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, 2010
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.SYES £NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). £YES £NO
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer £ | Accelerated filer £ |
Non-accelerated filer £ (Do not check if a smaller reporting company) | Smaller reporting company S |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): £YES SNO
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock, | 7,484,638 |
par value $1.00 per share | (Number of shares outstanding |
(Title of Class) | as of May 13, 2010) |
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TABLE OF CONTENTS | Page No. | |||
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27 | ||||
Item 4 - | Controls and Procedures | 27 | ||
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30 |
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CONSOLIDATED BALANCE SHEETS
March 31, 2010 | December 31, | |||||||
(Unaudited) | 2009(*) | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 13,004 | $ | 13,512 | ||||
Interest-earning deposits | 47,978 | 65,602 | ||||||
Federal funds sold | - | 5,048 | ||||||
Investment securities available for sale, at fair value | 137,063 | 125,760 | ||||||
Loans | 722,468 | 715,133 | ||||||
Allowance for loan losses | (16,500 | ) | (15,676 | ) | ||||
Net loans | 705,968 | 699,457 | ||||||
Accrued interest receivable | 3,680 | 3,600 | ||||||
Bank premises and equipment, net | 17,269 | 17,620 | ||||||
FHLB stock | 6,802 | 6,802 | ||||||
Investment in life insurance | 11,189 | 11,068 | ||||||
Other real estate owned | 11,897 | 10,708 | ||||||
Other assets | 15,770 | 17,574 | ||||||
Total assets | $ | 970,620 | $ | 976,751 | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
Deposits: | ||||||||
Noninterest-bearing demand | $ | 89,483 | $ | 90,668 | ||||
Money market, NOW accounts and savings accounts | 156,821 | 176,867 | ||||||
Time deposits, $100,000 and over | 327,341 | 305,667 | ||||||
Other time deposits | 185,708 | 192,820 | ||||||
Total deposits | 759,353 | 766,022 | ||||||
Borrowings | 112,543 | 112,543 | ||||||
Subordinated debentures | 12,372 | 12,372 | ||||||
Subordinated notes | 12,000 | 12,000 | ||||||
Accrued interest payable | 2,213 | 2,283 | ||||||
Other liabilities | 5,575 | 5,677 | ||||||
Total liabilities | 904,056 | 910,897 | ||||||
Commitments and Contingencies (Note 3) | ||||||||
Shareholders’ equity: | ||||||||
Common stock, $1.00 par value, 20,000,000 shares | ||||||||
authorized; 7,458,430 and 7,440,268 shares issued and | ||||||||
outstanding at March 31, 2010 and December 31, 2009, | ||||||||
respectively | 7,458 | 7,440 | ||||||
Additional paid-in capital | 33,450 | 33,346 | ||||||
Retained earnings | 24,644 | 24,625 | ||||||
Accumulated other comprehensive income | 1,012 | 443 | ||||||
Total shareholders' equity | 66,564 | 65,854 | ||||||
Total liabilities and shareholders' equity | $ | 970,620 | $ | 976,751 |
* Derived from audited consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
(Amounts in thousands, | ||||||||
except per share data) | ||||||||
Interest and dividend income: | ||||||||
Loans, including fees | $ | 10,493 | $ | 9,753 | ||||
Investment securities: | ||||||||
Taxable | 708 | 1,430 | ||||||
Tax-exempt | 365 | 613 | ||||||
Dividends | 57 | 68 | ||||||
Interest-earning deposits and Federal Funds sold | 29 | 6 | ||||||
Total interest and dividend income | 11,652 | 11,870 | ||||||
Interest expense: | ||||||||
Deposits | 2,612 | 4,036 | ||||||
Borrowings | 1,007 | 1,009 | ||||||
Subordinated debentures | 50 | 100 | ||||||
Subordinated notes | 255 | - | ||||||
Total interest expense | 3,923 | 5,145 | ||||||
Net interest income | 7,729 | 6,725 | ||||||
Provision for loan losses | 2,061 | 1,642 | ||||||
Net interest income after provision for loan losses | 5,668 | 5,083 | ||||||
Non-interest income: | ||||||||
Service charges on deposit accounts | 505 | 550 | ||||||
Other service charges, commissions and fees | 529 | 355 | ||||||
Gain on sale of investment securities | 254 | 691 | ||||||
Impairment loss on investment securities available for sale | (125 | ) | - | |||||
Impairment loss on non-marketable investments | - | (154 | ) | |||||
Merchant fees | 122 | 105 | ||||||
Income from investment in bank-owned life insurance | 122 | 126 | ||||||
Total non-interest income | 1,407 | 1,673 | ||||||
Non-interest expenses: | ||||||||
Salaries | 2,770 | 2,527 | ||||||
Employee benefits | 528 | 618 | ||||||
Occupancy expense | 333 | 272 | ||||||
Equipment expense | 409 | 389 | ||||||
Professional and consulting fees | 838 | 554 | ||||||
FDIC assessment | 498 | 139 | ||||||
Other taxes and licenses | 81 | 86 | ||||||
Merchant processing expense | 99 | 88 | ||||||
Loss on sale of other real estate owned | 476 | 115 | ||||||
Other | 1,170 | 923 | ||||||
Total non-interest expenses | 7,202 | 5,711 | ||||||
Income (loss) before income taxes | (127 | ) | 1,045 | |||||
Provision for income taxes | (220 | ) | 138 | |||||
Net income | $ | 93 | $ | 907 | ||||
Basic net income per common share | $ | 0.01 | $ | 0.13 | ||||
Diluted net income per common share | $ | 0.01 | $ | 0.13 |
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
(Amounts in thousands) | ||||||||
Net income | $ | 93 | $ | 907 | ||||
Other comprehensive income: | ||||||||
Securities available for sale: | ||||||||
Unrealized holding gains on available for sale securities | 1,076 | 375 | ||||||
Tax effect | (428 | ) | (144 | ) | ||||
Reclassification of net gains recognized in net income | (254 | ) | (537 | ) | ||||
Tax effect | 98 | 207 | ||||||
Reclassification of impairment loss recognized in net income | 125 | - | ||||||
Tax effect | (48 | ) | - | |||||
Total other comprehensive income (loss) | 569 | (99 | ) | |||||
Comprehensive income | $ | 662 | $ | 808 |
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
Accumulated | ||||||||||||||||||||||||
Additional | other | Total | ||||||||||||||||||||||
Common stock | paid-in | Retained | comprehensive | shareholders' | ||||||||||||||||||||
Shares | Amount | capital | earnings | income | equity | |||||||||||||||||||
(Amounts in thousands, except share and per share data) | ||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2009 | 7,440,268 | $ | 7,440 | $ | 33,346 | $ | 24,625 | $ | 443 | $ | 65,854 | |||||||||||||
Net income | - | - | - | 93 | - | 93 | ||||||||||||||||||
Other comprehensive income | - | - | - | - | 569 | 569 | ||||||||||||||||||
Issuance of common stock | 18,162 | 18 | 77 | - | - | 95 | ||||||||||||||||||
Stock based compensation | - | - | 27 | - | - | 27 | ||||||||||||||||||
Cash dividends of $.01 per share | - | - | - | (74 | ) | - | (74 | ) | ||||||||||||||||
BALANCE AT MARCH 31, 2010 | 7,458,430 | $ | 7,458 | $ | 33,450 | $ | 24,644 | $ | 1,012 | $ | 66,564 |
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
(Amounts in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | 93 | 907 | ||||||
Adjustments to reconcile net income to net cash | ||||||||
provided by operating activities: | ||||||||
Provision for loan losses | 2,061 | 1,642 | ||||||
Provision for depreciation and amortization | 330 | 278 | ||||||
Net amortization of bond premiums and discounts | 553 | 5 | ||||||
Stock based compensation | 27 | 24 | ||||||
Gain on sale of investment securities | (254 | ) | (691 | ) | ||||
Loss on disposition of premises and equipment | 92 | - | ||||||
Loss on sale of other real estate owned | 476 | 115 | ||||||
Income from investment in life insurance | (121 | ) | (126 | ) | ||||
Impairment loss on investment securities available for sale | 125 | - | ||||||
Impairment loss on non-marketable investments | - | 154 | ||||||
Changes in assets and liabilities: | ||||||||
Other assets | 1,427 | 92 | ||||||
Interest receivable | (80 | ) | 290 | |||||
Other liabilities | (70 | ) | 1,401 | |||||
Interest payable | (102 | ) | (264 | ) | ||||
Net cash provided by operating activities | 4,556 | 3,827 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from sales and calls of investment securities available for sale | 14,164 | 90,866 | ||||||
Purchases of investment securities available for sale | (24,944 | ) | (104,575 | ) | ||||
Purchase of FHLB stock | - | (279 | ) | |||||
Proceeds of fed funds sold | 5,048 | - | ||||||
Net increase in loans | (11,422 | ) | (27,168 | ) | ||||
Purchase of bank premises and equipment | (71 | ) | (67 | ) | ||||
Proceeds from sales of other real estate owned | 1,234 | 169 | ||||||
Net expenditures on other real estate owned | (49 | ) | - | |||||
Net cash used by investing activities | (16,040 | ) | (41,054 | ) | ||||
Cash flow from financing activities: | ||||||||
Net (repayments of) proceeds from borrowings | - | (1,500 | ) | |||||
Net increase (decrease) in deposit accounts | (6,669 | ) | 32,271 | |||||
Proceeds from issuance of common stock | 95 | 306 | ||||||
Cash dividends paid | (74 | ) | (588 | ) | ||||
Net cash provided by financing activities | (6,648 | ) | 30,489 | |||||
Net increase in cash and cash equivalents | (18,132 | ) | (6,738 | ) | ||||
Cash and cash equivalents at beginning of period | 79,114 | 28,875 | ||||||
Cash and cash equivalents at end of the period | $ | 60,982 | $ | 22,137 | ||||
Schedule of noncash investing and financing activities: | ||||||||
Transfers of loans to other real estate owned | $ | 2,850 | $ | 1,197 | ||||
Net transfers of other assets to investment securities available for sale | 678 | - |
The accompanying notes are an integral part of the consolidated financial statements.
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NOTE 1 - 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 month periods ended March 31, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts of Four Oaks Fincorp, Inc. (the "Company") and its wholly-owned subsidiaries, Four Oaks Bank & Trust Company (the “Bank”) and Four Oaks Mortgage Services, LLC, a mortgage origination subsidiary. All significant intercompany transactions and balances have been eliminated in consolidation. 160;Operating results for the three month periods ended March 31, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.
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, 2009. This Quarterly Report should be read in conjunction with such Annual Report.
Certain prior year amounts have been reclassified in the consolidated financial statements to conform with the current year presentation. The reclassifications had no effect on previously reported net income or shareholders’ equity.
NOTE 2 - NET INCOME PER SHARE
Basic earnings per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company related 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 income divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Weighted average number of common shares | ||||||||
used in computing basic net income per share | 7,443,411 | 6,932,493 | ||||||
Effect of dilutive stock options | - | - | ||||||
Weighted average number of common shares and | ||||||||
dilutive potential common shares used in | ||||||||
computing diluted net income per share | 7,443,411 | 6,932,493 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 2 - NET INCOME PER SHARE (Continued)
Stock options that have exercise prices greater than the average market price of the common shares or stock options outstanding do not have a dilutive effect and are considered antidilutive. As of March 31, 2010 and 2009, there were 335,134 and 311,403 antidilutive stock options outstanding, respectively.
NOTE 3 - COMMITMENTS
At March 31, 2010, loan commitments were as follows (in thousands):
Commitments to extend credit | $ | 36,209 | ||
Undisbursed lines of credit | 56,348 | |||
Financial stand-by letters of credit | 287 | |||
Performance stand-by letters of credit | 2,007 |
NOTE 4 – INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available for sale as of March 31, 2010 and December 31, 2009 are as follows:
March 31, 2010 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Amortized | unrealized | unrealized | Fair | |||||||||||||
cost | gains | losses | value | |||||||||||||
(Amounts in thousands) | ||||||||||||||||
State and municipal securities | $ | 36,539 | $ | 456 | $ | 34 | $ | 36,961 | ||||||||
Taxable municipal securities | 15,642 | 29 | 185 | 15,486 | ||||||||||||
Mortgage-backed securities | 79,752 | 1,902 | 52 | 81,602 | ||||||||||||
Equity securities | 3,456 | 40 | 482 | 3,014 | ||||||||||||
$ | 135,389 | $ | 2,427 | $ | 753 | $ | 137,063 | |||||||||
December 31, 2009 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Amortized | unrealized | unrealized | Fair | |||||||||||||
cost | gains | losses | value | |||||||||||||
(Amounts in thousands) | ||||||||||||||||
State and municipal securities | $ | 36,976 | $ | 437 | $ | 24 | $ | 37,389 | ||||||||
Taxable municipal securities | 12,397 | 8 | 360 | 12,045 | ||||||||||||
Mortgage-backed securities | 72,758 | 1,541 | 5 | 74,294 | ||||||||||||
Equity securities | 2,902 | - | 870 | 2,032 | ||||||||||||
$ | 125,033 | $ | 1,986 | $ | 1,259 | $ | 125,760 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 4 – INVESTMENT SECURITIES (Continued)
The following table shows 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, 2010 and December 31, 2009. As of March 31, 2010, the unrealized losses relate to eight mortgage-backed securities, 25 municipal securities, and 13 equity securities. Ten of the 13 equity securities had continuous unrealized losses for more than 12 months. The unrealized losses relate to debt securities that have incurred fair value reductions due to higher market interest rates since the securities were purchased and equity securities that have declined in market value since the securities were purchased.
For the three months ended March 31, 2010, the Company determined one marketable equity security was other than temporarily impaired resulting in an impairment loss of $125,000. The investment was deemed to be other than temporarily impaired given the severity and significant length of time the investment has been impaired. This and other factors led to the conclusion of insufficient support for recovery in a reasonable period of time. The fair value of this investment at March 31, 2010 is $125,000.
The unrealized losses on debt and mandatory redeemable preferred equity securities are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, none of the securities other than those mentioned above are deemed to be other than temporarily impaired.
March 31, 2010 | |||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | ||||||||||||||||||||
value | losses | value | losses | value | losses | ||||||||||||||||||||
(Amounts in thousands) | |||||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||||
State and municipal securities | $ | 4,777 | $ | 34 | $ | - | $ | - | $ | 4,777 | $ | 34 | |||||||||||||
Taxable municipal securities | 9,608 | 185 | - | - | 9,608 | 185 | |||||||||||||||||||
Mortgage-backed securities | 13,831 | 52 | - | - | 13,831 | 52 | |||||||||||||||||||
Equity securities | 1,456 | 420 | 239 | 62 | 1,695 | 482 | |||||||||||||||||||
Total temporarily impaired | |||||||||||||||||||||||||
securities | $ | 29,672 | $ | 691 | $ | 239 | $ | 62 | $ | 29,911 | $ | 753 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 4 – INVESTMENT SECURITIES (Continued)
December 31, 2009 | |||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | ||||||||||||||||||||
value | losses | value | losses | value | losses | ||||||||||||||||||||
(Amounts in thousands) | |||||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||||
State and municipal securities | $ | 3,982 | $ | 24 | $ | - | $ | - | $ | 3,982 | $ | 24 | |||||||||||||
Taxable municipal securities | 11,012 | 360 | - | - | 11,012 | 360 | |||||||||||||||||||
Mortgage-backed securities | 3,423 | 5 | - | - | 3,423 | 5 | |||||||||||||||||||
Equity securities | 1,315 | 566 | 606 | 278 | 1,921 | 844 | |||||||||||||||||||
Total temporarily impaired | |||||||||||||||||||||||||
securities | $ | 19,732 | $ | 955 | $ | 606 | $ | 278 | $ | 20,338 | $ | 1,233 | |||||||||||||
Equity securities | $ | 111 | $ | 26 | $ | - | $ | - | $ | 111 | $ | 26 | |||||||||||||
Total other than temporarily | |||||||||||||||||||||||||
impaired securities | $ | 111 | $ | 26 | $ | - | $ | - | $ | 111 | $ | 26 |
The amortized cost and fair value of available for sale securities at March 31, 2010 by contractual maturities are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized | Fair | |||||||
cost | value | |||||||
(Amounts in thousands) | ||||||||
Due within one year | $ | 7,978 | $ | 8,042 | ||||
Due after one year through five years | 226 | 229 | ||||||
Due after five years through ten years | 9,237 | 9,286 | ||||||
Due after ten years | 114,492 | 116,492 | ||||||
Total debt securities | 131,931 | 134,047 | ||||||
Equity securities | 3,456 | 3,014 | ||||||
$ | 135,389 | $ | 137,063 |
Securities with a carrying value of approximately $115.9 million and $100.9 million at March 31, 2010 and December 31, 2009, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
Proceeds from sales and calls of investment securities available for sale amounted to $14.2 million and $90.9 million, for the three months ended March 31, 2010 and 2009, respectively. These transactions generated gross realized gains of $254,000 and $718,000, for the three months ending March 31, 2010 and 2009, respectively, and also generated gross realized losses of $27,000 for the three months ended March 31, 2009.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 5 – LOANS
The following is a summary of the loan portfolio at the periods represented:
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
(Amounts in thousands) | ||||||||
Commercial real estate: | ||||||||
Construction and land development | $ | 226,667 | $ | 233,012 | ||||
Farmland | 31,816 | 19,577 | ||||||
Commercial non-owner occupied | 90,645 | 85,216 | ||||||
Total commercial real estate loans | 349,128 | 337,805 | ||||||
Commercial owner occupied real estate | 94,339 | 99,533 | ||||||
Commercial | 67,044 | 66,976 | ||||||
Residential mortgages | 157,698 | 152,975 | ||||||
Home equity | 39,206 | 40,401 | ||||||
Consumer - other | 15,440 | 17,854 | ||||||
Total other loans | 373,727 | 377,739 | ||||||
Less: Net deferred loan fees | (387 | ) | (411 | ) | ||||
Total Loans | $ | 722,468 | $ | 715,133 |
The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The recorded investment in loans considered impaired totaled $31.9 million and $30.2 million at March 31, 2010 and December 31, 2009, respectively. This amount consisted of both accrual and nonaccrual loans. Impaired loans of $25.6 million and $22.7 million had related allowances for loan losses of $7.8 and $6.4 million at March 31, 2010 and December 31, 2009, respectively.
In the acquisition of Nuestro Banco on December 31, 2009, the Company acquired $2.3 million in estimated contractually required payments to be received from impaired loans. This amount was discounted by $1.3 million representing the nonaccretable difference and an additional $53,000 representing the accretable yield, which resulted in acquired impaired loans with a fair value of $947,000. There has been no change in the estimated cash flows associated with these acquired impaired loans as of and for the three months ended March 31, 2010. Management will continue to monitor the estimated cash flows related to these impaired loans on an ongoing basis.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 6 – FAIR VALUE MEASUREMENT
The Company records securities available for sale and derivative assets or liabilities 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 reportin g 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.
The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“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 dete rmine 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. As of March 31, 2010 and December 31, 2009, the Company carried marketable equity securities available for sale at fair value hierarchy Level 1.
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. As of March 31, 2010 and December 31, 2009, the types of financial assets and liabilities the Company carried at fair value hierarchy Level 2 included securities available for sale.
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. As of March 31, 2010 and December 31, 2009, the Company valued certain financial assets measured on a recurring and non-recurring basis, at fair value hierarchy Level 3.
Fair Value Measured on a Recurring Basis. The Company measures certain assets at fair value on a recurring basis, as described below.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 6 – FAIR VALUE MEASUREMENT (Continued)
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 those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
Fair Value on a Recurring Basis. Below is a table that presents information about assets measured at fair value on a recurring basis at March 31, 2010 and December 31, 2009:
Fair Value Measurements at | ||||||||||||||||||||
March 31, 2010 Using | ||||||||||||||||||||
Quoted Prices | ||||||||||||||||||||
Total Carrying | in Active | Significant | ||||||||||||||||||
Amount in The | Assets | Markets | Other | Significant | ||||||||||||||||
Consolidated | Measured | for Identical | Observable | Unobservable | ||||||||||||||||
Balance Sheet | at Fair Value | Assets | Inputs | Inputs | ||||||||||||||||
Description | 3/31/2010 | 3/31/2010 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Tax exempt securities | $ | 36,961 | $ | 36,961 | $ | - | $ | 38,172 | $ | - | ||||||||||
Taxable municipal | ||||||||||||||||||||
securities | 15,486 | 15,486 | - | 13,273 | 1,003 | |||||||||||||||
Agency mortgage-backed | ||||||||||||||||||||
securities | 81,602 | 81,602 | - | 81,601 | - | |||||||||||||||
Equity securities | 3,014 | 3,014 | 1,558 | 125 | 1,331 | |||||||||||||||
Total available for sale | ||||||||||||||||||||
securities | $ | 137,063 | $ | 137,063 | $ | 1,558 | $ | 133,171 | $ | 2,334 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
NOTE 6 – FAIR VALUE MEASUREMENT (Continued)
Fair Value Measurements at | ||||||||||||||||||||
December 31, 2009 Using | ||||||||||||||||||||
Quoted Prices | ||||||||||||||||||||
Total Carrying | in Active | Significant | ||||||||||||||||||
Amount in The | Assets | Markets | Other | Significant | ||||||||||||||||
Consolidated | Measured | for Identical | Observable | Unobservable | ||||||||||||||||
Balance Sheet | at Fair Value | Assets | Inputs | Inputs | ||||||||||||||||
Description | 12/31/2009 | 12/31/2009 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Tax exempt securities | $ | 37,389 | $ | 37,389 | $ | - | $ | 37,389 | $ | - | ||||||||||
Taxable municipal | ||||||||||||||||||||
securities | 12,045 | 12,045 | - | 12,045 | - | |||||||||||||||
Agency mortgage-backed | ||||||||||||||||||||
securities | 74,294 | 74,294 | - | 59,987 | 14,307 | |||||||||||||||
Equity securities | 2,032 | 2,032 | 271 | 117 | 1,644 | |||||||||||||||
Total available for sale | ||||||||||||||||||||
securities | $ | 125,760 | $ | 125,760 | $ | 271 | $ | 109,538 | $ | 15,951 |
The table below presents the reconciliation for the period of December 31, 2009 to March 31, 2010 for all Level 3 assets that are measured at fair value on a recurring basis. At March 31, 2010, $14.3 million of agency mortgage-backed securities were transferred from Level 3 to Level 2 resulting from enhanced measurement capabilities of third party valuations.
Available-for-sale securities | ||||
(Amounts in thousands) | ||||
Beginning Balance December 31, 2009 | $ | 15,951 | ||
Total realized and unrealized gains or losses: | ||||
Included in other comprehensive income | (313 | ) | ||
Purchases, issuances and settlements | 1,003 | |||
Transfers out of Level 3 | (14,307 | ) | ||
Ending Balance March 31, 2010 | $ | 2,334 | ||
Fair Value Measured on a Nonrecurring Basis. The Company measures certain assets at fair value on a nonrecurring basis, as described below.
Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310, “Receivables” and ASC 450, “Contingencies”. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cas h flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with ASC 820, impaired loans with an allowance established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans totaled $31.9 million at March 31 , 2010. Of such loans, $25.6 million had specific loss allowances aggregating $7.8 million at that date for a net fair value of $17.8 milion. Of those specific allowances, all were determined using Level 3 inputs.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
NOTE 6 – FAIR VALUE MEASUREMENT (Continued)
Goodwill and Other Intangible Assets
Goodwill and identified intangible assets are subject to impairment testing. When appropriate, a projected cash flow valuation method is used in the completion of impairment testing. This valuation method requires a significant degree of management judgment. In the event the projected undiscounted net operating cash flows are less than the carrying value, the asset is recorded at fair value as determined by the valuation model. As such, the Company classifies goodwill and other intangible assets subjected to nonrecurring fair value adjustments as Level 3. At March 31, 2010, there were no fair value adjustments related to intangible assets of $393,000. The goodwill of $6.1 million was considered completely impaired at December 31, 2009.
Other Real Estate Owned
Other real estate owned are adjusted to net realizable value upon transfer of the loans to other real estate owned. Subsequently, other real estate owned are carried at the lower of carrying value or net realizable value. Net realizable value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral adjusted for selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. At March 31, 2010 and December 31, 2009, there were no additional fair value adjustments required after transfer related to other real estate owned of $11.9 million and $10.7 million, respectively.
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC 825, “Financial Instruments” 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 ind ication 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.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Cash and Cash Equivalents
The carrying amounts of cash and cash equivalents are equal to the fair value due to the liquid nature of the financial instruments.
Investment Securities Available for Sale
Fair values of investment securities available for sale are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans
Fair values have been estimated by type of loan: residential real estate loans, consumer loans, and commercial and other loans. For variable-rate loans that reprice frequently and with no significant credit risk, fair values are based on carrying values. The fair values of fixed rate loans are estimated by discounting the future cash flows using the current rates at which loans with similar terms would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for current liquidity and market conditions. The Company has assigned no fair value to off-balance sheet financial instruments since they are either short term in nature or subject to immediate repricing.
FHLB Stock
The carrying amount of FHLB stock approximates fair value.
Investment in Life Insurance
The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.
Deposits
The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at period-end. Fair value of time deposits is estimated by discounting the future cash flows using the current rate offered for similar deposits with the same maturities.
Borrowings and Subordinated Debentures
The fair values of borrowings and subordinated debentures are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collection requirements.
Accrued Interest Receivable and Payable
The carrying amounts of accrued interest approximate fair value.
The following table presents information for financial assets and liabilities as of March 31, 2010 and December 31, 2009:
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
March 31, 2010 | December 31, 2009 | |||||||||||||||
Carrying amount | Estimated fair value | Carrying amount | Estimated fair value | |||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 60,982 | $ | 60,982 | $ | 79,862 | $ | 79,862 | ||||||||
Securities available for sale | 137,063 | 137,063 | 125,760 | 125,760 | ||||||||||||
Loans, net | 705,968 | 702,315 | 699,457 | 695,094 | ||||||||||||
FHLB stock | 6,802 | 6,802 | 6,802 | 6,802 | ||||||||||||
Investment in life insurance | 11,189 | 11,189 | 11,068 | 11,068 | ||||||||||||
Accrued interest receivable | 3,680 | 3,680 | 3,600 | 3,600 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Deposits | $ | 759,353 | 751,845 | 766,022 | 755,890 | |||||||||||
Subordinated debentures/promissory notes | 24,372 | 24,300 | 24,372 | 18,161 | ||||||||||||
Borrowings | 112,543 | 114,497 | 112,543 | 115,106 | ||||||||||||
Accrued interest payable | 2,213 | 2,213 | 2,283 | 2,283 |
NOTE 8 – OTHER RECENT ACCOUNTING PRONOUNCEMENTS
In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 166 “Accounting for Transfers of Financial Assets – an amendment of the FASB Statement No. 140” (“ASC 860”), which eliminates the concept of a qualifying special purpose entity (“QSPE”), changes the requirements for derecognizing financial assets, and requires additional disclosures including information about continuing exposure to risks related to transferred financial assets. ASC 860 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The disclosure requirements must be applied to transfers that occurred before and after the effective date. The adoption on January 1, 2010, did not have a material impact on the Co mpany's consolidated financial statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“ASC 810”), which contains new criteria for determining the primary beneficiary, eliminates the exception to consolidating QSPEs, requires continual reconsideration of conclusions reached in determining the primary beneficiary, and requires additional disclosures. ASC 810 is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments (e.g., for newly-consolidated VIEs). The adoption on January 1, 2010, did not have a material impact on the Company's consolidated financial statements.
ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASC 820”): Improving Disclosures about Fair Value Measurements. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:
A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and in the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 8 – OTHER RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:
· | For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and |
· | A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. |
ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. Adoption as of January 1, 2010 did not have a material effect on the Company’s financial statements.
Other accounting standards that have been issued by the FASB are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.
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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.
Comparison of Financial Condition at
March 31, 2010 and December 31, 2009
The Company’s total assets declined from $976.8 million at December 31, 2009 to $970.6 million at March 31, 2010, a decrease of $6.1 million, or 0.6%. The Company’s liquid assets, consisting of cash and cash equivalents and investment securities available for sale, decreased $11.9 million during the three months ended March 31, 2010 compared to liquid assets as of December 31, 2009, primarily from a decrease in cash and cash equivalents of $23.2 million. Gross loans increased by $7.3 million or 1.0% from $715.1 million at December 31, 2009 to $722.5 million at March 31, 2010. The Company’s loan portfolio increase is due mainly to growth in the commercial real estate sector. Deposits decreased $6.7 million or 0.9% from $766.0 million at December 31, 2009 to $759.4 million at March 31, 2010. & #160;Deposits from the Company’s local market continued to be its primary funding source, accounting for 74.0% of overall deposits, while wholesale deposits increased by $17.1 million or 9.5% for the three month period.
Total shareholders’ equity increased approximately $710,000 from $65.9 million at December 31, 2009 to $66.6 million at March 31, 2010. The increase resulted primarily from net income of $93,000, the issuance of shares of common stock valued at $95,000, stock compensation expense of $27,000 and other comprehensive income of $569,000. Offsetting this increase were dividends paid to the Company’s shareholders of $74,000 during the first three months of 2010. At March 31, 2010, both the Company and Four Oaks Bank & Trust Company, the Company’s wholly-owned subsidiary (the “Bank”), were considered to be well capitalized as such term is defined in applicable federal regulations.
Results of Operations for the Three Months Ended
March 31, 2010 and 2009
Net Income. Net income for the three months ended March 31, 2010 was $93,000, or $.01 basic net income per share, as compared with net income of $907,000, or $.13 basic and diluted net income per share, for the three months ended March 31, 2009, a decrease of $814,000 or $.12 basic net income per share. The primary reasons for this decline in net income are approximately $600,000 of nonrecurring expenses related to our acquisition of Nuestro Banco, a $420,000 increase in the provision for loan losses to $2.1 million in the first quarter of 2010 as compared to $1.6 million for the first quarter of 2009, and additional Federal Deposit Insurance Corporation (“FDIC”) insuranc e premiums of $359,000.
Net Interest Income. Like most financial institutions, 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.
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Net interest income for the three months ended March 31, 2010 was $7.7 million, an increase of $1.0 million compared to the three months ended March 31, 2009. The increase was primarily due to a decrease in the cost of deposits. Average interest-earning assets increased $27.8 million for the quarter and average interest-bearing liabilities increased $20.4 million for the same period. Margins increased during the period, primarily due to the cost of liabilities continuing to decrease as yields on assets decreased at a slower pace, resulting in an increase in the Company’s net interest margin by 35 basis points from 3.10% during the three months ended March 31, 2009 to 3.45% during the three months ended March 31, 2010.
Provision for Loan Losses. The provision for loan losses was $2.1 million and $1.6 million for the three months ended March 31, 2010 and 2009, respectively, an increase of $420,000. Net charge-offs of $1.2 million were recorded for the three months ended March 31, 2010 compared to net charge-offs of $734,000 during the three months ended March 31, 2009. Net charge-offs as a percentage of average loans increased 7 basis points, from 0.10% for the three month period ended March 31, 2009 to 0.17% for the three month period ended March 31, 2010. Non-accrual loans decreased from $24.4 million to $19.1 million during the quarter ended March 31, 2010. The majority of this decrease relates t o nonaccrual loans being taken into other real estate owned. In addition, the Company has $56.2 million in loans in the coastal North Carolina region which are collateralized by properties that have seen significant declines in value. The Company has evaluated these loans in determining its allowance for loan losses as of March 31, 2010, and has determined that its exposure to loss on these loans is either mitigated by the values of the underlying collateral or addressed by our increased provision. At March 31, 2010, impaired loans, which include non-accrual loans, totaled $31.9 million. Of these loans, $25.6 million have specific loss allowances that aggregate $7.8 million. Loan growth, increased levels of past due loans and nonperforming assets, and further deterioration of the local economy led us to increase our allowance for loan losses to 2.28% of gross loans at March 31, 2010 as compared to 1.48% as of March 31, 2009. Management believes that the allowance is adequate to absorb proba ble losses inherent in the loan portfolio.
Non-Interest Income. Non-interest income decreased $266,000 for the three months ended March 31, 2010 to $1.4 million as compared to $1.7 million for the same period in 2009. The decrease is primarily due to a decrease of $437,000 in gain on sale of investment securities and a $174,000 increase in other service charges, commissions, and fees.
Non-Interest Expenses. Non-interest expenses increased $1.5 million to $7.2 million for the three months ended March 31, 2010 compared to $5.7 million for the three months ended March 31, 2009. The primary increases in non-interest expense for the three months ended March 31, 2010 included increase in the FDIC insurance premium of $359,000, merger expenses related to the acquisition of Nuestro Banco of $600,000, and losses on the sales of other real estate owned and related foreclosure expenses of $451,000. Offsetting these were decreases in legal fees of $111,000 and consulting fees of $67,000. There were no other significant increases in any of the remaining non-interest expenses.
Provision for Income Taxes. The Company's provision for income taxes, as a percentage of income (loss) before income taxes, was 173.24% and 13.21% for the three months ended March 31, 2010 and 2009, respectively. The increase resulted because non-taxable income from investment securities and life insurance caused the taxable loss to exceed the book loss before income taxes, resulting in a larger percentage tax benefit.
Asset Quality
Past due and nonaccrual loans, as extracted from the Call Reports of March 31, 2010 and December 31, 2009, were as follows (in thousands):
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March 31, | Decmber 31, | |||||||
2010 | 2009 | |||||||
Nonaccrual loans: | ||||||||
Commercial and all other loans | $ | 768 | $ | 386 | ||||
Real estate loans | 18,176 | 19,535 | ||||||
Home equity | 94 | 94 | ||||||
Installment loans | 47 | 90 | ||||||
Total nonaccrual loans | $ | 19,085 | $ | 20,105 | ||||
Other real estate owned: | ||||||||
Commercial and all other loans | 1,507 | 1,775 | ||||||
Real estate loans | 10,390 | 8,933 | ||||||
Total other real estate owned | $ | 11,897 | $ | 10,708 | ||||
Total nonperforming assets | $ | 30,982 | $ | 30,813 | ||||
Past due 90 days or more and still accruing: | ||||||||
Commercial and all other loans | $ | 81 | $ | 20 | ||||
Real estate loans | 2,037 | 1,153 | ||||||
Home equity | 43 | - | ||||||
Installment loans | 9 | 10 | ||||||
Credit cards and related plans | 22 | 22 | ||||||
Total past due 90 days and still accruing | $ | 2,192 | $ | 1,205 | ||||
Nonperforming loans to gross loans | 2.64 | % | 2.81 | % | ||||
Nonperforming assets to total assets | 3.19 | % | 3.15 | % | ||||
Allowance coverage of nonperforming loans | 86.46 | % | 77.97 | % |
The following table summarizes performing troubled debt restructurings (“TDRs”), which are all classified as impaired loans for purposes of the loan loss allowance calculation, as of March 31, 2010 and December 31, 2009:
March 31, | Decmber 31, | |||||||
2010 | 2009 | |||||||
Performing TDRs: | ||||||||
Commercial and all other loans | $ | 751 | $ | 705 | ||||
Real estate loans | 11,815 | 8,851 | ||||||
Installment loans | 7 | 28 | ||||||
Total performing TDRs | $ | 12,573 | $ | 9,584 |
Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. The gross interest income that would have been recorded for loans accounted for on a nonaccrual basis at March 31, 2010 was approximately $237,000. This amount represents interest income that would have been recorded if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination, if held for part of the period.
Other real estate owned was $11.9 million and $10.7 million at March 31, 2010 and December 31, 2009, respectively. The amount of interest recognized on impaired loans during the portion of 2010 that the loans were considered impaired was approximately $172,000.
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The following table summarizes the bank’s loan loss experience by quarter (in thousands, except ratios):
March 31, | December 31, | March 31, | ||||||||||
2010 | 2009 | 2009 | ||||||||||
Balance at beginning of period | 15,676 | 16,326 | 9,542 | |||||||||
Charge-offs: | ||||||||||||
Commercial and other | 130 | 999 | 123 | |||||||||
Real estate | 942 | 4,575 | 525 | |||||||||
Installment loans to individuals | 190 | 22 | 88 | |||||||||
Credit cards and related plans | 53 | 89 | 50 | |||||||||
Net charge offs | 1,315 | 5,685 | 788 | |||||||||
Recoveries: | ||||||||||||
Commercial and other | 1 | 3 | 26 | |||||||||
Real estate | 3 | 31 | 2 | |||||||||
Installment loans | 74 | 1 | 14 | |||||||||
Credit cards and related plans | - | 26 | 12 | |||||||||
Net recoveries | 78 | 61 | 54 | |||||||||
Net charge-offs | 1,237 | 5,624 | 734 | |||||||||
Additions charged to operations | 2,061 | 4,974 | 1,642 | |||||||||
Balance at end of year | $ | 16,500 | $ | 15,676 | $ | 10,450 | ||||||
Ratio of net charge-offs during the quarter to average gross | ||||||||||||
loans outstanding during the year | 0.17 | % | 0.79 | % | 0.10 | % |
Loan Portfolio Concentration. The following table presents an analysis of the Company’s loan portfolio by collateral type as of March 31, 2010 (unaudited).
March 31, 2010 | ||||||||||||||||||||
Nonaccrual | ||||||||||||||||||||
Loans to | Allowance | ALLL to | ||||||||||||||||||
Loans | Nonaccrual | Loans | for Loan | Loans | ||||||||||||||||
Outstanding | Loans | Outstanding | Losses | Outstanding | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||
Residential ADC | 125,418 | 11,194 | 1.55 | % | 2,670 | 0.37 | % | |||||||||||||
Farmland | 31,816 | 83 | 0.01 | % | 677 | 0.09 | % | |||||||||||||
Other construction and development | 101,249 | 1,676 | 0.23 | % | 2,156 | 0.30 | % | |||||||||||||
Commercial non-owner occupied | 90,645 | 986 | 0.14 | % | 1,930 | 0.27 | % | |||||||||||||
Total commercial real estate | 349,128 | 13,939 | 1.93 | % | 7,433 | 1.03 | % | |||||||||||||
Commercial owner occupied | 94,339 | 2,147 | 0.30 | % | 2,009 | 0.28 | % | |||||||||||||
Commercial: | ||||||||||||||||||||
Commercial and industrial | 54,189 | 662 | 0.09 | % | 1,432 | 0.20 | % | |||||||||||||
Municipal | 7,127 | - | 0.00 | % | 188 | 0.03 | % | |||||||||||||
Agriculture | 2,255 | 107 | 0.01 | % | 60 | 0.01 | % | |||||||||||||
Other | 3,473 | - | 0.00 | % | 92 | 0.01 | % | |||||||||||||
Total commercial | 67,044 | 769 | 0.11 | % | 1,772 | 0.25 | % | |||||||||||||
Residential mortgage: | ||||||||||||||||||||
First lien, closed-end | 151,377 | 1,918 | 0.27 | % | 3,647 | 0.50 | % | |||||||||||||
Junior lien, closed-end | 6,321 | 171 | 0.02 | % | 152 | 0.02 | % | |||||||||||||
Total residential mortgage | 157,698 | 2,089 | 0.29 | % | 3,799 | 0.53 | % | |||||||||||||
Home equity lines | 39,206 | 94 | 0.01 | % | 945 | 0.13 | % | |||||||||||||
Consumer – other | 15,440 | 47 | 0.01 | % | 542 | 0.07 | % | |||||||||||||
Less: Net deferred loan fees | (387 | ) | - | - | ||||||||||||||||
Total loans | $ | 722,468 | $ | 19,085 | 2.64 | % | 16,500 | 2.28 | % |
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Given 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 (“ADC”) properties. As of March 31, 2010, approximately 88.6% 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. 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. The following tables present an an alysis of the Company’s commercial real estate portfolio, excluding commercial loans secured by commercial owner occupied properties, as of March 31, 2010:
Residential ADC Portfolio Analysis by Type
As of March, 2010 | ||||||||||||
Residential Land/ Development | Residental Construction | Total | ||||||||||
(Dollars in thousands) | ||||||||||||
Loans outstanding | $ | 74,831 | $ | 50,587 | $ | 125,418 | ||||||
Loans outstanding to gross loans | 10.35 | % | 7.00 | % | 15.80 | % | ||||||
Nonaccrual loans | $ | 7,014 | $ | 4,180 | $ | 11,194 | ||||||
Nonaccrual loans to loans in category | 0.97 | % | 0.58 | % | 1.55 | % | ||||||
Allowance for loan losses | $ | 1,593 | $ | 1,077 | $ | 2,670 | ||||||
Allowance for loan losses in category | 2.14 | % | 2.12 | % | 2.13 | % |
Residential ADC Portfolio Analysis by Type
As of March, 2010 | ||||||||||||||||||||||||
Loans Outstanding | Percentage of Total Loans Outstanding | Nonaccrual Loans | Nonaccrual Loans to Loans Outstanding | Allowance for Loan Losses | ALLL to Loans Outstanding | |||||||||||||||||||
�� | ||||||||||||||||||||||||
Triangle | $ | 51,866 | 7.18 | % | $ | 6,132 | 4.89 | % | $ | 1,104 | 0.88 | % | ||||||||||||
Coastal | 41,423 | 5.73 | % | 4,672 | 3.73 | % | 882 | 0.70 | % | |||||||||||||||
Eastern | 22,070 | 3.05 | % | 390 | 0.31 | % | 470 | 0.37 | % | |||||||||||||||
Sandhills | 9,919 | 1.37 | % | - | 0.00 | % | 211 | 0.17 | % | |||||||||||||||
Other | 140 | 0.02 | % | - | 0.00 | % | 3 | 0.00 | % | |||||||||||||||
Total | $ | 125,418 | 17.35 | % | $ | 11,194 | 8.93 | % | $ | 2,670 | 2.13 | % |
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Other Commercial Real Estate Portfolio Analysis by Type
As of March, 2010 | ||||||||||||||||||||
Commercial Land/ Development | Commercial Construction | Multifamily | Commercial Real Estate Secured | Total | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Loans outstanding | $ | 67,013 | $ | 14,748 | $ | 5,109 | $ | 105,024 | $ | 191,894 | ||||||||||
Loans outstanding to gross loans | 9.27 | % | 2.04 | % | 0.71 | % | 14.53 | % | 26.55 | % | ||||||||||
Nonaccrual loans | $ | 1,600 | $ | - | $ | 462 | $ | 600 | $ | 2,662 | ||||||||||
Nonaccrual loans to loans in category | 0.83 | % | 0.00 | % | 0.24 | % | 0.31 | % | 1.39 | % | ||||||||||
Allowance for loan losses | $ | 1,451 | $ | 319 | $ | 43 | $ | 2,273 | $ | 4,086 | ||||||||||
Allowance for loan losses in category | 2.16 | % | 2.16 | % | 0.84 | % | 2.16 | % | 2.13 | % |
Other Commercial Real Estate Portfolio Analysis by Region
As of March, 2010 | ||||||||||||||||||||||||
Loans Outstanding | Percentage of Total Loans Outstanding | Nonaccrual Loans | Nonaccrual Loans to Loans Outstanding | Allowance for Loan Losses | ALLL to Loans Outstanding | |||||||||||||||||||
Triangle | $ | 137,453 | 19.02 | % | $ | 1,904 | 0.99 | % | $ | 2,927 | 1.53 | % | ||||||||||||
Sandhills | 26,868 | 3.72 | % | - | 0.00 | % | 572 | 0.30 | % | |||||||||||||||
Other | 17,442 | 2.41 | % | 462 | 0.24 | % | 371 | 0.19 | % | |||||||||||||||
Eastern | 6,008 | 0.83 | % | 296 | 0.15 | % | 128 | 0.07 | % | |||||||||||||||
Coastal | 4,123 | 0.57 | % | - | 0.00 | % | 88 | 0.05 | % | |||||||||||||||
Total | $ | 191,894 | 26.55 | % | $ | 2,662 | 1.39 | % | $ | 4,086 | 2.13 | % |
The Company utilizes interest reserves on certain commercial real estate loans to fund the interest payments which are funded from loan proceeds. The decision to establish a loan-funded interest reserve upon origination of a loan is based on the feasibility of the project, the creditworthiness of the borrower and guarantors and the protection provided by the real estate and other collateral. For the lender, an interest reserve may provide an effective means for addressing the cash flow characteristics of a properly underwritten ADC loan. Similarly, for the borrower, interest reserves may provide the funds to service the debt until the property is developed, and cash flow is generated from the sale or lease of the developed property.
Although potentially beneficial to the lender and the borrower, the use of interest reserves carries certain risks. Of particular concern is the possibility that an interest reserve may not accurately reflect problems with a borrower’s willingness or ability to repay the debt consistent with the terms and conditions of the loan obligation. For example, a project that is not completed in a timely manner or falters once completed may appear to perform if the interest reserve keeps the loan current. In some cases, a lender may extend, renew, or restructure the term of certain loans, providing additional interest reserves to keep the loan current. As a result, the financial condition of the project may not be apparent and developing problems may not be addressed in a timely manner. Consequently, a lender may end up with a matured loa n where the interest reserve has been fully advanced, and the borrower’s financial condition has deteriorated. In addition, the project may not be complete, its sale or lease-up may not be sufficient to ensure timely repayment of the debt or the value of the collateral may have declined, exposing the lender to increasing credit losses. At March 31, 2010, the Company had $20.5 million of loans with interest reserves.
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Liquidity and Capital Resources
The Company’s liquidity position is primarily dependent upon the Bank’s need to respond to loan demand, the short-term demand for funds caused by withdrawals from deposit accounts (other than time deposits) and the liquidity of its assets. The Bank’s primary liquidity sources include cash and amounts due from other banks, federal funds sold, and U.S. Government agency and other marketable investment securities. The Bank also has the ability to borrow funds from the Federal Reserve Bank and the Federal Home Loan Bank of Atlanta (“FHLB”) and to purchase federal funds from other financial institutions. 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 y ears 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. Management believes that the Bank’s liquidity sources are adequate to meet its operating needs and the operating needs of the Bank for the next eighteen months. Total shareholders’ equity was $66.6 million or 6.9% of total assets at March 31, 2010 and $65.9 million or 6.7% of total assets at December 31, 2009. Additionally, we have available lines of credit from various correspondent banks to purchase federal funds on a short-term basis of approximately $17.0 million. As of March 31, 2010, the Bank has the credit capacity to borrow up to $194.1 million, from the FHLB, with $112.5 million outstandin g as of March 31, 2010 and December 31, 2010.
The Bank remained well capitalized with total risk based capital of 13.20%, tier 1 risk based capital of 10.26%, and leverage ratio of 7.69% at March 31, 2010, as compared to 10.82%, 9.56%, and 7.33%, respectively, at March 31, 2009. The minimum levels to be considered “well capitalized’ for each of these ratios are 10%, 6%, and 5%, respectively, but in the current banking climate, management believes higher capital levels are prudent for safe and sound bank management. Therefore our capital plan establishes our goal to maintain minimum ratios of 12%, 8%, and 7%, respectively, throughout this difficult banking cycle. We maintained our quarterly dividend payments in the first quarter of 2010, although at a reduced level. While maintaining our dividend payments is desirable, capital preservati on is our highest priority in the near future. In order to preserve capital, we decreased the level of dividends paid to our shareholders from the $0.085 per share that was paid in the first quarter of 2009 to $0.01 per share paid in the first quarter of 2010, a decrease of 88.2%. Book value per share at March 31, 2010 and 2009 was $8.92 and $9.65, respectively. Tangible book value per share at March 31, 2010 was $8.87 as compared to $8.71 at March 31, 2009.
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, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which statements represent the Company’s judgment concerning the future and are subject to risks and uncertainties that could cause its 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.
The Company cautions that any such forward-looking statements are further qualified by important factors that could cause its actual operating results to differ materially from those anticipated in the forward-looking statements, including, without limitation, 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, the failure of assumptions underlying the establishment of the allowance for loan losses, the low trading volume of the Company’s common stock, other considerations described in connection with specific forward-looking statements and other cautionary elements specified in the Company’s periodic filings with the Securities and Exchange Commission (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.
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
Not applicable.
ITEM 4T – 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 Commission’s 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 are effective, in that they provide reasonable assurances that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods req uired by the Commission’s rules and forms.
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) during the period covered by this Quarterly Report that the Company believes have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.
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Other than as set forth below, 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, 2009.
Our real estate and land acquisition and development loans are based upon estimates of costs and the value of the complete project.
We extend real estate land loans, construction loans, and acquisition and development loans to builders and developers, primarily for the construction/development of properties. We originate these loans on a presold and speculative basis and they include loans for both residential and commercial purposes. At March 31, 2010, our loan portfolio was comprised of $226.7 million of real estate and land acquisition and development loans, or 31.4% of total loans.
In general, construction and land lending involves additional risks because of the inherent difficulty in estimating a property’s value both before and at completion of the project. Construction costs may exceed original estimates as a result of increased materials, labor, or other costs. In addition, because of current uncertainties in the residential and commercial real estate markets, property values have become more difficult to determine than they have been historically. Construction and land acquisition and development loans often involve the repayment dependent, in part, on the ability of the borrower to sell or lease the property. These loans also require ongoing monitoring. In addition, speculative construction loans to a residential builder are often associated with homes that are not presold, and thus pose a greater po tential risk than construction loans to individuals on their personal residences. At March 31, 2010, $33.9 million of our residential construction loans were for speculative construction loans. Slowing housing sales have been a contributing factor to an increase in non-performing loans as well as an increase in delinquencies. Residential construction loans and commercial construction loans represented 53.9% and 7.5%, respectively, of our non-performing assets at March 31, 2010.
Our non-owner occupied commercial real estate loans may be dependent on factors outside the control of our borrowers.
We originate non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. This may be adversely affected by changes in the economy or local market conditions. Non-owner occupied commercial real estate loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. If we foreclose on a non-owner occupied commercial real estate loan, our holding period for the collateral typically is longer than a 1-4 family residenti al property because there are fewer potential purchasers of the collateral. Additionally, non-owner occupied commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on non-owner occupied commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
As of March 31, 2010, our non-owner occupied commercial real estate loans totaled $90.6 million, or 12.6% of our total loan portfolio.
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A portion of our commercial real estate loan portfolio utilizes interest reserves which may not accurately portray the financial condition of the project and the borrower’s ability to repay the loan.
Some of our commercial real estate loans utilize interest reserves to fund the interest payments and are funded from loan proceeds. Our decision to establish a loan-funded interest reserve upon origination of a loan is based on the feasibility of the project, the creditworthiness of the borrower and guarantors and the protection provided by the real estate and other collateral. When applied appropriately, an interest reserve can benefit both the lender and the borrower. For the lender, an interest reserve provides an effective means for addressing the cash flow characteristics of a properly underwritten ADC loan. Similarly, for the borrower, interest reserves provide the funds to service the debt until the property is developed, and cash flow is generated from the sale or lease of the developed property.
Although potentially beneficial to the lender and the borrower, our use of interest reserves carries certain risks. Of particular concern is the possibility that an interest reserve may not accurately reflect problems with a borrower’s willingness or ability to repay the debt consistent with the terms and conditions of the loan obligation. For example, a project that is not completed in a timely manner or falters once completed may appear to perform if the interest reserve keeps the loan current.
In some cases, we may extend, renew, or restructure the term of certain loans, providing additional interest reserves to keep the loan current. As a result, the financial condition of the project may not be apparent and developing problems may not be addressed in a timely manner. Consequently, we may end up with a matured loan where the interest reserve has been fully advanced, and the borrower’s financial condition has deteriorated. In addition, the project may not be complete, its sale or lease-up may not be sufficient to ensure timely repayment of the debt or the value of the collateral may have declined, exposing us to increasing credit losses. As of March 31, 2010, our commercial real estate loans with interest reserves totaled $17.5 million or 2.4% of our total loan portfolio.
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The following exhibits are filed as part of this Quarterly Report on Form 10-Q.
Exhibit No. Description
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 |
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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 17, 2010 | By: | /s/ Ayden R. Lee, Jr. |
Ayden R. Lee, Jr. | ||
Chairman, President and | ||
Chief Executive Officer | ||
Date: May 17, 2010 | By: | /s/ Nancy S. Wise |
Nancy S. Wise | ||
Executive Vice President and | ||
Chief Financial Officer |
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Exhibit Index
Exhibit No. Description
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 |