UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2014
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 | |
incorporation or organization) | Identification Number) |
6114 U.S. 301 SOUTH, FOUR OAKS, NC 27524 |
(Address of principal executive office, including zip code) |
(919) 963-2177 |
(Registrant's telephone number, including area code) |
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. xYES oNO
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) xYES oNO
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer 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 Exchange Act):
oYES xNO
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock, | 8,867,653 |
par value $1.00 per share | (Number of shares outstanding |
(Title of Class) | May 13, 2014 |
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TABLE OF CONTENTS | Page No. | |
March 31, 2014 (Unaudited) and December 31, 2013 | ||
Three Months Ended March 31, 2014 and 2013 | ||
Consolidated Statements of Comprehensive Income (Unaudited) | ||
Three Months Ended March 31, 2014 and 2013 | ||
Three Months Ended March 31, 2014 and 2013 | ||
Three Months Ended March 31, 2014 and 2013 | ||
Item 2 - | Unregistered Sales of Equity Securities and Use of Proceeds | |
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Part I. FINANCIAL INFORMATION
Item 1 – FINANCIAL STATEMENTS
FOUR OAKS FINCORP, INC.
CONSOLIDATED BALANCE SHEETS
March 31, 2014 | December 31, | ||||||
(Unaudited) | 2013(*) | ||||||
(amounts in thousands, except share data) | |||||||
ASSETS | |||||||
Cash and due from banks | $ | 8,350 | $ | 11,890 | |||
Interest-earning deposits | 142,610 | 116,739 | |||||
Cash and cash equivalents | 150,960 | 128,629 | |||||
CDs held for investment | 28,665 | 31,850 | |||||
Investment securities available for sale, at fair value | 23,224 | 32,566 | |||||
Investment securities held to maturity, at amortized cost | 94,228 | 98,013 | |||||
Total investment securities | 117,452 | 130,579 | |||||
Loans | 482,822 | 492,712 | |||||
Allowance for loan losses | (11,516 | ) | (11,590 | ) | |||
Net loans | 471,306 | 481,122 | |||||
Mortgage loans held for sale | 363 | — | |||||
Accrued interest receivable | 1,509 | 1,576 | |||||
Bank premises and equipment, net | 12,381 | 12,571 | |||||
FHLB stock | 5,778 | 6,076 | |||||
Investment in life insurance | 14,434 | 14,380 | |||||
Foreclosed assets | 7,404 | 8,502 | |||||
Other assets | 5,971 | 6,261 | |||||
Total assets | $ | 816,223 | $ | 821,546 | |||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||
Deposits: | |||||||
Noninterest-bearing demand | $ | 233,523 | $ | 228,203 | |||
Money market, NOW accounts and savings accounts | 161,253 | 166,102 | |||||
Time deposits, $100,000 and over | 157,156 | 162,403 | |||||
Other time deposits | 97,300 | 100,912 | |||||
Total deposits | 649,232 | 657,620 | |||||
Borrowings | 112,000 | 112,000 | |||||
Subordinated debentures | 12,372 | 12,372 | |||||
Subordinated promissory notes | 12,000 | 12,000 | |||||
Accrued interest payable | 1,680 | 1,642 | |||||
Other liabilities | 4,534 | 4,289 | |||||
Total liabilities | 791,818 | 799,923 | |||||
Commitments (Note B) | |||||||
Shareholders’ equity: | |||||||
Common stock, $1.00 par value, 80,000,000 shares authorized; 8,867,653 and 7,977,657 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively. | 8,868 | 7,978 | |||||
Additional paid-in capital | 34,308 | 34,269 | |||||
Accumulated deficit | (19,033 | ) | (20,390 | ) | |||
Accumulated other comprehensive income (loss) | 262 | (234 | ) | ||||
Total shareholders' equity | 24,405 | 21,623 | |||||
Total liabilities and shareholders' equity | $ | 816,223 | $ | 821,546 |
(*) Derived from audited consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended | |||||||
March 31, | |||||||
2014 | 2013 | ||||||
(amounts in thousands, except share data) | |||||||
Interest and dividend income: | |||||||
Loans, including fees | $ | 6,561 | $ | 6,996 | |||
Taxable investments | 655 | 249 | |||||
Dividends | 82 | 99 | |||||
Interest-earning deposits | 158 | 168 | |||||
Total interest and dividend income | 7,456 | 7,512 | |||||
Interest expense: | |||||||
Deposits | 735 | 950 | |||||
Borrowings | 1,002 | 1,002 | |||||
Subordinated debentures | 49 | 51 | |||||
Subordinated promissory notes | 252 | 252 | |||||
Total interest expense | 2,038 | 2,255 | |||||
Net interest income | 5,418 | 5,257 | |||||
Provision for loan losses | — | 35 | |||||
Net interest income after provision for loan losses | 5,418 | 5,222 | |||||
Non-interest income: | |||||||
Service charges on deposit accounts | 400 | 465 | |||||
Other service charges, commissions and fees | 704 | 730 | |||||
Gains on sale of investment securities available for sale, net | 124 | 49 | |||||
Recovery of impairment loss and gain on redemption of preferred shares | 89 | — | |||||
Total other-than-temporary impairment loss | — | (64 | ) | ||||
Portion of loss recognized in other comprehensive income | — | 64 | |||||
Net impairment loss recognized in earnings | — | — | |||||
Income from investment in life insurance | 54 | 69 | |||||
Other | 731 | 796 | |||||
Total non-interest income | 2,102 | 2,109 | |||||
Non-interest expenses: | |||||||
Salaries | 2,411 | 2,783 | |||||
Employee benefits | 486 | 536 | |||||
Occupancy expenses | 290 | 347 | |||||
Equipment expenses | 299 | 363 | |||||
Professional and consulting fees | 567 | 703 | |||||
FDIC assessments | 454 | 441 | |||||
Foreclosed asset-related costs, net | 364 | 454 | |||||
Collection expenses | 182 | 357 | |||||
Other | 1,110 | 1,270 | |||||
Total non-interest expenses | 6,163 | 7,254 | |||||
Income before income taxes | 1,357 | 77 | |||||
Income tax | — | — | |||||
Net income | $ | 1,357 | $ | 77 | |||
Basic net income per common share | $ | 0.17 | $ | 0.01 | |||
Diluted net income per common share | $ | 0.17 | $ | 0.01 | |||
Weighted Average Shares Outstanding, Basic | 8,036,990 | 7,821,582 | |||||
Weighted Average Shares Outstanding, Diluted | 8,049,359 | 7,821,582 |
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended | |||||||
March 31, | |||||||
2014 | 2013 | ||||||
(amounts in thousands) | |||||||
Net income | $ | 1,357 | $ | 77 | |||
Other comprehensive income (loss): | |||||||
Securities available for sale: | |||||||
Unrealized gains on securities available for sale | 648 | 17 | |||||
Tax effect | — | (8 | ) | ||||
Reclassification of gains recognized in net income | (124 | ) | (49 | ) | |||
Tax effect | — | 20 | |||||
Amortization of unrealized gains on investment securities transferred from available-for-sale to held-to-maturity | (28 | ) | — | ||||
Portion of other-than-temporary loss recognized in other comprehensive income | — | (64 | ) | ||||
Tax effect | — | 26 | |||||
Total other comprehensive income (loss) | 496 | (58 | ) | ||||
Comprehensive income | $ | 1,853 | $ | 19 |
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
Common stock | Additional paid-in capital | Accumulated deficit | Accumulated other comprehensive income | Total shareholders' equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
(amounts in thousands, except share data) | ||||||||||||||||||||||
BALANCE, DECEMBER 31, 2012 | 7,815,385 | $ | 7,815 | $ | 34,192 | $ | (20,040 | ) | $ | 709 | $ | 22,676 | ||||||||||
Net income | — | — | — | 77 | — | 77 | ||||||||||||||||
Other comprehensive loss | — | — | — | — | (58 | ) | (58 | ) | ||||||||||||||
Issuance of common stock | 27,887 | 28 | 5 | — | — | 33 | ||||||||||||||||
Stock based compensation | — | — | 15 | — | — | 15 | ||||||||||||||||
BALANCE, MARCH 31, 2013 | 7,843,272 | $ | 7,843 | $ | 34,212 | $ | (19,963 | ) | $ | 651 | $ | 22,743 |
Common stock | Additional paid-in capital | Accumulated deficit | Accumulated other comprehensive income | Total shareholders' equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
(amounts in thousands, except share data) | ||||||||||||||||||||||
BALANCE, DECEMBER 31, 2013 | 7,977,657 | $ | 7,978 | $ | 34,269 | $ | (20,390 | ) | $ | (234 | ) | $ | 21,623 | |||||||||
Net income | — | — | — | 1,357 | — | 1,357 | ||||||||||||||||
Other comprehensive income | — | — | — | — | 496 | 496 | ||||||||||||||||
Issuance of common stock | 889,996 | 890 | 39 | — | — | 929 | ||||||||||||||||
Stock based compensation | — | — | — | — | — | |||||||||||||||||
BALANCE, MARCH 31, 2014 | 8,867,653 | $ | 8,868 | $ | 34,308 | $ | (19,033 | ) | $ | 262 | $ | 24,405 |
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended | |||||||
March 31, | |||||||
2014 | 2013 | ||||||
(amounts in thousands) | |||||||
Cash flows from operating activities: | |||||||
Net income | $ | 1,357 | $ | 77 | |||
Adjustments to reconcile net income to net cash provided by operations: | |||||||
Provision for loan losses | — | 35 | |||||
Provision for depreciation and amortization | 220 | 264 | |||||
Net amortization of bond premiums and discounts | 325 | 469 | |||||
Stock based compensation | — | 15 | |||||
Gain on sale of investment securities | (124 | ) | (49 | ) | |||
Gain on sale of branches | — | (586 | ) | ||||
Loss on sale of foreclosed assets, net | 20 | 39 | |||||
Valuation adjustment on foreclosed assets | 212 | 415 | |||||
Earnings on bank-owned life insurance | (54 | ) | (69 | ) | |||
Gain on sale of mortgage loans held for sale | (110 | ) | (165 | ) | |||
Originations of mortgage loans held for sale | (4,723 | ) | (6,513 | ) | |||
Proceeds from sale of mortgage loans held for sale | 4,470 | 6,985 | |||||
Recovery of impairment loss and gain on redemption of preferred shares | (89 | ) | — | ||||
Changes in assets and liabilities: | |||||||
Other assets | 124 | 3,190 | |||||
Accrued interest receivable | 67 | 301 | |||||
Other liabilities | 245 | (1,190 | ) | ||||
Accrued interest payable | 38 | (197 | ) | ||||
Net cash provided by operating activities | 1,978 | 3,021 | |||||
Cash flows from investing activities: | |||||||
Proceeds from sales and calls of investment securities available for sale | 13,406 | 2,197 | |||||
Proceeds from paydowns of investment securities available for sale | 261 | 3,124 | |||||
Proceeds from paydowns of investment securities held to maturity | 3,472 | 1,420 | |||||
Purchases of investment securities available for sale | (3,462 | ) | (10,007 | ) | |||
Purchases of investment securities held to maturity | — | (5,250 | ) | ||||
Net cash from sale of branches | — | (39,622 | ) | ||||
Redemption (purchase) of CDs held for investment | 3,185 | (1,960 | ) | ||||
Redemption of FHLB stock | 298 | 339 | |||||
Net decrease in loans outstanding | 9,563 | 12,598 | |||||
Purchases of bank premises and equipment | (30 | ) | (58 | ) | |||
Proceeds from sales of foreclosed assets | 1,119 | 1,376 | |||||
Net recoveries on foreclosed assets | — | 4 | |||||
Net cash provided by (used in) investing activities | 27,812 | (35,839 | ) | ||||
Cash flows from financing activities: | |||||||
Net decrease in deposit accounts | (8,388 | ) | (3,376 | ) | |||
Proceeds from issuance of common stock | 929 | 33 | |||||
Net cash used in financing activities | (7,459 | ) | (3,343 | ) | |||
Change in cash and cash equivalents | 22,331 | (36,161 | ) | ||||
Cash and cash equivalents at beginning of period | 128,629 | 183,150 | |||||
Cash and cash equivalents at end of period | $ | 150,960 | $ | 146,989 |
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended | |||||||
March 31, | |||||||
2014 | 2013 | ||||||
(amounts in thousands) | |||||||
Supplemental disclosures of cash flow information: | |||||||
Interest paid on deposits and borrowings | $ | (2,000 | ) | $ | (2,452 | ) | |
Supplemental disclosure for sale of branches: | |||||||
Proceeds from sale of fixed assets | $ | — | $ | 1,867 | |||
Proceeds from sale of loans | — | 15,061 | |||||
Assumption of customer deposits | — | (57,361 | ) | ||||
Gain on sale of branches | — | 586 | |||||
Proceeds from sale of other assets | — | 225 | |||||
Total proceeds paid to First Bank | $ | — | $ | (39,622 | ) | ||
Supplemental disclosures of noncash investing and financing activities: | |||||||
Unrealized gains (losses) on investment securities available for sale, net of taxes | $ | 496 | $ | (58 | ) | ||
Transfers of loans to foreclosed assets | 253 | 918 | |||||
Loans transferred from held for sale to held for investment | — | 1,469 |
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE A - BASIS OF PRESENTATION
In management’s opinion, the financial information contained in the accompanying unaudited consolidated financial statements reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three months ended March 31, 2014 and 2013, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts and transactions of Four Oaks Fincorp, Inc., a bank holding company incorporated under the laws of the State of North Carolina (the “Company”), and its wholly-owned subsidiary, Four Oaks Bank & Trust Company (the “Bank”). Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014.
The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. This Quarterly Report should be read in conjunction with such Annual Report.
Certain amounts previously presented in our Consolidated Financial Statements for the prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods' Statements of Operations, Comprehensive Income (Loss), or Shareholders' Equity as previously reported.
NOTE B - COMMITMENTS AND CONTIGENCIES
The following table presents loan commitments at March 31, 2014.
March 31, 2014 | |||
(amounts in thousands) | |||
Commitments to extend credit | $ | 21,477 | |
Undisbursed lines of credit | 51,601 | ||
Financial stand-by letters of credit | 228 | ||
Performance stand-by letters of credit | 467 | ||
Legally binding commitments | 73,773 | ||
Unused credit card lines | 14,507 | ||
Total | $ | 88,280 |
On May 20, 2013, the U.S. Department of Justice ("DOJ") issued a subpoena to the Bank requiring the production of documents in connection with an investigation of consumer fraud related to third party payment processing. In connection with this investigation, the Bank negotiated a civil settlement with the DOJ (the "Consent Order"), which was filed with the United States District Court for the Eastern District of North Carolina on January 8, 2014. The Consent Order was filed contemporaneously with the filing of a complaint by the DOJ alleging violation of a variety of laws, including money laundering laws. As part of the terms of the Consent Order, the Bank agreed to pay a civil monetary penalty in the amount of $1.0 million, plus a civil forfeiture in the amount of $200,000. The Consent Order was approved by the United States District Court for the Eastern District of North Carolina on April 25, 2014 and payment of the civil monetary penalty and civil forfeiture occurred on May 1, 2014.
In October 2013, multiple putative class action lawsuits were filed in United States district courts across the country against a number of different banks based on the banks' alleged role in "payday lending". Four of these lawsuits, pending in the Northern District of Georgia, the Middle District of North Carolina, the District of Maryland, and the Southern District of Florida, name the Bank as one of the defendants. The lawsuits allege that, by processing Automated Clearing House transactions indirectly on behalf of "payday lenders," the Bank is illegally participating in an enterprise to collect unlawful debts and is therefore liable to plaintiffs for damages under the federal Racketeer Influenced and Corrupt Organizations Act.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The lawsuits also allege a variety of state law claims. The Bank moved to dismiss each of these lawsuits. The Middle District of North Carolina granted the motion in part and denied it in part. The motions to dismiss in the three other cases are awaiting decision.
The Company is a party to certain other legal actions in the ordinary course of our business. The Company believes these 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, the Company's 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 C - NET INCOME PER SHARE
Basic net income per share represents earnings credited to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted net income per share reflects 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 income per common share have been computed based upon net income 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:
Three Months Ended | ||||||
March 31, | ||||||
2014 | 2013 | |||||
Weighted average number of common shares used in computing basic net income per common share | 8,036,990 | 7,821,582 | ||||
Effect of dilutive stock options | 12,369 | — | ||||
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per common share | 8,049,359 | 7,821,582 |
For the three month period ended March 31, 2014, there were 12,369 dilutive shares as the average market price for the shares than the exercise price. For the three month period ended March 31, 2013 all stock options were considered anti-dilutive because the average market price for the shares during the period was less than the assumed proceeds that would be received by the Company upon exercise of the options.
For the periods ended March 31, 2014 and 2013, there were 192,930 and 308,880 anti-dilutive stock options outstanding, respectively, which represented all of the options outstanding for both periods.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
NOTE D– INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available for sale and securities held to maturity as of March 31, 2014 and December 31, 2013 are as follows:
March 31, 2014 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Securities Available for Sale: | (amounts in thousands) | ||||||||||||||
Taxable municipal securities | $ | 9,638 | $ | 146 | $ | 19 | $ | 9,765 | |||||||
Mortgage-backed securities | |||||||||||||||
GNMA | 13,000 | 11 | 57 | 12,954 | |||||||||||
Trust preferred securities | 500 | — | 90 | 410 | |||||||||||
Equity securities | 53 | 42 | — | 95 | |||||||||||
Total | $ | 23,191 | $ | 199 | $ | 166 | $ | 23,224 |
March 31, 2014 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Securities Held to Maturity: | (amounts in thousands) | ||||||||||||||
Taxable municipal securities | $ | 3,622 | $ | — | $ | 93 | $ | 3,529 | |||||||
Mortgage-backed securities | |||||||||||||||
GNMA | 86,352 | 322 | 1,136 | 85,538 | |||||||||||
FNMA | 4,254 | 1 | 1 | 4,254 | |||||||||||
Total | $ | 94,228 | $ | 323 | $ | 1,230 | $ | 93,321 |
December 31, 2013 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Securities Available for Sale: | (amounts in thousands) | ||||||||||||||
Taxable municipal securities | $ | 6,176 | $ | — | $ | 243 | $ | 5,933 | |||||||
Mortgage-backed securities | |||||||||||||||
GNMA | 25,773 | — | 296 | 25,477 | |||||||||||
FNMA | — | — | — | — | |||||||||||
Trust preferred securities | 1,175 | — | 150 | 1,025 | |||||||||||
Equity securities | 98 | 33 | — | 131 | |||||||||||
Total | $ | 33,222 | $ | 33 | $ | 689 | $ | 32,566 |
December 31, 2013 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
Securities Held to Maturity: | (amounts in thousands) | ||||||||||||||
Taxable Municipals | $ | 3,635 | $ | 3 | $ | 157 | $ | 3,481 | |||||||
Mortgage-backed securities | |||||||||||||||
GNMA | 89,892 | 162 | 2,171 | 87,883 | |||||||||||
FNMA | 4,486 | 19 | 4,467 | ||||||||||||
Total | $ | 98,013 | $ | 165 | $ | 2,347 | $ | 95,831 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
During the second quarter of 2013, the Company transferred $76.5 million of available-for-sale state and municipal debt and mortgage-backed securities to the held-to-maturity category, reflecting the Company's intent to hold those securities to maturity. Transfers of investment securities into the held-to-maturity category from the available-for-sale category are made at fair value at the date of transfer. The related $228,000 of unrealized holding gains that were included in the transfer is retained in the carrying value of the held-to-maturity securities and is included in accumulated other comprehensive income. This amount will be amortized as an adjustment to interest income over the remaining life of the securities. This will offset the impact of amortization of the net premium created in the transfer. There were no gains or losses recognized as a result of this transfer.
The following tables show gross unrealized losses and fair values of investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at March 31, 2014 and December 31, 2013.
March 31, 2014 | |||||||||||||||||||||||
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 | $ | 1,479 | $ | 19 | $ | — | $ | — | $ | 1,479 | $ | 19 | |||||||||||
Mortgage-backed securities - GNMA | 9,858 | 57 | — | — | 9,858 | 57 | |||||||||||||||||
Trust preferred securities | — | — | 410 | 90 | 410 | 90 | |||||||||||||||||
Total temporarily impaired securities | $ | 11,337 | $ | 76 | $ | 410 | $ | 90 | $ | 11,747 | $ | 166 |
March 31, 2014 | |||||||||||||||||||||||
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: | |||||||||||||||||||||||
Taxable municipal securities | $ | 3,529 | $ | 93 | $ | — | $ | — | $ | 3,529 | $ | 93 | |||||||||||
Mortgage-backed securities: | |||||||||||||||||||||||
GNMA | 54,630 | 1,055 | 2,179 | 81 | 56,809 | 1,136 | |||||||||||||||||
FNMA | 2,911 | 1 | — | — | 2,911 | 1 | |||||||||||||||||
Total temporarily impaired securities | $ | 61,070 | $ | 1,149 | $ | 2,179 | $ | 81 | $ | 63,249 | $ | 1,230 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2013 | |||||||||||||||||||||||
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 | $ | 5,933 | $ | 243 | $ | — | $ | — | $ | 5,933 | $ | 243 | |||||||||||
Mortgage-backed securities | |||||||||||||||||||||||
GNMA | 25,477 | 296 | — | — | 25,477 | 296 | |||||||||||||||||
FNMA | — | — | — | — | — | — | |||||||||||||||||
Trust preferred securities | — | — | 410 | 90 | 410 | 90 | |||||||||||||||||
Total temporarily impaired securities | $ | 31,410 | $ | 539 | $ | 410 | $ | 90 | $ | 31,820 | $ | 629 | |||||||||||
Other than temporary impairment | |||||||||||||||||||||||
Trust preferred securities | $ | — | $ | — | $ | 615 | $ | 60 | $ | 615 | $ | 60 | |||||||||||
Total other than temporarily impaired securities | $ | — | $ | — | $ | 615 | $ | 60 | $ | 615 | $ | 60 |
December 31, 2013 | |||||||||||||||||||||||
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: | |||||||||||||||||||||||
Taxable municipal securities | $ | 2,776 | $ | 157 | $ | — | $ | — | $ | 2,776 | $ | 157 | |||||||||||
Mortgage-backed securities: | |||||||||||||||||||||||
GNMA | 74,830 | 2,073 | 2,223 | 98 | 77,053 | 2,171 | |||||||||||||||||
FNMA | 4,467 | 19 | — | — | 4,467 | 19 | |||||||||||||||||
Total temporarily impaired securities | $ | 82,073 | $ | 2,249 | $ | 2,223 | $ | 98 | $ | 84,296 | $ | 2,347 |
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 March 31, 2014 resulted from changing market interest rates compared to the yields available at the time the underlying securities were purchased. The unrealized gains and losses on trust preferred securities at March 31, 2014 resulted from changes in market values and available third party valuations. As of March 31, 2014 there were 32 of 54 Government National Mortgage Association ("GNMA") mortgage backed securities ("MBS"), 2 of 3 Federal National Mortgage Association ("FNMA") MBS securities, 12 of 20 taxable municipal securities, and one trust preferred security that contained net unrealized losses. Management identified no impairment related to credit quality. At March 31, 2014 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 three months ended March 31, 2014.
-12-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The amortized cost and fair value of available for sale and held to maturity securities at March 31, 2014 by contractual maturities are shown on the following table. 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 | ||||||
(amounts in thousands) | |||||||
Taxable municipal securities: | |||||||
Due after one year through five years | $ | — | $ | — | |||
Due after five years through ten years | — | — | |||||
Due after ten years | 9,638 | 9,765 | |||||
Total taxable municipal securities | 9,638 | 9,765 | |||||
Mortgage-backed securities - GNMA/FNMA: | |||||||
Due within one year | — | — | |||||
Due after one year through five years | — | — | |||||
Due after five years through ten years | 13,000 | 12,954 | |||||
Due after ten years | — | — | |||||
Total mortgage-backed securities - GNMA/FNMA | 13,000 | 12,954 | |||||
Other securities: | |||||||
Trust preferred securities | 500 | 410 | |||||
Equity securities | 53 | 95 | |||||
Total other securities | 553 | 505 | |||||
Total available for sale securities | $ | 23,191 | $ | 23,224 | |||
Held to Maturity | |||||||
Amortized Cost | Fair Value | ||||||
(amounts in thousands) | |||||||
Taxable municipal securities: | |||||||
Due within one year | — | — | |||||
Due after one year through five years | 989 | 980 | |||||
Due after five years through ten years | 2,633 | 2,549 | |||||
Due after ten years | — | — | |||||
Total taxable municipal securities | 3,622 | 3,529 | |||||
Mortgage-backed securities - GNMA/FNMA: | |||||||
Due within one year | — | — | |||||
Due after one year through five years | 54,621 | 54,656 | |||||
Due after five years through ten years | 29,033 | 28,473 | |||||
Due after ten years | 6,952 | 6,663 | |||||
Total mortgage-backed securities - GNMA/FNMA | 90,606 | 89,792 | |||||
Total Munis, GNMA, FNMA securities | $ | 94,228 | $ | 93,321 |
Securities with a carrying value of approximately $83.0 million and $92.8 million at March 31, 2014 and December 31, 2013, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. Sales and calls of securities available for sale for the three months ended March 31, 2014 and 2013 of $13.4 million and $2.2 million generated gross realized gains of $124,000 and $49,000, respectively, and no gross realized losses for either period. There was an additional $89,000 recovery of a prior period impairment loss and an additional gain on the redemption of one trust preferred security as of March 31, 2014.
-13-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
NOTE E – LOANS
The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures, which are reviewed on a regular basis. Each class of loans detailed below is subject to risks that could have an adverse impact on the credit quality of the loan portfolio. Loans are primarily made in the Company's market area in North Carolina, principally Johnston County, and parts of Wake, Harnett, Duplin, Sampson, and Moore counties.
Commercial and industrial loans
Each commercial loan or lease is underwritten based primarily upon the customer's ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. A complete understanding of the borrower's businesses, including the experience and background of the principals, is obtained prior to approval. To the extent that the loan or lease is secured by collateral, the likely value of the collateral and what level of strength the collateral brings to the transaction is evaluated. This collateral is generally comprised of personal property or business assets, such as inventory or accounts receivable. To the extent that the principals or other parties provide personal guarantees, the relative financial strength and liquidity of each guarantor is assessed. Common risks include general economic conditions within the markets the Bank serves, as well as risks that are specific to each transaction, including operational performance of the business, collectability of receivables, demand for products and services, personal events such as disability or change in marital status, and reductions in the value of collateral.
Commercial construction and land development loans
Commercial construction and land development loans are fully underwritten based on the borrower's repayment capacity and experience, as well as the project's structure, market, and financial feasibility. All debts and sources of income are analyzed prior to commitment. These loans are highly dependent on the supply and demand for commercial real estate and developed lots in the markets served by the Bank. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for customers.
Commercial real estate loans
Commercial real estate loans consist primarily of loans secured by nonresidential owner or non-owner occupied real estate, multifamily housing, and agricultural loans. Owner-occupied commercial properties are real estate properties whose loan repayment capacities are based on the credit strength and cash flow of the business occupying and operating the property. Non-owner occupied and multifamily commercial real estate are primarily dependent on successful operation or management of the property. The primary risk associated with these loans is the ability of the income-producing property to collateralize the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in customers having to provide rental rate concessions to achieve adequate occupancy rates. While commercial real estate loans are normally secured by commercial buildings for office, storage and warehouse space, it is possible that the liquidation of the collateral will not fully satisfy the obligation.
Residential construction loans
Residential construction loans are made to both individuals and builders/contractors and are typically secured by 1-4 family residential property. The Bank has stringent underwriting and initial investment requirements for new residential construction loans. The primary source of repayment on these loans comes from funds due to the sale of the underlying property or from permanent financing obtained by the individual building the residence. Significant and rapid declines in real estate values or demand can result in increased difficulty in selling these properties and/or converting these construction loans to permanent loans. Such a decline in values has led to unprecedented levels of foreclosures and losses within the banking industry.
Residential mortgage loans
Each residential mortgage loan is underwritten by performing an analysis of the borrower's cash flow, as well as reviewing credit reports for items such as payment history, credit utilization, length of credit history, types of credit currently in use, and recent credit inquiries. Since these loans are secured by collateral, the likely value of that collateral is evaluated. Common risks to these loans that are not specific to individual transactions include general economic conditions within the markets the Bank serves, particularly unemployment and potential declines in real estate values. Personal events such as disability or change in marital status also add risk to residential mortgage loans. Revolving mortgage loans are often secured by second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values.
-14-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
A substantial decline in collateral value could render a second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies and disputes with first lien holders that may further weaken the collateral position. Further, the open-end structure of these loans creates the risk that customers may draw on the lines in excess of the collateral value if there have been significant declines since origination.
Consumer and other loans
Consumer and other loans include loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles, including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment. Consumer loan collections are sensitive to job loss, illness and other personal factors.
The classification of loans as of March 31, 2014 and December 31, 2013 are summarized as follows:
March 31, 2014 | December 31, 2013 | ||||||
(amounts in thousands) | |||||||
Commercial and industrial | $ | 25,626 | $ | 25,858 | |||
Commercial construction and land development | 62,599 | 66,253 | |||||
Commercial real estate | 208,783 | 214,159 | |||||
Residential construction | 28,626 | 28,697 | |||||
Residential mortgage | 146,841 | 147,300 | |||||
Consumer | 7,041 | 6,750 | |||||
Consumer credit cards | 2,189 | 2,339 | |||||
Business credit cards | 1,175 | 1,124 | |||||
Other | 446 | 738 | |||||
Gross loans | 483,326 | 493,218 | |||||
Less: | |||||||
Net deferred loan fees | (504 | ) | (506 | ) | |||
Net loans before allowance | 482,822 | 492,712 | |||||
Allowance for loan losses | (11,516 | ) | (11,590 | ) | |||
Total net loans | $ | 471,306 | $ | 481,122 |
Nonperforming assets at March 31, 2014 and December 31, 2013 consist of the following:
March 31, 2014 | December 31, 2013 | ||||||
(amounts in thousands) | |||||||
Loans past due ninety days or more and still accruing | $ | 9 | $ | 23 | |||
Nonaccrual loans | 28,250 | 27,227 | |||||
Foreclosed assets | 7,404 | 8,502 | |||||
Total | $ | 35,663 | $ | 35,752 |
-15-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Allowance for Loan Losses
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 at least quarterly during which time those loans that are identified as impaired are evaluated individually.
The following tables are an analysis of the allowance for loan losses by loan class, as of and for the three months ended March 31, 2014 and 2013 and as of and for the twelve months ended December 31, 2013.
Three Months Ended | |||||||||||||||||||||||||||||||
March 31, 2014 | |||||||||||||||||||||||||||||||
Real Estate | |||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate | Residential Construction | Residential Mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
Allowances for loan losses: | (amounts in thousands) | ||||||||||||||||||||||||||||||
Balance, December 31, 2013 | $ | 1,290 | $ | 4,083 | $ | 2,262 | $ | 287 | $ | 3,522 | $ | 72 | $ | 74 | $ | 11,590 | |||||||||||||||
Provision for loan losses | — | — | — | — | — | — | — | — | |||||||||||||||||||||||
Loans charged-off | (23 | ) | (153 | ) | (207 | ) | — | (67 | ) | (42 | ) | — | (492 | ) | |||||||||||||||||
Recoveries | 39 | 42 | 159 | — | 142 | 15 | 21 | 418 | |||||||||||||||||||||||
Net (charge-offs) recoveries | 16 | (111 | ) | (48 | ) | — | 75 | (27 | ) | 21 | (74 | ) | |||||||||||||||||||
Balance, March 31, 2014 | $ | 1,306 | $ | 3,972 | $ | 2,214 | $ | 287 | $ | 3,597 | $ | 45 | $ | 95 | $ | 11,516 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 265 | $ | 509 | $ | 874 | $ | 137 | $ | 470 | $ | — | $ | — | $ | 2,255 | |||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 1,041 | $ | 3,463 | $ | 1,340 | $ | 150 | $ | 3,127 | $ | 45 | $ | 95 | $ | 9,261 | |||||||||||||||
Loans: | |||||||||||||||||||||||||||||||
Ending Balance | $ | 26,801 | $ | 62,599 | $ | 208,783 | $ | 28,626 | $ | 146,841 | $ | 9,230 | $ | 446 | $ | 483,326 | |||||||||||||||
Less Ending Balance: individually evaluated for impairment | $ | 796 | $ | 11,180 | $ | 12,429 | $ | 695 | $ | 9,714 | $ | 553 | $ | — | $ | 35,367 | |||||||||||||||
Ending balance: collectively evaluated for impairment (1) | $ | 26,005 | $ | 51,419 | $ | 196,354 | $ | 27,931 | $ | 137,127 | $ | 8,677 | $ | 446 | $ | 447,959 |
(1) In 2013, the the Bank began evaluating small dollar homogeneous impaired loans collectively for impairment and these impaired loans are included in this total. At March 31, 2014 there were $1.8 million in impaired loans collectively evaluated for impairment with $233,000 in reserves established.
-16-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Three Months Ended | |||||||||||||||||||||||||||||||
March 31, 2013 | |||||||||||||||||||||||||||||||
Real Estate | |||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate | Residential Construction | Residential Mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
Allowances for loan losses: | (amounts in thousands) | ||||||||||||||||||||||||||||||
Balance, December 31, 2012 | $ | 1,185 | $ | 7,251 | $ | 2,961 | $ | 423 | $ | 4,471 | $ | 188 | $ | 70 | $ | 16,549 | |||||||||||||||
Provision for loan losses | (12 | ) | 941 | (252 | ) | 39 | (702 | ) | 30 | (9 | ) | 35 | |||||||||||||||||||
Loans charged-off | (18 | ) | (660 | ) | (238 | ) | — | (610 | ) | (91 | ) | — | (1,617 | ) | |||||||||||||||||
Recoveries | 23 | 87 | 1 | — | 123 | 46 | — | 280 | |||||||||||||||||||||||
Net (charge-offs) recoveries | 5 | (573 | ) | (237 | ) | — | (487 | ) | (45 | ) | — | (1,337 | ) | ||||||||||||||||||
Balance, March 31, 2013 | $ | 1,178 | $ | 7,619 | $ | 2,472 | $ | 462 | $ | 3,282 | $ | 173 | $ | 61 | $ | 15,247 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 500 | $ | 1,496 | $ | 270 | $ | 60 | $ | 721 | $ | 5 | $ | — | $ | 3,052 | |||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 678 | $ | 6,123 | $ | 2,202 | $ | 402 | $ | 2,561 | $ | 168 | $ | 61 | $ | 12,195 | |||||||||||||||
Loans: | |||||||||||||||||||||||||||||||
Ending Balance | $ | 29,202 | $ | 84,843 | $ | 200,939 | $ | 20,895 | $ | 140,820 | $ | 9,281 | $ | 960 | $ | 486,940 | |||||||||||||||
Less Ending Balance: individually evaluated for impairment | $ | 1,287 | $ | 19,339 | $ | 17,268 | $ | 833 | $ | 15,237 | $ | 10 | $ | — | $ | 53,974 | |||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 27,915 | $ | 65,504 | $ | 183,671 | $ | 20,062 | $ | 125,583 | $ | 9,271 | $ | 960 | $ | 432,966 |
-17-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Twelve Months Ended | |||||||||||||||||||||||||||||||
December 31, 2013 | |||||||||||||||||||||||||||||||
Real Estate | |||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate | Residential Construction | Residential Mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
Allowances for loan losses: | (amounts in thousands) | ||||||||||||||||||||||||||||||
Balance, December 31, 2012 | $ | 1,185 | $ | 7,251 | $ | 2,961 | $ | 423 | $ | 4,471 | $ | 188 | $ | 70 | $ | 16,549 | |||||||||||||||
Provision for loan losses | 2 | 4 | 15 | 2 | 11 | 1 | — | 35 | |||||||||||||||||||||||
Loans charged-off | (411 | ) | (3,759 | ) | (2,220 | ) | (138 | ) | (1,559 | ) | (271 | ) | — | (8,358 | ) | ||||||||||||||||
Recoveries | 514 | 587 | 1,506 | — | 599 | 154 | 4 | 3,364 | |||||||||||||||||||||||
Net (charge-offs) recoveries | 103 | (3,172 | ) | (714 | ) | (138 | ) | (960 | ) | (117 | ) | 4 | (4,994 | ) | |||||||||||||||||
Balance, December 31, 2013 | $ | 1,290 | $ | 4,083 | $ | 2,262 | $ | 287 | $ | 3,522 | $ | 72 | $ | 74 | $ | 11,590 | |||||||||||||||
Ending Balance: individually evaluated for impairment | $ | 80 | $ | 264 | $ | 887 | $ | 137 | $ | 457 | $ | — | $ | — | $ | 1,825 | |||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 1,210 | $ | 3,819 | $ | 1,375 | $ | 150 | $ | 3,065 | $ | 72 | $ | 74 | $ | 9,765 | |||||||||||||||
Loans: | |||||||||||||||||||||||||||||||
Ending Balance | $ | 26,982 | $ | 66,253 | $ | 214,159 | $ | 28,697 | $ | 147,300 | $ | 9,089 | $ | 738 | $ | 493,218 | |||||||||||||||
Less Ending Balance: individually evaluated for impairment | 652 | 12,234 | 12,345 | 1,181 | 11,043 | — | — | 37,455 | |||||||||||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 26,330 | $ | 54,019 | $ | 201,814 | $ | 27,516 | $ | 136,257 | $ | 9,089 | $ | 738 | $ | 455,763 |
(1) In mid 2013, theBank began evaluating small dollar homogeneous impaired loans collectively for impairment and these impaired loans are included in this total. At March 31, 2014 there were $1.7 million in impaired loans collectively evaluated for impairment with $226,000 in reserves established.
Credit Quality Indicators
The Company 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 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.
-18-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
•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 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 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 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, however, loans are not typically made if the grade is Special Mention at inception without management approval.
• | Grade 6 -8 - Substandard (Grade 6), Doubtful (Grade 7) and Loss (Grade 8) |
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. Loans are not typically made if graded Substandard or worse at inception without management's approval.
-19-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Credit Risk Profile by Creditworthiness Class and Credit Card Portfolio Exposure
The following tables are an analysis of the creditworthiness class by loan class and credit card portfolio exposure as of
March 31, 2014 and December 31, 2013.
March 31, 2014 | |||||||||||||||||||||||||||||||
Real Estate | |||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate | Residential Construction | Residential Mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
(amounts in thousands) | |||||||||||||||||||||||||||||||
1 - Lowest Risk | $ | 2,061 | $ | — | $ | — | $ | — | $ | — | $ | 1,591 | $ | 8 | $ | 3,660 | |||||||||||||||
2 - Satisfactory Quality | 759 | 522 | 2,408 | 181 | 13,649 | 367 | 14 | 17,900 | |||||||||||||||||||||||
3 - Satisfactory | |||||||||||||||||||||||||||||||
- Merits Attention | 9,322 | 12,244 | 73,494 | 2,470 | 53,886 | 3,398 | 191 | 155,005 | |||||||||||||||||||||||
4 - Low Satisfactory | 12,363 | 35,954 | 118,786 | 24,877 | 56,758 | 1,023 | 109 | 249,870 | |||||||||||||||||||||||
5 - Special mention | 198 | 1,849 | 2,460 | 288 | 8,377 | 63 | 124 | 13,359 | |||||||||||||||||||||||
6-8 - Substandard | 923 | 12,030 | 11,635 | 810 | 14,171 | 599 | — | 40,168 | |||||||||||||||||||||||
$ | 25,626 | $ | 62,599 | $ | 208,783 | $ | 28,626 | $ | 146,841 | $ | 7,041 | $ | 446 | $ | 479,962 |
March 31, 2014 | |||||||
Consumer - Credit Card | Business- Credit Card | ||||||
(amounts in thousands) | |||||||
Performing | $ | 2,105 | $ | 1,131 | |||
Non Performing | 84 | 44 | |||||
Total | $ | 2,189 | $ | 1,175 | |||
Total Loans | $ | 483,326 |
December 31, 2013 | |||||||||||||||||||||||||||||||
Real Estate | |||||||||||||||||||||||||||||||
Commercial and Industrial | Commercial Construction and Land Development | Commercial Real Estate | Residential Construction | Residential Mortgage | Consumer | Other | Totals | ||||||||||||||||||||||||
(amounts in thousands) | |||||||||||||||||||||||||||||||
1 - Lowest Risk | $ | 2,014 | $ | — | $ | — | $ | — | $ | — | $ | 1,365 | $ | 8 | $ | 3,387 | |||||||||||||||
2 - Satisfactory Quality | 646 | 374 | 2,696 | 2 | 12,811 | 412 | 15 | 16,956 | |||||||||||||||||||||||
3 - Satisfactory | |||||||||||||||||||||||||||||||
- Merits Attention | 9,639 | 14,296 | 75,898 | 3,473 | 53,144 | 3,628 | 482 | 160,560 | |||||||||||||||||||||||
4 - Low Satisfactory | 12,616 | 36,723 | 121,522 | 23,779 | 57,460 | 1,235 | 107 | 253,442 | |||||||||||||||||||||||
5 - Special mention | 137 | 1,922 | 2,558 | 262 | 8,450 | 63 | 126 | 13,518 | |||||||||||||||||||||||
6-8 - Substandard | 806 | 12,938 | 11,485 | 1,181 | 15,435 | 47 | — | 41,892 | |||||||||||||||||||||||
$ | 25,858 | $ | 66,253 | $ | 214,159 | $ | 28,697 | $ | 147,300 | $ | 6,750 | $ | 738 | $ | 489,755 |
-20-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2013 | |||||||
Consumer- Credit Card | Business- Credit Card | ||||||
(amounts in thousands) | |||||||
Performing | $ | 2,316 | $ | 1,124 | |||
Non Performing | 23 | — | |||||
Total | $ | 2,339 | $ | 1,124 | |||
Total Loans | $ | 493,218 |
Age Analysis of Past Due Loans
The following tables are an age analysis of past due loans by loan class, as of March 31, 2014 and December 31, 2013.
March 31, 2014 | ||||||||||||||||||||
30-89 Days Past Due | Nonaccrual and Greater than 90 Days Past Due (1) | Total Past Due | Current | Total Loans | ||||||||||||||||
(amounts in thousands) | ||||||||||||||||||||
Commercial & industrial | $ | — | $ | 811 | — | $ | 811 | $ | 24,815 | $ | 25,626 | |||||||||
Commercial construction and land development | 271 | 11,178 | 11,449 | 51,150 | 62,599 | |||||||||||||||
Commercial real estate | 5 | 6,099 | 6,104 | 202,679 | 208,783 | |||||||||||||||
Residential construction | — | 695 | 695 | 27,931 | 28,626 | |||||||||||||||
Residential mortgage | 753 | 8,906 | 9,659 | 137,182 | 146,841 | |||||||||||||||
Consumer | 56 | 561 | 617 | 6,424 | 7,041 | |||||||||||||||
Consumer credit cards | 78 | 6 | 84 | 2,105 | 2,189 | |||||||||||||||
Business credit cards | 41 | 3 | 44 | 1,131 | 1,175 | |||||||||||||||
Other loans | — | — | — | 446 | 446 | |||||||||||||||
Total | $ | 1,204 | $ | 28,259 | $ | 29,463 | $ | 453,863 | $ | 483,326 |
(1) Nonaccruals and Greater than 90 Days Past Due is comprised of $9,000 in credit card loans that were past due more than 90 days and still accruing interest, as well as $28.3 million of loans in nonaccrual status.
-21-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2013 | |||||||||||||||||||
30-89 Days Past Due | Nonaccrual and Greater than 90 Days Past Due (1) | Total Past Due | Current | Total Loans | |||||||||||||||
(amounts in thousands) | |||||||||||||||||||
Commercial & industrial | $ | 34 | $ | 651 | $ | 685 | $ | 25,173 | $ | 25,858 | |||||||||
Commercial construction and land development | 252 | 9,536 | 9,788 | 56,465 | 66,253 | ||||||||||||||
Commercial real estate | 749 | 6,391 | 7,140 | 207,019 | 214,159 | ||||||||||||||
Residential construction | — | 695 | 695 | 28,002 | 28,697 | ||||||||||||||
Residential mortgage | 421 | 9,943 | 10,364 | 136,936 | 147,300 | ||||||||||||||
Consumer | 11 | 11 | 22 | 6,728 | 6,750 | ||||||||||||||
Consumer credit cards | 76 | 23 | 99 | 2,240 | 2,339 | ||||||||||||||
Business credit cards | 52 | — | 52 | 1,072 | 1,124 | ||||||||||||||
Other loans | — | — | — | 738 | 738 | ||||||||||||||
Total | $ | 1,595 | $ | 27,250 | $ | 28,845 | $ | 464,373 | $ | 493,218 |
(1) Nonaccruals and Greater than 90 Days Past Due is comprised of $23,000 in credit card loans that were past due more than 90 days and still accruing interest, as well as $27.2 million of loans in nonaccrual status.
Impaired Loans
Impaired loans are those loans for which the Bank does not expect full repayment of all principal and accrued interest when due either under the terms of the original loan agreement or within reasonably modified contractual terms. If the loan has been restructured, such as in the case of a troubled debt restructuring ("TDR"), the loan continues to be considered impaired for the duration of the restructured loan term. Whereas loans which are classified as Substandard (Risk Grade 6) are not necessarily impaired, all loans which are classified as Doubtful (Risk Grade 7) are considered impaired.
Once a loan has been determined to meet the definition of impairment, the amount of that impairment is measured through one of a number of available methods; a calculation of the net present value of the expected future cash flows of the loan discounted by the effective interest rate of the loan, through the observable market value of the loan or should the loan be collateral dependent, upon the fair market value of the underlying assets securing the loan. If a deficit is calculated, the amount of the measured impairment results in the establishment of a specific valuation allowance or reserve or charge-off, and is incorporated into the Bank's allowance for loan and lease losses.
When a loan has been designated as impaired and full collection of principal and interest under the contractual terms is not assured, the impaired loan will be placed into nonaccrual status and interest income will not be recognized. Payments received against such loans are initially applied fully to the principal balance of the note until the principal balance is satisfied. Subsequent payments are thereupon applied to the accrued interest balance which only then results in the recognition of interest income. Payments received against accruing impaired loans are applied in the same manner as that of accruing loans which have not been deemed impaired. The recorded investment in impaired notes does not include deferred fees or accrued interest and management deems this amount to be immaterial.
-22-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The following table illustrates the impaired loans by loan class as of March 31, 2014 and December 31, 2013.
March 31, 2014 | |||||||||||||||||||
Year to Date | |||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | |||||||||||||||
(amounts in thousands) | |||||||||||||||||||
With no related allowance recorded: | |||||||||||||||||||
Commercial and industrial | $ | 388 | $ | 425 | $ | — | $ | 390 | $ | — | |||||||||
Commercial construction and land development | 9,347 | 13,478 | — | 9,604 | 5 | ||||||||||||||
Commercial real estate other | 8,467 | 10,323 | — | 8,747 | 44 | ||||||||||||||
Residential construction | — | — | — | — | — | ||||||||||||||
Residential mortgage | 8,883 | 10,530 | — | 9,000 | 25 | ||||||||||||||
Consumer | 561 | 775 | — | 578 | — | ||||||||||||||
Subtotal: | 27,646 | 35,531 | — | 28,319 | 74 | ||||||||||||||
With an allowance recorded: | |||||||||||||||||||
Commercial and industrial | $ | 460 | $ | 539 | $ | 265 | $ | 463 | $ | — | |||||||||
Commercial construction and land development | 2,057 | 3,313 | 509 | 2,086 | 3 | ||||||||||||||
Commercial real estate other | 4,166 | 4,458 | 874 | 4,179 | 40 | ||||||||||||||
Residential construction | 695 | 1,134 | 137 | 695 | — | ||||||||||||||
Residential mortgage | 2,113 | 2,308 | 470 | 2,119 | 5 | ||||||||||||||
Consumer | — | — | — | — | — | ||||||||||||||
Subtotal: | 9,491 | 11,752 | 2,255 | 9,542 | 48 | ||||||||||||||
Totals: | |||||||||||||||||||
Commercial | 24,885 | 32,536 | 1,648 | 25,469 | 92 | ||||||||||||||
Consumer | 561 | 775 | — | 578 | — | ||||||||||||||
Residential | 11,691 | 13,972 | 607 | 11,814 | 30 | ||||||||||||||
Grand Total | $ | 37,137 | $ | 47,283 | $ | 2,255 | $ | 37,861 | $ | 122 |
At March 31, 2014, the recorded investment in loans considered impaired totaled $37.1 million. Of the total investment in loans considered impaired, $9.5 million were found to show specific impairment for which a $2.3 million valuation allowance was recorded; the remaining $27.6 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 which would require a valuation allowance. At March 31, 2014, the average recorded investment in impaired loans was approximately $37.9 million. The amount of interest recognized on impaired loans during the portion of the year that they were considered impaired was approximately $122,000.
-23-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
December 31, 2013 | |||||||||||||||||||
Year to Date | |||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | |||||||||||||||
(amounts in thousands) | |||||||||||||||||||
With no related allowance recorded: | |||||||||||||||||||
Commercial and industrial | $ | 380 | $ | 517 | $ | — | $ | 491 | $ | 2 | |||||||||
Commercial construction and land development | 11,142 | 15,809 | — | 13,259 | 168 | ||||||||||||||
Commercial real estate other | 8,437 | 10,131 | — | 9,190 | 132 | ||||||||||||||
Residential construction | 486 | 486 | — | 474 | 26 | ||||||||||||||
Residential mortgage | 10,948 | 12,731 | — | 11,624 | 121 | ||||||||||||||
Consumer | 11 | 22 | — | 17 | — | ||||||||||||||
Other | — | — | — | — | — | ||||||||||||||
Subtotal: | 31,404 | 39,696 | — | 35,055 | 449 | ||||||||||||||
With an allowance recorded: | |||||||||||||||||||
Commercial and industrial | $ | 309 | $ | 322 | $ | 80 | $ | 321 | $ | — | |||||||||
Commercial construction and land development | 1,315 | 2,033 | 264 | 1,348 | — | ||||||||||||||
Commercial real estate other | 4,026 | 4,096 | 888 | 4,104 | 136 | ||||||||||||||
Residential construction | 695 | 1,134 | 137 | 749 | — | ||||||||||||||
Residential mortgage | 1,427 | 1,593 | 456 | 1,499 | 8 | ||||||||||||||
Consumer | — | — | — | — | — | ||||||||||||||
Other | — | — | — | — | — | ||||||||||||||
Subtotal: | 7,772 | 9,178 | 1,825 | 8,021 | 144 | ||||||||||||||
Totals: | |||||||||||||||||||
Commercial | 25,609 | 32,908 | 1,232 | 28,713 | 438 | ||||||||||||||
Consumer | 11 | 22 | — | 17 | — | ||||||||||||||
Residential | 13,556 | 15,944 | 593 | 14,346 | 155 | ||||||||||||||
Grand Total | $ | 39,176 | $ | 48,874 | $ | 1,825 | $ | 43,076 | $ | 593 |
At December 31, 2013, the recorded investment in loans considered impaired totaled $39.2 million. Of the total investment in loans considered impaired, $7.8 million were found to show specific impairment for which a $1.8 million valuation allowance was recorded; the remaining $31.4 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 which would require a valuation allowance. For the year ended December 31, 2013, the average recorded investment in impaired loans was approximately $43.1 million. The amount of interest recognized on impaired loans during the portion of the year that they were considered impaired was approximately $593,000.
-24-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Loans on Nonaccrual Status
The following table illustrates nonaccrual loans by loan class as of March 31, 2014 and December 31, 2013.
March 31, 2014 | December 31, 2013 | ||||||
(amounts in thousands) | |||||||
Commercial & industrial | $ | 811 | $ | 651 | |||
Commercial construction and land development | 11,178 | 9,536 | |||||
Commercial real estate | 6,099 | 6,391 | |||||
Residential construction | 695 | 695 | |||||
Residential mortgage | 8,906 | 9,943 | |||||
Consumer | 561 | 11 | |||||
Total | $ | 28,250 | $ | 27,227 |
Troubled Debt Restructurings
For the Three Months Ended March 31, 2014
Loans are classified as a TDR when, for economic or legal reasons which result in a debtor experiencing financial difficulties, the Bank grants a concession through a modification of the original loan agreement that would not otherwise be considered. Generally concessions are granted as a result of a borrower's inability to meet the contractual repayment obligations of the initial loan terms and in the interest of improving the likelihood of recovery of the loan. The Bank may grant these concessions by a number of means such as (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 upon a bankruptcy plan. However, the Bank only restructures loans for borrowers 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 of the underlying collateral or business.
Loans in the process of renewal or modification are reviewed by the Bank to determine if the risk grade assigned is accurate based on updated information. All loans identified by the Bank's internal loan grading system to pose a heightened level of risk at or prior to renewal or modification are additionally 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 whether a concession has been granted. If the Bank determines that both conditions have been met, the loan will be classified as a TDR. If the Bank determines that both conditions have not been met, the loan is not classified as a TDR, but would typically then be monitored for any additional deterioration. Documentation to support this determination of TDR classification is maintained within the credit file.
The Bank's policy with respect to accrual of interest on loans restructured as part of 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 monthly payments. If the borrower does not perform under the restructured terms, the loan would remain on or be placed on nonaccrual status. The Company closely monitors 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.
-25-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The following table provides a summary of loans modified as TDRs at March 31, 2014 and December 31, 2013 (amounts in thousands).
March 31, 2014: | Accrual | Nonaccrual | Total TDRs | Allowance for Loan Losses Allocated | ||||||||||||
Commercial & industrial | $ | 37 | $ | 458 | $ | 495 | $ | 158 | ||||||||
Commercial construction and land development | 225 | 5,312 | 5,537 | 76 | ||||||||||||
Commercial real estate | 4,417 | 4,002 | 8,419 | 185 | ||||||||||||
Residential mortgage | 1,979 | 553 | 2,532 | 234 | ||||||||||||
Consumer | — | 2,350 | 2,350 | — | ||||||||||||
Total modifications | $ | 6,658 | $ | 12,675 | $ | 19,333 | $ | 653 |
December 31, 2013: | Accrual | Nonaccrual | Total TDRs | Allowance for Loan Losses Allocated | ||||||||||||
Commercial & industrial | $ | 37 | $ | 301 | $ | 338 | $ | — | ||||||||
Commercial construction and land development | 227 | 6,699 | 6,926 | 34 | ||||||||||||
Commercial real estate | 4,447 | 4,204 | 8,651 | 223 | ||||||||||||
Residential mortgage | 2,319 | 3,055 | 5,374 | 229 | ||||||||||||
Other | — | 1 | 1 | — | ||||||||||||
Total modifications | $ | 7,030 | $ | 14,260 | $ | 21,290 | $ | 486 |
For the three months ended March 31, 2014 there were no new TDRs identified. Additionally, there were no TDR loans modified during the previous 12 months that had a payment default for the three months ended March 31, 2014.
The table below details TDRs that the Bank has entered into during the twelve months ended March 31, 2014. The one TDR executed during the previous 12 months has been converted to nonaccrual.
For the 12 month period ended March 31, 2014 | ||||||||||||||||||||||||||||
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 | |||||||||||||||||||||
(amounts in thousands, except number of loans) | ||||||||||||||||||||||||||||
Below market interest rate | — | $ | — | — | $ | — | — | $ | — | — | $ | — | ||||||||||||||||
Extended payment terms | — | — | — | — | 1 | 55 | — | — | ||||||||||||||||||||
Forgiveness of principal | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Total | — | $ | — | — | $ | — | 1 | $ | 55 | — | $ | — |
NOTE F – FAIR VALUE MEASUREMENT
The Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 820, "Fair Value Measurements and Disclosures" ("ASC 820") defines fair value, establishes a framework for measuring fair value under U.S. 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, "Financial Instruments" ("ASC 825") provides companies with an option to report selected financial assets and liabilities at fair value.
-26-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
As of March 31, 2014, 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.
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, and certain equity securities. The Company’s mortgage-backed securities were primarily issued by the GNMA, with additional mortgage-backed securities issued by the FNMA. As of March 31, 2014, all of the Company’s mortgage-backed securities were agency issued and designated as Level 2 securities. Securities classified as Level 3 include trust preferred securities in less liquid markets.
-27-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The following table presents information about assets measured at fair value on a recurring basis at March 31, 2014 and December 31, 2013.
Fair Value Measurements at | |||||||||||||||||||
March 31, 2014, 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 | 3/31/2014 | 3/31/2014 | (Level 1) | (Level 2) | (Level 3) | ||||||||||||||
(amounts in thousands) | |||||||||||||||||||
Taxable municipal securities | $ | 9,765 | $ | 9,765 | $ | — | $ | 9,765 | $ | — | |||||||||
Mortgage-backed securities | |||||||||||||||||||
GNMA | 12,954 | 12,954 | — | 12,954 | — | ||||||||||||||
FNMA | — | — | — | — | — | ||||||||||||||
Trust preferred securities | 410 | 410 | — | — | 410 | ||||||||||||||
Equity securities | 95 | 95 | 84 | 11 | — | ||||||||||||||
Total available for sale securities | $ | 23,224 | $ | 23,224 | $ | 84 | $ | 22,730 | $ | 410 |
Fair Value Measurements at | |||||||||||||||||||
December 31, 2013, 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 | 12/31/2013 | 12/31/2013 | (Level 1) | (Level 2) | (Level 3) | ||||||||||||||
(amounts in thousands) | |||||||||||||||||||
Taxable municipal securities | $ | 5,933 | $ | 5,933 | $ | — | $ | 5,933 | $ | — | |||||||||
Mortgage-backed securities | |||||||||||||||||||
GNMA | 25,477 | 25,477 | — | 25,477 | — | ||||||||||||||
FNMA | — | — | — | — | — | ||||||||||||||
Trust preferred securities | 1,025 | 1,025 | — | — | 1,025 | ||||||||||||||
Equity securities | 131 | 131 | 70 | 61 | — | ||||||||||||||
Total available for sale securities | $ | 32,566 | $ | 32,566 | $ | 70 | $ | 31,471 | $ | 1,025 |
-28-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The following table presents the reconciliation for the three months ended March 31, 2014 and 2013 for all Level 3 assets that are measured at fair value on a recurring basis.
For the Three Months Ended | |||||||
March 31, | |||||||
Securities available-for-sale | |||||||
2014 | 2013 | ||||||
(amounts in thousands) | |||||||
Beginning Balance | $ | 1,025 | $ | 1,006 | |||
Total realized and unrealized gains or (losses): | |||||||
Included in earnings | — | — | |||||
Included in other comprehensive income (loss) | — | 19 | |||||
Purchases, issuances and settlements | (615 | ) | — | ||||
Transfers in (out) of Level 3 | — | — | |||||
Ending Balance | $ | 410 | $ | 1,025 | |||
Fair Value Measured on a Nonrecurring Basis. The Company measures certain assets at fair value on a nonrecurring basis, as described below.
Impaired Loans. The Company does not record loans at fair value on a recurring basis. However, when a loan is considered impaired, it is evaluated for impairment and written down to its estimated fair value or an allowance for loan losses is established. The fair value of impaired loans is estimated using one of the following available methods: a calculation of the net present value of the expected future cash flows of the loan discounted by the effective interest rate or by determining the fair market value of the underlying collateral securing the loan using appraised values discounted for other market adjustments. Those impaired loans not requiring a write down or valuation allowance represent loans for which the estimated fair value exceeds the recorded investment in such loans. When the fair value of an impaired loan is based on an observable market price or a current appraised value with no adjustments, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available, or the Company determines the fair value of the collateral is further impaired below the appraised value, and there is no observable market price, the impaired loan is classified as nonrecurring Level 3.
As of March 31, 2014, the Bank identified $22.7 million in impaired loans that were carried at fair value which included $9.5 million in loans that required a specific valuation allowance of $2.3 million and an additional $13.2 million in loans without a specific valuation allowance that have previously been written down to fair value. As of December 31, 2013, the Bank identified $20.0 million in impaired loans that were carried at fair value which included $7.8 million in loans that required a specific valuation allowance of $1.8 million and an additional $12.3 million in loans without a specific valuation allowance that have previously been written down to fair value.
The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a recurring and nonrecurring basis at March 31, 2014 (amounts in thousands, except percentages):
Total Carrying Amount | |||||
Nonrecurring measurements: | |||||
Impaired loans | $ | 20,419 | Collateral discounts | 9-50% | |
Foreclosed assets | $ | 7,404 | Discounted appraisals | 10-30% | |
Recurring measurements: | |||||
Trust preferred securities | $ | 410 | Probability of default | 10-20% | |
Loss given default | 100% |
Foreclosed Assets
Foreclosed assets are adjusted to fair value less estimated selling costs 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.
-29-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Given the lack of observable market prices for identical properties, the Company records foreclosed assets as non-recurring Level 3. Through the three month period ended March 31, 2014, the Company recognized approximately $212,000 in valuation reductions on foreclosed assets and the carrying value of foreclosed assets was $7.4 million at March 31, 2014. As of and for the year ended December 31, 2013, there was $1.6 million recognized in valuation adjustments on foreclosed assets and the carrying value of foreclosed assets was $8.5 million at December 31, 2013.
The following table presents information about individually identified impaired loans and foreclosed assets measured on a non-recurring basis at fair value at March 31, 2014 and December 31, 2013.
Fair Value Measurements at | |||||||||||||||||||
March 31, 2014, 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 | |||||||||||||||
3/31/2014 | 3/31/2014 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
(amounts in thousands) | |||||||||||||||||||
Impaired loans | $ | 20,419 | $ | 20,419 | $ | — | $ | — | $ | 20,419 | |||||||||
Foreclosed assets | $ | 7,404 | $ | 7,404 | $ | — | $ | — | $ | 7,404 |
Fair Value Measurements at | |||||||||||||||||||
December 31, 2013, 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 | |||||||||||||||
12/31/2013 | 12/31/2013 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
(amounts in thousands) | |||||||||||||||||||
Impaired loans | $ | 18,215 | $ | 18,215 | $ | — | $ | — | $ | 18,215 | |||||||||
Foreclosed assets | $ | 8,502 | $ | 8,502 | $ | — | $ | — | $ | 8,502 |
NOTE G - FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC 825 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 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.
CDs Held for Investment
These investments are valued at carrying amounts for fair value purposes.
Securities Available for Sale, and Securities Held to Maturity
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.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
Loans Held For Sale
The fair value of mortgage loans held for sale is based on commitments on hand from investors within the secondary market for loans with similar characteristics.
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.
Premises and Equipment, Held for Sale
The carrying amount of Premises and equipment held for sale approximates fair value.
Deposits
The fair value of non-maturing deposits such as noninterest-bearing demand, money market, NOW, and savings accounts, are by definition, equal to the amount payable on demand. Fair value for maturing deposits such as CDs and IRAs are estimated using a discounted cash flow approach that applies current interest rates to expected maturities.
Borrowings, Subordinated Debentures, and Subordinated Promissory Notes
The fair value of borrowings, 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.
Accrued Interest Receivable and Payable
The carrying amounts of accrued interest approximates fair value.
-31-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
The following table presents information for financial assets and liabilities as of March 31, 2014 and December 31, 2013.
March 31, 2014 | |||||||||||||||||
Carrying Value | Estimated Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
Financial assets: | (amounts in thousands) | ||||||||||||||||
Cash and cash equivalents | $ | 150,960 | $ | 150,960 | $ | 150,960 | $ | — | $ | — | |||||||
CDs held for investment | 28,665 | 28,665 | — | 28,665 | — | ||||||||||||
Securities available for sale | 23,224 | 23,224 | 84 | 22,730 | 410 | ||||||||||||
Securities held to maturity | 94,228 | 93,321 | — | 93,321 | — | ||||||||||||
Loans held for sale | 363 | 363 | — | — | 363 | ||||||||||||
Loans, net | 471,306 | 449,165 | — | — | 449,165 | ||||||||||||
FHLB stock | 5,778 | 5,778 | — | 5,778 | — | ||||||||||||
Accrued interest receivable | 1,509 | 1,509 | — | 1,509 | — | ||||||||||||
Financial liabilities: | |||||||||||||||||
Deposits | $ | 649,232 | $ | 651,148 | $ | — | $ | 651,148 | $ | — | |||||||
Subordinated debentures and subordinated promissory notes | 24,372 | 24,372 | — | — | 24,372 | ||||||||||||
Borrowings | 112,000 | 120,898 | — | 120,898 | — | ||||||||||||
Accrued interest payable | 1,680 | 1,680 | — | 1,680 | — |
December 31, 2013 | |||||||||||||||||
Carrying Value | Estimated Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
Financial assets: | (amounts in thousands) | ||||||||||||||||
Cash and cash equivalents | $ | 128,629 | $ | 128,629 | $ | 128,629 | $ | — | $ | — | |||||||
CDs held for investment | 31,850 | 31,850 | — | 31,850 | — | ||||||||||||
Securities available for sale | 32,566 | 32,566 | 50 | 31,491 | 1,025 | ||||||||||||
Securities held to maturity | 98,013 | 95,831 | — | 95,831 | — | ||||||||||||
Loans held for sale | — | — | — | — | — | ||||||||||||
Loans, net | 481,122 | 458,254 | — | — | 458,254 | ||||||||||||
FHLB stock | 6,076 | 6,076 | — | 6,076 | — | ||||||||||||
Premises and equipment, held for sale | — | — | — | — | — | ||||||||||||
Accrued interest receivable | 1,576 | 1,576 | — | 1,576 | — | ||||||||||||
Financial liabilities: | |||||||||||||||||
Deposits | $ | 657,620 | $ | 659,733 | $ | — | $ | 659,733 | $ | — | |||||||
Subordinated debentures and subordinated promissory notes | 24,372 | 24,369 | — | — | 24,369 | ||||||||||||
Borrowings | 112,000 | 121,519 | — | 121,519 | — | ||||||||||||
Accrued interest payable | 1,642 | 1,642 | — | 1,642 | — |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
NOTE H – OTHER RECENT ACCOUNTING PRONOUNCEMENTS
New Accounting Standards
In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This update seeks to eliminate the diversity in practice in the presentation of unrecognized tax benefits by providing explicit guidance on the financial statement presentation of an unrecognized tax benefit with a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This amendment is effective for annual and interim periods beginning after December 15, 2013. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.
In January 2014, the FASB issued ASU No. 2014-04, Receivables–Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This update clarifies that an in substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This amendment is effective for annual and interim periods beginning after December 15, 2014. Management does not expect the adoption of this guidance to have a material impact on the Company's 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 I – SUBORDINATED DEBT
The Company is currently prohibited by the Written Agreement, described in Note J of these Notes to Consolidated Financial Statements, from paying interest on its subordinated promissory notes and on its subordinated debentures in connection with its trust preferred securities (TPS) 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 first quarter of 2014. The Company exercised its right to defer regularly scheduled interest payments on its outstanding TPS and as of March 31, 2014, $750,000 of interest payments have been accrued for and deferred pursuant to the terms of the indenture governing the TPS. The Company may not pay any cash dividends on its common stock, $1.00 par value per share (the "Common Stock") until it is current on interest payments on such TPS. 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.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
NOTE J - REGULATORY RESTRICTIONS
North Carolina banking law requires that the Bank may not pay a dividend that would reduce its capital below the applicable required capital. In addition, 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 the three months ended March 31, 2014.
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. The Bank’s actual capital amounts and ratios are also presented in the table below. At March 31, 2014 the Bank was classified as well capitalized for regulatory capital purposes.
Actual | Minimum For Capital Adequacy Purposes | Minimum To be Well Capitalized under Prompt Corrective Action Provisions | ||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||
As of March 31, 2014: | (amounts in thousands, except ratios) | |||||||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 52,062 | 11.5 | % | $ | 36,259 | 8.0 | % | $ | 45,324 | 10.0 | % | ||||||||
Tier I Capital (to Risk Weighted Assets) | 46,325 | 10.2 | % | 18,129 | 4.0 | % | 27,194 | 6.0 | % | |||||||||||
Tier I Capital (to Average Assets) | 46,325 | 5.7 | % | 32,606 | 4.0 | % | 40,758 | 5.0 | % | |||||||||||
As of December 31, 2013: | ||||||||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 50,601 | 10.9 | % | $ | 37,057 | 8.0 | % | $ | 46,322 | 10.0 | % | ||||||||
Tier I Capital (to Risk Weighted Assets) | 44,739 | 9.7 | % | 18,529 | 4.0 | % | 27,793 | 6.0 | % | |||||||||||
Tier I Capital (to Average Assets) | 44,739 | 5.5 | % | 32,529 | 4.0 | % | 40,661 | 5.0 | % |
The Company is also subject to capital requirements. At March 31, 2014 and December 31, 2013, the Company’s total capital to risk weighted assets, Tier 1 capital to risk weighted assets, and Tier 1 capital to average assets were 11.0%, 7.1%, and 3.9%, and 10.7%, 6.3%, and 3.6%, respectively.
In late May 2011, the Company and the Bank entered into a formal written agreement (the "Written Agreement") with the Federal Reserve Bank of Richmond (the "FRB") and the North Carolina Office of the Commissioner of Banks (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 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. |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
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 and the Bank continue to be committed to addressing and resolving the issues raised in the Written Agreement. Upon initial receipt of the Written Agreement, the Board of Directors 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 address outstanding items that are not in full compliance. In the initial efforts to comply, several control changes were implemented to address the 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 implemented additional controls around obtaining updated collateral valuations as required by regulation and established new policies to further reduce Commercial Real Estate concentrations, ensure current financial information is evaluated, and control interest only loans. The Bank also created a separate Special Assets department and in 2012 added additional resources to provide adequate attention and expertise to problem loan management. Other areas also addressed include 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. At this time, the Company is in partial compliance with the provisions of the Written Agreement.
-35-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements - (Continued)
NOTE K - SECURITIES PURCHASE AGREEMENT
On March 24, 2014, the Company entered into a securities purchase agreement (the "Securities Purchase Agreement") with Kenneth R. Lehman, a private investor (the “Standby Investor”). Pursuant to the Securities Purchase Agreement, the Standby Investor has agreed to purchase from the Company (the “Standby Offering”), for $1.00 per share, the lesser of (i) 10,000,000 shares of Common Stock, (ii) if the Rights Offering (as defined below) is completed, all shares of Common Stock not purchased by shareholders exercising their basic subscription privilege, and (iii) the maximum number of shares that he may purchase without causing an “ownership change” under Section 382(g) of the Internal Revenue Code of 1986, as amended (based on all shares of Common Stock outstanding at the completion of the Rights Offering and the Standby Offering). In addition, the Securities Purchase Agreement provides the Standby Investor a right of first refusal to purchase an additional 6,000,000 shares subject to the limitations outlined in clauses (ii) and (iii) above.
Pursuant to the Securities Purchase Agreement, on March 27, 2014, the Company closed the initial sale of 875,000 shares of Common Stock to the Standby Investor. The Securities Purchase Agreement contemplates a subsequent closing of the remaining number of shares based on the formula above and the Standby Investor’s decision on whether to exercise his right of first refusal. The Company has agreed that if for any reason it does not complete the Rights Offering, the Standby Investor will still be permitted to purchase shares of Common Stock as set forth above.
The Securities Purchase Agreement contains customary representations, warranties, and various covenants, including, among others, covenants by the Company to (i) adopt a restricted stock plan for the benefit of the Company’s officers, (ii) adopt an asset resolution plan, and (iii) establish a rights plan to protect the Company’s deferred tax asset. Consummation of the Standby Offering is subject to (a) receipt of required regulatory approvals and non-objections, (b) receipt by the Company of a letter from an independent accounting firm related to the Company’s deferred tax asset, and (c) other customary closing conditions set forth in the Securities Purchase Agreement. The Company has also agreed to enter into a registration rights agreement with the Standby Investor (the “Registration Rights Agreement”), which will provide the Standby Investor demand registration and piggyback registration rights with respect to the Standby Investor’s resale of shares purchased under the Securities Purchase Agreement, subject to customary limitations. The Company has agreed to pay the expenses associated with any registration statements filed with the Securities and Exchange Commission (the “Commission”) pursuant to the Registration Rights Agreement. Between the closing of the Standby Offering and the third anniversary of the closing date, for as long as the Standby Investor owns at least 25% of the Company’s outstanding shares of Common Stock, if the Company makes any public or non-public offering of any equity or any securities, options, or debt that are convertible or exchangeable into equity or that include an equity component, the Standby Investor will be afforded the opportunity to acquire from the Company for the same price and on the same terms as such securities are proposed to be offered to others, up to the amount in the aggregate required to enable him to maintain his proportionate common stock-equivalent interest in the Company.
In addition, on March 26, 2014, the Company announced that it intends to conduct a rights offering of up to approximately $26.6 million (the “Rights Offering”). In the Rights Offering, the Company will distribute, at no charge, non-transferable subscription rights to its shareholders as of a future record date. For each share of Common Stock held as of the record date, a shareholder will receive a non-transferable right to purchase three shares of Common Stock at a subscription price of $1.00 per share (the “Basic Subscription Privilege”). Shareholders who exercise their Basic Subscription Privilege in full will have the opportunity to subscribe for additional shares for pro rata allocation in the event that not all available shares are purchased pursuant to the Basic Subscription Privilege or by the Standby Investor pursuant to the Securities Purchase Agreement, subject to certain limitations.
The Company intends to commence the Rights Offering during the second or third quarter of 2014.
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information about the major components of the financial condition and results of operations of Four Oaks Fincorp, Inc. (the “Company”) and its subsidiaries and should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto in Part I, Item 1 of this Quarterly Report. Unless the context otherwise indicates, references in this report to "we," "us" and "our" refer to the Company and its subsidiaries.
--
-36-
On March 24, 2014, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with Kenneth R. Lehman (the “Standby Investor”), which could result in net proceeds to the Company of up to $26.1 million. Please see "Liquidity and Capital Resources " for a description of the Securities Purchase Agreement and the Company’s contemplated rights offering to its shareholders (the “Rights Offering”).
Regulatory Update
In late May 2011, the Company and Four Oaks Bank and 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 (the "FRB") and the North Carolina Office of the Commissioner of Banks (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 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 and the Bank continue to be committed to addressing and resolving the issues raised in the Written Agreement. Upon initial receipt of the agreement, the Board of Directors 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 address outstanding items that are not in full compliance. In our initial efforts to comply, several control changes were implemented to address the 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 implemented additional controls around obtaining updated collateral valuations as required by regulation and established new policies to further reduce Commercial Real Estate concentrations, ensure current financial information is evaluated, and control interest only loans.
-37-
The Bank also created a separate Special Assets department and in 2012 added additional resources to provide adequate attention and expertise to problem loan management. Other areas also addressed include 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. At this time, the Company is in partial compliance with the provisions of the Written Agreement.
Comparison of Financial Condition at
March 31, 2014 and December 31, 2013
The Company’s total assets declined $5.3 million during the three month period ending March 31, 2014 or 0.65% from the balance at December 31, 2013 of $821.5 million to $816.2 million at March 31, 2014. Cash and cash equivalents increased approximately $22.3 million primarily due to increases in interest bearing deposit accounts at the Federal Reserve. Gross loans declined $9.9 million due to payoffs, paydowns, and charge offs. CDs held for investment declined $3.2 million due to scheduled maturities and investment securities declined $13.1 million. The changes in investments were primarily the result of $13.4 million in sales, $3.7 million in paydowns, net of $3.5 million in investment security purchases. Additionally, foreclosed assets declined $1.1 million as sales continued to outpace additions.
Total deposits decreased $8.4 million or 1.28% for the three month period ended March 31, 2014 as compared to December 31, 2013. Although total deposits declined, non interest bearing demand deposits increased by $5.3 million as the shift from interest bearing to non interest bearing continues.
Total shareholders’ equity increased from $21.6 million at December 31, 2013 to $24.4 million at March 31, 2014, due to an increase in accumulated other comprehensive income of $496,000, net income of $1.4 million, and shares of common stock purchased by the Standby Investor pursuant to the Securities Purchase Agreement.
Results of Operations for the Three Months Ended
March 31, 2014 and 2013
Net Income. Net income for the three months ended March 31, 2014 was $1.4 million, or $0.17 per basic and diluted share, as compared to net income of $77,000, or $0.01 per basic and diluted share, for the three months ended March 31, 2013. The $1.3 million increase in profits is primarily due to declines in non-interest expenses.
Net Interest Income. The primary component of earnings for the Bank is net interest income. Net interest income 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 for the three months ended March 31, 2014 was $5.4 million, as compared to $5.3 million for the quarter ended March 31, 2013. Average interest earning assets declined $35.6 million primarily due to declines in both the loan and investment portfolio; however interest and dividend income remained fairly constant with a $56,000 decline period over period. Average interest bearing liabilities decreased $85.0 million from the quarter ended March 31, 2013 and average rates paid on these deposits increased 6 basis points from 1.43% to 1.49%. The net interest margin increased 21 basis points to 2.83% for the quarter ended March 31, 2014 as compared to 2.62% the quarter ended March 31, 2013.
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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.
Our non-performing assets, which consist of loans past due 90 days or more, foreclosed assets, and loans in nonaccrual status, decreased to $35.7 million at March 31, 2014 from $35.8 million at December 31, 2013. This decrease was primarily due to improvements in the housing market and real estate construction, and the continued resolution of problem assets by Bank staff. During the three months ended March 31, 2014, no provision for loan losses was recognized in earnings compared to a provision of $35,000 for the three months ended March 31, 2013. Net charge-offs as a percentage of average loans decreased 24 basis points, from 0.26% for the three month period ended March 31, 2013 to 0.02% for the three month period ended March 31, 2014. Nonaccrual loans at March 31, 2014 were $28.3 million representing an increase from $27.2 million at December 31, 2013. At March 31, 2014, impaired loans, which include nonaccrual loans, troubled debt restructuring and other impaired loans, were $37.1 million. Of these loans, $9.5 million have specific loss allowances that aggregate $2.3 million. Impaired loan charge-offs, upgrades, and principal reductions have reduced the impaired loan population from $39.2 million at December 31, 2013 to $37.1 million at March 31, 2014. The allowance for loan losses was 2.39% of gross loans at March 31, 2014 as compared to 2.35% as of December 31, 2013. Management believes that the allowance is adequate to absorb probable losses inherent in the loan portfolio.
Non-Interest Income. Non-interest income was unchanged at $2.1 million for the three months ended March 31, 2014 and March 31, 2013. While the total was unchanged, each period did contain certain nonrecurring items which constituted the primary changes within non-interest income. During the 2014 period there was $538,000 in other non-interest income recorded resulting from settlements reached with certain third party payment processors, whereas in the 2013 period there was a deposit premium of $586,000 recognized from the sale of two branches to First Bank.
Non-Interest Expenses. Non-interest expense decreased $1.1 million to $6.2 million for the three months ended March 31, 2014 compared to $7.3 million for the three months ended March 31, 2013, primarily due to decreases in salaries and benefits of $422,000, loan collection expenses of $175,000, and professional and consulting fees of $136,000. The sale of two branches, reductions in nonperforming assets, and overall operational efficiencies led to these expense reductions.
Income Taxes. 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. A valuation allowance is established when it is more likely than not that all or some portion of the deferred tax asset will not be realized. In order to determine if the deferred tax asset is realizable, we performed an analysis that evaluates historical pre-tax earnings, projected future earnings, credit quality trends, taxable temporary differences and the cause and probability of recurrence of those circumstances leading to current taxable losses. Based on historical negative credit quality trends and cumulative losses, we did not consider any current or future taxable earnings in determining the recoverability of the deferred tax assets, and have therefore maintained a full valuation allowance against the net deferred tax asset. The Company expects its income tax expense (benefit) will be negligible until profitability has been restored for a reasonable time and such profitability is considered sustainable. At that time, the valuation allowance would be reversed. Reversal of the valuation allowance requires a great deal of judgment and will be based on circumstances that exist as of that future date.
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Asset Quality
Management is committed to a proactive nonaccrual and problem loan identification philosophy. This philosophy is implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified quickly and the risk of loss minimized. The following table provides detailed information regarding nonperforming assets, and past due loans as of March 31, 2014 and December 31, 2013.
March 31, 2014 | December 31, 2013 | ||||||
Nonaccrual loans: | (amounts in thousands, except ratios) | ||||||
Commercial and industrial | $ | 811 | $ | 651 | |||
Commercial construction and land development | 11,178 | 9,536 | |||||
Commercial real estate | 6,099 | 6,391 | |||||
Residential construction | 695 | 695 | |||||
Residential mortgage | 8,906 | 9,943 | |||||
Consumer | 561 | 11 | |||||
Total nonaccrual loans | $ | 28,250 | $ | 27,227 | |||
Foreclosed assets: | |||||||
Commercial and industrial | $ | 44 | $ | 44 | |||
Commercial construction and land development | 5,858 | 6,364 | |||||
Commercial real estate | 709 | 1,077 | |||||
Residential construction | — | 42 | |||||
Residential mortgage | 793 | 975 | |||||
Total foreclosed assets | $ | 7,404 | $ | 8,502 | |||
Past due 90 days or more and still accruing: | |||||||
Business credit cards | $ | 3 | $ | — | |||
Consumer credit cards | 6 | 23 | |||||
Total past due 90 days and still accruing | $ | 9 | $ | 23 | |||
Total nonperforming assets | $ | 35,663 | $ | 35,752 | |||
Nonaccrual loans to gross loans | 5.85 | % | 5.53 | % | |||
Nonperforming assets to total assets | 4.37 | % | 4.35 | % | |||
Allowance coverage of nonperforming loans | 40.75 | % | 42.53 | % |
Nonaccrual loans as a percentage of gross loans has increased to 5.85% as of March 31, 2014 compared to 5.53% as of December 31, 2013. The allowance for loan losses as a percentage of nonaccrual loans has decreased to 40.75% as of March 31, 2014 compared to 42.53% as of December 31, 2013. The allowance for loan losses on individually reviewed impaired loans totaled $2.3 million as of March 31, 2014, compared to $1.8 million as of December 31, 2013, a 24% increase. The increase was primarily the result of declines in fair market value of collateral securing a portion of impaired loans. The allowance for loan losses on the loans reviewed collectively decreased from $9.8 million as of December 31, 2013 to $9.3 million due primarily to improved charge-off trends.
Loans are classified as a troubled debt restructure ("TDR") when, for economic or legal reasons which result in a debtor experiencing financial difficulties, the Bank grants a concession through a modification of the original loan agreement that would not otherwise be considered. Generally concessions are granted as a result of a borrower's inability to meet the contractual repayment obligations of the initial loan terms and in the interest of improving the likelihood of recovery of the loan. We may grant these concessions by a number of means such as (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 upon a bankruptcy plan. However, the Bank only restructures loans for borrowers 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 of the underlying collateral or business.
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Loans in the process of renewal or modification are reviewed by the Bank to determine if the risk grade assigned is accurate based on updated information. All loans identified by the Bank's internal loan grading system to pose a heightened level of risk at or prior to renewal or modification are additionally 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 whether a concession has been granted. If the Bank determines that both conditions have been met, the loan will be classified as a TDR. If the Bank determines that both conditions have not been met, the loan is not classified as a TDR, but would typically then be monitored for any additional deterioration. Documentation to support this determination of TDR classification is maintained within the credit file.
The Bank's policy with respect to accrual of interest on loans restructured as part of 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 monthly payments. If the borrower does not perform under the restructured terms, the loan would remain on or be placed on nonaccrual status. We 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.
The following table presents performing and nonperforming TDRs at March 31, 2014 and December 31, 2013.
March 31, 2014 | December 31, 2013 | ||||||
Performing TDRs: | (amounts in thousands) | ||||||
Commercial industrial | $ | 37 | $ | 37 | |||
Commercial construction and land development | 225 | 227 | |||||
Commercial real estate | 4,417 | 4,447 | |||||
Residential mortgage | 1,979 | 2,319 | |||||
Total performing TDRs | $ | 6,658 | $ | 7,030 |
March 31, 2014 | December 31, 2013 | ||||||
Nonperforming TDRs: | (amounts in thousands) | ||||||
Commercial industrial | $ | 458 | $ | 301 | |||
Commercial construction and land development | 5,312 | 6,699 | |||||
Commercial real estate | 4,002 | 4,204 | |||||
Residential mortgage | 553 | 3,055 | |||||
Consumer | 2,350 | 1 | |||||
Total nonperforming TDRs | $ | 12,675 | $ | 14,260 |
Other impaired loans are loans which are currently performing and are not included as nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or restructured loans, so they are evaluated individually by management in assessing the adequacy of our allowance for loan losses.
At March 31, 2014 there were 128 foreclosed properties valued at a total of $7.4 million and 202 nonaccrual loans totaling $28.3 million. At December 31, 2013, there were 197 foreclosed properties valued at a total of $8.5 million and 208 nonaccrual loans totaling $27.2 million.
The gross interest income that would have been recorded for non-performing loans for the three months ended March 31, 2014 and March 31, 2013, was approximately $349,000 and $212,000, respectively. The amount of interest recognized for performing TDRs during the first three months of 2014 was approximately $84,000.
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The following table summarizes the Bank’s allocation of allowance for loan losses by loan category at March 31, 2014, and December 31, 2013.
March 31, 2014 | December 31, 2013 | ||||||||||||
Amount | % of Loans in each category | Amount | % of Loans in each category | ||||||||||
(amounts in thousands, except ratios) | |||||||||||||
Commercial and industrial | $ | 1,306 | 11 | % | $ | 1,290 | 11 | % | |||||
Commercial construction and land development | 3,972 | 35 | % | 4,083 | 35 | % | |||||||
Commercial real estate | 2,214 | 19 | % | 2,262 | 20 | % | |||||||
Residential construction | 287 | 3 | % | 287 | 2 | % | |||||||
Residential mortgage | 3,597 | 31 | % | 3,522 | 30 | % | |||||||
Consumer | 45 | — | % | 72 | 1 | % | |||||||
Other | 95 | 1 | % | 74 | 1 | % | |||||||
Total | $ | 11,516 | 100 | % | $ | 11,590 | 100 | % |
A summary of the allowance for the three months ended period ending March 31, 2014 and 2013 is as follows:
Three Months Ended | ||||||||
March 31, | ||||||||
2014 | 2013 | |||||||
(amounts in thousands) | ||||||||
Balance, beginning of period | $ | 11,590 | $ | 16,549 | ||||
Provision for loan losses | — | 35 | ||||||
Allowance before net (charge-offs) recoveries | 11,590 | 16,584 | ||||||
Loans charged-off | (492 | ) | (1,617 | ) | ||||
Recoveries | 418 | 280 | ||||||
Net (charge-offs) recoveries | (74 | ) | (1,337 | ) | ||||
Balance, end of period | $ | 11,516 | $ | 15,247 |
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The following table summarizes the Bank's loan loss experience for the three months ended March 31, 2014 and 2013.
Three Months Ended | ||||||||
March 31, | ||||||||
2014 | 2013 | |||||||
(amounts in thousands, except ratios) | ||||||||
Balance at beginning of period | $ | 11,590 | $ | 16,549 | ||||
Charge-offs: | ||||||||
Commercial and industrial | 23 | 18 | ||||||
Commercial construction and land development | 153 | 660 | ||||||
Commercial real estate | 207 | 238 | ||||||
Residential construction | — | — | ||||||
Residential mortgage | 67 | 610 | ||||||
Consumer | 42 | 91 | ||||||
Total charge-offs | 492 | 1,617 | ||||||
Recoveries: | ||||||||
Commercial and industrial | 39 | 23 | ||||||
Commercial construction and land development | 42 | 87 | ||||||
Commercial real estate | 159 | 1 | ||||||
Residential construction | — | — | ||||||
Residential mortgage | 142 | 123 | ||||||
Consumer | 15 | 46 | ||||||
Other | 21 | — | ||||||
Total recoveries | 418 | 280 | ||||||
Net (charge-offs) | (74 | ) | (1,337 | ) | ||||
Provision for loan losses | — | 35 | ||||||
Balance at end of period | $ | 11,516 | $ | 15,247 | ||||
Ratio of net charge-offs during the period to average gross loans outstanding during the period | 0.02 | % | 0.26 | % |
As the Company continues to work through problem loans, net charge-offs continue to improve. The Bank has dedicated resources to focus on the resolution of nonperforming assets which has contributed to the improved results.
Because of the nature of the Company’s primary markets and business, a significant portion of the loan portfolio is secured by commercial real estate, including residential and commercial acquisition, development, and construction properties. As of March 31, 2014 approximately 92.5% of the loan portfolio had real estate as a primary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower. Real estate values in many markets have declined over the past year, which may continue to negatively impact the ability of certain borrowers to repay their loans, while other markets are recovering their values. The Company continues to thoroughly review and monitor its commercial real estate concentration and sets limits by sector and region based on this internal review.
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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 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 of Atlanta (the "FHLB") 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 demands for liquidity are expected declines in short term demand deposits held for clearing Automated Clearing House ("ACH") transactions for the third party payment processor and anticipated funding under credit commitments to customers.
Due to contract terminations with certain ACH third party payment processors, we expect related demand deposits to decline during 2014. These deposits totaled $115.1 million as of March 31, 2014 and $117.1 million as of December 31, 2013. Management is actively monitoring the changes in these deposits and the Company has access to other funding sources to replace these deposits as needed to maintain adequate liquidity.
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.
On March 24, 2014, the Company entered into the Securities Purchase Agreement with the Standby Investor. Pursuant to the Securities Purchase Agreement, the Standby Investor has agreed to purchase from the Company (the “Standby Offering”), for $1.00 per share, the lesser of (i) 10,000,000 shares of common stock, $1.00 par value per share (the “Common Stock”), (ii) if the Rights Offering is completed, all shares of Common Stock not purchased by shareholders exercising their basic subscription privilege, and (iii) the maximum number of shares that he may purchase without causing an “ownership change” under Section 382(g) of the Internal Revenue Code of 1986, as amended (based on all shares of Common Stock outstanding at the completion of the Rights Offering and the Standby Offering). In addition, the Securities Purchase Agreement provides the Standby Investor a right of first refusal to purchase an additional 6,000,000 shares subject to the limitations outlined in clauses (ii) and (iii) above.
Pursuant to the Securities Purchase Agreement, on March 27, 2014, the Company closed the initial sale of 875,000 shares of Common Stock to the Standby Investor. The Securities Purchase Agreement contemplates a subsequent closing of the remaining number of shares based on the formula above and the Standby Investor’s decision on whether to exercise his right of first refusal. The Company has agreed that if for any reason it does not complete the Rights Offering, the Standby Investor will still be permitted to purchase shares of Common Stock as set forth above.
The Securities Purchase Agreement contains customary representations, warranties, and various covenants, including, among others, covenants by the Company to (i) adopt a restricted stock plan for the benefit of the Company’s officers, (ii) adopt an asset resolution plan, and (iii) establish a rights plan to protect the Company’s deferred tax asset. Consummation of the Standby Offering is subject to (a) receipt of required regulatory approvals and non-objections, (b) receipt by the Company of a letter from an independent accounting firm related to the Company’s deferred tax asset, and (c) other customary closing conditions set forth in the Securities Purchase Agreement. The Company has also agreed to enter into a registration rights agreement with the Standby Investor (the “Registration Rights Agreement”), which will provide the Standby Investor demand registration and piggyback registration rights with respect to the Standby Investor’s resale of shares purchased under the Securities Purchase Agreement, subject to customary limitations. The Company has agreed to pay the expenses associated with any registration statements filed with the SEC pursuant to the Registration Rights Agreement. Between the closing of the Standby Offering and the third anniversary of the closing date, for as long as the Standby Investor owns at least 25% of the Company’s outstanding shares of Common Stock, if the Company makes any public or non-public offering of any equity or any securities, options, or debt that are convertible or exchangeable into equity or that include an equity component, the Standby Investor will be afforded the opportunity to acquire from the Company for the same price and on the same terms as such securities are proposed to be offered to others, up to the amount in the aggregate required to enable him to maintain his proportionate common stock-equivalent interest in the Company.
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In addition, on March 26, 2014, the Company announced that it intends to conduct a Rights Offering of up to approximately $26.6 million (the “Rights Offering”). In the Rights Offering, the Company will distribute, at no charge, non-transferable subscription rights to its shareholders as of a future record date. For each share of Common Stock held as of the record date, a shareholder will receive a non-transferable right to purchase three shares of Common Stock at a subscription price of $1.00 per share (the “Basic Subscription Privilege”). Shareholders who exercise their Basic Subscription Privilege in full will have the opportunity to subscribe for additional shares for pro rata allocation in the event that not all available shares are purchased pursuant to the Basic Subscription Privilege or by the Standby Investor pursuant to the Securities Purchase Agreement, subject to certain limitations.
The Company intends to commence the Rights Offering during the second or third quarter of 2014.
Management believes that the Bank’s liquidity sources are adequate to meet its operating needs for the next eighteen months. Total shareholders’ equity was $24.4 million or 3.0% of total assets at March 31, 2014 and $21.6 million or 2.6% of total assets at December 31, 2013. 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 that remains unused at March 31, 2014. As of March 31, 2014, the Bank has the credit capacity to borrow up to $163.2 million, from the FHLB with $112.0 million outstanding. Our future liquidity sources and requirements will depend on a number of factors, including the availability of additional financing through the Rights Offering, Standby Offering or other sales of equity securities or otherwise.
The Company had total risk based capital of 11.0%, Tier 1 risk based capital of 7.1%, and leverage ratio of 3.9% at March 31, 2014, as compared to 10.7%, 6.3% and 3.6%, respectively, at December 31, 2013. The Bank had total risk based capital of 11.5%, Tier 1 risk based capital of 10.2%, and leverage ratio of 5.7% at March 31, 2014, as compared to 10.9%, 9.7%, and 5.5%, respectively, at December 31, 2013. At March 31, 2014 the Bank is well capitalized.
The Company is currently prohibited by the Written Agreement from paying interest on its subordinated promissory notes and on its subordinated debentures in connection with its trust preferred securities ("TPS") 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 every quarter when approval was required. The Company exercised its right to defer regularly scheduled interest payments on its outstanding TPS and as of March 31, 2014, $750,000 of interest payments have been accrued for and deferred pursuant to the terms of the indenture governing the TPS. The Company may not pay any cash dividends on its Common Stock until it is current on interest payments on such TPS. 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.
Recent Developments
On April 25, 2014, the United States District Court for the Eastern District of North Carolina approved a civil settlement with the DOJ relating to an investigation of consumer fraud related to third party payment processing, pursuant to which the Company and the Bank paid a $1.2 million civil penalty on May 1, 2014 and have agreed to abide by certain conditions relating to the provision of banking services for some categories of merchants.
Forward-Looking Information
Information set forth in this Quarterly Report on Form 10-Q, under the caption “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 (the "Securities Act"), 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.
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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 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 (through the Rights Offering, Standby Offering or otherwise), 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, the risks discussed in Part II, Item 1A. Risk Factors, and other considerations described in connection with specific forward-looking statements and other cautionary elements specified in the Company's periodic filings with the Commission, including without limitation, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.
Any forward-looking statements contained in this Quarterly Report on Form 10-Q 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.
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4 – 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 Quarterly 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 Chief Financial Officer have concluded that as of the end of the period covered by this Quarterly 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 Commission under the Exchange Act is recorded, processed, summarized and reported, within the time periods required by the Commission's rules and forms.
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 period covered by this Quarterly Report that the Company believes have materially affected or are likely to materially affect, its internal control over financial reporting.
Part II. OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
On May 20, 2013, the DOJ issued a subpoena to the Bank requiring the production of documents in connection with an investigation of consumer fraud related to third party payment processing. In connection with this investigation, the Bank negotiated a civil settlement with the DOJ (the "Consent Order"), which was filed with the United States District Court for the Eastern District of North Carolina on January 8, 2014. The Consent Order was filed contemporaneously with the filing of a complaint by the DOJ alleging violation of a variety of laws, including money laundering laws. As part of the terms of the Consent Order, the Bank agreed to pay a civil monetary penalty in the amount of $1 million, plus a civil forfeiture in the amount of $200,000. The Consent Order was approved by the United States District Court for the Eastern District of North Carolina on April 25, 2014 and payment of the civil monetary penalty and civil forfeiture occurred on May 1, 2014.
In October 2013, multiple putative class action lawsuits were filed in United States district courts across the country against a number of different banks based on the banks' alleged role in "payday lending". Four of these lawsuits, pending in the Northern District of Georgia, the Middle District of North Carolina, the District of Maryland, and the Southern District of Florida, name
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the Bank as one of the defendants. The lawsuits allege that, by processing ACH transactions indirectly on behalf of "payday lenders", the Bank is illegally participating in an enterprise to collect unlawful debts and is therefore liable to plaintiffs for damages under the federal Racketeer Influenced and Corrupt Organizations Act. The lawsuits also allege a variety of state law claims. The Bank moved to dismiss each of these lawsuits. The Middle District of North Carolina granted the motion in part and denied it in part. The motions to dismiss in the three other cases are awaiting decision.
We are party to certain other legal actions in the ordinary course of our business. We believe these 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 1A - RISK FACTORS
There have been no material changes in the Company’s risk factors from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2013, except that the risks related to the approval and timing of the Consent Order are no longer applicable.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On March 27, 2014, the Company closed the sale of 875,000 shares of Common Stock to the Standby Investor pursuant to the Securities Purchase Agreement for aggregate consideration of $875,000. The shares of Common Stock were offered and sold to the Standby Investor in reliance upon the exemption from the registration requirements of the Securities Act afforded by Regulation D promulgated thereunder. The Securities Purchase Agreement was a privately negotiated transaction that did not involve general solicitation, and the Standby Investor is an “accredited investor” as defined in Regulation D. Please see "Liquidity and Capital Resources" for a description of the Securities Purchase Agreement.
ITEM 6 - EXHIBITS
The following exhibits are filed as part of this Quarterly Report on Form 10-Q.
Exhibit No. | Description |
10.1 | Securities Purchase Agreement, dated as of March 24, 2014, between Four Oaks Fincorp, Inc. and Kenneth R. Lehman (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on March 26, 2014). |
10.2 | Form of Registration Rights Agreement with Kenneth R. Lehman (included as part of Exhibit 10.1). |
31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.2 | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
32.2 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
101 | The following materials from Four Oaks Fincorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 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 Income; (iv) Consolidated Statement of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FOUR OAKS FINCORP, INC. | |||
Date: | May 15, 2014 | By: | /s/ Ayden R. Lee, Jr. |
Ayden R. Lee, Jr. | |||
Chairman, President and | |||
Chief Executive Officer | |||
Date: | May 15, 2014 | By: | /s/ Nancy S. Wise |
Nancy S. Wise | |||
Executive Vice President and | |||
Chief Financial Officer |
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Exhibit Index
Exhibit No. | Description |
10.1 | Securities Purchase Agreement, dated as of March 24, 2014, between Four Oaks Fincorp, Inc. and Kenneth R. Lehman (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on March 26, 2014). |
10.2 | Form of Registration Rights Agreement with Kenneth R. Lehman (included as part of Exhibit 10.1). |
31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.2 | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
32.2 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
101 | The following materials from Four Oaks Fincorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 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 Income; (iv) Consolidated Statement of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements. |
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