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 June 30, 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, | 7,501,408 | |
par value $1.00 per share | (Number of shares outstanding | |
(Title of Class) | as of August 12, 2010) |
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FOUR OAKS FINCORP, INC.
June 30, 2010 | December 31, | |||||||
(Unaudited) | 2009(*) | |||||||
ASSETS | (Amounts in thousands, except share data) | |||||||
Cash and due from banks | $ | 13,596 | $ | 13,512 | ||||
Interest-earning deposits | 57,736 | 65,602 | ||||||
Federal funds sold | - | 5,048 | ||||||
Investment securities available for sale, at fair value | 114,573 | 125,760 | ||||||
Loans | 710,626 | 715,133 | ||||||
Allowance for loan losses | (17,290 | ) | (15,676 | ) | ||||
Net loans | 693,336 | 699,457 | ||||||
Accrued interest receivable | 3,591 | 3,600 | ||||||
Bank premises and equipment, net | 17,023 | 17,620 | ||||||
FHLB stock | 6,802 | 6,802 | ||||||
Investment in life insurance | 11,310 | 11,068 | ||||||
Other real estate owned | 13,333 | 10,708 | ||||||
Other assets | 15,333 | 17,574 | ||||||
Total assets | $ | 946,633 | $ | 976,751 | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
Deposits: | ||||||||
Noninterest-bearing demand | $ | 88,523 | $ | 90,668 | ||||
Money market, NOW accounts and savings accounts | 150,342 | 176,867 | ||||||
Time deposits, $100,000 and over | 321,153 | 305,667 | ||||||
Other time deposits | 177,443 | 192,820 | ||||||
Total deposits | 737,461 | 766,022 | ||||||
Borrowings | 112,407 | 112,543 | ||||||
Subordinated debentures | 12,372 | 12,372 | ||||||
Subordinated notes | 12,000 | 12,000 | ||||||
Accrued interest payable | 1,856 | 2,283 | ||||||
Other liabilities | 3,347 | 5,677 | ||||||
Total liabilities | 879,443 | 910,897 | ||||||
Shareholders’ equity: | ||||||||
Common stock; $1.00 par value, 20,000,000 shares | ||||||||
authorized; 7,501,408 and 7,440,268 shares issued and | ||||||||
outstanding at June 30, 2010 and December 31, 2009, | ||||||||
respectively | 7,501 | 7,440 | ||||||
Additional paid-in capital | 33,660 | 33,346 | ||||||
Retained earnings | 24,858 | 24,625 | ||||||
Accumulated other comprehensive income | 1,171 | 443 | ||||||
Total shareholders' equity | 67,190 | 65,854 | ||||||
Total liabilities and shareholders' equity | $ | 946,633 | $ | 976,751 | ||||
(*) Derived from audited consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
-3-
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(Amounts in thousands, except per share data) | ||||||||||||||||
Interest and dividend income: | ||||||||||||||||
Loans, including fees | $ | 10,590 | $ | 10,169 | $ | 21,083 | 19,922 | |||||||||
Investment securities: | ||||||||||||||||
Taxable | 778 | 859 | 1,486 | 2,289 | ||||||||||||
Tax-exempt | 374 | 776 | 739 | 1,389 | ||||||||||||
Dividends | 144 | 131 | 201 | 199 | ||||||||||||
Interest-earning deposits and Federal funds sold | 31 | 3 | 60 | 9 | ||||||||||||
Total interest and dividend income | 11,917 | 11,938 | 23,569 | 23,808 | ||||||||||||
Interest expense: | ||||||||||||||||
Deposits | 2,542 | 3,416 | 5,152 | 7,452 | ||||||||||||
Borrowings | 1,018 | 1,052 | 2,025 | 2,061 | ||||||||||||
Subordinated debentures | 51 | 80 | 101 | 180 | ||||||||||||
Subordinated notes | 258 | 60 | 513 | 60 | ||||||||||||
Total interest expense | 3,869 | 4,608 | 7,791 | 9,753 | ||||||||||||
Net interest income | 8,048 | 7,330 | 15,778 | 14,055 | ||||||||||||
Provision for loan losses | 3,075 | 4,372 | 5,136 | 6,014 | ||||||||||||
Net interest income after provision for loan losses | 4,973 | 2,958 | 10,642 | 8,041 | ||||||||||||
Non-interest income: | ||||||||||||||||
Service charges on deposit accounts | 503 | 561 | 1,008 | 1,111 | ||||||||||||
Other service charges, commissions and fees | 531 | 395 | 1,036 | 750 | ||||||||||||
Gain on sale of investment securities | 1,132 | 695 | 1,387 | 1,386 | ||||||||||||
Impairment loss on investment securities available for sale | - | (27 | ) | (125 | ) | (27 | ) | |||||||||
Impairment loss on non-marketable investments | - | - | - | (154 | ) | |||||||||||
Gain on sale of loans | 13 | 18 | 13 | 18 | ||||||||||||
Merchant fees | 154 | 127 | 275 | 232 | ||||||||||||
Income from investment in bank-owned life insurance | 121 | 126 | 242 | 252 | ||||||||||||
Total non-interest income | 2,454 | 1,895 | 3,836 | 3,568 | ||||||||||||
Non-interest expenses: | ||||||||||||||||
Salaries | 2,663 | 2,570 | 5,433 | 5,097 | ||||||||||||
Employee benefits | 495 | 401 | 1,023 | 1,020 | ||||||||||||
Occupancy expense | 327 | 271 | 660 | 543 | ||||||||||||
Equipment expense | 409 | 434 | 818 | 823 | ||||||||||||
Professional and consulting fees | 658 | 706 | 1,496 | 1,260 | ||||||||||||
FDIC assessment | 658 | 581 | 1,156 | 720 | ||||||||||||
Other taxes and licenses | 80 | 126 | 161 | 212 | ||||||||||||
Merchant processing expense | 132 | 105 | 231 | 193 | ||||||||||||
Other real estate owned, net | 691 | 63 | 1,143 | 179 | ||||||||||||
Collection expenses | 229 | 90 | 373 | 148 | ||||||||||||
Other | 933 | 949 | 1,959 | 1,812 | ||||||||||||
Total non-interest expenses | 7,275 | 6,296 | 14,453 | 12,007 | ||||||||||||
Income (loss) before income taxes | 152 | (1,443 | ) | 25 | (398 | ) | ||||||||||
Provision (benefit) for income taxes | (137 | ) | (738 | ) | (357 | ) | (600 | ) | ||||||||
Net income (loss) | $ | 289 | $ | (705 | ) | $ | 382 | 202 | ||||||||
Basic net income (loss) per common share | $ | 0.04 | $ | (0.10 | ) | $ | 0.05 | $ | 0.03 | |||||||
Diluted net income (loss) per common share | $ | 0.04 | $ | (0.10 | ) | $ | 0.05 | $ | 0.03 |
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(Amounts in thousands) | ||||||||||||||||
Net income (loss) | $ | 289 | $ | (705 | ) | $ | 382 | $ | 202 | |||||||
Other comprehensive income (loss): | ||||||||||||||||
Securities available for sale: | ||||||||||||||||
Unrealized holding gains on available | ||||||||||||||||
for sale securities | 1,397 | 134 | 2,474 | 663 | ||||||||||||
Tax effect | (542 | ) | (45 | ) | (971 | ) | (247 | ) | ||||||||
Reclassification of net gains recognized in net income | (1,132 | ) | (695 | ) | (1,387 | ) | (1,386 | ) | ||||||||
Tax effect | 436 | 268 | 535 | 534 | ||||||||||||
Reclassification of impairment loss recognized in net income | - | 27 | 125 | 27 | ||||||||||||
Tax effect | - | (10 | ) | (48 | ) | (10 | ) | |||||||||
Total other comprehensive income (loss) | 159 | (321 | ) | 728 | (419 | ) | ||||||||||
Comprehensive income (loss) | $ | 448 | $ | (1,026 | ) | $ | 1,110 | $ | (217 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
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 | - | - | - | 382 | - | 382 | ||||||||||||||||||
Other comprehensive income | - | - | - | - | 728 | 728 | ||||||||||||||||||
Issuance of common stock | 61,140 | 61 | 255 | - | - | 316 | ||||||||||||||||||
Stock based compensation | - | - | 59 | - | - | 59 | ||||||||||||||||||
Cash dividends of $ .02 per share | - | - | - | (149 | ) | - | (149 | ) | ||||||||||||||||
BALANCE AT JUNE 30, 2010 | 7,501,408 | $ | 7,501 | $ | 33,660 | $ | 24,858 | $ | 1,171 | $ | 67,190 |
The accompanying notes are an integral part of the consolidated financial statements.
-6-
Six Months Ended | ||||||||
June 30, | ||||||||
2010 | 2009 | |||||||
(Amounts in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 382 | $ | 202 | ||||
Adjustments to reconcile net income to net cash | ||||||||
provided by operating activities: | ||||||||
Provision for loan losses | 5,136 | 6,014 | ||||||
Depreciation and amortization | 652 | 555 | ||||||
Net amortization of bond premiums and discounts | 515 | 45 | ||||||
Stock based compensation | 59 | 39 | ||||||
Gain on sale of investment securities | (1,387 | ) | (1,386 | ) | ||||
Gain on sale of loans | (13 | ) | (18 | ) | ||||
Loss on disposition of premises and equipment | 91 | - | ||||||
Net loss on other real estate owned | 179 | 61 | ||||||
Valuation adjustment on other real estate owned | 964 | 112 | ||||||
Income from investment in life insurance | (242 | ) | (252 | ) | ||||
Impairment loss on investment securities available for sale | 125 | 27 | ||||||
Impairment loss on non-marketable investments | - | 154 | ||||||
Changes in assets and liabilities: | ||||||||
Other assets | 1,757 | (1,230 | ) | |||||
Interest receivable | 9 | 426 | ||||||
Other liabilities | (2,330 | ) | (1,997 | ) | ||||
Interest payable | (427 | ) | (222 | ) | ||||
Net cash provided by operating activities | 5,470 | 2,530 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from sales and calls of investment securities available for sale | 46,322 | 138,547 | ||||||
Purchases of investment securities available for sale | (33,176 | ) | (117,718 | ) | ||||
Purchase of FHLB stock | - | (243 | ) | |||||
Proceeds from redemptions of Federal Funds sold | 5,048 | - | ||||||
Net increase in loans | (6,609 | ) | (43,113 | ) | ||||
Purchase of bank premises and equipment | (146 | ) | (476 | ) | ||||
Proceeds from sales of other real estate owned | 3,913 | 744 | ||||||
Net expenditures on other real estate owned | (74 | ) | - | |||||
Net cash provided (used) by investing activities | 15,278 | (22,259 | ) | |||||
Cash flow from financing activities: | ||||||||
Net repayments from borrowings | (136 | ) | (1,635 | ) | ||||
Net increase (decrease) in deposit accounts | (28,561 | ) | 15,628 | |||||
Proceeds from issuance of common stock | 316 | 739 | ||||||
Issuance of subordinated promissory notes | - | 7,800 | ||||||
Cash dividends paid | (149 | ) | (1,182 | ) | ||||
Net cash provided (used) by financing activities | (28,530 | ) | 21,350 | |||||
Net increase (decrease) in cash and cash equivalents | (7,782 | ) | 1,621 | |||||
Cash and cash equivalents at beginning of period | 79,114 | 28,875 | ||||||
Cash and cash equivalents at end of the period | $ | 71,332 | $ | 30,496 | ||||
Schedule of noncash investing and financing activities: | ||||||||
Transfers of loans to other real estate owned | $ | 7,607 | $ | 3,895 |
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
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 and six month periods ended June 30, 2010 and 2009, 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 subsidiaries, Four Oaks Bank & Trust Company and Four Oaks Mortgage Services, LLC, the Company’s mortgage origination subsidiary. All signi ficant intercompany transactions have been eliminated. Operating results for the three and six month periods ended June 30, 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 (LOSS) PER SHARE
Basic earnings (loss) per share represents income (loss) available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options.
Basic and diluted net income (loss) per common share have been computed based upon net income (loss) 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 | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Weighted average number of common shares | ||||||||||||||||
used in computing basic net income (loss) per common share | 7,487,615 | 6,998,994 | 7,465,635 | 6,965,927 | ||||||||||||
Effect of dilutive stock options | - | - | - | - | ||||||||||||
Weighted average number of common shares and | ||||||||||||||||
dilutive potential common shares used in | ||||||||||||||||
computing diluted net income (loss) per common share | 7,487,615 | 6,998,994 | 7,465,635 | 6,965,927 |
-8-
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 do not have a dilutive effect and are considered antidilutive. As of June 30, 2010 and 2009, there were 335,134 and 311,403 antidilutive stock options outstanding, respectively, which represented all of the options outstanding for both periods.
NOTE 3 - COMMITMENTS
At June 30, 2010, loan commitments were as follows (in thousands):
Undisbursed lines of credit | $ | 65,747 | ||
Commitments to extend credit | 33,790 | |||
Performance stand-by letters of credit | 2,007 | |||
Financial stand-by letters of credit | 287 |
NOTE 4 – INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available for sale as of June 30, 2010 and December 31, 2009 are as follows:
June 30, 2010 | ||||||||||||||||
Amortized | Gross unrealized | Gross unrealized | Fair | |||||||||||||
cost | gains | losses | value | |||||||||||||
(Amounts in thousands) | ||||||||||||||||
State and municipal securities | $ | 37,384 | $ | 433 | $ | 42 | $ | 37,775 | ||||||||
Taxable municipal securities | 17,633 | 393 | 29 | 17,997 | ||||||||||||
Mortgage-backed securities | 54,083 | 1,633 | 31 | 55,685 | ||||||||||||
Equity securities | 3,534 | 58 | 476 | 3,116 | ||||||||||||
$ | 112,634 | $ | 2,517 | $ | 578 | $ | 114,573 | |||||||||
December 31, 2009 | ||||||||||||||||
Amortized | Gross unrealized | Gross 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 |
-9-
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 June 30, 2010 and December 31, 2009. As of June 30, 2010, the unrealized losses relate to three mortgage-backed securities, six tax exempt municipal securities, four taxable municipal securities, and 13 equity securities. Eleven 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 fair value of this investment was $121,000 at June 30, 2010, with an unrealized loss of $4,000.
The unrealized losses on debt 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.
June 30, 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 | $ | 3,703 | $ | 42 | $ | - | $ | - | $ | 3,703 | $ | 42 | ||||||||||||
Taxable municipal securities | 2,447 | 29 | - | - | 2,447 | 29 | ||||||||||||||||||
Mortgage-backed securities | 4,189 | 31 | - | - | 4,189 | 31 | ||||||||||||||||||
Equity securities | 1,466 | 409 | 59 | 67 | 1,525 | 476 | ||||||||||||||||||
Total temporarily impaired securities | $ | 11,805 | $ | 511 | $ | 59 | $ | 67 | $ | 11,864 | $ | 578 |
-10-
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 June 30, 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 | $ | 226 | $ | 230 | ||||
Due after one year through five years | 70 | 74 | ||||||
Due after five years through ten years | 14,356 | 14,490 | ||||||
Due after ten years | 94,448 | 96,663 | ||||||
Total debt securities | 109,100 | 111,457 | ||||||
Equity securities | 3,534 | 3,116 | ||||||
$ | 112,634 | $ | 114,573 |
Securities with a carrying value of approximately $68.1 million and $100.9 million at June 30, 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 $46.3 million and $138.5 million for the six months ended June 30, 2010 and 2009, respectively. These transactions generated gross realized gains of $1.4 million, for each of the six month periods ending June 30, 2010 and 2009.
-11-
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:
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
(Amounts in thousands) | ||||||||
Commercial real estate: | ||||||||
Construction and land development | $ | 214,024 | $ | 233,012 | ||||
Farmland | 30,377 | 19,577 | ||||||
Multi-family | 20,095 | 18,106 | ||||||
Commercial non-owner occupied | 94,877 | 85,216 | ||||||
Commerical owner occupied real estate | 101,679 | 99,533 | ||||||
Total commercial real estate loans | 461,052 | 455,444 | ||||||
Commerical | 66,678 | 66,976 | ||||||
Residential mortgage | 129,635 | 134,869 | ||||||
Home equity | 39,651 | 40,401 | ||||||
Consumer - other | 14,026 | 17,854 | ||||||
Total other loans | 249,990 | 260,100 | ||||||
Less: Net deferred loan fees | (416 | ) | (411 | ) | ||||
Total Loans | $ | 710,626 | $ | 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 $38.0 million and $30.2 million at June 30, 2010 and December 31, 2009, respectively. This amount consisted of both accrual and nonaccrual loans. Impaired loans of $26.5 million and $22.7 million had related allowances for loan losses of $8.9 and $6.4 million at June 30, 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 and six months ended June 30, 2010. Management will continue to monitor the estimated cash flows related to these impaired loans on an ongoing basis.
-12-
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 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. As of June 30, 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 June 30, 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 June 30, 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. Securitie s classified as Level 3 include certain equity investments and 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.
Below is a table that presents information about assets measured at fair value on a recurring basis at June 30, 2010 and December 31, 2009:
Fair Value Measurements at June 30, 2010 Using | ||||||||||||||||||||
Total Carrying Amount in the Consolidated Balance Sheet | Assets Measured at Fair Value | Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||||
Description | 6/30/2010 | 6/30/2010 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Tax exempt securites | $ | 37,775 | $ | 37,775 | $ | - | $ | 37,775 | $ | - | ||||||||||
Taxable municipal securities | 17,996 | 17,996 | - | 17,996 | - | |||||||||||||||
Agency mortgage-backed securities | 55,686 | 55,686 | - | 55,686 | - | |||||||||||||||
Equity securities | 3,116 | 3,116 | 1,649 | 121 | 1,346 | |||||||||||||||
Total available for sale securities | $ | 114,573 | $ | 114,573 | $ | 1,649 | $ | 111,578 | $ | 1,346 |
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
NOTE 6 – FAIR VALUE MEASUREMENT (Continued)
Fair Value Measurements at December 31, 2009 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 | 12/31/2009 | 12/31/2009 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Tax exempt securites | $ | 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 June 30, 2010 for all Level 3 assets that are measured at fair value on a recurring basis. During this period, $14.3 million of agency mortgage-backed securities were transferred from Level 3 to Level 2 resulting from enhanced measurement capabilities.
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 | (298 | ) | ||
Purchases, issuances and settlements | - | |||
Transfers out of Level 3 | (14,307 | ) | ||
Ending Balance June 30, 2010 | $ | 1,346 |
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 cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 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 $38.0 million at June 30, 2010. Of such loans, $26.5 million had specific loss allowances aggregating $8.9 million at that date for a net fair value of $17.6 million. Of those specific allowances, all were determined using Level 3 inputs.
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FOUR OAKS FINCORP, INC.
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 June 30, 2010, there were no fair value adjustments related to intangible assets of $381,000. The goodwill of $6.1 million was considered completely impaired at December 31, 2009.
Other Real Estate Owned
Other real estate owned is 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. T hrough the six month period ended June 30, 2010, the Company recognized approximately $1.0 million in valuation reductions on other real estate owned resulting in the adjustment of the fair value of other real estate owned to $13.3 million at June 30, 2010. As of and for the year ended December 31, 2009, there was no valuation adjustment on other real estate owned required and therefore no adjustment was required to be made to the fair value of other real estate owned of $10.7 million as of that date.
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. However, the values derived likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts of approximately 1% were subtracted to reflect the illiquid and distressed conditions at June 30, 2010 and December 31, 200 9. 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. In order to estimate fair value at December 31, 2009, we used the weighted average rate of actual borrowings as the reinvestment rate. Given that many of the convertible borrowings were approaching their first option date at June 30, 2010, we changed our benchmark to the rate for structured convertible Bermudan borrowings, causing a change in the fair values, as compared to December 31, 2009.
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 June 30, 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)
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying amount | Estimated fair value | Carrying amount | Estimated fair value | |||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 71,332 | $ | 71,332 | $ | 79,862 | $ | 79,862 | ||||||||
Securities available for sale | 114,573 | 114,573 | 125,760 | 125,760 | ||||||||||||
Loans, net | 693,336 | 689,812 | 699,457 | 695,094 | ||||||||||||
FHLB stock | 6,802 | 6,802 | 6,802 | 6,802 | ||||||||||||
Investment in life insurance | 11,310 | 11,310 | 11,068 | 11,068 | ||||||||||||
Accrued interest receivable | 3,591 | 3,591 | 3,600 | 3,600 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Deposits | $ | 737,461 | $ | 731,694 | $ | 766,022 | $ | 755,890 | ||||||||
Subordinated debentures | 24,372 | 24,363 | 24,372 | 18,161 | ||||||||||||
Borrowings | 112,407 | 138,805 | 112,543 | 115,106 | ||||||||||||
Accrued interest payable | 1,856 | 1,856 | 2,283 | 2,283 |
NOTE 8 – OTHER RECENT ACCOUNTING PRONOUNCEMENTS
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 variable interest entities (“VIEs”)). The adoption on January 1, 2010, did not have a material impact on the Company's consolidated financial statements.
In December 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-16 “Accounting for Transfers of Financial Assets” to amend ASC Topic 860, “Transfers and Servicing,” (“ASC 860”) for the issuance of Statement of Financial Accounting Standards (“SFAS”) No. 166 “Accounting for Transfers of Financial Assets – an amendment of the FASB Statement No. 140.” The amendments in this update eliminate the concept of a qualifying special purpose entity (“QSPE”), change the requirements for derecognizing financial assets, and require 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 fi scal 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 Company's consolidated financial statements.
In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements,” (“ASU 2010-06”) to amend ASC 820. ASU 2010-06 requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in ASC 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 ASC Subtopic 820-10 to now require a reporting entity to 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 to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measure ments using significant unobservable inputs. For the six months ended June 30, 2010, there were no transfers in or out of Level 1 and Level 2.
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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.
In April 2010, the FASB issued ASU No. 2010-18, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset,” (“ASU 2010-18”) to amend ASC Topic 320, “Receivables.” The amendments in ASU 2010-18 provide that for acquired troubled loans which meet the criteria to be accounted for within a pool, modifications to one or more of these loans does not result in the removal of the modified loan from the pool even if the modification would otherwise be considered a troubled debt restructuring. The pool of assets in which the loan is included will continue to be considered for impairment. The amendments do not apply to loans not meeting the criteria to be accounted for within a pool. These amendments are effective for modifications of loans accounted for within pools occurring in the first interim or annual period ending on or after July 15, 2010. The adoption is not expected to have a material effect on the Company's financial condition and results of operations.
In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” (“ASU 2010-20”) to amend ASC Topic 320, “Receivables.” The amendments in ASU 2010-20 are intended to provide disclosures that facilitate financial statement users’ evaluation of the nature of credit risk inherent in the entity’s portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption is not expected to have a material effect on the Company's financial condition and results of operations.
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.
NOTE 9 – SHAREHOLDERS’ EQUITY
The Company and Bank are currently prohibited from declaring or paying dividends without prior approval of regulatory authorities.
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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
June 30, 2010 and December 31, 2009
The Company’s total assets declined from $976.8 million at December 31, 2009 to $946.6 million at June 30, 2010, a decrease of $30.2 million, or 3.0%. The Company’s liquid assets, consisting of cash and cash equivalents and investment securities available for sale, decreased $24.0 million during the six months ended June 30, 2010 compared to liquid assets as of December 31, 2009, primarily from a decrease in cash and cash equivalents of $7.8 million. Gross loans decreased by $4.5 million or 0.6% from $715.1 million at December 31, 2009 to $710.6 million at June 30, 2010. The Company’s loan portfolio decrease is due mainly to transfers from loans to other real estate owned, charge-offs, and a decline in loan demand. Deposits decreased $28.6 million or 3.7% from $766.0 million at December 31, 2009 to $737.5 million at June 30, 2010. Deposits from the Company’s local market continued to be its primary funding source, accounting for 75.6% of overall deposits, while wholesale deposits decreased by $20.6 million or 11.4% for the six month period.
Total shareholders’ equity increased approximately $1.3 million from $65.9 million at December 31, 2009 to $67.2 million at June 30, 2010. The increase resulted primarily from net income of $382,000, the issuance of shares of common stock of $316,000, and other comprehensive income of $728,000. Offsetting this increase were dividends paid to the Company’s shareholders of $149,000 during the first six months of 2010. At June 30, 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
June 30, 2010 and 2009
Net Income (Loss). Net income for the three months ended June 30, 2010 was $289,000, or $.04 basic and diluted net income per share, as compared with a net loss of $705,000, or $.10 basic and diluted net loss per share, for the three months ended June 30, 2009, an increase of $994,000 or $.14 basic and diluted net income per share. The primary reasons for this increase in net income are a decline in interest expense of $739,000, and a decrease in the provision for loan losses of $1.3 million.
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 June 30, 2010 was $8.0 million, an increase of $0.7 million compared to the three months ended June 30, 2009. The increase was due to a decrease in the cost of deposits, which was primarily driven by the repricing of deposits at maturity during the second quarter at much lower rates than the same quarter of the prior year. The average yield on interest-bearing liabilities for the quarter ended June 30, 2010 declined 40 basis points from 2.34% at June 30, 2009 to 1.94% at June 30, 2010. Average interest-earning assets increased $7.7 million for the quarter and average interest-bearing liabilities increased $12.6 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 29 basis points from 3.26% during the three months ended June 30, 2009 to 3.55% during the three months ended June 30, 2010.
Provision for Loan Losses. The provision for loan losses was $3.1 million and $4.4 million for the three months ended June 30, 2010 and 2009, respectively, a decrease of $1.3 million. Net charge-offs of $3.5 million were recorded for the three months ended June 30, 2010 compared to net charge-offs of $1.5 million during the three months ended June 30, 2009. Nonaccrual loans decreased from $25.6 million at June 30, 2009 to $17.0 million at June 30, 2010. The majority of this decrease relates to nonaccrual loans being transferred to other real estate owned. In addition, the Company has $46.3 million in loans in the coastal North Carolina region which are collateralized by properties th at have seen significant declines in value. The Company has evaluated these loans in determining its allowance for loan losses as of June 30, 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 provision. At June 30, 2010, impaired loans, which include nonaccrual loans and troubled debt restructuring, totaled $38.0 million. Of these loans, $26.5 million have specific loss allowances that aggregate $8.9 million. Increased levels of charge-offs, past due loans and nonperforming assets, and further deterioration of the local economy led us to increase our allowance for loan losses to 2.43% of gross loans at June 30, 2010, as compared to 2.19% as of December 31, 2009, and 1.85% as of June 30, 2009. Management believes that the allowance is adequate to absorb probable losses inherent in the loan portfolio.
Non-Interest Income. Non-interest income increased $559,000 for the three months ended June 30, 2010 to $2.5 million as compared to $1.9 million for the same period in 2009. The increase is primarily due to an increase of $437,000 in gain on sale of investment securities.
Non-Interest Expenses. Non-interest expenses increased $980,000 to $7.3 million for the three months ended June 30, 2010 compared to $6.3 million for the three months ended June 30, 2009. The primary increases in non-interest expense for the three months ended June 30, 2010 included an increase in the Federal Deposit Insurance Corporation (“FDIC”) insurance premium of $77,000 and net losses on other real estate owned and related foreclosure expenses of $628,000. 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 90.13% and 51.14% for the three months ended June 30, 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 income (loss) before income taxes, resulting in a larger percentage tax benefit.
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Results of Operations for the Six Months Ended
June 30, 2010 and 2009
Net Income. Net income for the six months ended June 30, 2010 was $382,000, or $.05 basic and diluted net income per share, as compared with net income of $202,000, or $.03 basic and diluted net income per share, for the six months ended June 30, 2009, an increase of $180,000 or $.02 basic and diluted net income per share. The primary reasons for this increase in net income are a decline in interest expense of $2.0 million, and a decrease in the provision for loan losses of $878,000.
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.
Net interest income for the six months ended June 30, 2010 was $15.8 million, an increase of $1.7 million compared to the six months ended June 30, 2009. The increase was due to a decrease in the cost of deposits, which was primarily driven by the repricing of deposits at maturity at much lower rates than the prior period. The average yield on interest-bearing liabilities for the six months ended June 30, 2010 declined 54 basis points from 2.50% at June 30, 2009 to 1.96% at June 30, 2010. Average interest-earning assets increased $12.3 million for the six month period and average interest-bearing liabilities increased $16.5 million for the same period. Margins increased during the period, primarily due to the decrease in the cost of deposits as yields on assets decreased at a slower pace, resulting in an increase in the Company’s net interest margin by 34 basis points from 3.16% during the six months ended June 30, 2009 to 3.50% during the six months ended June 30, 2010.
Provision for Loan Losses. The provision for loan losses was $5.1 million and $6.0 million for the six months ended June 30, 2010 and 2009, respectively, a decrease of $878,000. Net charge-offs of $3.5 million were recorded for the six months ended June 30, 2010 compared to net charge-offs of $2.3 million during the six months ended June 30, 2009. Net charge-offs as a percentage of average loans increased 17 basis points, from 0.32% for the six month period ended June 30, 2009 to 0.49% for the six month period ended June 30, 2010. Nonaccrual loans decreased from $25.6 million at June 30, 2009 to $17.0 million at June 30, 2010. The majority of this decrease relates to nonac crual loans being transferred to other real estate owned. In addition, the Company has $46.3 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 June 30, 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 provision. At June 30, 2010, impaired loans, which include nonaccrual loans and troubled debt restructuring, totaled $38.0 million. Of these loans, $26.5 million have specific loss allowances that aggregate $8.9 million. Increased levels of charge-offs, past due loans and nonperforming assets, and further deterioration of the local economy led us to increase our allowance for loan losses to 2.43% of gross loans at June 30, 2010, as compared to 2.19% as of December 31, 2009, and 1.85% as of June 30, 2009. Management belie ves that the allowance is adequate to absorb probable losses inherent in the loan portfolio.
Non-Interest Income. Non-interest income increased $269,000 for the six months ended June 30, 2010, to $3.9 million as compared to $3.6 million for the same period in 2009. The increase is primarily due to an increase of $286,000 in other service charges, commissions, and fees.
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Non-Interest Expenses. Non-interest expenses increased $2.5 million to $14.5 million for the six months ended June 30, 2010 compared to $12.0 million for the six months ended June 30, 2009. The primary increases in non-interest expense for the six months ended June 30, 2010 included an increase in the FDIC insurance premium of $436,000, merger expenses related to the acquisition of Nuestro Banco of $600,000, and net losses on other real estate owned and related foreclosure expenses of $964,000. 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 before income taxes, was 1,428.0% and 150.75% for the six months ended June 30, 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 income before income taxes, resulting in a larger percentage tax benefit.
Asset Quality
Past due and nonaccrual loans as of June 30, 2010 and December 31, 2009, were as follows (in thousands):
June 30, | Decmber 31, | |||||||
2010 | 2009 | |||||||
Nonaccrual loans: | ||||||||
Commercial and all other loans | $ | 637 | $ | 386 | ||||
Real estate loans | 16,048 | 19,535 | ||||||
Home equity | 298 | 94 | ||||||
Installment loans | 31 | 90 | ||||||
Total nonaccrual loans | $ | 17,014 | $ | 20,105 | ||||
Other real estate owned: | ||||||||
Commercial and non-residential | 2,231 | 1,775 | ||||||
Residential | 11,102 | 8,933 | ||||||
Total other real estate owned | $ | 13,333 | $ | 10,708 | ||||
Total nonperforming assets | $ | 30,347 | $ | 30,813 | ||||
Past due 90 days or more and still accruing: | ||||||||
Commercial and all other loans | $ | 166 | $ | 20 | ||||
Real estate loans | 2,067 | 1,153 | ||||||
Home equity | 67 | - | ||||||
Installment loans | 32 | 10 | ||||||
Credit cards and related plans | 43 | 22 | ||||||
Total past due 90 days and still accruing | $ | 2,375 | $ | 1,205 | ||||
Nonperforming loans to gross loans | 2.39 | % | 2.81 | % | ||||
Nonperforming assets to total assets | 3.21 | % | 3.15 | % | ||||
Allowance coverage of nonperforming loans | 101.62 | % | 77.97 | % |
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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 June 30, 2010 and December 31, 2009:
June 30, | Decmber 31, | |||||||
2010 | 2009 | |||||||
Performing TDRs: | ||||||||
Commercial and all other loans | $ | 773 | $ | 668 | ||||
Real estate loans | 20,211 | 8,578 | ||||||
Installment loans | 7 | 28 | ||||||
Total performing TDRs | $ | 20,991 | $ | 9,274 |
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 June 30, 2010 was approximately $378,000. 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. The amount of interest recognized on impaired loans during the portion of 2010 that the loans were considered impaired was approximately $482,000.
Other real estate owned was $13.3 million and $10.7 million at June 30, 2010 and December 31, 2009, respectively.
The following table summarizes the bank’s loan loss experience for the six months ended June 30, 2010 and 2009 (in thousands, except ratios):
June 30, | June 30, | |||||||
2010 | 2009 | |||||||
Balance at beginning of period | $ | 15,676 | $ | 10,450 | ||||
Charge-offs: | ||||||||
Commercial and other | 242 | 114 | ||||||
Real estate | 3,185 | 1,345 | ||||||
Installment loans to individuals | 263 | 69 | ||||||
Credit cards and related plans | 90 | 28 | ||||||
Total charge offs | 3,780 | 1,556 | ||||||
Recoveries: | ||||||||
Commercial and other | 7 | 4 | ||||||
Real estate | 88 | 2 | ||||||
Installment loans | 162 | 13 | ||||||
Credit cards and related plans | 1 | 4 | ||||||
Total recoveries | 258 | 23 | ||||||
Net charge-offs | 3,522 | 1,533 | ||||||
Provision for loan losses | 5,136 | 4,372 | ||||||
Balance at end of period | $ | 17,290 | $ | 13,289 | ||||
Ratio of net charge-offs during the quarter to average gross | ||||||||
loans outstanding during the year | 0.49 | % | 0.32 | % |
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Loan Portfolio Concentration. The following table presents an analysis of the Company’s loan portfolio by collateral type as of June 30, 2010 (unaudited).
As of June 30, 2010 | ||||||||||||||||||||
Nonaccrual | Allowance | |||||||||||||||||||
Loans to | for Loan | ALLL to | ||||||||||||||||||
Loans | Nonaccrual | Loans | Losses | Loans | ||||||||||||||||
Outstanding | Loans | Outstanding | ("ALLL") | Outstanding | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||
Residential ADC | $ | 117,956 | $ | 10,294 | 1.45 | % | $ | 7,092 | 1.00 | % | ||||||||||
Multifamily | 20,095 | 31 | 0.00 | % | 320 | 0.05 | % | |||||||||||||
Farmland | 30,377 | 83 | 0.01 | % | 168 | 0.02 | % | |||||||||||||
Other construction and development | 96,068 | 1,622 | 0.23 | % | 1,200 | 0.17 | % | |||||||||||||
Commercial non-owner occupied | 94,877 | 464 | 0.07 | % | 969 | 0.14 | % | |||||||||||||
Commercial owner occupied | 101,679 | 1,601 | 0.23 | % | 1,110 | 0.16 | % | |||||||||||||
Total commercial real estate | 461,052 | 14,095 | 1.98 | % | 10,859 | 1.53 | % | |||||||||||||
Commercial: | ||||||||||||||||||||
Commercial and industrial | 52,842 | 530 | 0.07 | % | 1,745 | 0.25 | % | |||||||||||||
Municipal | 7,054 | - | 0.00 | % | 155 | 0.02 | % | |||||||||||||
Agriculture | 3,352 | 107 | 0.02 | % | 109 | 0.02 | % | |||||||||||||
Other | 3,430 | - | 0.00 | % | 75 | 0.01 | % | |||||||||||||
Total commercial | 66,678 | 637 | 0.09 | % | 2,084 | 0.29 | % | |||||||||||||
Residential mortgage: | ||||||||||||||||||||
First lien, closed-end | 123,427 | 1,697 | 0.24 | % | 2,894 | 0.41 | % | |||||||||||||
Junior lien, closed-end | 6,208 | 255 | 0.04 | % | 347 | 0.05 | % | |||||||||||||
Total residential mortgage | 129,635 | 1,952 | 0.28 | % | 3,241 | 0.46 | % | |||||||||||||
Home equity lines | 39,651 | 298 | 0.04 | % | 796 | 0.11 | % | |||||||||||||
Consumer – other | 14,026 | 32 | 0.00 | % | 310 | 0.04 | % | |||||||||||||
Less: Net deferred loan fees | (416 | ) | - | - | ||||||||||||||||
Total loans | $ | 710,626 | $ | 17,014 | 2.64 | % | $ | 17,290 | 2.43 | % |
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 June 30, 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 r eview. The following tables present an analysis of the Company’s commercial real estate portfolio, excluding commercial loans secured by commercial owner occupied properties, as of June 30, 2010:
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Residential ADC Portfolio Analysis by Type
As of June 30, 2010 | ||||||||||||
Residential Land/ Development | Residental Construction | Total | ||||||||||
(Dollars in thousands) | ||||||||||||
Loans outstanding | $ | 72,010 | $ | 45,946 | $ | 117,956 | ||||||
Loans outstanding to gross loans | 10.13% | 6.47% | 16.60% | |||||||||
Nonaccrual loans | $ | 7,815 | $ | 2,479 | $ | 10,294 | ||||||
Nonaccrual loans to loans in category | 1.10% | 0.35% | 1.45% | |||||||||
Allowance for loan losses | $ | 6,079 | $ | 1,013 | $ | 7,092 | ||||||
Allowance for loan losses in category | 8.44% | 2.20% | 6.01% |
Residential ADC Portfolio Analysis by Region
As of June 30, 2010 | ||||||||||||||||||||||||
Loans Outstanding | Percentage of Total Loans Outstanding | Nonaccrual Loans | Nonaccrual Loans to Loans Outstanding | Allowance for Loan Losses | ALLL to Loans Outstanding | |||||||||||||||||||
Triangle | $ | 45,569 | 6.41 | % | $ | 4,875 | 4.13 | % | $ | 1,315 | 1.11 | % | ||||||||||||
Coastal | 40,438 | 5.69 | % | 5,124 | 4.34 | % | 5,352 | 4.54 | % | |||||||||||||||
Eastern | 20,387 | 2.87 | % | 295 | 0.25 | % | 301 | 0.26 | % | |||||||||||||||
Sandhills | 11,423 | 1.61 | % | - | 0.00 | % | 123 | 0.10 | % | |||||||||||||||
Other | 139 | 0.02 | % | - | 0.00 | % | 1 | 0.00 | % | |||||||||||||||
Total | $ | 117,956 | 16.60 | % | $ | 10,294 | 8.73 | % | 7,092 | 6.01 | % |
Other Commercial Real Estate Portfolio Analysis by Type
As of June 30, 2010 | ||||||||||||||||
Commercial Land/ Development | Commercial Construction | Commercial Real Estate Secured | Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Loans outstanding | $ | 66,494 | $ | 17,367 | $ | 107,084 | $ | 190,945 | ||||||||
Loans outstanding to gross loans | 9.36% | 2.44% | 15.07% | 26.87% | ||||||||||||
Nonaccrual loans | $ | 1,622 | $ | - | $ | 28 | $ | 1,650 | ||||||||
Nonaccrual loans to loans in category | 0.83% | 0.00% | 0.31% | 1.39% | ||||||||||||
Allowance for loan losses | $ | 744 | $ | 110 | $ | 1,315 | $ | 2,169 | ||||||||
Allowance for loan losses in category | 1.12% | 0.63% | 1.23% | 1.14% |
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Other Commercial Real Estate Portfolio Analysis by Region
As of June 30, 2010 | ||||||||||||||||||||||||
Loans Outstanding | Percentage of Total Loans Outstanding | Nonaccrual Loans | Nonaccrual Loans to Loans Outstanding | Allowance for Loan Losses | ALLL to Loans Outstanding | |||||||||||||||||||
Triangle | $ | 153,282 | 21.57 | % | $ | 1,624 | 0.85 | % | $ | 1,749 | 0.92 | % | ||||||||||||
Sandhills | 25,756 | 3.62 | % | 462 | 0.24 | % | 254 | 0.13 | % | |||||||||||||||
Other | 5,786 | 0.81 | % | - | 0.00 | % | 37 | 0.02 | % | |||||||||||||||
Eastern | 3,488 | 0.49 | % | - | 0.00 | % | 22 | 0.01 | % | |||||||||||||||
Coastal | 2,633 | 0.37 | % | - | 0.00 | % | 107 | 0.06 | % | |||||||||||||||
Total | $ | 190,945 | 26.87 | % | $ | 2,086 | 1.09 | % | 2,169 | 1.14 | % |
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 June 30, 2010, the Company had $20.6 million of loans with interest reserves.
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 $67.2 million or 7.1% of total assets at June 30, 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 $24 million. As of June 30, 2010, the Bank has the credit capacity to borrow up to $189.3 million, from the FHLB, with $112.4 and $112.5 million out standing as of June 30, 2010 and December 31, 2009, respectively.
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The Bank remained well capitalized with total risk based capital of 13.27%, tier 1 risk based capital of 10.33%, and leverage ratio of 7.70% at June 30, 2010, as compared to 11.66%, 9.32%, and 7.19%, respectively, at June 30, 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. The Company and Bank are currently prohibited from declaring or paying dividends without approval of the supervisory authorities. We received approval and maintained our quarterly dividend payments in the second quarter of 2010, although at a reduced level. While maintaining our dividend payments is desirable, capital preservation 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 second quarter of 2009 to $0.01 per share paid in the second quarter of 2010, a decrease of 88.2%. Book value per share at June 30, 2010 and 2009 was $8.96 and $9.39, respectively. Tangible book value per share at June 30, 2010 was $8.91 as compared to $8.47 at June 30, 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.
Not applicable.
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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. Based on such evaluation, the Company’s 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 assurance 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 specified in the Commission’s rules and forms and is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
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.
Not applicable.
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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 June 30, 2010, our loan portfolio was comprised of $214.0 million of real estate and land acquisition and development loans, or 30.1% 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 June 30, 2010, $33.5 million of our residential construction loans were for speculative construction loans. Slowing housing sales have been a contributing factor to an increase in nonperforming loans as well as an increase in delinquencies. Residential construction loans and commercial construction loans represented 33.9% and 5.4%, respectively, of our nonperforming assets at June 30, 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 June 30, 2010, our non-owner occupied commercial real estate loans totaled $101.7 million, or 14.3% 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 June 30, 2010, our commercial real estate loans with interest reserves totaled $20.6 million or 2.89% of our total loan portfolio.
Legislative and regulatory actions taken now or in the future to address the current liquidity and credit crisis in the financial industry may significantly affect our liquidity and financial condition.
The Federal Reserve, U.S. Congress, the U.S. Treasury Department, the FDIC and others have taken numerous actions to address the current liquidity and credit situation in the financial markets. These measures include actions to encourage loan restructuring and modification for homeowners, the establishment of significant liquidity and credit facilities for financial institutions and investment banks, and coordinated efforts to address liquidity and other weaknesses in the banking sector.
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was intended primarily to overhaul the financial regulatory framework following the global financial crisis and will impact all financial institutions including our holding company and the Bank. The Dodd-Frank Act contains provisions that will, among other things, establish a Bureau of Consumer Financial Protection, establish a systemic risk regulator, consolidate certain federal bank regulators, and impose increased corporate governance and executive compensation requirements. While many of the provisions in the Dodd-Frank Act are aimed at financial institutions significantly larger than us, it will likely increase our regulatory compliance burden and may have a material adverse effe ct on us, including by increasing the costs associated with our regulatory examinations and compliance measures. However, it is too early for us to fully assess the impact of the Dodd-Frank Act and subsequent regulatory rulemaking processes on our business, financial condition, or results of operations.
Further, the U.S. Congress and state legislatures and federal and state regulatory authorities continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including interpretation and implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer or increasing the ability of non-banks to offer competing financial services and products. While we cannot predict the regulatory changes that may be borne out of the current economic crisis, and we cannot predict whether we will become subject to increased regulatory scrutiny by any of these regulatory agencies, any regulatory changes or scrutiny could increase or decrease the cost of doing bus iness, limit or expand our permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations, and other institutions. We cannot predict whether additional legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
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We are subject to examination and scrutiny by a number of regulatory authorities, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations, or financial position and could become subject to formal or informal regulatory orders.
We are subject to examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions, and requirements on us and our banking subsidiaries if they determine, upon conclusion of their examination or otherwise, violations of laws with which we or our subsidiaries must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, cease and desist orders, civil money penalties and termination of deposit insurance and bank closures. Enforcement actions may be taken regardless of the capital levels o f the institutions, and regardless of prior examination findings. In late July 2010, we entered into a Memorandum of Understanding (“MOU”) with the Federal Reserve Bank of Richmond and the North Carolina Office of the Commissioner of Banks. The MOU requires certain actions, which fall into two basic categories: (i) actions designed to reduce the Bank's non-performing loans and other real estate owned, which relate to, among other things, board oversight procedures, credit risk management, loan policies, and appraisal procedures, and (ii) actions designed to maintain capital, including, among others, policies and procedures relating to liquidity and funds management, detailed budgeting, capital planning, and requirements that the Company obtain regulatory approval before payment by the Company of dividends on common stock or its trust preferred se curities, payment of dividends by the Bank to the Company, redemption of shares of the Company's common stock, incurrence of or increases in indebtedness of the Company, or cash expenditures outside the normal course of business.
Recent amendments to the FRB’s Regulation E may negatively impact our non-interest income.
We are committed to expeditiously addressing and resolving the issues raised in the MOU, and our board of directors and management have already initiated actions to comply with its provisions. A material failure to comply with the terms of the MOU could subject us to additional regulatory actions and restrictions on our business, which may have a material adverse effect on our future results of operations and financial condition.
Recent amendments to the FRB’s Regulation E may negatively impact our non-interest income.
On November 12, 2009, the Board of Governors of the Federal Reserve System announced the final rules amending Regulation E that prohibit financial institutions from charging fees to consumers for paying overdrafts on automated teller machine and one-time debit card transactions, unless a consumer consents, or opts-in, to the overdraft service for those types of transactions. Compliance with this regulation is effective July 1, 2010 for new consumer accounts and August 15, 2010 for existing consumer accounts. The impact that these new rules will have on us is unknown at this time, but they do have the potential to reduce our non-interest income and this reduction could be material.
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: August 16, 2010 | By: | /s/ Ayden R. Lee, Jr. | |
Ayden R. Lee, Jr. | |||
Chairman, President and Chief Executive Officer |
Date: August 16, 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 |