significantly higher than the prevailing rates in its normal market area. Moreover, if the Bank becomes less than adequately capitalized, it will be subject to additional interest restrictions and must adopt a capital restoration plan acceptable to the FDIC. The Bank also would become subject to increased regulatory oversight and would be increasingly restricted in the scope of its permissible activities. 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.
The Bank’s actual capital amounts and ratios are also presented in the table below (dollars in thousands):
Actual | Minimum for Capital Adequacy Purposes | Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||
As of December 31, 2011: | ||||||||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 56,733 | 9.8 | % | $ | 46,584 | 8.0 | % | $ | 58,230 | 10.0 | % | ||||||||
Tier I Capital (to Risk Weighted Assets) | 49,283 | 8.5 | % | 23,292 | 4.0 | % | 34,938 | 6.0 | % | |||||||||||
Tier I Capital (to Average Assets) | 49,283 | 5.4 | % | 36,514 | 4.0 | % | 45,642 | 5.0 | % | |||||||||||
As of December 31, 2010: | ||||||||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 65,196 | 9.8 | % | $ | 53,359 | 8.0 | % | $ | 66,698 | 10.0 | % | ||||||||
Tier I Capital (to Risk Weighted Assets) | 56,689 | 8.5 | % | 26,679 | 4.0 | % | 40,019 | 6.0 | % | |||||||||||
Tier I Capital (to Average Assets) | 56,689 | 5.9 | % | 38,540 | 4.0 | % | 48,175 | 5.0 | % |
The Company is also subject to these capital requirements. At December 31, 2011 and 2010, the Company’s total capital to risk weighted assets, Tier 1 capital to risk weighted assets and Tier 1 capital to average assets were 10.3%, 7.0% and 4.4% and 10.4%, 7.4%, and 5.2%, respectively.
In late May 2011, the Company and Four Oaks Bank & Trust Company, the Company's wholly-owned subsidiary (the “Bank”), entered into a formal written agreement (the “Written Agreement”) with the Federal Reserve Bank of Richmond ( “FRB”) and the North Carolina Office of the Commissioner of Banks (“NCCOB”). Under the terms of the Written Agreement, the Bank developed and submitted for approval, within the time periods specified, plans to:
• | revise lending and credit administration policies and procedures at the Bank and provide relevant training; |
• | enhance the Bank's real estate appraisal policies and procedures; |
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• | enhance the Bank's loan grading and independent loan review programs; |
• | improve the Bank's position with respect to loans, relationships, or other assets in excess of $750,000, which are now or in the future become past due more than 90 days, are on the Bank's problem loan list, or adversely classified in any report of examination of the Bank; and |
• | review and revise the Bank's current policy regarding the Bank's allowance for loan and lease losses and maintain a program for the maintenance of an adequate allowance. |
In addition, the Bank has agreed that it will:
• | refrain from extending, renewing, or restructuring any credit to or for the benefit of any borrower, or related interest, whose loans or other extensions of credit have been criticized in any report of examination of the Bank absent prior approval by the Bank's board of directors or a designated committee of the board in accordance with the restrictions in the Written Agreement; |
• | eliminate from its books, by charge-off or collection, all assets or portions of assets classified as “loss” in any report of examination of the Bank, unless otherwise approved by the FRB and the NCCOB; and |
• | take all necessary steps to correct all violations of law or regulation cited by the FRB and the NCCOB. |
In addition, the Company has agreed that it will:
• | refrain from taking any form of payment representing a reduction in capital from the Bank or make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities absent prior regulatory approval; |
• | refrain from incurring, increasing, or guaranteeing any debt without the prior written approval of the FRB; and |
• | refrain from purchasing or redeeming any shares of its stock without the prior written consent of the FRB. |
Under the terms of the Written Agreement, both the Company and the Bank have agreed to:
• | submit for approval a joint plan to maintain sufficient capital at the Company on a consolidated basis and at the Bank on a stand-alone basis; |
• | notify the FRB and the NCCOB if the Company's or the Bank's capital ratios fall below the approved capital plan's minimum ratios; |
• | refrain from declaring or paying any dividends absent prior regulatory approval; |
• | comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers of the Company and the Bank and legal and regulatory limitations on indemnification and severance payments; and |
• | submit annual business plans and budgets and quarterly joint written progress reports regarding compliance with the Written Agreement. |
The Company is committed to expeditiously addressing and resolving the issues raised in the Written Agreement. As such, the Board of Directors has established an Enforcement Action Committee that meets regularly to monitor the Bank's progress on compliance with the Written Agreement. The Bank has made progress on multiple provisions included in the Written Agreement and continues to aggressively work to implement any necessary changes to policies and procedures. Several control changes have been implemented to address the financial reporting material weaknesses, identified as of December 31, 2010, of identification and valuation of impaired loans, the support and validation of the allowance for loan losses, and the valuation of foreclosed assets. Additionally, the Bank has implemented additional controls around obtaining updated collateral valuations as required by regulation and has established new policies to further reduce Commercial Real Estate concentrations, ensure current financial information is evaluated, and control interest only loans. Other areas also being addressed are the adequacy of credit resources, portfolio risk management and reporting,and consistency and compliance when dealing with loan workouts. A material failure to comply with the terms of the Written Agreement could subject the Company to additional regulatory actions and further restrictions on its business. These regulatory actions and resulting restrictions on the Company's business may have a material adverse effect on its future results of operations and financial condition.
Since the Company and the bank entered the Written Agreement, management has had frequent and regular communication with the FRB and NCCOB. This communication has involved:
• | updates on the progress involving each of the actions outlined in the Written Agreement; |
• | specific steps taken by the Company to remain in compliance with the Written Agreement; and |
• | communications, verbally and via interim internal reports, regarding the financial status of the Company including, but not limited to, the Company's key capital ratios. |
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To date, the Company has not received any disagreement from the regulatory authorities regarding actions taken or contemplated. Nor has the Company received any indication that additional measures are required beyond those contained in the Written Agreement. Despite the actions taken thus far, there is no assurance that additional measures or actions will not be required by the regulatory authorities in the future.
NOTE L - COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial 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 conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness 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 obtained varies but may include real estate, stocks, bonds, and certificates of deposit.
Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Bank is committed.
Stand-by letters of credit are conditional lending commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Financial instruments whose contract amounts represent credit risk (amounts in thousands) :
Commitments to extend credit | $ | 43,052 | |
Undisbursed lines of credit | 19,876 | ||
Performance stand-by letters of credit | 1,659 | ||
Financial stand-by letters of credit | 378 | ||
Legally binding commitments | 64,965 | ||
Credit card lines | 13,718 | ||
Total | $ | 78,683 |
Litigation Proceedings
On July 16, 2010, Thomas Caffrey and Eddie Alvarez, former officers and employees of Nuestro Banco, filed a lawsuit against the Company in the General Court of Justice, Superior Court Division, in Wake County, North Carolina. The Company removed the case to the United States District Court for the Eastern District of North Carolina. The complaint alleged that Mr. Caffrey and Mr. Alvarez were entitled to severance under the terms of offer letters that they received from Immigrant Financial Services, the predecessor to Nuestro Banco, and under the terms of unexecuted draft severance agreements that were negotiated before the consummation of the Company’s acquisition of Nuestro Banco. In addition to severance, Mr. Caffrey and Mr. Alvarez sought double damages and attorneys’ fees. The Company denied that any severance was owed to Mr. Caffrey or Mr. Alvarez, both of whom were discharged by Nuestro Banco prior to the consummation of the Company’s acquisition. On June 29, 2011, the federal
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court dismissed with prejudice all claims based on the offer letters, while remanding to state court the remaining claims that were based on the unexecuted draft severance agreements. The plaintiffs appealed this decision to the United States Court of Appeals for the Fourth Circuit. On July 5, 2011, Four Oaks filed a motion for judgment on the pleadings in state court, seeking judgment on all remaining claims. Four Oaks also filed a motion to stay discovery. In November 2011, the parties reached an agreement to settle the lawsuit, the United States Court of Appeals for the Fourth Circuit dismissed the appeal, and a Stipulation of Dismissal was filed in the United States District Court for the Eastern District of North Carolina. The settlement is reflected in the results of operations for the year ended December 31, 2011.
We are party to certain other legal actions in the ordinary course of our business. We believe these other actions are routine in nature and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition, results of operations, cash flows or prospects. If, however, our assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, our business, financial condition, results of operations, cash flows and prospects could be adversely affected.
NOTE M – FAIR VALUE MEASUREMENTS
ASC 820 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. ASC 820 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, ASC 820 does not expand the use of fair value in any new circumstances. ASC 825 provides companies with an option to report selected financial assets and liabilities at fair value. As of December 31, 2011, the Company had not elected to measure any financial assets or liabilities using the fair value option under ASC 825; therefore the adoption of ASC 825 had no effect on the Company’s financial condition or results of operations.
The Company records securities available for sale at fair value on a recurring basis. Fair value is a market-based measurement and is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the assets or owes the liability. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, each reporting entity is required to consider factors specific to the transaction and the asset or liability, the principal or most advantageous market for the asset or liability, and market participants with whom the entity would transact in the market.
ASC 820 establishes a fair value hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of how market-observable the fair value measurement is and defines the level of disclosure. ASC 820 clarifies fair value in terms of the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal (or most advantageous) market for the asset or liability at the measurement date (an exit price). In order to determine the fair value or the exit price, entities must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the reporting entity to define the inputs for fair value and level of hierarchy.
Outlined below is the application of the fair value hierarchy established by ASC 820 to the Company’s financial assets that are carried at fair value.
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the entity’s own assumptions.
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Fair Value on a Recurring Basis. The Company measures certain assets at fair value on a recurring basis, as described below.
Investment Securities Available for Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include equity securities traded on an active exchange, such as the New York Stock Exchange. Level 2 securities include taxable municipalities and mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. The Company’s mortgage-backed securities were primarily issued by the Government National Mortgage Association (“GNMA”), with additional mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”). As of December 31, 2011, all of the Company’s mortgage-backed securities were agency issued and designated as Level 2 securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Below are tables that present information about assets measured at fair value on a recurring basis at December 31, 2011 and 2010:
Fair Value Measurements at December 31, 2011, Using | ||||||||||||||||||||
Total Carrying Amount in the Consolidated Balance Sheet | Assets Measured at Fair Value | Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||||
Description | 12/31/2011 | 12/31/2011 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Taxable municipal securities | $ | 17,919 | $ | 17,919 | $ | — | $ | 17,919 | $ | — | ||||||||||
Mortgage-backed securities GNMA | 73,629 | 73,629 | — | 73,629 | — | |||||||||||||||
Trust preferred securities | 1,085 | 1,085 | — | — | 1,085 | |||||||||||||||
Equity securities | 157 | 157 | 157 | — | — | |||||||||||||||
Total available for sale securities | $ | 92,790 | $ | 92,790 | $ | 157 | $ | 91,548 | $ | 1,085 |
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Fair Value Measurements at December 31, 2010 Using | ||||||||||||||||||||
Total Carrying Amount in the Consolidated Balance Sheet | Assets Measured at Fair Value | Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||||
Description | 12/31/2010 | 12/31/2010 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Taxable municipal securities | $ | 30,021 | $ | 30,021 | $ | — | $ | 30,021 | $ | — | ||||||||||
Mortgage-backed securities | ||||||||||||||||||||
GNMA | 100,447 | 100,447 | — | 100,447 | — | |||||||||||||||
Trust preferred securities | 1,299 | 1,299 | — | — | 1,299 | |||||||||||||||
Equity securities | 403 | 403 | 403 | — | — | |||||||||||||||
Total available for sale securities | $ | 132,170 | $ | 132,170 | $ | 403 | $ | 130,468 | $ | 1,299 |
The table below presents reconciliation for the years ended December 31, 2011 and 2010 for all Level 3 assets that are measured at fair value on a recurring basis. During the year ended December 31, 2011, no securities were transferred from Level 3 to Level 2.
Available-for-sale Securities | |||||||
2011 | 2010 | ||||||
(Dollars in thousands) | |||||||
Beginning Balance | $ | 1,299 | $ | 15,601 | |||
Total realized and unrealized gains or (losses): | |||||||
Included in earnings | (575 | ) | — | ||||
Included in other comprehensive income | 361 | 5 | |||||
Purchases, issuances and settlements | — | — | |||||
Transfers in (out) of Level 3 | — | (14,307 | ) | ||||
Ending Balance | $ | 1,085 | $ | 1,299 |
Fair Value on a Nonrecurring Basis. The Company measures certain assets at fair value on a nonrecurring basis, as described below.
Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310, “Receivables” and ASC 450, “Contingencies”. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2011, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans totaled $93.1 million at December 31,
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2011. Of such loans, $34.4 million had specific loss allowances aggregating $7.4 million at that date for a net fair value of $27.0 million. At December 31, 2010 impaired loans totaled $72.1 million, of such loans $34.2 million had specific loss allowances aggregating $8.4 million for a net fair value of $25.8 million. Of those specific allowances, all were determined using Level 3 inputs.
Foreclosed Assets
Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Given the lack of observable market prices for identical properties, the Company records foreclosed assets as non-recurring Level 3. At December 31, 2011, fair value adjustments of $2.8 million were recorded to the foreclosed real estate of $12.2 million. At December 31, 2010, there were $3.1 million fair value adjustments required after transfer related to foreclosed real estate of $8.8 million .
Below are tables that present information about foreclosed assets measured at fair value on a recurring basis at December 31, 2011 and 2010:
Fair Value Measurements at December 31, 2011, Using | ||||||||||||||||||||
Description | Total Carrying Amount in the Consolidated Balance Sheet 12/31/11 | Assets Measured at Fair Value 12/31/2011 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Loans | $ | 27,018 | $ | 27,018 | $ | — | $ | — | $ | 27,018 | ||||||||||
Foreclosed assets | $ | 12,159 | 12,159 | — | — | 12,159 |
Fair Value Measurements at December 31, 2010, Using | ||||||||||||||||||||
Description | Total Carrying Amount in the Consolidated Balance Sheet 12/31/10 | Assets Measured at Fair Value 12/31/2010 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Loans | $ | 25,843 | $ | 25,843 | $ | — | $ | — | $ | 25,843 | ||||||||||
Foreclosed assets | $ | 8,805 | 8,805 | — | 8,805 |
NOTE N - STOCK OPTION PLAN
The Company has a non-qualified stock option plan for certain key employees under which it is authorized to issue options for up to 1,542,773 shares of common stock. Options are granted at the discretion of the Company’s Board of Directors at an exercise price approximating market value, as determined by a committee of Board members. All options granted subsequent to a 1997 amendment will be 100% vested after either one or two years from the grant date and will expire after such a period as is determined by the Board at the time of grant. Options granted for 2010 and 2011 have a two year vesting provision.
A summary of option activity under the Plan for the year ended December 31, 2011, is presented below:
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Shares | Option Price Per Share | Weighted- Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||
Outstanding at January 1, 2011 | 329,756 | $ | 12.89 | |||||||||
Granted | 60,000 | 3.00 | ||||||||||
Exercised | — | — | ||||||||||
Forfeited | (15,250 | ) | 7.18 | |||||||||
Expired | (37,400 | ) | 24.41 | |||||||||
Balance at December 31, 2011 | 337,106 | $ | 10.11 | 2.34 | — | |||||||
Exercisable at December 31, 2011 | 226,575 | $ | 12.97 | 1.69 | — |
The weighted average exercise price of all exercisable options at December 31, 2011 is $12.97. There were 250,298 shares reserved for future issuance under the Company’s stock option plan at December 31, 2011.
A summary of the status of the Company's non-vested options as of December 31, 2011 and changes during the year then ended is presented below:
Shares | Weighted average grant date fair value | ||||
Non-vested - December 31, 2010 | 115,381 | 1.99 | |||
Granted | 60,000 | 1.34 | |||
Vested | (5,381 | ) | 1.51 | ||
Forfeited/Expired | (59,469 | ) | 1.51 | ||
Non-vested - December 31, 2011 | 110,531 | 1.59 |
As of December 31, 2011 and 2010, there was $44,583 and $64,359 of unrecognized compensation cost related to non-vested share-based compensation arrangements, respectively.
Additional information concerning the Company’s stock options at December 31, 2011 is as follows:
Exercise Price | Number Outstanding | Contractual Life (Years) | Number Exercisable | |||
$3.00 | 55,675 | 4.16 | 0 | |||
$5.50 | 54,825 | 3.15 | 0 | |||
$8.64 | 51,875 | 2.16 | 51,846 | |||
$10.92 | 116,001 | 1.64 | 115,999 | |||
$15.55 | 46,425 | 0.15 | 46,425 | |||
$40.79 | 12,305 | 6.07 | 12,305 | |||
337,106 | 2.34 | 226,575 |
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2011 and 2010:
2011 | 2010 | |||||
Dividend yield | — | % | .64 | % | ||
Expected volatility | 48.80 | % | 36.60 | % | ||
Risk free interest rate | 2.13 | % | 2.40 | % | ||
Expected life | 5 years | 5 years |
The weighted average fair value of options granted during 2011 and 2010, was $1.34 and $1.85, respectively.
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NOTE O - OTHER EMPLOYEE BENEFITS
Supplemental Retirement
In 1998, the Company’s subsidiary, Four Oaks Bank & Trust Company, adopted a Supplemental Executive Retirement Plan (“SERP”) for its president. The Company has purchased life insurance policies in order to provide future funding of benefit payments. SERP benefits will accrue and vest during the period of employment and will be paid in annual benefit payments over the officer’s remaining life commencing with the officer’s retirement. The liability accrued under the SERP plan amounts to $366,000 and $317,000 at December 31, 2011 and 2010, respectively. During 2011 and 2010, the expense attributable to the SERP amounted to $49,000 and $43,000 respectively.
Employment Agreements
The Company has entered into employment agreements with certain of its executive officers to ensure a stable and competent management base. The agreements provide for benefits as spelled out in the contracts and cannot be terminated by the Company’s Board of Directors, except for cause, without prejudicing the officers’ rights to receive certain vested rights, including compensation. In addition, the Company has entered into severance compensation agreements with certain of its executive officers and key employees to provide them with severance pay benefits in the event of a change in control of the Company, as outlined in the agreements; the acquirer will be bound to the terms of the contracts.
Defined Contribution Plan
The Company sponsors a contributory profit-sharing plan in effect for substantially all employees. Participants may make voluntary contributions resulting in salary deferrals in accordance with Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Code”). The plans provide for employee contributions up to $16,500 of the participant's annual salary and an employer contribution of 25% matching of the first 6% of pre-tax salary contributed by each participant. Expenses related to these plans for the years ended December 31, 2011 and 2010 were $146,000 and $143,000, respectively. Contributions under the plan are made at the discretion of the Company’s Board of Directors.
Employee Stock Ownership Plan
The Company sponsors an employee stock ownership plan (ESOP) which makes the employees of the Company, owners of stock in the Company. The Four Oaks Bank & Trust Company’s Employee Stock Ownership Plan is available to full-time employees at least 21 years of age after six months of service. Contributions are voluntary by the Company and employees cannot contribute. Stock issued is purchased on the open market and the Company did not issue new shares in conjunction with this plan in 2011 and 2010.
Voluntary contributions are determined by the Company’s Board of Directors annually based on Company performance and are allocated to employees based on annual compensation. The Board of Directors determined that, due to the financial results for 2011 and 2010, no contributions would be made to the plan for 2011 and 2010.
Employee Stock Purchase and Bonus Plan
The Employee Stock Purchase and Bonus Plan (the “Purchase Plan”) is a voluntary plan that enables full-time employees of the Company and its subsidiaries to purchase shares of the Company’s common stock. The Purchase Plan is administered by a committee of the Board of Directors, which has broad discretionary authority to administer the Purchase Plan. The Company’s Board of Directors may amend or terminate the Purchase Plan at any time. The Purchase Plan is not intended to be qualified as an employee stock purchase plan under Section 423 of the Code.
Once a year, participants in the Purchase Plan purchase the Company’s common stock at fair market value. Participants are permitted to purchase shares under the Purchase Plan up to five percent (5%) of their compensation, with a maximum purchase amount of $1,000 per year. The Company matches, in cash, fifty percent (50%) of the amount of each participant’s purchase, up to $500. After withholding for income and employment taxes, participants use the balance of the Company’s matching grant to purchase shares of the Company’s common stock.
As of December 31, 2011, 368,544 shares of the Company’s common stock had been reserved for issuance under the Purchase Plan, and 261,596 shares had been purchased. During the years ended December 31, 2011 and 2010, 31,769 and 26,208 shares, respectively, were purchased under the Purchase Plan.
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NOTE P - LEASES
The Company has entered into non-cancelable operating leases for six branch facilities. Future minimum lease payments under the leases for future years are as follows (amounts in thousands):
Leases | |||
2012 | $ | 355 | |
2013 | 295 | ||
2014 | 262 | ||
2015 | 269 | ||
2016 | 211 | ||
2017 and beyond | 971 | ||
$ | 2,363 |
In addition, the Company has leased a building from one of its former directors for approximately $1,081 per month in 2011 and $1,060 per month in 2010, under an operating lease on a month-to-month basis.
Total rental expense under operating leases for the years ended December 31, 2011 and 2010 amounted to $364,000 and $352,000, respectively.
NOTE Q- PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Four Oaks Fincorp, Inc. at December 31, 2011 and 2010, and for the years ended December 31, 2011 and 2010 is presented below:
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Condensed Balance Sheets | |||||||
Assets: | |||||||
Cash and cash equivalents | $ | 1,427 | $ | 1,732 | |||
Equity investment in subsidiaries | 51,120 | 55,820 | |||||
Investment securities available for sale | 1,241 | 1,702 | |||||
Other assets | 593 | 585 | |||||
Total assets | $ | 54,381 | $ | 59,839 | |||
Liabilities and Shareholders’ Equity: | |||||||
Other liabilities | $ | 317 | $ | 12 | |||
Subordinated debentures | 12,372 | 12,372 | |||||
Subordinated promissory notes | 12,000 | 12,000 | |||||
Shareholders' equity | 29,692 | 35,455 | |||||
Total liabilities and shareholders’ equity | $ | 54,381 | $ | 59,839 |
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For the Years Ended December 31, | |||||||
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Condensed Statements of Operations | |||||||
Equity in undistributed earnings of subsidiaries | $ | (7,556 | ) | $ | (27,764 | ) | |
Interest income | 147 | 708 | |||||
Gain on sale of investments, available for sale | 109 | — | |||||
Impairment loss on investment securities available for sale | (585 | ) | — | ||||
Other income | 140 | 130 | |||||
Other expenses | (1,345 | ) | (1,365 | ) | |||
Net loss | $ | (9,090 | ) | $ | (28,291 | ) |
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Condensed Statements of Cash Flows | |||||||
Operating activities: | |||||||
Net income (loss) | $ | (9,090 | ) | $ | (28,291 | ) | |
Equity in undistributed earnings of subsidiaries | 7,556 | 27,764 | |||||
Stock based compensation | 95 | 119 | |||||
Impairment loss on investment securities available for sale | 585 | 211 | |||||
Gain on sale of investments | (109 | ) | — | ||||
Increase in other assets | 118 | (49 | ) | ||||
(Decrease) increase in other liabilities | 305 | (124 | ) | ||||
Net cash (used in) provided by operating activities | (540 | ) | (370 | ) | |||
Investing activities: | |||||||
Investment in subsidiaries | (24 | ) | (10,576 | ) | |||
Repayment of loan to subsidiary | — | 12,180 | |||||
Net cash (used in) provided by investing activities | (24 | ) | 1,604 | ||||
Financing activities: | |||||||
Proceeds from issuance of common stock | 259 | 453 | |||||
Dividends paid to shareholders | — | (224 | ) | ||||
Net cash provided by financing activities | 259 | 229 | |||||
Net (decrease) increase in cash and cash equivalents | (305 | ) | 1,463 | ||||
Cash and cash equivalents, beginning of year | 1,732 | 269 | |||||
Cash and cash equivalents, end of year | $ | 1,427 | $ | 1,732 |
NOTE R - FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC 825-10-65-1 requires the disclosure of estimated fair values for financial instruments. Quoted market prices, if available, are utilized as an estimate of the fair value of financial instruments. Because no quoted market prices exist for a significant part of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net realizable value could be materially different from the estimates presented below. In addition, the estimates are only indicative of individual financial instruments’ values and should not
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be considered an indication of the fair value of the Company taken as a whole. The following methods and assumptions were used to estimate the fair value of each class of financial instrument.
Cash and Cash Equivalents
The carrying amounts of cash and cash equivalents are equal to the fair value due to the liquid nature of the financial instruments.
Investment Securities
Fair values of investment securities are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans
The fair value of loans has been estimated utilizing the net present value of future cash flows based upon contractual balances, prepayment assumptions, and applicable weighted average interest rates, adjusted for a 5% current liquidity and market discount assumption. The Company has assigned no fair value to off-balance sheet financial instruments since they are either short term in nature or subject to immediate repricing.
FHLB Stock
The carrying amount of FHLB stock approximates fair value.
Investment in Life Insurance
The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.
Deposits
The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at year-end. Fair value of time deposits is estimated by discounting the future cash flows using the current rate offered for similar deposits with the same maturities.
Borrowings, Subordinated Debentures and Subordinated Promissory Notes
The fair value of subordinated debentures and subordinated promissory notes is based on discounting expected cash flows at the interest rate from debt with the same or similar remaining maturities and collection requirements. The fair value of borrowings as of December 31, 2011 is based on the monthly Mark to Market schedule published by the lender FHLB which is indicative of current rates for similar borrowings of comparable remaining duration.
Accrued Interest Receivable and Payable
The carrying amounts of accrued interest approximate fair value.
The following table presents information for financial assets and liabilities as of December 31, 2011 and 2010 (amounts in thousands):
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2011 | 2010 | ||||||||||||||
Carrying Value | Estimated Fair Value | Carrying Value | Estimated Fair Value | ||||||||||||
Financial assets: | |||||||||||||||
Cash and cash equivalents | $ | 164,966 | $ | 164,966 | $ | 99,038 | $ | 99,038 | |||||||
Securities available for sale | 92,790 | 92,790 | 132,170 | 132,170 | |||||||||||
Securities held to maturity | 20,445 | 20,456 | — | — | |||||||||||
Loans, net | 581,091 | 554,624 | 660,154 | 636,441 | |||||||||||
FHLB stock | 6,553 | 6,553 | 6,747 | 6,747 | |||||||||||
Investment in life insurance | 13,827 | 13,827 | 11,550 | 11,550 | |||||||||||
Accrued interest receivable | 1,985 | 1,985 | 2,621 | 2,621 | |||||||||||
Financial liabilities: | |||||||||||||||
Deposits | $ | 745,889 | $ | 742,959 | $ | 769,216 | $ | 763,604 | |||||||
Subordinated debentures | 24,372 | 15,598 | 24,372 | 15,594 | |||||||||||
Borrowings | 112,000 | 126,313 | 112,271 | 124,616 | |||||||||||
Accrued interest payable | 1,437 | 1,437 | 1,612 | 1,612 |
NOTE S - CASH FLOW SUPPLEMENTAL DISCLOSURES
The following information is supplemental information regarding the cash flows for the years ended December 31, 2011 and 2010:
2011 | 2010 | ||||||
(Amounts in thousands) | |||||||
Cash paid for: | |||||||
Interest on deposits and borrowings | $ | 14,271 | $ | 15,953 | |||
Income taxes | — | — | |||||
Summary of non-cash investing and financing activities: | |||||||
Transfer from loans to foreclosed assets | 11,318 | 9,860 | |||||
Increase (decrease) in fair value of securities available for sale, net of tax | 2,974 | (2,365 | ) | ||||
Change in estimate of the fair value of assets acquired from Nuestro Banco | — | (91 | ) | ||||
Item 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
None
Item 9A - Controls and Procedures.
Disclosure Controls and Procedures
As required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation was carried out under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report. As defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act, the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on their evaluation, the Chief Executive Officer and
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Chief Financial Officer have concluded that as of the end of the period covered by this Annual Report, the Company's disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits to the SEC under the Exchange Act is recorded, processed, summarized and reported, within the time periods required by the SEC's rules and forms.
Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of internal control over financial reporting, based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the framework in Internal Control - Integrated Framework, management of the Company has concluded the Company maintained effective internal control over financial reporting as of December 31, 2011.
Remediation of Prior Year Material Weaknesses
As disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2010, the Company's management, including its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of internal control over financial reporting as of December 31, 2010. Based on that evaluation, management determined that, as of December 31, 2010, the Company's internal control over financial reporting was not effective due to the identification of certain material weaknesses related to effective identification and valuation of impaired loans, certain reconciliation and review procedures specific to the determination of the allowance for loan losses, and effective and timely valuation adjustments pertaining to foreclosed assets.
In order to remediate the material weaknesses, management took certain actions designed to strengthen the bank's internal loan review process. As part of such remedial measures, the bank established a Troubled Debt Committee in the fourth quarter of 2010 that meets on a weekly basis to discuss deteriorating credits, risk grades, nonaccrual status, impairment potential, and the appropriateness of potential charge-offs and write-downs of certain loans in the bank's portfolio. In the first quarter of 2011, the bank implemented new system specifications to automatically identify loans that reach 90 days past due and move such loans to nonaccrual status, after which management reviews the loans to verify their nonaccrual status. Also in the first quarter of 2011, the bank added a new qualitative factor to the model for determining the allowance for loan losses related to the potential margin of error in evaluating loans that are not assessed for specific reserves.
In the second quarter of 2011, the bank expanded the population of loans reviewed for specific impairment, implemented additional controls to ensure loans are graded appropriately, updated the appraisal and evaluation process, and enhanced the general reserve calculation. During the third quarter of 2011, additional loan portfolio reporting was created to assist management and the Board of Directors with portfolio monitoring. This includes reviews for changes in collateral values, potential risk grade or classification changes, and credit migration reports. Also in the third quarter of 2011, further enhancements were made to the appraisal and evaluation process which included engaging a third party to perform internal evaluations on behalf of the bank. Management also continued to work on defining, documenting, and enhancing the bank's policies and procedures around foreclosed assets.
Management completed its remediation of the material weaknesses as of September 30, 2011.
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Changes in Internal Control Over Financial Reporting
There have been no changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth quarter of 2011 that the Company believes have materially affected or are likely to materially affect, its internal control over financial reporting.
Item 9B - Other Information.
Not applicable.
PART III
Item 10 - Directors, Executive Officers and Corporate Governance.
Board of Directors
The number constituting our board of directors must be at least five (5), but not more than twenty-one (21). The number of directors within this variable range may be fixed or changed from time to time by our shareholders or our board of directors. Our board of directors has set the number of directors at eight (8). The members of our board of directors are elected by our shareholders to serve one (1) year terms. All of our directors hold office until the next annual meeting or until their successors are elected and qualified. The following table and accompanying biographies provide information on the members of our board of directors:
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Name | Age | Director Since | Positions and Offices with our Company & Business Experience During Past Five (5) Years |
Ayden R. Lee, Jr. | 63 | 1983 | Chairman of the Board of Directors, Chief Executive Officer, and President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. |
Michael A. Weeks | 60 | 2007 | Lead Independent Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Since 1987, Mr. Weeks has served as architect and President of Weeks Turner Architecture, P.A., a full service architectural firm. Mr. Weeks is also Member Manager of the following real estate development companies: PPPV, LLC, Atlantic Park, LLC, Weeks & Sherron, LLC, PTW Properties, LLC, Weeks Sherron & Turner, LLC, Serwee Associates, LLC, South Main Associates, LLC, Durant Business Center, LLC, Tryon Theater, LLC, Knightdale Business Partners, LLC, APMW, LLC, WRS, LLC, Brown Street, LLC, Mann’s Chapel Properties, LLC and Bud Leigh, LLC. Mr. Weeks also serves as Member Manager of a family farm, Weeks Associates, LLC, and co-owner of Lake Wheeler Mobile Estates, LLC, a mobile home park. In addition, Mr. Weeks has diverse experience serving on various government, community and private boards. |
Dr. R. Max Raynor, Jr. | 54 | 2000 | Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Dr. Raynor has been an optometrist since 1985 and owns Professional Eye Care, a full scope eye care practice, with locations in Benson, Clinton and Roseboro, North Carolina. |
Paula Canaday Bowman | 64 | 1989 | Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Ms. Bowman is a retired school teacher. Since 2006, Ms. Bowman has served as director of Benson Area Medical Center. |
William J. Edwards | 68 | 1990 | Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Since 1975, Mr. Edwards has served as President, Chief Executive Officer, and Chairman of the Board of Edwards Food Stores. |
Percy Y. Lee | 71 | 1992 | Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Since 1975, Mr. Lee has served as President of T.R. Lee Oil Co., a retailer of LP gas, gasoline, oil, and garage work and inspection station. Mr. Lee is also the co-owner of Lee Brother’s Partners, a rental property company and land developer, since 1990 and owner of Percy Lee Rental, a rental property company, since 2000. |
Warren L. Grimes | 64 | 1992 | Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Since 2001, Mr. Grimes has served as Executive Director of Smithfield Housing Authority, which provides public housing for low income persons. Mr. Grimes has also served as Partner in Reedy Creek Direct Marketing Associates, a website hosting company, as Chief Financial Officer of Reedy Creek Technologies, a software development company, and owned and operated a private solid waste business for 22 years. |
John W. Bullard | 60 | 2008 | Director of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Consultant to Four Oaks Bank & Trust Company. Since 2008, Mr. Bullard has owned Bullard Appraisals & Consulting, a real estate appraisal and consulting firm, and served as an associate broker with Keller Williams Realty, a residential and commercial real estate broker. From 2003 until its merger with Four Oaks Bank & Trust Company in 2008, Mr. Bullard served as President and Chief Executive Officer and a director of LongLeaf Community Bank. Mr. Bullard was appointed to the board of directors of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company pursuant to the merger agreement entered in connection with the merger of LongLeaf Community Bank with and into Four Oaks Bank & Trust Company. The board of directors of Four Oaks Fincorp, Inc. has determined that Mr. Bullard, who serves on the audit and risk committee of the board, meets the definition of “audit committee financial expert” as that term is defined under the Exchange Act. |
Factors Bearing on Qualifications of Directors and Nominees
The experience, qualifications, attributes, skills and other factors that lead our board of directors to conclude that each of our directors listed in the table above should serve or continue to serve as a director are described below.
Ayden R. Lee, Jr.
• | Management experience and understanding of our goals, values and culture through service as Chief Executive Officer since 1980, a director since 1983, President since 1989, and Chairman of the Board of Directors since 2006; |
• | Extensive knowledge of the banking industry and experience with various regulatory agencies; |
• | A certified public accountant (CPA); |
• | Accounting background and ability to read and analyze financial information; |
• | Leadership skills and ability to work with and motivate others; and |
• | Visible and active community leader. |
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Michael A. Weeks
• | Understanding of our culture, values and goals through service as a director of our company since 2007; |
• | Management experience through managing, operating, and growing a successful architectural firm since 1987; |
• | Ability to read and analyze financial statements and communicate with accounting professionals; |
• | Knowledge of the real estate market in a portion of our banking market through managing various real estate development companies; |
• | Familiarity with regulatory agencies and procedures gained from his broad-ranging experience on government and private boards and his real estate development activities; and |
• | Visible and active community leader. |
Dr. R. Max Raynor, Jr.
• | Understanding of our goals, values and culture through service as a director of our company since 2000; |
• | Management experience through managing, operating, and growing a successful eye care practice since 1985; |
• | Ability to identify with the financial needs of small and mid-sized businesses, which is an important segment of our customer base; and |
• | Visible and active community leader. |
Paula Canaday Bowman
• | Understanding of our goals, values and culture through service as a director of our company since 1989; |
• | Varied prior board experience through service on the nominating and corporate governance committee and the compensation committee and as director of Benson Area Medical Center; |
• | Knowledge of the economy in a large part of our market area; and |
• | Substantial personal financial interest in our long-term growth, stability and success because of her ownership of our stock. |
William J. Edwards
• | Understanding of our goals, values and culture through service as a director of our company since 1990; |
• | Ability to read and analyze financial statements; |
• | Management experience through managing, operating, and growing a successful retail company since 1975; and |
• | Ability to identify with the financial needs of small and mid-sized businesses, which is an important segment of our customer base. |
Percy Y. Lee
• | Understanding of our goals, values and culture through service as a director of our company since 1992; |
• | Management experience through managing, operating, and growing a successful retail and service company since 1975; |
• | Ability to identify with the financial needs of small and mid-sized businesses, which is an important segment of our customer base; and |
• | Knowledge of the real estate market in a portion of our banking market through ownership of rental property companies. |
Warren L. Grimes
• | Understanding of our goals, values and culture through service as a director of our company since 1992; |
• | Ability to read and analyze financial statements; |
• | Management experience as owner and operator of a private solid waste business for 22 years; and |
• | Familiarity with regulatory agencies and procedures gained from service as executive director of a public housing authority. |
John W. Bullard
• | Understanding of our goals, values and culture through service as a director of our company since 2008; |
• | Executive management experience and extensive knowledge of the banking industry through service as President and Chief Executive Officer and a director of LongLeaf Community Bank and various positions with other banks; |
• | Ability to read and analyze financial statements and communicate with accounting professionals; |
• | Knowledge of the real estate market in a portion of our banking market through experience as a real estate appraiser and broker; and |
• | Visible and active community leader. |
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Executive Officers
Certain information regarding our executive officers is set forth below. Executive officers are appointed by our board of directors, or a duly appointed officer if authorized by the board of directors, to hold office until their death, resignation, retirement, removal, disqualification or until their successor is appointed and qualified. Additional information regarding Mr. Lee is included in the director profiles set forth above.
Name | Age | Executive Officer Since | Positions and Offices with our Company & Business Experience During Past Five (5) Years |
Ayden R. Lee, Jr. | 63 | 1980 | Chief Executive Officer and President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company |
Clifton L. Painter | 63 | 1989 | Senior Executive Vice President, Chief Operating Officer and Chief Credit Officer of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Mr. Painter has been our Senior Executive Vice President since 1990, Chief Operating Officer since 1993, and Chief Credit Officer since 2005. From 1989 to 1990, Mr. Painter served as Senior Vice President, as City Executive from 1988 to 1993, and as Vice President and Branch Manager from 1986 to 1988. |
Nancy S. Wise | 56 | 1992 | Executive Vice President, Chief Financial Officer of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Ms. Wise has been our Executive Vice President and Chief Financial Officer since 2005. She joined our company as Senior Vice President and Chief Financial Officer in 1991. |
W. Leon Hiatt, III | 44 | 1996 | Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Chief Administrative Officer of Four Oaks Bank & Trust Company. Mr. Hiatt has been our Executive Vice President and Chief Administrative Officer of Four Oaks Bank & Trust Company since 2005. From 1996 to 2004, he served as our Senior Vice President, and from 1994 to 1996, he served as our Credit Administrator. |
Jeff D. Pope | 55 | 2004 | Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Chief Banking Officer of Four Oaks Bank & Trust Company. Mr. Pope has been our Executive Vice President and Chief Banking Officer of Four Oaks Bank & Trust Company since January 2009. From 2005 until January 2009, he served as Executive Vice President and Branch Administrator, and from 2000 until 2005, he served as Senior Vice President and Regional Executive. |
Lisa S. Herring | 36 | 2009 | Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Chief Risk Officer of Four Oaks Bank & Trust Company. Ms. Herring has been our Executive Vice President and Chief Risk Officer of Four Oaks Bank & Trust Company since July 2009. From 2005 until July 2009, Ms. Herring served as our Senior Vice President and General Auditor. From 2002 until 2005, Ms. Herring served as our Vice President and General Auditor. |
Additional Information Concerning our Directors and Executive Officers
There are no family relationships between any of our directors or executive officers. There are no material proceedings to which any of our directors or executive officers, or any of their associates, is a party adverse to us or has a material interest adverse to us.
To our knowledge, none of our directors or executive officers has been convicted in a criminal proceeding during the last ten years (excluding traffic violations or similar misdemeanors), and none of our directors or executive officers was a party to any judicial or administrative proceeding during the last ten years (except for any matters that were dismissed without sanction or settlement) that resulted in a judgment, decree, or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws, or a finding of any violation of federal or state securities laws.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our officers, directors, and persons who own more than ten percent (10%) of our equity securities to file reports of ownership and changes in ownership with the SEC. Officers, directors, and ten percent (10%) shareholders are required by SEC regulations to furnish us with copies of all Section 16(a) reports they file. Based solely on a review of the reports that were furnished to us by such persons and the written representations from our officers and directors, we believe that during the fiscal year ended December 31, 2011, all Section 16(a) filing requirements applicable to our officers, directors, and ten percent (10%) shareholders were satisfied.
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Code of Ethics
Our board of directors has adopted a code of ethics (our “Code of Ethics”) that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. A copy of our Code of Ethics is available at http://www.fouroaksbank.com in the “Investor Information” section under the listing for governance documents, or free of charge upon written request to the attention of the Corporate Secretary, Four Oaks Fincorp, Inc., P.O. Box 309, Four Oaks, North Carolina 27524 ((919) 963-2177). Consistent with Item 5.05 of Form 8-K, we intend to disclose future amendments to, or waivers from, our Code of Ethics on our website within four business days following the date of such amendment or waiver.
Item 11 - Executive Compensation.
Summary Compensation Table
The following table shows the annual and long-term compensation paid to, or accrued by us for, our CEO and our next two most highly compensated executive officers during 2011 for services rendered to us during the fiscal years ended December 31, 2010 and 2011. We refer to the persons identified in the table below as our “named executive officers.”
Name and Principal Position | Year | Salary ($) | Bonus ($) | Option awards ($)(1) | All other compensation ($)(2) | Total ($) | |||||||||||
Ayden R. Lee, Jr., Chairman, Chief Executive Officer and President | 2011 | $ | 267,502 | $ | 200 | $ | 6,690 | $ | 3,485 | (2) | $ | 277,877 | |||||
2010 | $ | 262,257 | $ | 200 | $ | 9,266 | $ | 3,532 | (3) | $ | 275,255 | ||||||
Clifton L. Painter, Senior Executive Vice President, Chief Operating Officer and Chief Credit Officer | 2011 | $ | 166,552 | $ | 200 | $ | 3,479 | $ | 2,862 | (4) | $ | 173,093 | |||||
2010 | $ | 163,286 | $ | 200 | $ | 4,818 | $ | 2,839 | (5) | $ | 171,143 | ||||||
Jeff D. Pope, Executive Vice President, Chief Banking Officer | 2011 | $ | 155,219 | $ | 200 | $ | 3,345 | $ | 2,692 | (6) | $ | 161,456 | |||||
2010 | $ | 152,174 | $ | 200 | $ | 4,633 | $ | 2,673 | (7) | $ | 159,680 |
(1) | Reflects the aggregate grant date fair value computed in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 718, Compensation – Stock Compensation (“ASC Topic 718”) of the option awards granted to each of our named executive officers. Assumptions used in the calculation of this amount for the fiscal years ended December 31, 2010 and 2011 are included in Note O of our audited financial statements included in this report. |
(2) | Includes $3,121 in contributions under our Four Oaks Bank & Trust Company Retirement Plan and $364 in life insurance premiums paid by us on behalf of the named executive officer. |
(3) | Includes $3,142 in contributions under our Four Oaks Bank & Trust Company Retirement Plan and $390 in life insurance premiums paid by us on behalf of the named executive officer. |
(4) | Includes $2,498 in contributions under our Four Oaks Bank & Trust Company Retirement Plan and $364 in life insurance premiums paid by us on behalf of the named executive officer. |
(5) | Includes $2,449 in contributions under our Four Oaks Bank & Trust Company Retirement Plan and $390 in life insurance premiums paid by us on behalf of the named executive officer. |
(6) | Includes $2,328 in contributions under our Four Oaks Bank & Trust Company Retirement Plan and $364 in life insurance premiums paid by us on behalf of the named executive officer. |
(7) | Includes $2,283 in contributions under our Four Oaks Bank & Trust Company Retirement Plan and $390 in life insurance premiums paid by us on behalf of the named executive officer. |
Amended and Restated Executive Employment Agreements
On December 11, 2008, we entered into Amended and Restated Executive Employment Agreements (the “Employment Agreements”) with the CEO and the other named executive officers. The Employment Agreements provide the named executive officers a base annual salary that may be increased at the discretion of the board of directors and also provide for additional benefits generally available to executive personnel and to all salaried employees, including insurance benefits, sick leave, and reimbursement of expenses incurred in the course of performing duties under the Employment Agreement. Each Employment Agreement provides for termination by us for Cause or Disability (each as defined in the Employment Agreements) of the executive officer as well as by us without Cause. In the event the executive officer’s employment is terminated without Cause prior to a Change in Control
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(as defined in the Employment Agreements) or because of Disability, the executive officer is entitled to receive as a lump sum an amount equal to his then current monthly salary for the greater of six months or the then remaining term of the Employment Agreement.
The Employment Agreements with each of our named executive officers also provide for certain severance benefits in the event the executive officer’s employment is terminated within two years following a Change in Control. If the executive officer’s employment is terminated by us within two years following a Change in Control without Cause or if the executive officer terminates his employment for Good Reason within two years following a Change in Control, then the executive officer is entitled to receive as a lump sum a severance payment equal to two times his most recent annual compensation, including the amount of his most recent bonus. In addition, the named executive officer is entitled to reimbursement for additional costs he incurs in obtaining health insurance benefits equivalent to the group benefit plan in which he participated prior to termination of employment for a 24-month period following the termination of employment or, if sooner, until he obtains comparable coverage in connection with subsequent employment.
2011 Stock Option Grants
Grants of stock options to our named executive officers under our Nonqualified Stock Option Plan are made completely at the discretion of the board of directors or the compensation committee after a fiscal year is ended based upon the actual performance of our common stock, the compensation committee’s discretionary assessment of an individual’s performance and responsibilities, and position with our company. Historically, the board of directors has granted options during its annual February meeting following the end of a fiscal year. The following table contains information about the options held by our named executive officers in 2011.
Outstanding Equity Awards at 2011 Fiscal Year-End
Name | Number of Securities underlying unexercised options (#) Exercisable | Number of Securities underlying unexercised options (#) Unexercisable | Option Exercise Price ($) | Option Expiration Date | ||||||||
Ayden R. Lee, Jr. | — | 5,000 | (1 | ) | $ | 3.00 | 2/28/2016 | |||||
— | 5,000 | (2 | ) | $ | 5.50 | 2/24/2015 | ||||||
5,000 | (3 | ) | — | $ | 8.64 | 2/25/2014 | ||||||
5,000 | (4 | ) | — | $ | 15.55 | 2/25/2012 | ||||||
Clifton L. Painter | — | 2,600 | (1 | ) | $ | 3.00 | 2/28/2016 | |||||
— | 2,600 | (2 | ) | $ | 5.50 | 2/24/2015 | ||||||
2,600 | (3 | ) | — | $ | 8.64 | 2/25/2014 | ||||||
2,600 | (4 | ) | — | $ | 15.55 | 2/25/2012 | ||||||
Jeff D. Pope | — | 2,500 | (1 | ) | $ | 3.00 | 2/28/2016 | |||||
— | 2,500 | (2 | ) | $ | 5.50 | 2/24/2015 | ||||||
2,500 | (3 | ) | — | $ | 8.64 | 2/25/2014 | ||||||
2,200 | (4 | ) | — | $ | 15.55 | 2/25/2012 |
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(1) | Option was granted on February 28, 2011 pursuant to our Nonqualified Stock Option Plan. This option has a two-year vesting period and expires five years after the date of grant. |
(2) | Option was granted on February 24, 2010 pursuant to our Nonqualified Stock Option Plan. This option has a two-year vesting period and expires five years after the date of grant. |
(3) | Option was granted on February 25, 2009 pursuant to our Nonqualified Stock Option Plan. This option is fully vested and exercisable and expires five years after the date of grant. |
(4) | Option was granted on February 25, 2008 pursuant to our Nonqualified Stock Option Plan. This option is fully vested and exercisable and expires four years after the date of grant. |
All of the options listed above expire on the earlier of the date indicated in the option expiration date column or 15 months after termination of the recipient’s employment, except in cases of death or disability. Options may be exercised to the extent they are vested. Upon termination of employment, all unvested options are forfeited, except in cases of death or disability, in which case the vesting is accelerated. Upon a merger in which we are not the surviving corporation, or liquidation or a sale of substantially all of our assets, outstanding options will become fully vested and exercisable and, to the extent not exercised, will terminate upon the effective date of such a transaction.
SERP
Under the terms of the Supplemental Executive Retirement Plan (“SERP”) adopted for Ayden R. Lee, Jr. by our subsidiary, Four Oaks Bank & Trust Company, upon Mr. Lee’s retirement from the bank, the bank will provide him with supplemental annual payments for the remainder of his life. The purpose of the SERP is to encourage Mr. Lee to remain as an employee of the bank and to reward him for contributing materially to the success of the bank. Under the SERP, upon Mr. Lee’s retirement on or after the normal retirement age of 65, the bank will be obligated to pay Mr. Lee in monthly installments an annual payment in an amount which, when added to Mr. Lee’s 401(k) benefits (based on future estimated amounts) and social security benefits (based on future estimated amounts), will ensure Mr. Lee a total normal retirement benefit equal to 75% of his Average Annual Compensation (as defined in the SERP) on the date of his retirement. If Mr. Lee retires before age 65, the annual payment as a percentage of Mr. Lee’s normal retirement benefit will vary (from 58% of normal retirement benefit at age 55 to 100% at age 62). The annual payments, which we are obligated to pay Mr. Lee each year after his retirement, are subject to certain limitations, including a maximum limit of $50,000 per year. In the event of a change of control (as defined in the SERP) of Four Oaks Fincorp, Inc. or the bank and termination of Mr. Lee’s employment within 24 months thereafter (for any reason, except termination by the bank for cause), Mr. Lee will be entitled to receive a lump sum cash payment equal to the actuarial equivalence of the greater of (i) the amount he would have been entitled to had he retired on such date or (ii) the amount of his pro rata normal retirement benefit under the SERP as of such date.
Qualified Retirement Plans
We sponsor the Four Oaks Bank & Trust Company Retirement Plan, which is a contributory profit-sharing plan in effect for substantially all employees. Participants may make voluntary contributions resulting in salary deferrals in accordance with Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Code”). The plan provides for employee contributions as a percentage of their annual salary up to the limit allowed by the Internal Revenue Service. We typically contribute matching funds of 25% of the first 6% of pre-tax salary contributed by each participant; however, contributions under the plan are made at the discretion of our board of directors.
We also sponsor the ESOP that makes our employees owners of stock in our company. The Four Oaks Bank & Trust Company’s Employee Stock Ownership Plan is available to full-time employees at least 21 years of age after six months of service. Contributions are voluntary by the company and employees cannot contribute. Stock issued is purchased on the open market, and we do not issue new shares in conjunction with the plan. Voluntary contributions are determined by our board of directors annually based on our performance and are allocated to employees based on annual compensation. No contributions were made for 2011 or 2010.
These plans apply to all qualified employees, including the named executive officers.
Severance and Change in Control Arrangements
Employment Agreements. As described in the “Amended and Restated Executive Employment Agreements” section above, we have Employment Agreements with each named executive officer and those Employment Agreements contain certain severance arrangements. As described above, if the executive officer’s employment is terminated without Cause prior to a Change in Control or because of Disability, the executive officer is entitled to receive as a lump sum an amount equal to his or her then current monthly salary for the greater of six months or the then remaining term of the Employment Agreement. In addition, the
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executive officer is entitled to receive certain severance benefits if his or her employment is terminated by us without Cause or by the executive officer for Good Reason within two years following a Change in Control. For purposes of the Employment Agreements, a Change in Control means one or more of the following occurrences:
• | A corporation, person or group acting in concert, as described in Section 14(d)(2) of the Exchange Act, holds or acquires beneficial ownership within the meaning of Rule 13d-3 promulgated under the Exchange Act of a number of shares of voting capital stock of Four Oaks Fincorp, Inc., which constitutes more than 33% of the company’s then outstanding shares entitled to vote.The consummation of a merger, share exchange, consolidation, or reorganization involving Four Oaks Fincorp, Inc. and any other corporation or entity as a result of which less than 50% of the combined voting power of Four Oaks Fincorp, Inc. or of the surviving or resulting corporation or entity after such transaction is held in the aggregate by the holders of the combined voting power of the outstanding securities of Four Oaks Fincorp, Inc. immediately prior to such transaction. |
• | All or substantially all of the assets of Four Oaks Bank & Trust Company or Four Oaks Fincorp, Inc. are sold, leased, or disposed of in one transaction or a series of related transactions. |
• | An agreement, plan, contract, or other arrangement is entered into providing for any occurrence which, as defined in the Employment Agreements, would constitute a Change in Control. |
Each of the Employment Agreements provides that if the executive officer’s employment is terminated following a Change in Control under the circumstances described above, he or she is entitled to receive a lump sum, cash severance payment equal to two times the amount of his or her most recent annual compensation, including the amount of his or her most recent bonus. In addition, the named executive officer is entitled to reimbursement for additional costs he or she incurs in obtaining health insurance benefits equivalent to the group benefit plan in which he or she participated prior to termination of employment for a 24-month period following the termination of employment or, if sooner, until he or she obtains comparable coverage in connection with subsequent employment.
Nonqualified Stock Option Plan. Our Nonqualified Stock Option Plan and the stock option agreements with each named executive officer provide the following:
• | In the event of any termination of a named executive officer’s employment that is either for cause or voluntary on the part of the officer and without our written consent, the options held by such officer immediately terminate. |
• | In the event that (i) we are liquidated, (ii) we merge or consolidate with another entity and are not the surviving or resulting corporation (an “Acceleration Event”), or (iii) we sell all or substantially all of our assets, the vesting period accelerates for options held by all named executive officers and such options are treated as fully vested immediately prior to such Acceleration Event. The named executive officers then have the right to exercise the fully vested options before the effective date of the Acceleration Event and, to the extent not exercised before the effective date of the Acceleration Event, such options terminate. |
• | In the event that the named executive officer’s employment shall otherwise terminate (except by reason of his or her death), such officer may exercise his or her options (to the extent vested) at any time within 15 months after such termination but not more than four years after the date of the option grant for awards granted prior to 2009 and not more than five years after the date of the option grant for awards granted beginning in 2009. In the event that a named executive officer shall die while employed by the company or within 15 months after the termination of employment, any legatee by will, personal representative or distribution of the options, may exercise the officer’s options (to the extent vested) at any time within 15 months after his or her death but not more than four years after the date of the option grant for awards granted prior to 2009 and not more than five years after the date of the option grant for awards granted beginning in 2009. |
SERP. Pursuant to Mr. Lee’s SERP, in the event of a change in control of Four Oaks Fincorp, Inc. or Four Oaks Bank & Trust Company and termination of Mr. Lee’s employment within 24 months thereafter (for any reason, except termination by the bank for cause), Mr. Lee will be entitled to receive a lump sum cash payment equal to the actuarial equivalence of the greater of (i) the amount he would have been entitled to had he retired on such date or (ii) the amount of his pro rata normal retirement benefit under the SERP as of such date.
Insurance. Upon the death of an executive, he or she is entitled to the life and accidental death and dismemberment insurance proceeds available through our benefit plans.
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2011 Director Compensation
We use a combination of cash and option awards to attract and retain qualified candidates to serve on our board of directors. In setting director compensation, we consider the significant amount of time directors expend in fulfilling their duties to us as well as the skill level required.
Our non-management directors were paid fees of $1,275 per month in 2011. The lead director was paid fees of $1,600 per month in 2011. In addition, the non-management chairman of each board committee was paid $375 and the other non-management directors were paid $325 for each board committee meeting they attended. During 2011, all of the non-management directors were paid a discretionary cash Christmas bonus of $200.
The table below summarizes the compensation paid by us to non-management directors for the fiscal year ended December 31, 2011.
Name (1) | Fees Earned or Paid in Cash ($) | Option Awards ($) (2) | All Other Compensation ($) (3) | Total ($) |
Paula Canaday Bowman | $17,575 | $669 | $200 | $18,444 |
William J. Edwards | $28,500 | $669 | $200 | $29,369 |
Warren L. Grimes | $28,525 | $669 | $200 | $29,394 |
Percy Y. Lee | $15,250 | $669 | $200 | $16,119 |
Dr. R. Max Raynor, Jr. | $18,150 | $669 | $200 | $19,019 |
Michael A. Weeks | $35,970 | $669 | $200 | $36,839 |
John W. Bullard | $30,050 | $669 | $20,133 | $50,852 |
(2) | Reflects the aggregate grant date fair value computed in accordance with FASB ASC Topic 718. Assumptions used in the calculation of this amount are included in Note O of our audited financial statements included in this report. As of December 31, 2011, each director has the following number of options outstanding: Paula Canaday Bowman 2,000; William J. Edwards 2,000; Warren L. Grimes 2,000; Percy Y. Lee 2,000; Dr. R. Max Raynor, Jr. 2,000; Michael A. Weeks 2,000; and John W. Bullard 22,277. Mr. Bullard received 20,777 options as a result of the assumption of LongLeaf Community Bank stock options in connection with the 2008 merger of LongLeaf Community Bank with and into Four Oaks Bank & Trust Company and not as compensation for service on the board of directors. |
(3) | Reflects a discretionary cash bonus of $200 for each director, $8,333 in consulting fees paid to Mr. Bullard and $11,600 in severance payments to Mr. Bullard during 2011. |
Agreements with John W. Bullard
On April 28, 2008, John W. Bullard was appointed to the boards of directors of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company pursuant to the terms of the merger agreement, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and LongLeaf Community Bank, dated December 10, 2007 (the “Merger Agreement”). Prior to the completion of the merger on April 17, 2008, Mr. Bullard served as LongLeaf Community Bank's President and Chief Executive Officer and as one of its directors. Under the terms of the Merger Agreement, we agreed to cause, as soon as reasonably practicable after the later of (A) the effective time of the Merger Agreement or (B) our first annual meeting following the date of the Merger Agreement, Mr. Bullard to be elected or appointed to the boards of directors of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, conditional upon Mr. Bullard's consent thereto and upon obtaining any necessary regulatory approvals.
On April 17, 2008, pursuant to the terms of the Merger Agreement, Mr. Bullard's employment agreement with LongLeaf Community Bank was terminated without “cause” (as defined in his employment agreement). In connection with the termination of his employment agreement with LongLeaf Community Bank, Mr. Bullard received approximately $298,069, which represents the amount payable as severance upon termination without cause in connection with a change in control under his employment agreement with LongLeaf Community Bank, paid in 36 equal monthly installments through April 2011.
Also on April 17, 2008 and pursuant to the terms of the Merger Agreement, Mr. Bullard entered into a three-year
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consulting agreement with Four Oaks Bank & Trust Company. Under the terms of the agreement, Mr. Bullard provided consulting services to Four Oaks Bank & Trust Company upon reasonable request. He received an annual retainer of $50,000, paid in substantially equal monthly installments, in exchange for his services and for certain obligations contained in the consulting agreement. Four Oaks Bank & Trust Company also paid expenses reasonably incurred by Mr. Bullard in rendering his consulting services.
Prior to the merger, Mr. Bullard beneficially owned 59,981 shares of LongLeaf Community Bank common stock and held options to purchase an aggregate of 18,000 shares of LongLeaf Community Bank common stock. As a result of the merger, Mr. Bullard's LongLeaf Community Bank common stock was converted into 32,508 shares of Four Oaks Fincorp, Inc. common stock. In addition, Four Oaks Fincorp, Inc. assumed all outstanding and unexercised options to purchase LongLeaf Community Bank common stock, resulting in Mr. Bullard receiving options to purchase 20,777 shares of Four Oaks Fincorp, Inc. common stock at an exercise price of $10.92 and with an expiration date of July 18, 2015.
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
Equity Compensation Plan Information
We maintain a Nonqualified Stock Option Plan (the “Option Plan”) and an Amended and Restated Employee Stock Purchase and Bonus Plan, as amended (referred to herein as the “Employee Stock Purchase and Bonus Plan” or the “Purchase Plan”). Neither of these plans are required to be, or has been, approved by our shareholders. We have also assumed (i) certain outstanding stock options granted under the LongLeaf Community Bank Director Stock Option Plan and LongLeaf Community Bank Employee Stock Option Plan in connection with our acquisition of LongLeaf Community Bank in April 2008 and (ii) certain outstanding stock options granted under the Nuestro Banco 2007 Nonstatutory Stock Option Plan and Nuestro Banco 2007 Incentive Stock Option Plan in connection with our acquisition of Nuestro Banco in December 2009. The following table sets forth aggregate information regarding our equity compensation plans as of December 31, 2011:
(a) | (b) | (c) | |||||||||
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | ||||||||
Equity compensation plans approved by security holders | N/A | N/A | N/A | ||||||||
Equity compensation plans not approved by security holders | 208,800 | (1 | ) | $ | 7.85 | 494,804 | (2 | ) | |||
Total | 208,800 | $ | 7.85 | 494,804 |
(1) | Represents shares issuable upon exercise of outstanding stock options under our Nonqualified Stock Option Plan. Excludes 116,001 shares issuable upon exercise of outstanding stock options assumed in the acquisition of LongLeaf Community Bank, which have a weighted-average exercise price of $10.92 per share, and 12,305 shares issuable upon exercise of outstanding stock options assumed in the acquisition of Nuestro Banco, which have a weighted-average exercise price of $40.79 per share.Includes 387,845 shares of our common stock remaining available for future issuance under our Nonqualified Stock Option Plan and 106,959 shares of our common stock remaining available for future issuance under our Employee Stock Purchase and Bonus Plan. |
Nonqualified Stock Option Plan
The Nonqualified Stock Option Plan provides for grants of nonqualified stock options to officers and directors of our company and its subsidiaries. The Option Plan is administered by the compensation committee of our board of directors, which has broad discretionary authority to administer the Option Plan. The board of directors may amend or terminate the Option Plan at any time, but no amendment or termination of the Option Plan may adversely affect the rights of optionees under prior awards
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without the optionees’ approval.
The Option Plan provides that the exercise price and number of shares subject to outstanding options will be appropriately adjusted upon a stock split, stock dividend, recapitalization, combination, consolidation, or similar transaction involving a change in our capitalization. Upon a merger in which we are not the surviving corporation, or a liquidation or a sale of substantially all of our assets, outstanding options will become fully vested and exercisable and, to the extent not exercised, will terminate upon the effective date of such a transaction.
As of March 28, 2012, 1,542,773 shares had been reserved for issuance under the Option Plan. As of March 28, 2012, there were 221,700 outstanding stock options, and 328,520 shares remained available for future grants. During 2011, options to purchase 60,000 shares of our common stock were granted at an average exercise price of $3.00 per share.
Employee Stock Purchase and Bonus Plan
The Employee Stock Purchase and Bonus Plan is a voluntary plan that enables full-time employees of our company and its subsidiaries to purchase shares of our common stock. The Purchase Plan is administered by the compensation committee of our board of directors, which has broad discretionary authority to administer the Purchase Plan. The board of directors may amend or terminate the Purchase Plan at any time. The Purchase Plan is not intended to be qualified as an employee stock purchase plan under Section 423 of the Code.
Once a year, participants in the Purchase Plan may purchase our common stock at fair market value equal to 5% of their compensation, up to $1,000. We match in cash 50% of the amount of each participant’s purchase, up to $500. After we withhold for income and employment taxes, participants use the balance of our matching grant to purchase shares of our common stock.
The Purchase Plan will terminate upon a merger in which we are not the surviving corporation, or a liquidation or a sale of substantially all of our assets. The Purchase Plan provides that the number of shares reserved for issuance thereunder will be appropriately adjusted upon a stock split, stock dividend, recapitalization, combination, consolidation, or similar transaction involving a change in our capitalization.
As of March 28, 2012, 368,554 shares of our common stock had been reserved for issuance under the Purchase Plan, and 261,596 shares had been purchased. During 2011, 31,769 shares were purchased under the Purchase Plan.
Security Ownership of Management and Certain Beneficial Owners
The following table sets forth certain information as of March 28, 2012 regarding shares of our common stock beneficially owned by: (i) each director; (ii) each director nominee; (iii) each executive officer named in the Summary Compensation Table in Item 11 of this Form 10-K; and (iv) all current directors and executive officers as a group. As of March 28, 2012, we are not aware of any person who beneficially owns more than five percent (5%) of our common stock. The business address for each of the persons listed below is 6114 US 301 South, Four Oaks, North Carolina 27524. Except as otherwise indicated, the persons listed below have sole voting and investment power with respect to all shares of our common stock owned by them, except to the extent that such power may be shared with a spouse. Fractional share amounts are rounded off to the nearest whole number.
Name of Beneficial Owner | Amount and Nature of Beneficial Ownership(1) | Percent of Class(1) |
Ayden R. Lee, Jr.(2) | 159,618 | 2.1% |
Paula Canaday Bowman(3) | 67,055 | * |
William J. Edwards(4) | 36,793 | * |
Warren L. Grimes(5) | 24,713 | * |
Percy Y. Lee(6) | 67,989 | * |
Dr. R. Max Raynor, Jr.(7) | 40,461 | * |
Clifton L. Painter(8) | 54,962 | * |
John W. Bullard(9) | 55,400 | * |
Jeff D. Pope(10) | 22,599 | * |
Michael A. Weeks(11) | 41,246 | * |
All Current Directors and Executive Officers as a Group (13 persons) (12) | 611,430 | 8.0% |
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*Less than 1%
(1) | Based upon 7,684,740 shares of common stock outstanding on March 28, 2012. The securities “beneficially owned” by an individual are determined in accordance with the definition of “beneficial ownership” set forth in the regulations of the SEC. Accordingly, they may include securities owned by or for, among others, the spouse and/or minor children of the individual and any other relative who resides in the home of such individual, as well as other securities as to which the individual has or shares voting or investment power or has the right to acquire within 60 days of March 28, 2012 under outstanding stock options. Beneficial ownership may be disclaimed as to certain of the securities. |
(2) | Includes 10,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012 and 34,725 shares owned by Mr. Lee’s spouse who has sole voting and investment power with respect to such shares. |
(3) | Includes 1,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012, and 47 shares held in the estate of Ms. Bowman’s deceased spouse. |
(4) | Includes 1,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012, 2,684 shares owned by Mr. Edwards’ spouse who has sole voting and investment power with respect to such shares, and 221 shares held in Mr. Edwards’ name as custodian for his granddaughter. |
(5) | Includes 1,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012, 10,677.6681 shares owned jointly with Mr. Grimes’ spouse, and 2,162.8215 shares owned by Mr. Grimes’ spouse who has sole voting and investment power with respect to such shares. |
(6) | Includes 1,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012, and 46,240.8131 shares owned jointly with Mr. Lee’s spouse. |
(7) | Includes 1,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012. |
(8) | Includes 5,200 shares subject to stock options which are exercisable within 60 days of March 28, 2012, 3,514 shares owned by Mr. Painter’s spouse who has sole voting and investment power with respect to such shares, and 601 shares held in Mr. Painter’s name as custodian for his child. |
(9) | Includes 21,777 shares subject to stock options which are exercisable within 60 days of March 28, 2012, and 9,981.0251 shares owned by Mr. Bullard’s spouse who has sole voting and investment power with respect to such shares. Mr. Bullard disclaims beneficial ownership of the shares held by his spouse. |
(10) | Includes 5,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012 and 2,985 shares pledged as security. |
(11) | Includes 1,000 shares subject to stock options which are exercisable within 60 days of March 28, 2012, 14,587 shares owned by Mr. Weeks’ spouse who has sole voting and investment power with respect to such shares, and 5,766.551 shares held in Mr. Weeks’ name as custodian for his children and grandchildren. |
(12) | For all current directors and executive officers as a group, includes a total of 61,102 shares subject to stock options which are exercisable within 60 days of March 28, 2012. |
Item 13 - Certain Relationships and Related Transactions, and Director Independence.
Certain Transactions
Certain of our directors and executive officers, members of their immediate families, and entities with which they are involved are customers of, and borrowers from, Four Oaks Bank & Trust Company in the ordinary course of business. Since January 1, 2010, loans outstanding to our directors and executive officers and their associates as a group amounted to a maximum of approximately 7,656,000 or 10.77% of the equity capital of the bank. All loans or other extensions of credit made by the bank to such individuals are made substantially on the same terms, including interest rates and collateral, as those prevailing at the time in comparable transactions with other customers. In the opinion of management, these loans do not involve more than normal risk of collectibility or contain other unfavorable features.
We sold $12 million aggregate principal amount of subordinated promissory notes in several closings from May through August 2009. In the initial closing on May 15, 2009, Percy Y. Lee, a current director of our company, and his spouse Joyce Lee jointly purchased $250,000 principal amount of the notes, and Peggy Edwards, the spouse of William J. Edwards, another director, also purchased $250,000 principal amount of the notes. We are obligated to pay interest on the notes at an annualized rate of 8.5% payable in quarterly installments commencing on the third month anniversary of the date of issuance of the notes. As of March 28, 2012, we have paid $58,438 in interest on each of the notes held by Mr. and Mrs. Lee and by Mrs. Edwards. We may prepay the notes held by Mr. and Mrs. Lee and Mrs. Edwards at any time after May 15, 2014 subject to compliance with applicable law.
Upon the occurrence, and during the continuation, of an event of default under which we fail to pay any amounts when due or fail to observe or perform any material covenant that remains uncured for 30 days, the notes will bear interest at a rate equal to the lesser of the existing interest rate plus 2% or the maximum rate permissible under law. In addition, payment of the notes will be
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automatically accelerated if we enter voluntary or involuntary bankruptcy or insolvency proceedings.
The notes are unsecured and subordinated to (i) all indebtedness we owe to our secured creditors and general creditors; (ii) obligations arising from off-balance sheet guarantees and direct credit substitutes; (iii) obligations associated with derivative products such as interest rate and foreign exchange contracts, commodity contracts and similar arrangements; and (iv) any such indebtedness or any debentures, notes or other evidence of indebtedness issued in exchange for or to refinance any senior indebtedness or any indebtedness arising from the satisfaction of any such senior indebtedness by a guarantor.
For a description of our agreements with Mr. Bullard in connection with our 2008 acquisition of LongLeaf Community Bank, please see “Agreements with John W. Bullard” in Item 11 of this Form 10-K. We had no other transactions with related persons in 2009 or 2010 required to be disclosed under Item 404(a) of Regulation S-K of the Exchange Act, and there are no such transactions currently proposed for 2011.
Director Independence
Our board of directors, in its business judgment, has made an affirmative determination that each of Paula Canaday Bowman, William J. Edwards, Warren L. Grimes, Percy Y. Lee, Dr. R. Max Raynor, Jr., and Michael A. Weeks meet the definition of “independent director” as that term is defined in the Nasdaq Listing Rules.
John W. Bullard, who serves on the audit and risk committee of the board of directors, does not meet the definition of “independent director” as that term is defined by Nasdaq Listing Rules or SEC rules and does not meet the special independence requirements applicable to audit committee members due to the transactions involving Mr. Bullard described under “Agreements with John W. Bullard” in Item 11 of this Form 10-K. The board of directors nevertheless appointed Mr. Bullard to the audit and risk committee because it determined that it was in our best interest to utilize Mr. Bullard’s significant financial experience through service on the audit and risk committee. In addition, our securities are quoted on the OTC Bulletin Board and are not listed on a national securities exchange. Therefore, neither the SEC nor the Nasdaq Listing Rules regarding independence are applicable to our board of directors.
Item 14 - Principal Accounting Fees and Services.
During the fiscal years ended December 31, 2011 and 2010, we retained our independent auditor, Dixon Hughes Goodman LLP, to provide services in the following categories and amounts:
2010 | 2009 | |
Audit Fees(1) | $250,164 | $164,586 |
Audit-Related Fees(2) | 9,995 | 36,639 |
Tax Fees(3) | 27,520 | 13,475 |
All Other Fees(4) | — | — |
TOTAL | $287,679 | $214,700 |
(1) | “Audit Fees” are fees for professional services billed by Dixon Hughes Goodman LLP for the audit of our annual financial statements, for the reviews of financial statements included in our quarterly reports on Form 10-Q and for services provided in connection with statutory and regulatory filings or engagements. |
(2) | “Audit-Related Fees” are fees billed for assurance and related services performed by Dixon Hughes Goodman LLP that are reasonably related to the performance of the audit or review of our financial statements, and are not reported above under “Audit Fees.” In 2011 and 2010, these services included accounting and reporting consultations, and life insurance consultation. regarding ASC 825. In 2010 , these services also included those related to an employee benefit plan audit and the acquisition of Nuestro Banco. |
(3) | “Tax Fees” are fees billed for professional services performed by Dixon Hughes Goodman LLP with respect to tax compliance, tax advice, and tax planning. In 2011 and 2010, these services included preparation of income tax returns and quarterly estimate income tax payments. Additionally, in 2011 these services included assistance with an IRS examination. |
(4) | “All Other Fees” are fees billed for other products and services provided by Dixon Hughes Goodman LLP that do not meet the above category descriptions. |
Our audit and risk committee has considered the compatibility of the non-audit services performed by and fees paid to Dixon Hughes Goodman LLP in fiscal year 2011 and fiscal year 2010 and determined that such services and fees were compatible
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with the independence of the public accountants. During fiscal year 2011, Dixon Hughes Goodman LLP did not utilize any personnel in connection with the audit other than its full-time, permanent employees.
Policy for Approval of Audit and Non-Audit Services. Before we engage an accountant for any audit or permissible non-audit service, we are required to obtain the approval of our audit and risk committee. In determining whether to approve a particular audit or permitted non-audit service, our audit and risk committee considers, among other things, whether such service is consistent with maintaining the independence of the independent public accountant. Our audit and risk committee also considers whether the independent auditor is best positioned to provide the most effective and efficient services to us and whether the service might be expected to enhance our ability to manage or control risk or improve audit quality. All audit fees, audit-related fees, tax fees, and all other fees for 2011 and 2010 were pre-approved by the audit and risk committee.
Item 15 – Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements. The following financial statements and supplementary data are included in Item 8 of Part II of this Annual Report on Form 10-K.
TABLE OF CONTENTS | |
Form 10-K Page | |
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to Consolidated Financial Statements.
(a)(3) Exhibits. The following exhibits are filed as part of this Annual Report on Form 10-K.
Exhibit No. | Description of Exhibit |
2.1 | Merger Agreement, dated as of December 10, 2007, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and LongLeaf Community Bank (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on December 13, 2007) |
2.2 | List of Schedules Omitted from Merger Agreement included as Exhibit 2.1 above (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed on December 13, 2007) |
2.3 | Merger Agreement, dated April 29, 2009, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and Nuestro Banco (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on May 1, 2009) |
2.4 | List of Schedules Omitted from Merger Agreement included as Exhibit 2.3 above (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed on May 1, 2009) |
2.5 | First Amendment to Merger Agreement, dated as of October 26, 2009, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and Nuestro Banco (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on October 27, 2009) |
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2.6 | Second Amendment to Merger Agreement, dated as of November 24, 2009, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and Nuestro Banco (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on November 30, 2009) |
3.1 | Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2008) |
3.2 | Bylaws of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997) |
4 | Specimen of Certificate for Four Oaks Fincorp, Common Stock (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997) |
10.1 | Amended and Restated Nonqualified Stock Option Plan (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement) |
10.2 | Amendment No. 1, effective September 1, 2009 to Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement) |
10.3 | Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 1, 2005) (management contract or compensatory plan, contract or arrangement) |
10.4 | Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on March 1, 2005) (management contract or compensatory plan, contract or arrangement) |
10.5 | Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement) |
10.6 | Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement) |
10.7 | Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement) |
10.8 | Amendment No. 1, effective September 1, 2009 to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.2 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement) |
10.9 | Summary of Non-Employee Director Compensation (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2009) (management contract or compensatory plan, contract or arrangement) |
10.10 | Fourth Amended and Restated Dividend Reinvestment and Stock Purchase Plan (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-175771) filed with the SEC on July 25, 2011) |
10.11 | Amended and Restated Declaration of Trust of Four Oaks Statutory Trust I, dated as of March 30, 2006 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006) |
10.12 | Guarantee Agreement of Four Oaks Fincorp, Inc. dated as of March 30, 2006 (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006) |
10.13 | Indenture, dated as of March 30, 2006 by and between Four Oaks Fincorp, Inc. and Wilmington Trust Company, as Trustee, relating to Junior Subordinated Debt Securities due June 15, 2036 (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006) |
10.14 | Consulting Agreement with John W. Bullard (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2008) |
10.15 | Amended and Restated Executive Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) |
10.16 | Amended and Restated Executive Employment Agreement with Clifton L. Painter (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) |
10.17 | Amended and Restated Executive Employment Agreement with Jeff D. Pope (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) |
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10.18 | Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) |
10.19 | Written Agreement, effective May 24, 2011, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company, the Federal Reserve Bank of Richmond, and the State of North Carolina Office of the Commissioner of Banks (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on May 26, 2011) |
21 | Subsidiaries of Four Oaks Fincorp, Inc. |
23 | Consent of Dixon Hughes Goodman LLP |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
32.2 | Certification of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
101 | The following materials from Four Oaks Fincorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Comprehensive Loss; (iv) Consolidated Statements of Shareholders' Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text. * |
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
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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.
FOUR OAKS FINCORP, INC. | ||||
Date: | March 30, 2012 | By: | /s/ Ayden R. Lee, Jr. | |
Ayden R. Lee, Jr. Chairman, President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated
Date: | March 30, 2012 | /s/ Ayden R. Lee, Jr. | |
Ayden R. Lee, Jr. Chairman, President and Chief Executive Officer |
Date: | March 30, 2012 | /s/ Nancy S. Wise | |
Nancy S. Wise Executive Vice President and Chief Financial Officer |
Date: | March 30, 2012 | /s/ William J. Edwards | |
William J. Edwards Director |
Date: | March 30, 2012 | /s/ Warren L. Grimes | |
Warren L. Grimes Director |
Date: | March 30, 2012 | /s/ Dr. R. Max Raynor, Jr. | |
Dr. R. Max Raynor, Jr. Director |
Date: | March 30, 2012 | /s/ Paula Canaday Bowman | |
Paula Canaday Bowman Director |
Date: | March 30, 2012 | /s/ Percy Y. Lee | |
Percy Y. Lee Director |
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Date: | March 30, 2012 | /s/ John W. Bullard | |
John W. Bullard Director |
Date: | March 30, 2012 | /s/ Michael A. Weeks | |
Michael A. Weeks Director |
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EXHIBIT INDEX
Exhibit No. | Description of Exhibit | |
2.1 | Merger Agreement, dated as of December 10, 2007, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and LongLeaf Community Bank (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on December 13, 2007) | |
2.2 | List of Schedules Omitted from Merger Agreement included as Exhibit 2.1 above (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed on December 13, 2007) | |
2.3 | Merger Agreement, dated April 29, 2009, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and Nuestro Banco (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on May 1, 2009) | |
2.4 | List of Schedules Omitted from Merger Agreement included as Exhibit 2.3 above (incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed on May 1, 2009) | |
2.5 | First Amendment to Merger Agreement, dated as of October 26, 2009, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and Nuestro Banco (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on October 27, 2009) | |
2.6 | Second Amendment to Merger Agreement, dated as of November 24, 2009, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company and Nuestro Banco (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on November 30, 2009) | |
3.1 | Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2008) | |
3.2 | Bylaws of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997) | |
4 | Specimen of Certificate for Four Oaks Fincorp, Common Stock (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997) | |
10.1 | Amended and Restated Nonqualified Stock Option Plan (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement) | |
10.2 | Amendment No. 1, effective September 1, 2009 to Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement) | |
10.3 | Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 1, 2005) (management contract or compensatory plan, contract or arrangement) | |
10.4 | Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on March 1, 2005) (management contract or compensatory plan, contract or arrangement) | |
10.5 | Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement) | |
10.6 | Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement) | |
10.7 | Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement) | |
10.8 | Amendment No. 1, effective September 1, 2009 to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.2 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement) | |
10.9 | Summary of Non-Employee Director Compensation (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2009) (management contract or compensatory plan, contract or arrangement) | |
10.10 | Fourth Amended and Restated Dividend Reinvestment and Stock Purchase Plan (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-175771) filed with the SEC on July 25, 2011) | |
10.11 | Amended and Restated Declaration of Trust of Four Oaks Statutory Trust I, dated as of March 30, 2006 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006) |
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10.12 | Guarantee Agreement of Four Oaks Fincorp, Inc. dated as of March 30, 2006 (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006) | |
10.13 | Indenture, dated as of March 30, 2006 by and between Four Oaks Fincorp, Inc. and Wilmington Trust Company, as Trustee, relating to Junior Subordinated Debt Securities due June 15, 2036 (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006) | |
10.14 | Consulting Agreement with John W. Bullard (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2008) | |
10.15 | Amended and Restated Executive Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) | |
10.16 | Amended and Restated Executive Employment Agreement with Clifton L. Painter (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) | |
10.17 | Amended and Restated Executive Employment Agreement with Jeff D. Pope (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) | |
10.18 | Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement) | |
10.19 | Written Agreement, effective May 24, 2011, by and among Four Oaks Fincorp, Inc., Four Oaks Bank & Trust Company, the Federal Reserve Bank of Richmond, and the State of North Carolina Office of the Commissioner of Banks (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on May 26, 2011) | |
21 | Subsidiaries of Four Oaks Fincorp, Inc. | |
23 | Consent of Dixon Hughes Goodman LLP | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101 | The following materials from Four Oaks Fincorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Comprehensive Loss; (iv) Consolidated Statements of Shareholders' Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text. * |
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
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