UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2011
Commission File Number 0-23971
__________________________
Citizens South Banking Corporation
(Exact name of registrant as specified in its charter)
__________________________
| Delaware | 54-2069979 |
| (State or other jurisdiction of | (I.R.S. Employer |
| incorporation or organization) | Identification Number) |
| | |
| 519 South New Hope Road, Gastonia, NC | 28054 |
| (Address of principal executive offices) | (Zip code) |
(704) 868-5200
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
| Common Stock, par value $0.01 per share | The NASDAQ Stock Market, LLC |
| (Title of class) | (Name of exchange on which registered) |
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.
Yes [ ] No [x]
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. Yes [ ] No [x]
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days. Yes [x] 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 during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [x]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company [x]
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the last sale price on March 27, 2012, as reported by the Nasdaq Global Market, was approximately $46.8 million.
As of March 30, 2012, there were 11,506,324 shares of the common stock, $0.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2012 Annual Meeting of Stockholders of the Registrant are included by reference into Part III.
CITIZENS SOUTH BANKING CORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2011
TABLE OF CONTENTS
Forward-Looking Statements
This report contains certain forward-looking statements with respect to the Company’s financial condition, results of operations and business of the Company and the Bank. These statements are based on assumptions and estimates with respect to future business strategies and decisions that are subject to change based on changes in the economic and competitive environment in which we operate. Such forward- looking statements can be identified by the use of words such as “may,” “would,” “could,” “will,” “expect,” “believe,” “estimate,” “intend,” and “plan,” as well as similar expressions. Such statements are based on our current beliefs and expectations and are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond our control. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. Factors that could cause such a difference include, but are not limited to, 1) the timing and amount of revenues that may be recognized by the Company, 2) changes in local or national economic trends, 3) increased competition among depository and financial institutions, 4) continuation of current revenue and expense trends (including trends affecting charge-offs and provisions for loan losses), 5) changes in interest rates and the shape of the yield curve, and 6) adverse legal, regulatory or accounting changes and other risk factors described below under Item 1A. “Risk Factors” of this Annual Report. Forward-looking statements speak only as of the date they are made and the Company is under no duty to update these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.
General
Citizens South Banking Corporation (the “Company”) is a Delaware corporation that owns all of the outstanding shares of common stock of Citizens South Bank (the "Bank"). The shares of common stock of the Company trade on the Nasdaq Global Market under the ticker symbol “CSBC.” The Company’s principal business activities are overseeing and directing the business of the Bank. The Company’s assets consist primarily of the outstanding capital stock of the Bank, deposits held at the Bank and investment securities. The Company became the holding company for the Bank on September 30, 2002, in connection with the mutual-to-stock conversion of Citizens South Holdings, MHC, the mutual holding company of Citizens South Banking Corporation, a federal corporation, formerly named Gaston Federal Bancorp, Inc., which was originally formed on March 18, 1998 for the purpose of acting as the holding company for the Bank. As of December 31, 2011, the Company had total assets of $1.1 billion, total loans of $733.8 million, total deposits of $876.1 million, and shareholders’ equity of $92.7 million.
Citizens South Bank was chartered in 1904 and currently operates as a federally chartered savings bank. The Bank is headquartered in Gastonia, North Carolina, which is located approximately 20 miles west of Charlotte, North Carolina. The Bank’s executive office is located at 519 South New Hope Road, P.O. Box 2249, Gastonia, North Carolina 28053-2249 and its telephone number is (704) 868-5200. The Company also maintains a website at www.citizenssouth.com that includes important information on our Bank, including a list of our products and services, branch locations and current financial information. Information on our website should not be considered a part of this Annual Report.
The Bank provides a full range of retail products, commercial banking services, and mortgage lending services to local customers through our 21 branch offices located in North Carolina, South Carolina, and Georgia. Our primary banking activities include the acceptance of deposits and the origination of loans. We offer retail deposit products such as checking, savings, NOW and money market accounts, as well as time deposits and individual retirement accounts. For business customers, the Bank offers commercial analysis deposit accounts, business checking accounts, and repurchase agreements (also called securities sold under agreement to repurchase). The Bank is a member of the Certificate of Deposit Account Registry Service (“CDARS”), which gives our customers the ability to obtain FDIC insurance on deposits of up to $50 million, while continuing to work directly with our Bank. The Bank also offers a wide variety of consumer and commercial loans including business loans, real estate loans, residential loans and consumer loans. We offer consumer and business credit cards, debit cards, commercial letters of credit, safe deposit box rentals, and electronic funds transfer services, including automated clearing house, or ACH, and wire transfers. In addition, the Bank offers online banking, remote deposit capture, cash management, bank-by-phone capabilities, and ATM services. The Bank also acts as a broker in the sale of uninsured financial products.
The Bank’s results of operations are heavily dependent on net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. Results of operations are also materially affected by the Bank’s provision for loan losses, noninterest income, and noninterest expense. Noninterest income primarily consists of fee income generated from deposit accounts, mortgage banking fees, commissions earned from the sale of uninsured investment products, increases in the cash value of bank-owned life insurance policies, net gains from the sale of assets and other noninterest income items. The Bank’s noninterest expense primarily consists of compensation and employee benefits, occupancy expense, professional services, advertising, deposit insurance, loan collection expenses, other real estate owned value adjustments and expenses, amortization of intangible assets, impairment of investments, and other noninterest expenses. Results of operations are also significantly affected by local economic and competitive conditions, changes in interest rates, and actions of regulatory and governmental authorities.
In September 2011, the Company entered into a Securities Purchase Agreement with the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued and sold to the Treasury 20,500 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series C for aggregate proceeds of $20,500,000. The Securities Purchase Agreement was entered into, and the Series C Preferred Stock was issued, pursuant to the Treasury’s Small Business Lending Fund program (“SBLF”), as established under the Small Business Jobs Act of 2010. The Series C Preferred Stock is entitled to receive non-cumulative dividends payable quarterly. The dividend rate was initially set at 4.84% per annum based upon the initial level of qualified small business lending (“QSBL”) by the Bank. The dividend rate for future dividend periods will be set based upon the percentage change in the QSBL between each dividend period and the baseline QSBL level. This dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods, from 1% per annum to 7% per annum for the eleventh through the first half of the nineteenth dividend periods. If the Series C Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%. As a result of the Company’s participation in SBLF, the Company redeemed all 20,500 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A it sold to the Treasury on December 12, 2008, as a part of the Troubled Asset Relief Program (“TARP”). Subsequently in November 2011, the Company repurchased from the Treasury a warrant to purchase 428,870 shares of the Company. The warrant was issued to Treasury on December 12, 2008, in connection with the Company’s participation in the Treasury’s Capital Purchase Program as part of the TARP.
In April 2011, the Bank entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (“FDIC”), as receiver for New Horizons Bank (“NHB”), to acquire substantially all of the assets and assume substantially all of the liabilities of NHB. New Horizons Bank was a Georgia state-chartered bank headquartered in East Ellijay, Georgia. NHB was established in 2004 and operated from one location in East Ellijay, Georgia. The fair values of the assets acquired and liabilities assumed were determined based on the requirements of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820: Fair Value Measurements and Disclosures. The fair value amounts are subject to change for up to one year after the closing date of the acquisition as additional information relative to closing date fair values becomes available. In connection with the acquisition, the Bank entered into two loss-share agreements with the FDIC that covered approximately $69.3 million of the $71.2 million of loans that were acquired from the FDIC (the “covered loans”) and all of the $11.6 million of OREO that was acquired from the FDIC (collectively referred to as “covered assets”). One loss-share agreement covers certain residential loans and OREO for a period of ten years. The other loss-share agreement covers all remaining covered assets for a period of five years. Pursuant to the terms of the loss-share agreements, the FDIC is obligated to reimburse the Bank for 80% of all eligible losses, which begins with the first dollar of loss occurred, and certain collection and disposition expenses with respect to covered assets. The Bank has a corresponding obligation to reimburse the FDIC for 80% of eligible recoveries with respect to covered assets for a period of ten years for residential properties and eight years for all other covered assets. The Bank recorded an estimated receivable from the FDIC in the amount of $19.9 million, which represents the discounted value of the FDIC’s estimated portion of the expected future loan losses. Any losses incurred on the remaining $1.9 million in acquired loans not covered under shared-loss agreements will be the sole responsibility of the Bank. Also, new loans made after the acquisition date are not covered by FDIC loss-share agreements. After applying purchase accounting adjustments to the acquired assets and liabilities, the Company recognized an initial $4.4 million pre-tax gain from the acquisition which was included as a component of noninterest income. Net of fair market adjustments, the Bank acquired $49.3 million of loans and assumed $96.7 million of total deposits. Citizens South Bank received a $12.8 million discount on the assets acquired and paid a $748,000, or 1%, deposit premium (excluding market placed deposits). Also, as a part of this acquisition, the Company recorded a $1.6 million core deposit intangible that will be amortized over an eight-year period under the accelerated method. Additional details may be found in Note 3 – FDIC-Assisted Acquisitions of Section 8. of this Annual Report.
In March 2010, the Bank entered into a purchase and assumption agreement with the FDIC, as receiver for Bank of Hiawassee, to acquire substantially all of the assets and assume substantially all of the liabilities of Bank of Hiawassee. The Bank of Hiawassee was a Georgia state-chartered bank headquartered in Hiawassee, Georgia, and operated five full-service offices in the North Georgia area. The fair values of the assets acquired and liabilities assumed were determined based on the requirements of FASB ASC Topic 820: Fair Value Measurements and Disclosures. The fair value amounts are subject to change for up to one year after the closing date of the acquisition as additional information relative to closing date fair values becomes available. The acquired loans, also referred to as “covered loans,” are covered by two loss-share agreements between the FDIC and the Bank, which afford the Bank significant protection against future loan losses. Under these loss-share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans, five years for losses on all other loans and eight years for recoveries on all other loans. The Bank recorded an estimated receivable from the FDIC in the amount of $36.3 million, which represents the discounted value of the FDIC’s estimated portion of the expected future loan losses. New loans made after the acquisition date are not covered by the FDIC loss-share agreements. After applying purchase accounting adjustments to the acquired assets and liabilities, the Company recognized an initial $18.7 million pre-tax gain from the acquisition which was included as a component of noninterest income. Net of fair market adjustments, the Bank acquired $183.2 million of loans and assumed $292.2 million of total deposits and $31.6 million of borrowed money. Citizens South Bank received a $33.6 million discount on the assets acquired and paid a $2.5 million, or 1%, deposit premium, resulting in net proceeds of $31.1 million to Citizens South Bank funded by the FDIC. Also, as a part of this acquisition, the Company recorded a $1.6 million core deposit intangible that will be amortized over an eight-year period under the accelerated method. Additional details may be found in Note 3 – FDIC-Assisted Acquisitions of Section 8. of this Annual Report.
Market Area and Competition
Banking is very competitive in the markets that we serve. We compete against large commercial financial institutions, other community banks, savings and loan associations, credit unions, mortgage companies, brokerage companies, and various other institutions that offer credit or solicit deposits to small businesses and consumers. Many of our competitors have broad geographic diversity and have greater access to credit markets, lower costs of funding, higher lending limits, and greater media exposure than our Company. However, we believe that we compete effectively in our markets by using our strong community roots and support which we have fostered over our 107 years of community banking. We encourage our employees to participate in local civic organizations and we support many local community events. We focus on providing superior personal service to small businesses and local consumers through our network of 21 full-service offices. We also offer a wide variety of products and services including remote deposit capture and on-line banking that compete effectively with much larger competitors.
We consider our primary market area to be the North Carolina Counties of Gaston, Rowan, Iredell, Union, Mecklenburg, Cabarrus, Lincoln, and Cleveland, the South Carolina County of York, and the Georgia Counties of Union, Fannin, Gilmer and Towns. Our market areas represent the metropolitan area of Charlotte, North Carolina and the Northern Georgia area. The metropolitan area of Charlotte has a diverse economic base that includes business sectors in banking and finance, energy, insurance, manufacturing, textiles, apparel, fabricated metals, construction, health care, transportation, retail trade, telecommunications, government services, and education. In 2011, the Charlotte metropolitan area experienced decreases in housing prices, an increased unemployment rate, decreased housing starts and housing sales, and decreased commercial activity. However, the economic slowdown in the Charlotte metropolitan area has generally been less severe than the economic slowdown experienced in other large metropolitan areas of the country. The North Georgia market, which is located in the mountains and has a number of large lakes in the area, is a popular vacation destination and second home market for those living in the Atlanta metropolitan area. As such, this market is predominately comprised of small businesses that support retirees, second home owners, and vacationers. The economic slowdown in the Atlanta region has had an adverse effect on the North Georgia market. Conversely, as the economic conditions in the Atlanta region improve, the North Georgia market should also begin to improve.
Employees
As of December 31, 2011, the Company had 201 full-time and 37 part-time employees, none of whom is represented by a collective bargaining unit. The Company provides employee benefit programs, including an Employee Stock Ownership Plan, an employer match 401(k) retirement plan, group life, disability, heath, and dental insurance, and paid vacation and sick leave. Management believes its working relationship with its employees is good.
Subsidiaries
Citizens South Banking Corporation is a unitary savings and loan holding company that owns all of the outstanding stock of Citizens South Bank. In addition, the Company has a wholly-owned non-consolidated subsidiary, CSBC Statutory Trust I, which was used to issue $15 million of trust preferred securities. The proceeds from these obligations were invested in the Bank as Tier I capital. These obligations represent a full and unconditional guarantee by the Company of the trust’s obligations under the preferred securities.
The Bank has two subsidiaries, Citizens South Financial Services, Inc, and Citizens Properties, LLC. Citizens South Financial Services, Inc. primarily owns stock in a title insurance company which is used by the Bank for certain real estate transactions. Citizens Properties, LLC was formed in January 2012 for the purpose of holding title to certain real estate that was acquired by the Bank through foreclosure.
Supervision and Regulation
The following discussion summarizes certain material elements of the regulatory framework applicable to Citizens South Banking Corporation and its subsidiaries. These summaries of statutes and regulations are not intended to be complete and such summaries are qualified in their entirety by reference to such statutes and regulations. A change in the statutes, regulations, or regulatory policies applicable to the Company, or its subsidiaries, could have a material effect on the business of the Company.
General. Citizens South Banking Corporation is a unitary savings and loan holding company that is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (“Federal Reserve”). As such, the Company is required to serve as a source of financial strength to its subsidiary depository institution and to commit resources to support the depository institution as needed. The Federal Reserve also has the authority to require the Company to terminate any activity or to relinquish control of a nonbank subsidiary upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of the holding company or the depository institution.
Citizens South Bank is a federally chartered stock savings bank and derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and the regulations of the Office of the Comptroller of the Currency (“OCC”). Under these laws and regulations, Citizens South Bank may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of investment securities and certain other assets. Citizens South Bank also may establish subsidiaries that may engage in activities not otherwise permissible for the Bank, including real estate investment and securities and insurance brokerage. The Bank is subject to examination, supervision, and regulation by the OCC, as its primary federal regulator, and the FDIC, as the deposit insurer. Citizens South Bank is also a member of and owns stock in the Federal Home Loan Bank of Atlanta (“FHLB”), which is a part of the Federal Home Loan Bank System. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers or acquisitions. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the insurance fund and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Citizens South Bank is also regulated to a lesser extent by the Federal Reserve, governing reserves to be maintained against deposits and other matters. Citizens South Bank’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of the Bank’s loan documents.
Dodd-Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted on July 21, 2010, has significantly changed the current bank regulatory structure and affected the lending, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act eliminated the Office of Thrift Supervision and required that federal savings associations be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Federal Reserve to supervise and regulate all savings and loan holding companies.
The Dodd-Frank Act requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository institutions, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. In addition, the proceeds of trust preferred securities (“TPS”) are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010, by bank or savings and loan holding companies with less than $15 billion of assets. The Company’s $15 million of TPS will be grandfathered under this legislation.
The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months. These new leverage and capital requirements must take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Banks and savings institutions with $10.0 billion or less in assets, such as Citizens South Bank, will be examined by their applicable bank regulators. The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives the state attorneys general the ability to enforce applicable federal consumer protection.
Standards for Safety and Soundness and Enforcement. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, loan concentrations, compensation, and other operational and managerial standards as the agency deems appropriate. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan. The OCC has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement action against all “institution-affiliated parties,” including certain shareholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive, a cease and desist order, removal of officers and/or directors of the institution, receivership, conservatorship, civil penalties, or the termination of deposit insurance. The FDIC also has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If action is not taken by the OCC, the FDIC has authority to take action under specified circumstances. As of December 31, 2011, there were no outstanding enforcement actions against the Company or the Bank by any regulatory agencies.
Capital Adequacy. The various federal bank regulators, including the OCC, have adopted risk-based capital requirements for assessing bank capital adequacy. These standards define what qualifies as capital and establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risks. These regulations require banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for savings banks receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. For capital adequacy purposes, a bank is placed in one of the following five categories based on the bank’s capital: 1) well capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital); 2) adequately capitalized (at least 4% leverage capital (3% for savings banks receiving the highest rating on the CAMELS rating system), 4% Tier 1 risk-based capital and 8% total risk-based capital); 3) undercapitalized (less than 4% leverage capital (3% for savings banks receiving the highest rating on the CAMELS rating system), 4% Tier 1 risk-based capital or less than 8% total risk-based capital,); 4) significantly undercapitalized (less than 3% leverage capital, 3% Tier 1 risk-based capital or less than 6% total risk-based capital,); and 5) critically undercapitalized (less than 2% tangible capital). At December 31, 2011 and 2010, Citizens South Bank met the criteria for being considered “well-capitalized” for all three regulatory capital standards.
Capital Distributions. OCC regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the capital account. A savings bank must file an application for approval of a capital distribution if: 1) the total capital distributions for the applicable calendar year exceed the sum of the savings bank’s net income for that year to date plus the savings bank’s retained net income for the preceding two years; 2) the bank would not be at least adequately capitalized following the distribution; 3) the distribution would violate any applicable statute, regulation, agreement or OCC-imposed condition; or 4) the savings bank is not eligible for expedited treatment of its filings. Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must file a notice with the Federal Reserve at least 30 days before the board of directors declares a dividend or approves a capital distribution. The OCC may disapprove a notice or application if: 1) the savings bank would be undercapitalized following the distribution; 2) the proposed capital distribution raises safety and soundness concerns; or 3) the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
Changes in Control. Federal law prohibits a savings and loan holding company from acquiring direct or indirect control of another savings institution or holding company thereof, without prior written approval of the OCC. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the OCC must consider the financial and managerial resources, future prospects of the savings institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
In addition, under the Change in Bank Control Act, no person may acquire control of a savings and loan holding company such as Citizens South Banking Corporation unless the Federal Reserve has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Control, as defined under federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the company’s directors, or a determination by the regulator that the acquirer has the power to direct, or directly or indirectly to exercise a controlling influence over, the management or policies of the institution. Acquisition of more than 10% of any class of a savings and loan holding company’s voting stock constitutes a rebuttable presumption of control under the regulations under certain circumstances including where, is the case with Citizens South Banking Corporation, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934.
Community Reinvestment Act and Fair Lending Laws. All savings banks have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings bank, the OCC is required to assess the savings bank’s record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A bank’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the OCC, as well as other federal regulatory agencies and the Department of Justice. Citizens South Bank received a “Satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Transactions with Affiliates. A federal savings bank’s authority to engage in transactions with its affiliates is limited by OCC regulations and by Sections 23A and 23B of the Federal Reserve Act (“FRA”) and its implementing regulations. The term affiliates for these purposes generally means any company that controls or is under common control with an institution. Citizens South Banking Corporation and its subsidiaries are affiliates of Citizens South Bank. In general, transactions with affiliates must be on terms that are as favorable to the savings bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings bank’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings bank. In addition, OCC regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
Loans to Insiders. Citizens South Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Citizens South Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by Citizens South Bank’s Board of Directors.
Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations. Assessment rates currently range from 2.5 to 45 basis points of total assets less tangible equity. The FDIC may adjust the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment. No institution may pay a dividend if in default of the federal deposit insurance assessment.
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. That payment is established quarterly and during the quarter ended December 31, 2011 equaled 0.68 basis points of total assets less tangible capital.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. We cannot predict what insurance assessment rates will be in the future. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing. We do not know of any practice, condition or violation that might lead to termination of deposit insurance.
Qualified Thrift Lender Test. As a federal savings bank, Citizens South Bank is subject to a qualified thrift lender (“QTL”) test. Under the QTL test, Citizens South Bank must maintain at least 65% of its portfolio assets in qualified thrift investments in at least nine months of the most recent 12-month period. A savings bank that fails the qualified thrift lender test must operate under specified restrictions. The Dodd-Frank Act made noncompliance with the QTL Test potentially subject to agency enforcement action for a violation of law. At December 31, 2011, Citizens South Bank maintained approximately 77% of its portfolio assets in qualified thrift investments and satisfied the QTL test.
Federal Home Loan Bank System. Citizens South Bank is a member of the FHLB, which provides a central credit facility primarily for member institutions. As a member of the FHLB of Atlanta, Citizens South Bank is required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to 0.15% of the Bank’s total assets. Also, the Bank is required to acquire and hold capital stock in the amount of 4.5% of outstanding borrowings from the FHLB. As of December 31, 2011, Citizens South Bank was in compliance with these requirements.
Federal Reserve System. The Federal Reserve Board regulations require savings banks to maintain reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At December 31, 2011, Citizens South Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the OCC.
USA Patriot Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Obstruct Terrorism Acts (the “Patriot Act”) gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The Patriot Act also contains additional laws and regulations regarding money laundering, financial transparency, and customer identification verification. We have established appropriate policies, procedures and systems designed to comply with these regulations.
Holding Company Regulation. The Company is a unitary savings and loan holding company, subject to regulation and supervision by the Federal Reserve. The Federal Reserve has enforcement authority over the Company and its non-savings institution subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a risk to the Bank.
The Company’s activities are limited to those activities permissible for financial holding companies or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance, incidental to financial activities or complementary to a financial activity. The Dodd-Frank Act added that any savings and loan holding company that engages in activities permissible for a financial holding company must meet the qualitative requirements for a bank holding company to be a financial holding company and conduct the activities in accordance with the requirements that would apply to a financial holding company’s conduct of the activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Federal Reserve, and certain additional activities authorized by Federal Reserve regulations.
Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring control of another savings institution or holding company thereof, without prior written approval of the Federal Reserve. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve must consider the financial and managerial resources and future prospects of the savings institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital, as is currently the case with bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.
The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
The Federal Reserve has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The policy statement also provides for regulatory review prior to a holding company redeeming or repurchasing regulatory capital instruments when the holding company is experiencing financial weaknesses or redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of a quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies could affect the ability of Citizens South Banking Corporation to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.
The Emergency Economic Stabilization Act of 2008. In 2008 the Congress enacted The Emergency Economic Stabilization Act of 2008 (“EESA”) which provides the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. One of the provisions resulting from the legislation is the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”), which provides for direct equity investment in perpetual preferred stock by the U.S. Treasury Department in qualified financial institutions. In 2008 Citizens South Banking Corporation was approved to participate in the CPP and received $20.5 million pursuant to this program. The Company repaid this investment in 2011 and is no longer subject to the restrictions of the TARP CPP.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. We have prepared policies, procedures and systems designed to ensure compliance with the Sarbanes-Oxley Act and related regulations.
Federal Securities Laws. Citizens South Banking Corporation common stock is registered with the SEC pursuant to Section 12(b) of the Exchange Act. Citizens South Banking Corporation is subject to the reporting requirements, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
Federal Taxation. The Company and the Bank are subject to the provisions of the Internal Revenue Code of 1986, as amended, in the same general manner as other corporations. For federal income tax purposes, the Bank reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its federal income tax returns.
State Taxation - North Carolina. Under North Carolina law, the corporate income tax is 6.9% of federal taxable income as computed under the Code, subject to certain prescribed adjustments. In addition, an annual state franchise tax is imposed at a rate of 0.15% applied to the greatest of the Company’s capital stock, surplus and undivided profits, investment in tangible property in North Carolina or 55% of the appraised valuation of property in North Carolina.
State Taxation - Delaware. Delaware franchise taxes are imposed on the Company. Two methods are provided for calculating the tax and the lesser tax is payable. The first method is based on the authorized number of shares. The tax under this method is $90.00 for the first 10,000 authorized shares plus $50.00 for each additional 10,000 authorized shares or part thereof. The second method is based on an assumed par value capital. The tax rate under this method is $200 per $1,000,000 or portion thereof of assumed par value capital. Assumed par is computed by dividing total assets by total issued shares (including treasury shares). Assumed par value capital is calculated by multiplying the lesser of assumed par or stated par value by total authorized shares.
An investment in our common stock involves certain risks. You should carefully consider the material risk factors described below and all other information contained in this Annual Report on Form 10-K before you decide to buy our common stock. If any of the events described below occur, the Company’s financial condition or results of operations could be materially adversely affected. In that event, the Company’s stock price may decline. It is possible that risks and uncertainties not listed below may arise or become material in the future and affect our business.
A prolonged economic downturn, especially one affecting our geographic market area, has and will adversely affect our business and financial results.
The economic condition of the United States and the markets that we serve has experienced a prolonged slowdown. While economic growth has resumed, the rate of growth has been slow and unemployment remains at relatively high levels. The economic downturn in the Charlotte region has generally been less severe than the economic slowdown experienced in other larger metropolitan areas of the country. However, the Charlotte region did experience decreases in housing prices, an increased unemployment rate, decreased housing starts and housing sales and commercial activity. Our business is subject to periodic fluctuations based on local economic conditions in the Charlotte and North Georgia regions. These fluctuations are not predictable, cannot be controlled, and may have a material adverse impact on our operations and financial condition. Our operations are locally oriented and community-based. Accordingly, we expect to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets we serve.
Weakness in our market areas could adversely affect our earnings and consequently our financial condition because borrowers may not be able to repay their loans, the value of the collateral securing loans to borrowers may decline, and the quality of our loan portfolio may decline. Any of these scenarios could require us to charge off a higher percentage of loans and/or increase provisions for loan losses, which would reduce our net income.
Due to our limited market areas, negative economic conditions may have a more noticeable effect on us than would be experienced by a larger institution that is able to spread these risks of unfavorable local economic conditions across a large number of diversified economies.
Strong competition within our market areas may limit our growth and profitability.
We face numerous competitors in both our community banking and mortgage banking operations in the Charlotte and North Georgia regions, which are our primary market areas. We compete for loan and deposit growth with large banks that have a regional or a national presence, other community banks, savings and loan associations, credit unions, brokerage and insurance firms, and other nonbank businesses, such as retailers that engage in consumer financing activities. Price competition for loans and deposits might result in earning less on our loans and paying more on our deposits, which would reduce our net interest income. Competition also makes it more challenging to grow loans and deposits and to hire and retain experienced employees. Some of the institutions with which we compete have substantially greater resources and lending limits than we do and may offer services that we do not provide.
Events that negatively impact the real estate market could hurt our business.
A significant portion of our loan portfolio has real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A continued weakening of the real estate market in our primary market areas could result in an increase in the number of borrowers that default on their loans and a reduction in the value of the collateral securing their loan. When we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholders’ equity are adversely affected.
We have added a significant number of loans secured by real estate over the past five years from new relationships as we have entered new markets through acquisitions and de novo offices. As a result, our loan portfolio may not be as seasoned as the loan portfolios of our competitors in some of these new markets. Should local real estate markets continue to weaken, we could experience higher default rates resulting in increased levels of nonperforming loans, which would likely result in higher loan losses and reduced earnings.
Nonresidential real estate loans increase our exposure to credit risks.
Over the last several years, we have increased our nonresidential real estate lending in order to improve the yield and reduce the duration of our assets. These loans may expose us to a greater risk of non-payment and loss than residential real estate loans because repayment often depends on the successful operations and earnings of the borrowers. Additionally, these loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. If loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.
If our nonperforming assets increase, our earnings will suffer.
Nonperforming assets consist of nonaccrual loans, loans 90 or more days delinquent, and other real estate owned. Our nonperforming assets adversely affect our net income in the following ways: 1) we do not record interest income on nonaccrual loans or other real estate owned; 2) there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our other real estate owned; and 3) the resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activities. As such, an increase in nonperforming assets will have an adverse effect on future earnings.
If the Company’s allowance for loan losses is not sufficient to cover actual loan losses, then our earnings could decrease.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of allowance for loan losses, we review our loan loss and delinquency experience, we evaluate current local economic conditions, and we analyze the collateral position of our loan portfolio. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in increases to our loan loss allowance. Material additions to our loan loss allowance would materially decrease our net income. In addition, federal regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities could have a material adverse effect on our financial condition and results of operations.
The Dodd-Frank Act, among other things, created a new Consumer Financial Protection Bureau, tightened capital standards and will continue to result in new laws and regulations that are expected to increase our costs of operations.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) is significantly changing the current bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act eliminated the primary federal regulator for Citizens South Banking Corporation and Citizens South Bank, which are now regulated by the Federal Reserve and the OCC, respectively. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impacts of the Dodd-Frank Act may not be known for many months or years. However, it is expected that the legislation and implementing regulations may materially increase our operating and compliance costs.
The Dodd-Frank Act requires minimum leverage, or Tier 1capital, and risk-based capital requirements for bank and savings and loan holding companies that are no less than those applicable to banks, which will exclude certain instruments that previously have been eligible for inclusion by bank holding companies as Tier 1 capital, such as trust preferred securities (“TPS”). TPS issued before May 19, 2010 by a bank holding company that had total assets of less than $15 billion as of December 31, 2009 are permanently grandfathered. The Company’s $15 million of TPS will be grandfathered under this legislation.
Effective July 21, 2011 is a provision of the Dodd-Frank Act that eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.
The Dodd-Frank Act also broadens the base for FDIC deposit insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution, rather than deposits. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and noninterest bearing transaction accounts have unlimited deposit insurance through December 31, 2012. The legislation also increases the required minimum reserve ratio for the Deposit Insurance Fund, from 1.15% to 1.35% of insured deposits, and directs the FDIC to offset the effects of increased assessments on depository institutions with less than $10 billion in assets.
In addition, the Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Banks and savings institutions with $10 billion or less in assets, like Citizens South Bank, will continue to be examined by their applicable bank regulators. The new legislation also weakens the federal preemption available for national banks and federal savings banks, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.
The Dodd-Frank Act requires publicly traded companies to give common stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. It also provides that the listing standards of the national securities exchanges shall require listed companies to implement and disclose “clawback” policies mandating the recovery of incentive compensation paid to executive officers in connection with accounting restatements. The legislation also directs the FRB to promulgate rules prohibiting excessive compensation paid to bank holding company executives.
Future legislative or regulatory actions responding to financial and market weakness could affect us adversely.
In response to the financial crises affecting the banking system and financial markets, the U.S. Congress has passed laws and the U.S. Treasury has promulgated programs designed to purchase assets from, provide equity capital to, and guarantee the liquidity of the financial services industry. However, there can be no assurance that actions of the U.S. Government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets will achieve the intended effect. The potential exists for additional federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, and the issuance of many formal enforcement orders is expected. Actions taken to date, as well as potential actions, may not have the beneficial effects that are intended, particularly with respect to the extreme levels of volatility and limited credit availability currently being experienced. In addition, new laws, regulations, and other regulatory changes will increase our costs of regulatory compliance and of doing business, and otherwise affect our operations. New laws, regulations, and other regulatory changes, along with negative developments in the financial services industry and the credit markets, may significantly affect the markets in which we do business, the markets for and value of our loans and investments, and our ongoing operations, costs and profitability.
Changes in interest rates could adversely affect the Company’s financial condition and results of operations.
Citizens South Banking Corporation’s results of operations and financial condition are affected by changes in interest rates. The Company’s results of operations depend substantially on net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Because the Company’s interest-earning assets generally reprice or mature more quickly than interest-bearing liabilities, a decrease in interest rates generally could result in a decrease in the Company’s net interest income. We are also subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, the Company is subject to reinvestment risk to the extent that it is unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Additionally, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans.
Changes in interest rates also affect the value of Citizens South Banking Corporation’s interest-earning assets, and in particular, its securities portfolio. Generally, the value of securities fluctuates inversely with changes in interest rates. Unrealized losses on securities available for sale, net of tax, are reported as a separate component of shareholders’ equity. As such, decreases in the fair value of securities available for sale resulting from increases in market interest rates, would have an adverse effect on shareholders’ equity.
Historically low interest rates may adversely affect our net interest income and profitability.
During the past three years it has been the policy of the Federal Reserve to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, market rates on the loans we have originated and the yields on securities we have purchased have been at lower levels than available prior to 2008. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets, which has been one factor contributing to the increase in our interest rate spread as interest rates decreased. However, our ability to lower our interest expense will be limited at these interest rate levels while the average yield on our interest-earning assets may continue to decrease. The Federal Reserve Board has recently indicated its intention to maintain low interest rates until at least late 2014. Accordingly, our net interest income may be adversely affected and may even decrease, which may have an adverse effect on our profitability.
The Standard & Poor’s downgrade in the U.S. government’s sovereign credit rating, and in the credit ratings of instruments issued, insured or guaranteed by certain related institutions, agencies and instrumentalities, could result in risks to Citizens South Banking Corporation and general economic conditions that we are not able to predict.
On August 5, 2011, Standard & Poor’s downgraded the U.S. long-term debt rating from its AAA rating to AA+. On August 8, 2011, Standard & Poor's downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. Instruments of this nature are key assets on the balance sheets of financial institutions, including Citizens South Bank. These downgrades could adversely affect the market value of such instruments, and could adversely impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. We cannot predict if, when or how these changes to the credit ratings will affect economic conditions. These ratings downgrades could result in a significant adverse impact to Citizens South Banking Corporation, and could exacerbate the other risks to which we are subject, including those described above.
We may face risks with respect to future expansion.
As a strategy, we have sought to increase the size of our operations by actively pursuing business development opportunities. We may seek whole bank or branch acquisitions in the future. Acquisitions and mergers involve a number of risks, including:
| | · | the time and costs associated with identifying and evaluating potential acquisitions and merger partners; |
| | · | the ability to finance an acquisition and possible ownership and economic dilution to existing stockholders; |
| | · | diversion of management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the acquired institution; |
| | · | the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on results of operations; and |
| | · | the risk of loss of key employees and customers. |
We may incur substantial costs to expand, and such expansion may not result in the levels of profits we seek. Integration efforts for any future mergers and acquisitions may not be successful and following any future merger or acquisition, after giving it effect, we may not achieve financial results comparable to or better than our historical experience.
The loss of key personnel may adversely affect us.
Our success is, and expected to remain, highly dependent on our senior management team and key officers. As a community bank, our management’s extensive knowledge of and relationships in the community generate a significant portion of our business. Successful execution of our business strategy will continue to place significant demands on our management and the loss of any such person’s services may adversely affect our growth and profitability.
Our trading volume is low compared with larger financial institutions.
The trading volume in the Company’s stock is comparable to other similarly-sized banks. However, this trading volume is low compared with larger financial institutions. As such, the liquidity of the Company’s stock is more limited than other companies which may adversely affect the price at which shares of our common stock may be sold.
Our information systems may experience a security breach, computer virus, or disruption of service.
Citizens South Bank relies heavily on communications and information systems to conduct its business, and provides its customers the ability to bank online. Our network could become vulnerable to unauthorized access, computer viruses, phishing schemes and other security problems. Citizens South Bank may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that Citizens South Bank’s activities or the activities of its customers involve the storage and transmission of confidential information, security breaches and viruses could expose Citizens South Bank to claims, litigation and other possible liabilities. Any failure, interruption, or breach in security or operational integrity of its systems could also result in failures or disruptions in our general ledger, deposit, loan, and other systems, and could subject us to additional regulatory scrutiny. Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in Citizens South Bank’s systems and could adversely affect its reputation and its ability to generate deposits.
A substantial decline in the value of our FHLB common stock may adversely affect our financial condition.
We own common stock of the FHLB of Atlanta in order to qualify for membership in the FHLB system, which enables us to borrow funds under the FHLB advance program. Recent published reports indicate that certain member banks of the FHLB system may be subject to asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capitalization of a FHLB, including the FHLB of Atlanta, could be substantially diminished. Consequently, given that there is no market for our FHLB of Atlanta common stock, we believe that there is a risk that our investment could be deemed other than temporarily impaired at some time in the future. If this occurs, it would adversely affect our results of operations and financial condition.
Declines in the value of certain investment securities could require write-downs, which would reduce our earnings.
A number of factors, or combinations of factors, could cause us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to these securities constitutes an impairment that is other than temporary. These factors include, but are not limited to, failure to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value, or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value. An other-than-temporary impairment write-down would reduce our earnings.
Various factors may make takeover attempts more difficult to achieve.
Provisions of the Company’s certificate of incorporation and bylaws, federal regulations, Delaware law and various other factors may make it more difficult for companies or persons to acquire control of Citizens South Banking Corporation without the consent of its Board of Directors. As a Citizens South Banking Corporation stockholder, you may want a takeover attempt to succeed because, for example, a potential acquirer could offer a premium over the then-prevailing price of Citizens South Banking Corporation’s common stock. The factors that may discourage takeover attempts or make them more difficult include:
Certificate of incorporation and statutory provisions. Provisions of the certificate of incorporation and bylaws of Citizens South Banking Corporation and Delaware law may make it more difficult and expensive to pursue a takeover attempt that management opposes. These provisions also would make it more difficult to remove Citizens South Banking Corporation’s current Board of Directors or management, or to elect new directors. These provisions include limitations on voting rights of beneficial owners of more than 10% of its common stock, supermajority voting requirements for certain business combinations and the election of directors to staggered terms of three years. The Company’s bylaws also contain provisions regarding the timing and content of shareholder proposals and nominations and qualification for service on the Board of Directors.
Required change in control payments and issuance of stock options and recognition plan shares. Citizens South Banking Corporation has entered into employment agreements and change of control agreements with certain executive officers, which will require payments to be made to them in the event their employment is terminated following a change in control of Citizens South Banking Corporation or Citizens South Bank. Citizens South Banking Corporation also has adopted plans to permit additional issuances of stock options and recognition plan shares to key employees and directors that will require payments to them in connection with a change in control of Citizens South Banking Corporation. These payments will have the effect of increasing the costs of acquiring the Company, thereby discouraging future takeover attempts.
The pre-tax gain we recorded upon the acquisition of New Horizons Bank is a preliminary amount and could be decreased.
We accounted for the New Horizons Bank acquisition under the purchase method of accounting, recording the acquired assets and liabilities of New Horizons Bank at fair value based on preliminary purchase accounting adjustments. Determining the fair value of assets and liabilities, particularly illiquid assets and liabilities, is a complicated process involving a significant amount of judgment regarding estimates and assumptions. Based on the preliminary adjustments made, the fair value of the assets we acquired exceeded the fair value of the liabilities assumed which resulted in an initial $4.4 million pre-tax gain for our company. Under purchase accounting, we have up to one year after the acquisition to finalize the fair value adjustments, meaning that until then we could materially adjust the preliminary fair value estimates of New Horizons Bank’s assets and liabilities based on new or updated information. Such adjustments could reduce the extent by which the assets acquired exceeded the liabilities assumed and would result in a decrease to the pre-tax gain that we recorded as of the acquisition date.
We may incur losses on acquired loans that are materially greater than we originally projected.
Both Bank of Hiawassee and New Horizons Bank had a significant amount of deteriorating and nonperforming loans that ultimately led to the closure of the banks. When we placed our bid with the FDIC to assume the assets and liabilities of these banks, we estimated an amount of future loan losses that we believed would occur and factored those expected losses into our bid amount. Estimating loan losses on an entire portfolio of loans is a difficult process that is dependent on a significant amount of judgment and estimates, especially for loan portfolios that have a high concentration of deteriorating and nonperforming loans like the loan portfolios that were acquired in these FDIC-assisted transactions. If we materially underestimated the extent of those losses, it could result in additional losses that would be reflected in the Company’s provision for loan losses.
We may experience difficulty in managing the loan and other real estate owned portfolios acquired from Bank of Hiawassee and New Horizons Bank within the limits of the loss protection provided by the FDIC.
In connection with the Bank’s FDIC-assisted acquisitions of Bank of Hiawassee and New Horizons Bank, Citizens South Bank entered into loss-sharing agreements with the FDIC that covered approximately $231.1 million of Bank of Hiawassee’s loans and approximately $82.6 million of New Horizons Bank’s loans and other real estate owned. Citizens South Bank will share in the losses, which begin with the first dollar of loss incurred, of the assets covered by the loss-sharing agreements, which include residential mortgage loans and nonresidential loans (collectively referred to as “covered loans”). Pursuant to the terms of the Bank of Hiawassee loss-sharing agreements, the FDIC is obligated to reimburse Citizens South Bank 80% of eligible losses of up to $102 million with respect to covered loans. The FDIC will reimburse Citizens South Bank for 95% of eligible losses in excess of $102 million with respect to covered loans. Citizens South Bank has a corresponding obligation to reimburse the FDIC for 80% or 95%, as applicable, of eligible recoveries with respect to covered loans. Pursuant to the terms of the New Horizons Bank loss-sharing agreements, the FDIC is obligated to reimburse Citizens South Bank 80% of eligible losses with respect to covered assets. Citizens South Bank has a corresponding obligation to reimburse the FDIC for 80% of eligible recoveries with respect to covered loans. Although we have expertise in asset resolution, we cannot guarantee that we will be able to adequately manage the covered loan portfolios within the limits of the loss protection provided by the FDIC.
We may engage in additional FDIC-assisted transactions, which could present additional risks to our business.
We may have opportunities to acquire the assets and liabilities of additional failed banks in FDIC-assisted transactions. We would be subject to many of the same risks that exist with respect to our acquisition of Bank of Hiawassee. In addition, because FDIC-assisted transactions are structured in a manner that do not allow us the time and access to information normally associated with preparing for and evaluating a negotiated acquisition, we may face additional risks in FDIC-assisted transactions, including additional strain on management resources, management of problem loans, problems related to integration of personnel and operating systems and impact to our capital resources requiring us to raise additional capital. We may not be successful in overcoming these risks or any other problems encountered in connection with FDIC-assisted transactions. Our inability to overcome these risks could have a material adverse effect on our business, financial condition and results of operations.
| UNRESOLVED STAFF COMMENTS |
None.
At December 31, 2011, the Company operated 21 full-service branch offices located in North Carolina, South Carolina, and Georgia. There were 16 full-service branch offices located in the Charlotte region. Twelve of these offices were owned by the Company including offices located in the North Carolina counties of Gaston (7), Rowan (2), Iredell (2) and Union (1). The remaining four offices, which were located in Monroe, Indian Trail, and Charlotte, North Carolina and Rock Hill, South Carolina, were leased. The Company also operated five full-service branch offices in North Georgia. These offices are all owned by the Company and are located in the Georgia counties of Fannin (1), Union (1), Gilmer (1) and Towns (2). Management considers the facilities to be well maintained and suitable for present operations.
Periodically there have been various claims and lawsuits involving the Company or the Bank, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. In the opinion of management, we are not a party to any pending legal proceedings that we believe would have a material adverse effect on the financial condition, operations, or cash flows of the Company or the Bank.
Not applicable.
| MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Company’s common stock is listed on the Nasdaq Global Market under the ticker symbol “CSBC.” Price and volume information is contained in The Wall Street Journal and other daily newspapers in the Nasdaq section under the Global Market System listings. Market makers in the Company’s common stock include Keefe, Bruyette & Woods, Inc., Sandler O’Neill & Partners, Howe Barnes Investments, Inc., Sterne, Agee, and Leach, Inc., Stifel Nicholas & Co., Fig Partners LLC, and others. As of February 14, 2012, the Company had 1,499 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 11,508,750 shares outstanding.
The following table sets forth quarterly closing market sales price ranges for the common stock and the cash dividend declared per share for the Company’s common stock over the past two years.
| | | Year Ending December 31, 2011 | | | Year Ending December 31, 2010 | |
| Quarter | | High | | | Low | | | Dividend | | | High | | | Low | | | Dividend | |
| 1st | | $ | 4.99 | | | $ | 4.25 | | | $ | 0.01 | | | $ | 6.19 | | | $ | 4.19 | | | $ | 0.04 | |
| 2nd | | | 5.19 | | | | 3.88 | | | | 0.01 | | | | 6.90 | | | | 4.76 | | | | 0.04 | |
| 3rd | | | 4.25 | | | | 3.00 | | | | 0.01 | | | | 6.33 | | | | 4.46 | | | | 0.04 | |
| 4th | | | 4.22 | | | | 2.90 | | | | 0.01 | | | | 5.10 | | | | 3.90 | | | | 0.01 | |
Dividend Policy. The Company’s common stockholders are entitled to receive cash dividends as the Board of Directors authorizes at the Board’s discretion. The Board of Directors considers the Company’s current and projected earnings as well as the Company’s capital levels on a quarterly basis to determine the amount of the quarterly dividend to be paid to the common stockholders. Based on this analysis, the Board of Directors lowered the quarterly dividend paid to common stockholders from $0.04 per share to $0.01 per share in the fourth quarter of 2010 due to lower earnings resulting from increased loan loss reserves. The Company has paid a cash dividend each year since converting from a mutual to stock form of ownership. We intend to continue to pay such quarterly cash dividends if such dividends are considered to be in the best interests of the common stockholders and if such payments will allow the Bank to maintain its capital status as “well capitalized” under applicable banking regulations.
Recent Sales of Unregistered Securities. Not applicable.
Repurchases of Equity Securities. There were no repurchases of equity securities during the year ended December 31, 2011. The most recent repurchase authorization was granted by the Board of Directors in June 2008, for the repurchase of up to 220,500 shares, or approximately 2.7% of the Company’s then outstanding shares of common stock. As of December 31, 2011, the Company had repurchased a total of 10,477 shares at an average price of $7.13 per share and had 210,023 shares remaining to be repurchased under this plan.
The following table presents selected information concerning the financial position of Citizens South Banking Corporation and its subsidiaries as of and for the dates indicated.
| Table 1 - Selected Consolidated Financial Information and Other Data | | | | | | | | | | |
| (Dollars in thousands, except per share and nonfinancial data) | | | | | | | | | | | | | |
| | | At or for the years ended | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | | | | |
| Summary of Operations: | | | | | | | | | | | | | | | |
| Interest income | | $ | 44,076 | | | $ | 43,915 | | | $ | 38,300 | | | $ | 42,991 | | | $ | 46,735 | |
| Interest expense | | | 10,538 | | | | 14,678 | | | | 16,526 | | | | 22,351 | | | | 26,500 | |
| Net interest income | | | 33,538 | | | | 29,237 | | | | 21,774 | | | | 20,640 | | | | 20,235 | |
| Provision for loan losses | | | 10,685 | | | | 14,050 | | | | 10,980 | | | | 3,275 | | | | 1,290 | |
| Net interest income after loan loss provision | | | 22,853 | | | | 15,187 | | | | 10,794 | | | | 17,365 | | | | 18,945 | |
| Noninterest income | | | 11,341 | | | | 27,136 | | | | 7,972 | | | | 5,635 | | | | 6,562 | |
| Noninterest expense | | | 34,655 | | | | 29,335 | | | | 50,272 | | | | 19,226 | | | | 17,895 | |
| Net income (loss) before income taxes | | | (461 | ) | | | 12,988 | | | | (31,506 | ) | | | 3,774 | | | | 7,612 | |
| Income tax expense (benefit) | | | (702 | ) | | | 4,349 | | | | (1,499 | ) | | | 639 | | | | 1,947 | |
| Net income (loss) | | | 241 | | | | 8,639 | | | | (30,007 | ) | | | 3,135 | | | | 5,665 | |
| Dividends on preferred stock | | | 1,526 | | | | 1,025 | | | | 1,034 | | | | 54 | | | | - | |
| Net income (loss) available to common shareholders | | $ | (1,285 | ) | | $ | 7,614 | | | $ | (31,041 | ) | | $ | 3,081 | | | $ | 5,665 | |
| | | | | | | | | | | | | | | | | | | | | |
| Per Common Share Data: | | | | | | | | | | | | | | | | | | | | |
| Net income (loss): | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | (0.11 | ) | | $ | 0.78 | | | $ | (4.19 | ) | | $ | 0.42 | | | $ | 0.74 | |
| Diluted | | | (0.11 | ) | | | 0.78 | | | | (4.19 | ) | | | 0.42 | | | | 0.73 | |
| Weighted average shares outstanding: | | | | | | | | | | | | | | | | | | | | |
| Basic | | | 11,459,046 | | | | 9,742,330 | | | | 7,410,692 | | | | 7,374,051 | | | | 7,688,022 | |
| Diluted | | | 11,459,046 | | | | 9,742,330 | | | | 7,410,692 | | | | 7,374,051 | | | | 7,753,940 | |
| End of year shares outstanding | | | 11,506,324 | | | | 11,508,750 | | | | 7,526,854 | | | | 7,515,957 | | | | 7,610,017 | |
| Cash dividends paid | | $ | 0.04 | | | $ | 0.13 | | | $ | 0.16 | | | $ | 0.34 | | | $ | 0.32 | |
| Dividend payout ratio | | NM | | | | 16.63 | % | | NM | | | | 81.38 | % | | | 43.80 | % |
| Book value | | | 6.27 | | | | 6.32 | | | | 6.87 | | | | 11.21 | | | | 11.05 | |
| Tangible book value | | | 6.15 | | | | 6.17 | | | | 6.80 | | | | 7.14 | | | | 6.96 | |
| | | | | | | | | | | | | | | | | | | | | |
| Selected End of Year Balances: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 1,080,460 | | | $ | 1,064,487 | | | $ | 791,532 | | | $ | 817,213 | | | $ | 779,140 | |
| Loans, net of deferred fees and costs | | | 733,788 | | | | 736,510 | | | | 610,201 | | | | 626,688 | | | | 559,956 | |
| Allowance for loan losses | | | 11,713 | | | | 11,924 | | | | 9,189 | | | | 8,026 | | | | 6,144 | |
| Investment securities | | | 147,899 | | | | 111,586 | | | | 83,370 | | | | 109,180 | | | | 116,412 | |
| Deposits | | | 876,056 | | | | 850,789 | | | | 609,345 | | | | 581,488 | | �� | | 590,765 | |
| Shareholders' equity | | | 92,659 | | | | 93,443 | | | | 72,322 | | | | 104,720 | | | | 84,033 | |
| | | | | | | | | | | | | | | | | | | | | |
| Selected Average Balances: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 1,089,962 | | | $ | 1,018,716 | | | $ | 830,244 | | | $ | 799,869 | | | $ | 753,085 | |
| Loans, net of deferred fees and costs | | | 742,618 | | | | 729,202 | | | | 621,949 | | | | 593,404 | | | | 526,913 | |
| Investment securities | | | 144,980 | | | | 95,452 | | | | 99,837 | | | | 111,473 | | | | 126,639 | |
| Deposits | | | 877,378 | | | | 798,009 | | | | 609,034 | | | | 580,811 | | | | 575,302 | |
| Shareholders' equity | | | 94,238 | | | | 90,304 | | | | 104,222 | | | | 85,232 | | | | 84,784 | |
| | | | | | | | | | | | | | | | | | | | | |
| Selected Financial Performance Ratios: | | | | | | | | | | | | | | | | | | | | |
Return on average assets (1) (2) | | | -0.12 | % | | | 0.75 | % | | | -3.74 | % | | | 0.39 | % | | | 0.75 | % |
Return on average common equity (1) (2) | | | -1.39 | % | | | 8.15 | % | | | -42.92 | % | | | 2.94 | % | | | 6.74 | % |
Noninterest income to average total assets (1) | | | 1.04 | % | | | 2.66 | % | | | 0.96 | % | | | 0.70 | % | | | 0.87 | % |
Noninterest expense to average total assets (2) | | | 3.18 | % | | | 2.88 | % | | | 6.06 | % | | | 2.40 | % | | | 2.38 | % |
Efficiency ratio (1) (2) | | | 77.22 | % | | | 52.04 | % | | | 169.00 | % | | | 73.17 | % | | | 66.78 | % |
| Table 1 - Selected Consolidated Financial Information and Other Data (continued) | | | | | | | |
| (Dollars in thousands, except per share and nonfinancial data) | | | | | | | | | | | | | |
| | | At or for the years ended | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | | | | |
| Net Interest Margin: | | | | | | | | | | | | | | | |
| Yield on earning assets | | | 4.60 | % | | | 4.81 | % | | | 5.19 | % | | | 6.11 | % | | | 7.13 | % |
| Cost of funds | | | 1.17 | % | | | 1.73 | % | | | 2.44 | % | | | 3.36 | % | | | 4.29 | % |
| Net Interest spread | | | 3.43 | % | | | 3.08 | % | | | 2.75 | % | | | 2.75 | % | | | 2.84 | % |
Net interest margin (taxable equivalent) | | | 3.50 | % | | | 3.21 | % | | | 2.98 | % | | | 2.97 | % | | | 3.14 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Credit Quality Information and Ratios: | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses - beginning of year | | $ | 11,924 | | | $ | 9,189 | | | $ | 8,026 | | | $ | 6,144 | | | $ | 5,764 | |
| Add: Provision for loan losses | | | 10,685 | | | | 14,050 | | | | 10,980 | | | | 3,275 | | | | 1,290 | |
| Less: Net charge-offs | | | 10,896 | | | | 11,315 | | | | 9,817 | | | | 1,393 | | | | 910 | |
| Allowance for loan losses - end of year | | $ | 11,713 | | | $ | 11,924 | | | $ | 9,189 | | | $ | 8,026 | | | $ | 6,144 | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses to total non-covered loans | | | 2.04 | % | | | 2.02 | % | | | 1.51 | % | | | 1.28 | % | | | 1.10 | % |
| Net charge-offs to average non-covered loans | | | 1.88 | % | | | 1.88 | % | | | 1.58 | % | | | 0.23 | % | | | 0.17 | % |
| Non-covered nonperforming loans to non-covered loans | | | 3.28 | % | | | 2.79 | % | | | 1.96 | % | | | 0.48 | % | | | 0.32 | % |
| Non-covered nonperforming assets to total assets | | | 2.57 | % | | | 2.26 | % | | | 2.15 | % | | | 0.69 | % | | | 0.30 | % |
| Non-covered nonperforming assets to total non-covered loans and other real estate owned | | | 4.76 | % | | | 4.03 | % | | | 2.77 | % | | | 0.90 | % | | | 0.42 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Nonperforming Assets: | | | | | | | | | | | | | | | | | | | | |
| Non-covered nonperforming loans | | $ | 18,811 | | | $ | 16,414 | | | $ | 11,990 | | | $ | 3,032 | | | $ | 1,812 | |
Nonperforming loans covered by FDIC loss share (3) | | | 44,056 | | | | 25,542 | | | | - | | | | - | | | | - | |
| Other real estate owned - non-covered | | | 8,936 | | | | 7,650 | | | | 5,067 | | | | 2,601 | | | | 529 | |
| Other real estate owned - covered by FDIC loss share | | | 8,635 | | | | 7,002 | | | | - | | | | - | | | | - | |
| Repossessed assets - covered by FDIC loss share | | | 111 | | | | | | | | | | | | | | | | | |
| Total nonperforming assets | | $ | 80,549 | | | $ | 56,608 | | | $ | 17,057 | | | $ | 5,633 | | | $ | 2,341 | |
| | | | | | | | | | | | | | | | | | | | | |
| Capital Ratios: | | | | | | | | | | | | | | | | | | | | |
| Tangible common equity | | | 6.56 | % | | | 6.69 | % | | | 6.47 | % | | | 6.82 | % | | | 7.08 | % |
| Leverage Capital (Bank only) | | | 9.44 | % | | | 9.74 | % | | | 10.44 | % | | | 10.40 | % | | | 8.74 | % |
| Tier 1 Risk-Based Capital (Bank only) | | | 14.35 | % | | | 15.54 | % | | | 12.98 | % | | | 12.01 | % | | | 10.25 | % |
| Total Risk-Based Capital (Bank only) | | | 15.60 | % | | | 16.80 | % | | | 14.07 | % | | | 13.07 | % | | | 11.21 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Other Data: | | | | | | | | | | | | | | | | | | | | |
| Number of banking offices | | | 21 | | | | 21 | | | | 16 | | | | 15 | | | | 15 | |
| Number of employees (full-time equivalents) | | | 222 | | | | 230 | | | | 138 | | | | 149 | | | | 153 | |
| | | | | | | | | | | | | | | | | | | | | |
| (1) | Includes the $19.7 million gain on acquisition of Bank of Hiawassee for the year ended December 31, 2010, and the $4.1 million gain on acquisition of New Horizons Bank for the year ended December 31, 2011. |
| (2) | Includes $29.6 million impairment of goodwill for the year ended December 31, 2009. Also includes acquisition and integration expenses of $792,000 for the year ended December 31, 2011, $1.1 million for the year ended December 31, 2010, and $220,000 for the year ended December 31, 2008. |
| (3) | The contractual balance of nonperforming loans covered by FDIC loss-share agreements totaled $55.4 million at December 31, 2011 and $31.2 millionat December 31, 2010. |
| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis is provided to assist readers in understanding and evaluating the financial condition and results of operations of the Company and its subsidiaries. The following discussion should be read in conjunction with the audited consolidated financial statements and related notes included in Item 8. of this Annual Report.
Executive Overview
For the year ended December 31, 2011, the Company reported net loss allocable to common stockholders of $1.3 million, or $0.11 per diluted share compared to net income available to common shareholders of $7.6 million, or $0.78 per diluted share, for the year ended December 31, 2010. A summary of the primary reasons for the change in net income and other significant events that occurred in 2011 is as follows:
| | · | In April 2011 the Bank acquired approximately $105.4 million of assets and assumed approximately $102.5 million of liabilities from New Horizons Bank in an FDIC-assisted transaction, net of fair value adjustments. As a result of this transaction the Bank posted a $4.1 million pre-tax gain on acquisition, or $2.9 million after-tax. In March 2010 the Bank acquired $343.3 million in assets and assumed $331.8 million of liabilities from Bank of Hiawassee in a FDIC-assisted transaction, net of fair value adjustments. As a result of this transaction, the Company posted a $19.7 million pre-tax gain from acquisition, or $11.5 million after-tax. These transactions have had a positive impact on the Company’s net interest income and noninterest income during the past two years. However, the acquisitions have also resulted in higher operating costs related to operating five additional offices, which has increased noninterest expenses. |
| | · | The Company’s total credit costs decreased slightly during 2011as the provision for loan losses decreased by $3.4 million to $10.7 million. However, write downs and expenses on other real estate owned increased by $3.2 million to $5.6 million for 2011. The higher than historical credit costs during the past two years reflect the continued weakness of the overall economy in the Company’s local markets. |
| | · | The Company’s net interest margin was 3.50% for the year ended December 31, 2011 compared to 3.21% for the year ended December 31, 2010. This 29 basis point improvement was primarily due to the Company’s cost of funds decreasing at a faster rate than its yield on assets. During 2011, the Company’s cost of funds decreased 56 basis points, while its yield on assets decreased only 21 basis points. |
| | · | The Company redeemed all of the $20.5 million of preferred stock and related warrants issued to the U.S. Treasury Department under the Capital Purchase Plan, a part of the Troubled Asset Relief Program (“TARP”). |
| | · | The Company issued $20.5 million of preferred stock as part of the U.S. Treasury Department’s Small Business Lending Fund (“SBLF”) initiative. Participation in the SBLF helped to facilitate the TARP repayment. |
| | · | The Company paid total cash dividends of $0.04 per share to common stockholders in 2011. |
Critical Accounting Policies and Estimates
The accounting and financial policies of the Company and its subsidiaries are prepared in accordance with accounting principles generally accepted in the United States and conform to general practices in the banking industry. We consider accounting policies that require difficult or subjective judgment and assumptions by management that have, or could have a material impact on the carrying value of certain assets or on income to be critical accounting policies. Changes in underlying factors, assumptions or estimates could have a material impact on our future financial condition and results of operations. Based on the size of the item or significance of the estimate, the following accounting policies are considered critical to our financial results.
Allowance for Loan Losses. The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses inherent in the Bank’s portfolio at the measurement date. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss for each type of loan and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of the collateral. Management has established a systematic method for periodically evaluating the credit quality of the loan portfolio in order to establish an allowance for loan losses. The methodology is consistently applied, set forth in a formal policy and includes a review of all loans in the portfolio on which full collectability may or may not be reasonably assured. Management’s periodic evaluation of the adequacy of the allowance is consistently applied and is based on our past loan loss experience, particular risks inherent in the different kinds of lending that we engage in, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions, and other relevant internal and external factors that affect loan collectability. Specific allowances are established for certain individual loans that management considers impaired. The remainder of the portfolio is segmented into groups of loans with similar risk characteristics for evaluation and analysis. We increase our allowance for loan losses by charging provisions for loan losses against our current period income. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.
Other-Than-Temporary Impairment. The Company reviews all investment securities with significant declines in fair value for potential other-than-temporary impairment on a periodic basis. The Company records an impairment charge when it believes an investment has experienced a decline in value that is other than temporary. Generally changes in market interest rates that result in a decline in value of an investment security are considered to be temporary, since the value of such investment can recover in the foreseeable future as market interest rates return to their original levels. However, such declines in value that are due to the underlying credit quality of the issuer or other adverse conditions that cannot be expected to improve in the foreseeable future, may be considered to be other than temporary. Management believes this is a critical accounting policy because this evaluation of the underlying credit or analysis of other conditions contributing to the decline in value involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.
Business Combinations, Method of Accounting for Loans Acquired, and FDIC Indemnification Asset. We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. In accordance with FASB ASC Topic 805, the FDIC Indemnification Asset was initially recorded at its fair value, and is measured separately from the loan assets and foreclosed assets because the loss sharing agreements are not contractually embedded in them or transferrable with them in the event of disposal.
Results of Operations
Overview. The Company reported a net loss allocable to common shareholders of $1.3 million, or $0.11 per diluted share, for the year ended December 31, 2011, compared to net income available to common shareholders of $7.6 million, or $0.78 per diluted share, for the year ended December 31, 2010. The primary contributing factor for the net loss in 2011 was higher than historical credit-related loan and other real estate owned expenses which totaled $16.3 million. The primary reason for the net income in 2010 was the $19.7 million gain from acquisition related to the FDIC-assisted acquisition of Bank of Hiawassee.
The table below summarizes the quarterly results of operations for the years ending December 31, 2011 and 2010.
| Table 2 - Quarterly Results of Operations | | | | | | | | | | | | | | | | | | | | | | |
| (Dollars in thousands, except per share data) | | | | | | | | | | | | | | | | | | | |
| | | 2011 Quarters | | | 2010 Quarters | |
| | | Fourth | | | Third | | | Second | | | First | | | Fourth | | | Third | | | Second | | | First | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Summary of Operations: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest income | | $ | 11,024 | | | $ | 11,246 | | | $ | 11,419 | | | $ | 10,387 | | | $ | 10,985 | | | $ | 11,596 | | | $ | 12,194 | | | $ | 9,112 | |
| Interest expense | | | 2,304 | | | | 2,554 | | | | 2,826 | | | | 2,855 | | | | 3,411 | | | | 3,790 | | | | 4,083 | | | | 3,393 | |
| Net interest income | | | 8,720 | | | | 8,692 | | | | 8,593 | | | | 7,532 | | | | 7,574 | | | | 7,806 | | | | 8,111 | | | | 5,719 | |
| Provision for loan losses | | | 4,635 | | | | 1,350 | | | | 1,700 | | | | 3,000 | | | | 5,000 | | | | 3,000 | | | | 3,000 | | | | 3,050 | |
| Net interest income after loan loss provision | | | 4,085 | | | | 7,342 | | | | 6,893 | | | | 4,532 | | | | 2,574 | | | | 4,806 | | | | 5,111 | | | | 2,669 | |
| Noninterest income | | | 1,985 | | | | 1,990 | | | | 5,886 | | | | 1,478 | | | | 2,274 | | | | 2,290 | | | | 2,415 | | | | 20,185 | |
| Noninterest expense | | | 8,779 | | | | 8,931 | | | | 9,270 | | | | 7,672 | | | | 7,918 | | | | 7,781 | | | | 7,279 | | | | 6,356 | |
| Net income (loss) before income taxes | | | (2,709 | ) | | | 401 | | | | 3,509 | | | | (1,662 | ) | | | (3,070 | ) | | | (685 | ) | | | 247 | | | | 16,498 | |
| Income tax expense (benefit) | | | (1,172 | ) | | | 28 | | | | 1,213 | | | | (771 | ) | | | (1,331 | ) | | | (413 | ) | | | (108 | ) | | | 6,201 | |
| Net income (loss) | | | (1,537 | ) | | | 373 | | | | 2,296 | | | | (891 | ) | | | (1,739 | ) | | | (272 | ) | | | 355 | | | | 10,297 | |
| Dividends and accretion of discount on preferred stock | | | 767 | | | | 247 | | | | 256 | | | | 256 | | | | 256 | | | | 256 | | | | 257 | | | | 257 | |
| Net income (loss) available to common shareholders | | $ | (2,304 | ) | | $ | 126 | | | $ | 2,040 | | | $ | (1,147 | ) | | $ | (1,995 | ) | | $ | (528 | ) | | $ | 98 | | | $ | 10,040 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Per Common Share Data: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | (0.20 | ) | | $ | 0.01 | | | $ | 0.18 | | | $ | (0.10 | ) | | $ | (0.18 | ) | | $ | (0.05 | ) | | $ | 0.01 | | | $ | 1.29 | |
| Diluted | | | (0.20 | ) | | | 0.01 | | | | 0.18 | | | | (0.10 | ) | | | (0.18 | ) | | | (0.05 | ) | | | 0.01 | | | | 1.29 | |
Net interest income. Net interest income is the largest component of our net income. Net interest income is the difference between total interest income, primarily on loan and investment portfolios, and interest expense, primarily on deposits and borrowings. Net interest income is determined by the rates earned and paid on interest-earning assets and interest-costing liabilities, the volume, or amount, of interest-earning assets and interest-costing liabilities, and the mix of interest earnings assets and interest costing liabilities.
The Company’s net interest income increased by $4.3 million, or 14.7%, from $29.2 million for the year ended December 31, 2010, to $33.5 million for the year ended December 31, 2011. During 2011 the Company experienced a 29 basis point increase in the net interest margin from 3.21% for 2010 to 3.50% for 2011. This increase in the net interest margin was caused in part by a 56 basis point decrease in the Company’s average cost of funds from 1.73% in 2010 to 1.17% for 2011. The benefit from the lower cost of funds was partly offset by a 21 basis point decrease in the average yield on assets from 4.81% in 2010 to 4.60% in 2011. Also contributing to the net interest margin expansion was a $44.1 million increase in the Company’s average interest-earning assets from $920.6 million in 2010 to $964.6 million in 2011. However, average interest-bearing liabilities increased by $56.1 million from $847.2 million in 2010 to $903.3 million in 2011, which partly offset the effects of the increase in average interest-earning assets.
Interest income for the year ended December 31, 2011, increased by $161,000, or 0.34%, to $44.1 million. Interest and fee income from loans decreased by $382,000, or 0.9%, to $40.2 million for the year ended December 31, 2011. This decrease was caused by a 15 basis point decrease in the average yield on loans in 2011 to 5.41% reflecting lower market interest rates in 2011. This decrease was partly offset by a $13.4 million increase in the average balance of loans to $742.6 million for 2011. Interest earned on investment securities increased by $655,000, or 21.4%, to $3.7 million for the year ended December 31, 2011. This increase in interest income on investment securities was due to a $49.5 million increase in the average outstanding balance of investment securities to $145.0 million in 2011. This increase was partly offset by a 65 basis point decrease in the average yield on investments to 2.56% in 2011. Interest earned on interest-bearing bank balances decreased by $112,000, or 35.7%, to $202,000 in 2011. This decrease was primarily due to an $18.9 million decrease in the average balance in 2011 coupled with a seven basis point decrease in the average yield of interest-bearing bank balances to 0.26% in 2011.
Interest expense decreased $4.1 million, or 28.2%, to $10.5 million for the year ended December 31, 2011. This decrease was largely due to a 56 basis point decrease in the average cost of funds from 1.73% in 2010 to 1.17% in 2011, reflecting lower market interest rates in 2011. Interest expense on deposits decreased $3.1 million, or 30.5%, to $7.1 million for the year ended December 31, 2011. This decrease was primarily due to a 50 basis point decrease in the average cost of deposits to 0.90% in 2011, reflecting lower market interest rates in 2011. The positive impact of a decrease in the cost of deposits was partly offset by a $65.5 million increase in average deposits to $795.9 million in 2011. Interest expense on borrowed money and retail repurchase agreements decreased by $420,000, or 12.0%, to $3.1 million in 2011. Average borrowed money and retail repurchase agreements decreased by $9.3 million, or 9.2%, to $92.0 million for 2011, while the average rate paid on borrowings and retail repurchase agreements decreased by 11 basis points to 3.35% for 2011. Average borrowings and retail repurchase agreements decreased due to maturities that were funded by cash flow funds generated from deposit growth. The Company may increase the level of borrowings to provide liquidity for operating purposes, to purchase investment securities, fund loan growth, and offset any deposit decreases. If these borrowing levels increase, we expect there will be a corresponding increase in interest expense. There was no change in the $15.4 million average balance of subordinated debt from 2010 to 2011. However, the average interest rate decreased by 3.79%. The interest rate on the subordinated debt was fixed at 6.1% for a period of five years and then the rate would adjust to the three month LIBOR rate plus 1.65% on a quarterly basis. The rate on this subordinated debt converted from a fixed rate to a lower adjustable rate in 2010, resulting in the decrease in the cost of funds in 2011.
Tables 3 and 4 below set forth certain information regarding the Company’s yield on interest-earnings assets and cost of interest-bearing liabilities for each of the years ended December 31, 2011, 2010 and 2009. Table 3 details the Company’s average assets and average liabilities and the respective yield or cost of each of the components that are detailed. Table 4 sets forth information regarding changes in our interest income and interest expense for the years indicated. For each category of our interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to 1) changes in volume, which are changes in average volume multiplied by the average rate for the previous period; 2) changes in rates which are changes in average rate multiplied by the average volume for the previous period; and (3) changes in rate/volume, which are allocated equally between rate and volume variances. The total change is the sum of the previous columns.
| Table 3 - Average Balances and Net Interest Income | | | | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| Interest-earning assets: (1) | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans (2) | | $ | 742,618 | | | $ | 40,306 | | | | 5.43 | % | | $ | 729,202 | | | $ | 40,690 | | | | 5.58 | % | | $ | 621,949 | | | $ | 33,801 | | | | 5.43 | % |
| Investment securities, tax effected | | | 144,980 | | | | 3,831 | | | | 2.64 | % | | | 95,452 | | | | 3,262 | | | | 3.42 | % | | | 99,837 | | | | 4,931 | | | | 4.94 | % |
| Interest-earning bank deposits | | | 77,038 | | | | 202 | | | | 0.26 | % | | | 95,922 | | | | 314 | | | | 0.33 | % | | | 27,001 | | | | 100 | | | | 0.37 | % |
| Total interest-earning assets | | | 964,636 | | | | 44,339 | | | | 4.60 | % | | | 920,576 | | | | 44,266 | | | | 4.81 | % | | | 748,787 | | | | 38,832 | | | | 5.19 | % |
| Other assets | | | 125,326 | | | | | | | | | | | | 98,140 | | | | | | | | | | | | 81,457 | | | | | | | | | |
| Total assets | | $ | 1,089,962 | | | | | | | | | | | $ | 1,018,716 | | | | | | | | | | | $ | 830,244 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | $ | 182,782 | | | $ | 745 | | | | 0.41 | % | | $ | 149,915 | | | $ | 1,221 | | | | 0.81 | % | | $ | 98,425 | | | $ | 1,112 | | | | 1.13 | % |
| Money market deposits | | | 153,865 | | | | 802 | | | | 0.52 | % | | | 136,997 | | | | 1,367 | | | | 1.00 | % | | | 112,996 | | | | 1,521 | | | | 1.35 | % |
| Savings deposits | | | 19,358 | | | | 33 | | | | 0.17 | % | | | 15,477 | | | | 37 | | | | 0.24 | % | | | 10,997 | | | | 34 | | | | 0.31 | % |
| Time deposits | | | 439,867 | | | | 5,548 | | | | 1.26 | % | | | 428,032 | | | | 7,637 | | | | 1.78 | % | | | 341,323 | | | | 9,251 | | | | 2.71 | % |
| Total deposits | | | 795,872 | | | | 7,128 | | | | 0.90 | % | | | 730,421 | | | | 10,262 | | | | 1.40 | % | | | 563,741 | | | | 11,918 | | | | 2.11 | % |
| Borrowed money and repurchase agreements | | | 91,991 | | | | 3,082 | | | | 3.35 | % | | | 101,296 | | | | 3,502 | | | | 3.46 | % | | | 97,239 | | | | 3,665 | | | | 3.77 | % |
| Subordinated debt | | | 15,464 | | | | 328 | | | | 2.12 | % | | | 15,464 | | | | 914 | | | | 5.91 | % | | | 15,464 | | | | 943 | | | | 6.10 | % |
| Total interest-bearing liabilities | | | 903,327 | | | | 10,538 | | | | 1.17 | % | | | 847,181 | | | | 14,678 | | | | 1.73 | % | | | 676,444 | | | | 16,526 | | | | 2.44 | % |
| Noninterest-bearing deposits | | | 81,506 | | | | | | | | | | | | 67,588 | | | | | | | | | | | | 45,293 | | | | | | | | | |
| Other liabilities | | | 10,891 | | | | | | | | | | | | 13,643 | | | | | | | | | | | | 4,285 | | | | | | | | | |
| Total liabilities | | | 995,724 | | | | | | | | | | | | 928,412 | | | | | | | | | | | | 726,022 | | | | | | | | | |
| Shareholders' equity | | | 94,238 | | | | | | | | | | | | 90,304 | | | | | | | | | | | | 104,222 | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 1,089,962 | | | | | | | | | | | $ | 1,018,716 | | | | | | | | | | | $ | 830,244 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income | | | | | | $ | 33,801 | | | | | | | | | | | $ | 29,588 | | | | | | | | | | | $ | 22,306 | | | | | |
| Interest rate spread (3) | | | | | | | | | | | 3.43 | % | | | | | | | | | | | 3.08 | % | | | | | | | | | | | 2.75 | % |
| Net interest margin (4) | | | | | | | | | | | 3.50 | % | | | | | | | | | | | 3.21 | % | | | | | | | | | | | 2.98 | % |
| Percentage of average interest-earning assets to average interest-bearing liabliities | | | | | | | | | | | 106.79 | % | | | | | | | | | | | 108.66 | % | | | | | | | | | | | 110.69 | % |
_____
| (1) | Yields and interest income on tax-exempt investments and loans have been adjusted on a tax equivalent basis using a tax rate of 34%. The taxable equivalent adjustments were $263, $351, and $532 for 2011, 2010, and 2009, respectively. The actual (non-tax equivalent) yield on loans was 5.41%, 5.56%, and 5.41% for 2011, 2010, and 2009, respectively. The actual (non-tax equivalent) yield on investments was 2.56%, 3.21% and 4.53% for 2011, 2010, and 2009, respectively. The actual (non-tax equivalent) net interest margin was 3.48%, 3.18%, and 2.91% for 2011, 2010, and 2009, respectively. |
| (2) | Average loan balances include nonaccrual loans. |
| (3) | Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of funds on interest-bearing liabilities. |
| (4) | Net interest margin is calculated by dividing net interest income by average interest-earning assets for the period. |
| Table 4 - Volume and Rate Variance Analysis | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | Increase (Decrease) due to | | | Increase (Decrease) due to | |
| | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | |
| Interest income: | | | | | | | | | | | | | | | | | | |
| Loans | | $ | 791 | | | $ | (1,175 | ) | | $ | (384 | ) | | $ | 5,964 | | | $ | 925 | | | $ | 6,889 | |
| Investment securities, tax effected | | | 1,011 | | | | (442 | ) | | | 569 | | | | (208 | ) | | | (1,461 | ) | | | (1,669 | ) |
| Interest-earning bank deposits | | | (56 | ) | | | (56 | ) | | | (112 | ) | | | 224 | | | | (10 | ) | | | 214 | |
| Total interest income | | | 1,746 | | | | (1,673 | ) | | | 73 | | | | 5,980 | | | | (546 | ) | | | 5,434 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 372 | | | | (848 | ) | | | (476 | ) | | | 234 | | | | (125 | ) | | | 109 | |
| Money market deposits | | | 196 | | | | (761 | ) | | | (565 | ) | | | 707 | | | | (861 | ) | | | (154 | ) |
| Savings deposits | | | 28 | | | | (32 | ) | | | (4 | ) | | | 7 | | | | (4 | ) | | | 3 | |
| Time deposits | | | 218 | | | | (2,307 | ) | | | (2,089 | ) | | | 4,677 | | | | (6,291 | ) | | | (1,614 | ) |
| Total deposits | | | 814 | | | | (3,948 | ) | | | (3,134 | ) | | | 5,625 | | | | (7,281 | ) | | | (1,656 | ) |
| Borrowed money and repurchase agreements | | | (314 | ) | | | (106 | ) | | | (420 | ) | | | 177 | | | | (340 | ) | | | (163 | ) |
| Subordinated debt | | | - | | | | (586 | ) | | | (586 | ) | | | - | | | | (29 | ) | | | (29 | ) |
| Total interest expense | | | 500 | | | | (4,640 | ) | | | (4,140 | ) | | | 5,802 | | | | (7,650 | ) | | | (1,848 | ) |
| Net interest income increase | | $ | 1,246 | | | $ | 2,967 | | | $ | 4,213 | | | $ | 178 | | | $ | 7,104 | | | $ | 7,282 | |
Provision for Loan Losses. The Company provided $10.7 million and $14.1 million in loan loss provisions for the years ended December 31, 2011 and 2010, respectively. The allowance for loan losses as a percentage of total non-covered loans was 2.04% at December 31, 2011, and 2.02% at December 31, 2010. The provision for loan losses was decreased due to a lower level of past due loans to non-covered loans and lower loan charge-offs during the respective years.
In 2011, the Charlotte area continued to exhibit sluggish economic conditions, but the economic slowdown in the Charlotte area has generally been less severe than the economic slowdown experienced in other large metropolitan areas of the country. Due to the slowdown in the local economy, the level of non-covered nonperforming loans increased by $2.4 million, to $18.8 million at December 31, 2011. As a result, the ratio of non-covered nonperforming loans to total non-covered loans increased from 2.79% at December 31, 2010, to 3.28% at December 31, 2011. Also, non-covered other real estate owned increased by $1.3 million to $8.9 million at December 31, 2011. As a result, non-covered nonperforming assets increased by $3.7 million to $27.7 million at December 31, 2011, resulting in an increase in the ratio of non-covered nonperforming assets to total assets from 2.26% at December 31, 2010, to 2.57% at December 31, 2011. Refer to “Allowance for Loan Losses” later in this section for further discussion.
Noninterest Income. Noninterest income decreased by $15.8 million from $27.1 million in 2010 to $11.3 million in 2011. The primary reason for the increase was the $19.7 million gain from the FDIC-assisted acquisition of Bank of Hiawassee acquisition in 2010 compared to the $4.1 million gain from the FDIC-assisted acquisition of New Horizons Bank in 2011. Table 5, which follows this discussion, presents a comparative analysis of the components of noninterest income for the past three years.
Service charges on deposit accounts increased primarily as a result of an increased number of demand deposit accounts resulting from the two FDIC-assisted acquisitions. These accounts typically generate monthly service charges and non-sufficient funds (“NSF”) fees on overdrafts. Mortgage banking income decreased largely due to fewer mortgage loan originations resulting from the April 2010 expiration of federal tax credits for first time home buyers. Mortgage loan originations for purchases decreased after the expiration of this tax credit. However originations for refinances increased due to lower long-term market interest rates in 2011. Commissions on sales of financial products decreased due to a decreased level of activity. Much of the Company’s level of activity is related to the performance of the stock market, which was volatile in 2011. Income from bank-owned life insurance decreased due to lower market rates. The decrease in the net gain on sale of investments available for sale was due to a $33.2 million reduction in the amount of investment securities that were sold in 2011 compared to 2010. The increase in the net loss on sale of other assets was primarily related to losses incurred from the sale of $15.3 million of other real estate in 2011 compared to $6.0 million in 2010. Given the Company’s increasing portfolio of other real estate owned, additional losses will likely be recognized from the disposal of its other real estate owned. Other noninterest income increased primarily as a result of higher safe deposit box rental fees, increased income from the operation of other real estate owned and higher dividends on FHLB stock.
| Table 5 - Noninterest Income | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| Noninterest income: | | | | | | | | | |
| Service charges on deposit accounts | | $ | 4,154 | | | $ | 3,932 | | | $ | 3,256 | |
| Mortgage banking income | | | 1,255 | | | | 1,525 | | | | 1,202 | |
| Commissions on sales of financial products | | | 267 | | | | 426 | | | | 191 | |
| Income from bank-owned life insurance | | | 777 | | | | 832 | | | | 770 | |
| Gain from acquisition | | | 4,140 | | | | 19,679 | | | | - | |
| Gain on sale of investments, available for sale | | | 111 | | | | 349 | | | | 2,198 | |
| Loss on sale of other assets | | | (342 | ) | | | (490 | ) | | | (285 | ) |
| Other income | | | 979 | | | | 883 | | | | 640 | |
| Total noninterest income | | $ | 11,341 | | | $ | 27,136 | | | $ | 7,972 | |
Noninterest Expense. The Company’s noninterest expense increased by $5.3 million, or 18.1%, from $29.3 million in 2010 to $34.7 million in 2011. The primary reason for the increase was the $3.2 million increase of write downs and expenses on other real estate owned and the additional expenses related to the operation of the offices acquired in the two FDIC-assisted acquisitions in 2011 compared to 2010.
Compensation and benefits expense increased primarily as a result of the increased number of employees resulting from the Bank of Hiawassee and New Horizons Bank acquisitions. The Company has integrated the operations of both acquired banks and has reduced the number of its employees through attrition and targeted layoffs. These reductions were largely focused in the areas related to commercial real estate due to the decreased originations in this area. Occupancy and equipment expense increased due to the addition of four additional offices during 2010 and one additional office in 2011. In 2011, the Company consolidated the operations of one of its leased facilities in Hiawassee, GA with an existing office in Hiawassee, GA. In 2012, we plan to relocate from an existing leased office in Monroe, NC to a more conveniently located owned facility in Monroe, NC. The net effect of this move on our expenses is expected to be neutral. Data processing and other technology expense increased due to the additional offices and personnel. Professional services increased slightly due to consulting fees related to compliance with new regulations and preparing for a new regulator. Advertising and business development costs decreased slightly due to a reduced level of marketing during this period of economic slowdown. As economic conditions improve, advertising and business development costs may increase. Loan collection and other expenses increased as a result of the New Horizons Bank acquisition which included an increased number of troubled loans. However, 80% of any related losses or qualified expenses on these acquired loans are covered by the FDIC. Deposit insurance increased primarily due to an increase in the amount of insured deposits, resulting from the acquisition of New Horizons Bank. The Company’s FDIC deposit insurance expense is not expected to increase materially in 2012. During 2011 the Company recognized a $4.3 million valuation adjustment on other real estate owned. This represented the decrease in the fair market value of real estate acquired by the Company though foreclosure or deed in lieu of foreclosure. Additional valuation adjustments on other real estate owned may be incurred in 2012 if real estate values continue to decrease. Due to the increased number of properties in other real estate owned, the Company’s expenses related to holding foreclosed properties increased in 2011. The increase in the amortization of intangible assets was due to additional amortization expense related to the core deposit intangibles that were booked as a result of the two FDIC-assisted acquisitions. These core deposit intangibles are amortizing over an eight year period on an accelerated basis. Estimated amortization expense in 2012 is expected to be $440,000. The impairment of investment securities in 2010 was primarily related to a $435,000 impairment on a $1.5 million subordinated debt obligation that was determined to be other-than-temporary. This investment was sold in 2011 for its adjusted book balance. In 2010 there were acquisition and integration expenses of $1.1 million for severance and other conversion-related costs related to the Bank of Hiawassee acquisition. Such expenses for the 2011 New Horizons Bank acquisition totaled $792,000. No additional acquisition or restructuring costs related to these acquisitions are expected for 2012. Other noninterest expenses were relatively flat over the past two years.
| Table 6 - Noninterest Expense | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| Noninterest Expense: | | | | | | | | | |
| Compensation and benefits | | $ | 15,000 | | | $ | 13,598 | | | $ | 9,818 | |
| Occupancy and equipment | | | 3,421 | | | | 3,302 | | | | 2,571 | |
| Data processing and other technology | | | 1,063 | | | | 927 | | | | 672 | |
| Professional services | | | 1,003 | | | | 981 | | | | 1,059 | |
| Advertising and business development | | | 320 | | | | 333 | | | | 365 | |
| Loan collection and other expenses | | | 1,361 | | | | 447 | | | | 238 | |
| Deposit insurance | | | 1,535 | | | | 1,326 | | | | 1,076 | |
| Office supplies | | | 248 | | | | 240 | | | | 142 | |
| Telephone and communications | | | 442 | | | | 406 | | | | 274 | |
| Other real estate owned valuation adjustments | | | 4,319 | | | | 1,382 | | | | 338 | |
| Other real estate owned expenses | | | 1,302 | | | | 993 | | | | 341 | |
| Amortization of intangible assets | | | 538 | | | | 517 | | | | 314 | |
| Impairment of investment securities | | | - | | | | 435 | | | | 754 | |
| Impairment of goodwill | | | - | | | | - | | | | 29,641 | |
| Acquisition and integration expenses | | | 792 | | | | 1,064 | | | | - | |
| Other expenses | | | 3,311 | | | | 3,384 | | | | 2,669 | |
| Total noninterest expense | | $ | 34,655 | | | $ | 29,335 | | | $ | 50,272 | |
Income Taxes. The Company recognized an income tax benefit of $702,000 in 2011 compared to income tax expense of $4.3 million for 2010. The change in the income tax provision was primarily due to a $13.4 million decrease in pretax income. The Company’s effective tax rate decreased slightly from 36.3% in 2010 to 35.3% in 2011.
Dividends and Accretion on Preferred Stock. Dividends and accretion of discount on preferred stock increased from $1.0 million in 2010 to $1.5 million in 2011. In 2011 the Company repurchased the preferred stock issued to the U.S. Treasury Department under the Capital Purchase Plan and cancelled the respective warrants. As a result, the Company accelerated the accretion of the remaining $584,000 unamortized discount on preferred stock in 2011. Also, the preferred stock issued under the Capital Purchase Plan had a dividend rate of 5.0%. This preferred stock was replaced with preferred stock issued by the U.S. Treasury Department under the Small Business Lending Fund which has an adjustable rate that is determined by the amount of the Company’s outstanding qualified small business loans. As of December 31, 2011, the dividend rate on the Company’s preferred stock was 3.3%. The dividend rate has a floor of 1.0%.
Investment Securities
The Company’s investment portfolio is an important source of liquidity and earnings. In order to preserve the Company’s principal investment and provide liquidity, the Company primarily invests in U.S. Treasury bonds, U.S. Government Agency obligations, mortgage-backed securities issued by government-sponsored entities, and bank-qualified municipal bonds. Investment securities increased by $36.3 million, or 32.5%, from $111.6 million at December 31, 2010, to $147.9 million at December 31, 2011. The increase was partly due to the acquisition of New Horizons Bank which added $9.7 million of investment securities. These acquired securities were comparable to the types of investment securities that were in the Company’s existing investment portfolio. Also contributing to the increase in investments, the Company purchased $73.1 million of investment securities. All of these securities were designated as held to maturity at the time of purchase. Partially offsetting these increases in investment securities, the Company sold $10.1 million in investment securities available for sale and received proceeds from $37.0 million in normal maturities, principal amortization, and calls. The sales of investment securities during 2011 were primarily for the purpose of reducing longer-term maturities and subsequently lowering the Company’s exposure to rising interest rates. Management expects that in 2012 the balances of its investment securities portfolios will increase as management invests its excess liquidity in order to generate increased future earnings.
Table 7 below summarizes the amortized cost, gross unrealized gains and losses, and estimated fair values of investment securities for the periods ended December 31, 2011, 2010, and 2009.
| Table 7 - Investment Securities Portfolio Composition | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | Amortized Cost | | | Gains | | | Losses | | | Fair Value | |
| | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | |
| U.S. Government Agency obligations | | $ | 7,168 | | | $ | 73 | | | $ | - | | | $ | 7,241 | |
| Municipal bonds | | | 6,578 | | | | 133 | | | | - | | | | 6,711 | |
| Mortgage-backed securities | | | 35,170 | | | | 330 | | | | 8 | | | | 35,492 | |
| SBA securities | | | 1,255 | | | | 71 | | | | - | | | | 1,326 | |
| Other securities | | | 1,488 | | | | 44 | | | | 166 | | | | 1,366 | |
| Subtotal | | | 51,659 | | | | 651 | | | | 174 | | | | 52,136 | |
| | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | |
| U.S. Treasury obligations | | | 9,972 | | | | 61 | | | | - | | | | 10,033 | |
| U.S. Government Agency obligations | | | 25,989 | | | | 74 | | | | 4 | | | | 26,059 | |
| Municipal bonds | | | 3,300 | | | | 99 | | | | - | | | | 3,399 | |
| Mortgage-backed securities | | | 52,502 | | | | 2,277 | | | | - | | | | 54,779 | |
| Other securities | | | 4,000 | | | | - | | | | 155 | | | | 3,845 | |
| Subtotal | | | 95,763 | | | | 2,511 | | | | 159 | | | | 98,115 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 147,422 | | | $ | 3,162 | | | $ | 333 | | | $ | 150,251 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | |
| U.S. Government Agency obligations | | $ | 19,297 | | | $ | 23 | | | $ | 122 | | | $ | 19,198 | |
| Municipal bonds | | | 11,602 | | | | 40 | | | | 128 | | | | 11,514 | |
| Mortgage-backed securities | | | 40,655 | | | | 293 | | | | 175 | | | | 40,773 | |
| Other securities | | | 2,781 | | | | 110 | | | | 68 | | | | 2,823 | |
| Subtotal | | | 74,335 | | | | 466 | | | | 493 | | | | 74,308 | |
| | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | |
| U.S. Treasury obligations | | | 9,955 | | | | - | | | | 38 | | | | 9,917 | |
| U.S. Government Agency obligations | | | 8,509 | | | | 4 | | | | 129 | | | | 8,384 | |
| Mortgage-backed securities | | | 14,814 | | | | 641 | | | | 37 | | | | 15,418 | |
| Other securities | | | 4,000 | | | | - | | | | 81 | | | | 3,919 | |
| Subtotal | | | 37,278 | | | | 645 | | | | 285 | | | | 37,638 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 111,613 | | | $ | 1,111 | | | $ | 778 | | | $ | 111,946 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2009 | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | |
| U.S. Government Agency obligations | | $ | 9,000 | | | $ | 32 | | | $ | 13 | | | $ | 9,019 | |
| Municipal bonds | | | 20,118 | | | | 98 | | | | 345 | | | | 19,871 | |
| Mortgage-backed securities | | | 19,258 | | | | 216 | | | | 115 | | | | 19,359 | |
| Other securities | | | 3,098 | | | | 141 | | | | 498 | | | | 2,741 | |
| Subtotal | | | 51,474 | | | | 487 | | | | 971 | | | | 50,990 | |
| | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | |
| U.S. Government Agency obligations | | | 26,464 | | | | 84 | | | | 305 | | | | 26,243 | |
| Mortgage-backed securities | | | 5,916 | | | | 117 | | | | - | | | | 6,033 | |
| Subtotal | | | 32,380 | | | | 201 | | | | 305 | | | | 32,276 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 83,854 | | | $ | 688 | | | $ | 1,276 | | | $ | 83,266 | |
The Company does not engage in, nor does it intend to engage in, investment trading. As such, the Company does not have any securities classified as trading. Each investment in the Company’s portfolio was classified as either available for sale or held to maturity on the date of purchase. Investment securities classified as available for sale are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of consolidated shareholders’ equity and as an item of other comprehensive income. Investment securities classified as held to maturity are carried at book value.
A summary of the contractual maturities of the Company’s investment securities portfolio at December 31, 2011, is shown in Table 8 below.
| Table 8- Maturity Distribution and Yields of Investment Securities | | | | | | | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| | | Amortized Cost | | | Fair Value | | | Book Yield (1) | |
| | | | | | | | | | |
| Available-for-Sale: | | | | | | | | | |
| U.S. Government Agency obligations: | | | | | | | | | |
| Due in one year or less | | $ | 2,020 | | | $ | 2,029 | | | | 0.71 | % |
| Due after one year through five years | | | 5,148 | | | | 5,212 | | | | 1.16 | % |
| | | | 7,168 | | | | 7,241 | | | | 1.04 | % |
| Municipal bonds: | | | | | | | | | | | | |
| Due in one year or less | | | 1,707 | | | | 1,708 | | | | 0.74 | % |
| Due after one year through five years | | | 1,842 | | | | 1,865 | | | | 2.45 | % |
| Due after five years through ten years | | | 827 | | | | 853 | | | | 5.82 | % |
| Due after ten years | | | 2,202 | | | | 2,285 | | | | 5.36 | % |
| | | | 6,578 | | | | 6,711 | | | | 3.40 | % |
| Mortgage-backed securities: | | | | | | | | | | | | |
| Due in one year or less | | | 6,574 | | | | 6,622 | | | | 2.05 | % |
| Due after one year through five years | | | 18,306 | | | | 18,490 | | | | 2.16 | % |
| Due after five years through ten years | | | 5,597 | | | | 5,658 | | | | 2.03 | % |
| Due after ten years | | | 4,693 | | | | 4,722 | | | | 2.51 | % |
| | | | 35,170 | | | | 35,492 | | | | 2.16 | % |
| SBA securities: | | | | | | | | | | | | |
| Due after five years through ten years | | | 1,255 | | | | 1,326 | | | | 4.03 | % |
| | | | 1,255 | | | | 1,326 | | | | 4.03 | % |
| Other securities: | | | | | | | | | | | | |
| Due after ten years | | | 13 | | | | 57 | | | | - | |
| | | | 13 | | | | 57 | | | | - | |
| | | | | | | | | | | | | |
| Total Available for Sale: | | | | | | | | | | | | |
| Due in one year or less | | $ | 10,301 | | | $ | 10,359 | | | | 1.57 | % |
| Due after one year through five years | | | 25,296 | | | | 25,567 | | | | 1.98 | % |
| Due after five years through ten years | | | 7,679 | | | | 7,837 | | | | 2.77 | % |
| Due after ten years | | | 6,908 | | | | 7,064 | | | | 3.41 | % |
| Equities | | | 1,475 | | | | 1,309 | | | | - | |
| | | $ | 51,659 | | | $ | 52,136 | | | | 2.21 | % |
| | | | | | | | | | | | | |
| Held to Maturity: | | | | | | | | | | | | |
| U.S. Treasury obligations: | | | | | | | | | | | | |
| Due in one year or less | | $ | 4,996 | | | $ | 5,010 | | | | 0.47 | % |
| Due after one year through five years | | | 4,976 | | | | 5,023 | | | | 0.76 | % |
| | | | 9,972 | | | | 10,033 | | | | 0.61 | % |
| U.S. Government Agency obligations: | | | | | | | | | | | | |
| Due after one year through five years | | | 6,999 | | | | 7,007 | | | | 1.25 | % |
| Due after five years through ten years | | | 16,995 | | | | 17,039 | | | | 1.62 | % |
| Due after ten years | | | 1,995 | | | | 2,013 | | | | 2.21 | % |
| | | | 25,989 | | | | 26,059 | | | | 1.57 | % |
| Municipal bonds: | | | | | | | | | | | | |
| Due after five years through ten years | | | 3,300 | | | | 3,399 | | | | 2.84 | % |
| | | | 3,300 | | | | 3,399 | | | | 2.84 | % |
| Mortgage-backed securities: | | | | | | | | | | | | |
| Due in one year or less | | | 11,418 | | | | 11,699 | | | | 2.73 | % |
| Due after one year through five years | | | 23,461 | | | | 24,054 | | | | 2.84 | % |
| Due after five years through ten years | | | 7,368 | | | | 7,633 | | | | 3.24 | % |
| Due after ten years | | | 10,255 | | | | 11,393 | | | | 5.36 | % |
| | | | 52,502 | | | | 54,779 | | | | 3.36 | % |
| Other securities: | | | | | | | | | | | | |
| Due after one year through five years | | | 3,000 | | | | 2,848 | | | | 1.30 | % |
| Due after five years through ten years | | | 1,000 | | | | 997 | | | | 6.00 | % |
| | | | 4,000 | | | | 3,845 | | | | 2.48 | % |
| Total Held to Maturity: | | | | | | | | | | | | |
| Due in one year or less | | $ | 16,414 | | | $ | 16,709 | | | | 2.04 | % |
| Due after one year through five years | | | 38,436 | | | | 38,932 | | | | 2.16 | % |
| Due after five years through ten years | | | 28,663 | | | | 29,068 | | | | 2.33 | % |
| Due after ten years | | | 12,250 | | | | 13,406 | | | | 4.85 | % |
| | | $ | 95,763 | | | $ | 98,115 | | | | 2.53 | % |
(1) Based on amortized cost, taxable-equivalent basis.
Loans
During 2011, loans outstanding decreased by $2.7 million from $736.5 million at December 31, 2010, to $733.8 million at December 31, 2011. Most of this decrease was concentrated in commercial land and residential development which decreased by $17.6 million, or 29.6%, and $8.8 million, or 26.4%, respectively. Given the continued slowdown in the local economy and real estate markets, the Company has focused on reducing its exposure to these types of loans. Historically, the Company has not actively originated commercial real estate loans that are secured by hotels, motels, golf courses, or resort properties. Also, the Company has not been an originator or purchaser of option adjustable rate or “no documentation” residential loans or “sub-prime” residential loans which were made to borrowers with lower credit ratings resulting from a poor payment history. The loans acquired in the 2011 acquisition of New Horizons Bank partly offset these decreases in loans. As of December 31, 2011, the acquired loans from New Horizons Bank totaled $44.3 million.
Loan Types. The Company makes various business and consumer loans in the normal course of business. A brief description of these types of loans is as follows:
One-to-four family residential – This portfolio primarily consists of loans secured by properties in the Company’s normal lending area. The Company originates fixed and adjustable rate loans for terms of 10 to 30 years, including conventional and jumbo loans. These loans generally have an original loan-to-value ratio (“LTV”) of 80% or less. Those loans with an initial LTV of more than 80% typically have private mortgage insurance to protect the Bank. This type of loan has historically possessed a lower than average level of loss to the Bank compared to the total loan portfolio loss.
Multifamily residential – This portfolio is moderately seasoned and is generally secured by properties in the Bank’s normal lending area. These loans generally have an initial LTV of 75% and an initial debt service coverage ratio of 1.2x to 1.0x. This Bank has not experienced any significant losses in this loan portfolio over the past 24 months.
Construction – This portfolio has decreased significantly over the past several years as fewer construction loans have been made during the economic downturn. These loans are generally located in the Company’s normal lending area and had an initial LTV of 80%. Approximately 57% of these loans are secured by residential properties and 43% are secured by commercial properties. This type of loan has historically possessed a lower than average level of loss to the Bank.
Commercial land and residential development – These portfolios include raw undeveloped land and developed residential lots held by builders and developers. Generally, the initial LTV for raw land is 65% and the initial LTV for developed lots is 90%. Given the significant decline in value for both developed and undeveloped land due to reduced demand, these loan portfolios possess an increased level of risk compared to other loan categories.
Other commercial real estate – This portfolio consists of nonresidential improved real estate which includes churches, shopping centers, office buildings, etc. These loans typically have an initial LTV of 75% and an initial debt service ratio of 1.2x to 1.0x. These properties are generally located in the Company’s normal lending area. Decreased rental income due to the economic slowdown has caused some deterioration in values. However, this loan portfolio has historically possessed a lower than average loss history compared to the Bank’s entire portfolio.
Consumer real estate – This category includes home equity lines of credit (“HELOCs”) and loans secured by residential lots purchased by consumers. The HELOCs generally had an adjustable rate tied to prime rate and a term of 15 years. The HELOCs initially had an LTV of up to 85%. The residential lot loans typically have a term of five years or less and are made at an initial LTV of up to 90%. Many of the properties securing these loans have declined in value over the past several years. However, the loss history for these types of loans has been lower than average for the Bank over the past 24 months.
Commercial business – These loans include loans to businesses that are not secured by real estate. These loans are typically secured by accounts receivable, inventory, equipment, etc. Commercial loans are typically granted to local businesses that have a strong track record of profitability and performance. This category of loans incurred slightly lower than average losses over the past 24 months compared to the Bank’s total loan portfolio loss.
Other consumer - These loans are either unsecured or secured by automobiles, marketable securities, etc. They are generally granted to local customers that generally have a banking relationship with our Bank. The loss history for this category of loans has been higher than the Bank average over the past 24 months.
The Company has a diversified loan portfolio with no material concentrations to any one borrower or industry. The Company continues to actively solicit owner-occupied commercial real estate loans, residential real estate loans, business loans, and consumer loans to customers located in the Company’s primary lending area. The Company originates and closes a large portion of all new one-to-four family residential loans as a broker for independent third parties on a servicing-released basis. This generates additional fee income and reduces the potential adverse effects of rising interest rates on the Company’s future earnings that normally result from holding long-term fixed-rate loans. In general, the Company retains in its portfolio residential loans that have an adjustable interest rate or are jumbo loans that are not marketable in the secondary market. These loans are underwritten to the fully-indexed rate and typically have a loan-to-value ratio of 80% or less. Management expects that in 2011 the Company’s portfolio of one-to-four family mortgage loans will continue to increase from its current level as a number of competitors have exited this business sector due to the housing slowdown. In addition, mortgage loan interest rates have become more attractive for borrowers, thus increasing opportunities for customers to refinance their existing mortgage loans. The Company does not service loans for the Freddie Mac or Fannie Mae.
The following table details the amounts and types of loans outstanding over the past five years ended December 31.
| Table 9 - Loan Portfolio Composition | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | Amount | | | % of Total Loans | | | Amount | | | % of Total Loans | | | Amount | | | % of Total Loans | | | Amount | | | % of Total Loans | | | Amount | | | % of Total Loans | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 151,500 | | | | 20.6 | % | | $ | 133,769 | | | | 18.2 | % | | $ | 90,289 | | | | 14.8 | % | | $ | 84,777 | | | | 13.5 | % | | $ | 78,572 | | | | 14.0 | % |
| Multifamily residential | | | 19,685 | | | | 2.7 | % | | | 23,667 | | | | 3.2 | % | | | 25,577 | | | | 4.2 | % | | | 23,359 | | | | 3.7 | % | | | 19,717 | | | | 3.5 | % |
| Construction | | | 20,857 | | | | 2.8 | % | | | 20,421 | | | | 2.8 | % | | | 22,325 | | | | 3.7 | % | | | 71,454 | | | | 11.4 | % | | | 90,949 | | | | 16.2 | % |
| Nonresidential real estate | | | 368,626 | | | | 50.3 | % | | | 379,325 | | | | 51.5 | % | | | 315,563 | | | | 51.7 | % | | | 298,255 | | | | 47.7 | % | | | 254,782 | | | | 45.6 | % |
| Commercial business | | | 49,027 | | | | 6.7 | % | | | 48,053 | | | | 6.5 | % | | | 38,442 | | | | 6.3 | % | | | 34,451 | | | | 5.5 | % | | | 33,583 | | | | 6.0 | % |
| Consumer | | | 124,093 | | | | 16.9 | % | | | 131,275 | | | | 17.8 | % | | | 118,005 | | | | 19.3 | % | | | 114,287 | | | | 18.2 | % | | | 82,363 | | | | 14.7 | % |
| Total loans | | $ | 733,788 | | | | 100.0 | % | | $ | 736,510 | | | | 100.0 | % | | $ | 610,201 | | | | 100.0 | % | | $ | 626,583 | | | | 100.0 | % | | $ | 559,966 | | | | 100.0 | % |
Table 10 below segregates the maturity distribution of the Company's loans by type and interest rate type as of December 31, 2011. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as becoming due within one year. Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses. Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of a loan is substantially less than its contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give us the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are substantially higher than current mortgage loan market rates. Our total amount of fixed-rate loans due after December 31, 2012 was $256.8 million and our total amount of adjustable-rate loans due one year after December 31, 2012 was $330.2 million.
| Table 10 - Loan Maturities | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Due in One Year or Less | | | Due Over One Year to Five Years | | | Due Over Five Years | | | Total | |
| By Loan Type: | | | | | | | | | | | | |
| One-to-four family residential | | $ | 14,780 | | | $ | 21,229 | | | $ | 115,491 | | | $ | 151,500 | |
| Multifamily residential | | | 1,852 | | | | 4,106 | | | | 13,727 | | | | 19,685 | |
| Construction | | | 2,603 | | | | 8,864 | | | | 9,390 | | | | 20,857 | |
| Commercial land | | | 19,543 | | | | 21,922 | | | | 327 | | | | 41,792 | |
| Residential development | | | 14,466 | | | | 10,073 | | | | - | | | | 24,539 | |
| Other commercial real estate | | | 64,784 | | | | 192,167 | | | | 45,344 | | | | 302,295 | |
| Consumer real estate | | | 7,329 | | | | 22,559 | | | | 84,781 | | | | 114,669 | |
| Commercial business | | | 19,360 | | | | 21,486 | | | | 8,181 | | | | 49,027 | |
| Other consumer | | | 2,060 | | | | 5,875 | | | | 1,489 | | | | 9,424 | |
| Total | | $ | 146,777 | | | $ | 308,281 | | | $ | 278,730 | | | $ | 733,788 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| By Interest Rate Type: | | | | | | | | | | | | | | | | |
| Fixed rate loans | | $ | 83,236 | | | $ | 177,867 | | | $ | 78,902 | | | $ | 340,005 | |
| Adjustable rate loans | | | 63,541 | | | | 130,414 | | | | 199,828 | | | | 393,783 | |
| Total | | $ | 146,777 | | | $ | 308,281 | | | $ | 278,730 | | | $ | 733,788 | |
Lending Policies. Our lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by management and approved annually by our Board of Directors. Our Board of Directors must approve all loans in excess of $4.0 million, or in any amount to borrowers with existing exposure to us in excess of $4.0 million, or in any amount that when added to the borrower’s existing exposure to us causes such total exposure to be in excess of $4.0 million. In addition, all unsecured loans in excess of $500,000, or in any amount that when added to a borrower’s existing unsecured exposure to us causes such unsecured exposure to be in excess of $500,000, must be approved by our Board of Directors. Loans of $4.0 million or less, or customers with exposure (including the proposed loan) of $4.0 million or less, or unsecured loans of $500,000 or less, or customers with unsecured exposure (including the proposed loan) of $500,000 or less, as applicable, may be approved individually or jointly by our lending officers within loan approval limits delegated by our Board of Directors. In addition, the Board of Directors has delegated “incremental” loan approval limits to certain officers which allow them to approve a new loan to an existing customer in an amount equal to, or less than, their incremental loan limit that would otherwise require approval by the Board of Directors or the additional approval of another lending officer. Any loan approved by a lending officer using their incremental loan limit must be ratified by the Board of Directors, or approved by another lending officer, as applicable, after the loan has been made.
Lending practices are reviewed on a regular basis to ensure that underwriting policies are consistently applied. Loan originations come from a number of sources including real estate agents, home builders, walk-in customers, referrals and existing customers. Loan officers also call on local businesses soliciting commercial products. We advertise our loan products in various print media including local newspapers as well as the Company’s website. In our marketing materials, we emphasize our community ties, personalized customer service, and an efficient underwriting and approval process. All real estate collateral is either evaluated or appraised by an independent certified appraiser in accordance with regulatory requirements. On new loan originations, we require hazard, title and, to the extent applicable, flood insurance on all securitized property.
Asset Quality
Nonperforming Assets and Delinquencies. When a borrower fails to make a required payment on a loan, we attempt to cure the deficiency by contacting the borrower and collecting the payment. Computer generated late notices are mailed 15 days after a payment is due. In most cases, deficiencies are cured promptly. If a delinquency continues, additional contact is made either through a notice or other means and we will attempt to work out a payment schedule and actively encourage delinquent residential mortgage borrowers to seek home ownership counseling. While we generally prefer to work with borrowers to resolve such problems, we will institute foreclosure or other proceedings, as necessary, to minimize any potential loss. Loans are placed on nonaccrual status if, in the opinion of management, principal and/or interest payments are not likely to be paid in accordance with the terms of the loan agreement, such as when principal or interest is past due 90 days or more. Interest accrued but not collected at the date the loan is placed on nonaccrual status is reversed against income in the current period. Loans may be reinstated to accrual status when payments have been made to bring the account under 90 days past due or, in the opinion of management, collection of the remaining past due balances can be reasonably expected. Generally, management will consider six consecutive monthly payments as evidence of collectability. Our Board of Directors is informed monthly of the total amount of loans which are more than 30 days delinquent.
Table 11 below sets forth information with respect to our past due loans, nonperforming assets, and credit quality ratios at December 31 for the past five years.
| Table 11 - Past Due Loans, Nonperforming Assets and Credit Quality Ratios | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | | | | |
| Past Due Loans: | | | | | | | | | | | | | | | |
| Loans 30 to 89 days past due and accruing: | | | | | | | | | | | | | | | |
| Not covered by FDIC loss share agreements | | $ | 4,933 | | | $ | 13,787 | | | $ | 9,889 | | | $ | 8,881 | | | $ | 3,503 | |
| Covered by FDIC loss share agreements | | | 5,372 | | | | 5,767 | | | | - | | | | - | | | | - | |
| Total loans 30 to 89 days past due and accruing | | $ | 10,305 | | | $ | 19,554 | | | $ | 9,889 | | | $ | 8,881 | | | $ | 3,503 | |
| | | | | | | | | | | | | | | | | | | | | |
| Nonperforming Assets: | | | | | | | | | | | | | | | | | | | | |
| Nonaccrual loans not covered by FDIC loss share agreeements | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 2,407 | | | $ | 1,864 | | | $ | 898 | | | $ | 199 | | | $ | 159 | |
| Construction loans | | | - | | | | 14 | | | | 1,048 | | | | 693 | | | | - | |
| Nonresidential real estate | | | 13,278 | | | | 9,720 | | | | 5,114 | | | | 1,310 | | | | 520 | |
| Commercial business | | | 168 | | | | 287 | | | | 71 | | | | - | | | | 146 | |
| Consumer | | | 2,623 | | | | 2,529 | | | | 1,004 | | | | 698 | | | | 221 | |
| Total non-covered nonaccrual loans | | | 18,476 | | | | 14,414 | | | | 8,135 | | | | 2,900 | | | | 1,046 | |
| FDIC-covered nonaccrual loans | | | 43,256 | | | | 25,016 | | | | - | | | | - | | | | - | |
| Total nonaccrual loans | | | 61,732 | | | | 39,430 | | | | 8,135 | | | | 2,900 | | | | 1,046 | |
| | | | | | | | | | | | | | | | | | | | | |
| Non-covered accruing loans past due 90 days or more : | | | | | | | | | | | | | | | | | |
| Nonresidential real estate | | | - | | | | 2,000 | | | | 3,786 | | | | 132 | | | | 766 | |
| Commercial business | | | - | | | | - | | | | 69 | | | | - | | | | - | |
| Consumer | | | 335 | | | | - | | | | - | | | | - | | | | - | |
| Total non-covered accruing loans past due 90 days or more | | | 335 | | | | 2,000 | | | | 3,855 | | | | 132 | | | | 766 | |
| FDIC-covered accruing loans past due 90 days or more | | | 800 | | | | 527 | | | | - | | | | - | | | | - | |
| Total accruing loans past due 90 days or more | | | 1,135 | | | | 2,527 | | | | 3,855 | | | | 132 | | | | 766 | |
| Total nonperforming loans | | | 62,867 | | | | 41,957 | | | | 11,990 | | | | 3,032 | | | | 1,812 | |
| �� | | | | | | | | | | | | | | | | | | | | |
| Non-covered other real estate owned | | | 8,936 | | | | 7,650 | | | | 5,067 | | | | 2,601 | | | | 529 | |
| FDIC-covered other real estate owned | | | 8,635 | | | | 7,002 | | | | - | | | | - | | | | - | |
| FDIC-covered repossessed assets | | | 111 | | | | - | | | | - | | | | - | | | | - | |
| Total other real estate owned and repossessed assets | | | 17,682 | | | | 7,650 | | | | 5,067 | | | | 2,601 | | | | 529 | |
| Total nonperforming assets | | $ | 80,549 | | | $ | 49,607 | | | $ | 17,057 | | | $ | 5,633 | | | $ | 2,341 | |
| | | | | | | | | | | | | | | | | | | | | |
| Credit Quality Ratios: | | | | | | | | | | | | | | | | | | | | |
| Non-covered past loans 30 to 89 days past due and accruing to year end non-covered loans | | | 0.86 | % | | | 2.34 | % | | | 1.62 | % | | | 1.42 | % | | | 0.63 | % |
| Non-covered nonperforming loans to year end non-covered loans | | | 3.28 | % | | | 2.79 | % | | | 1.96 | % | | | 0.48 | % | | | 0.32 | % |
| Non-covered nonperforming assets to total assets | | | 2.57 | % | | | 2.26 | % | | | 2.15 | % | | | 0.69 | % | | | 0.30 | % |
| Non-covered nonperforming assets to year end non-covered loans and other real estate owned | | | 4.76 | % | | | 4.03 | % | | | 2.77 | % | | | 0.90 | % | | | 0.42 | % |
Restructured Loans. In accordance with accounting principles generally accepted in the United States of America (“GAAP”), we are required to account for certain loan modifications or restructurings as troubled debt restructurings (“TDRs”). In general, the modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrowers that we would not otherwise consider. Debt restructurings or loan modifications for a borrower do not necessarily always constitute TDRs. Also, troubled debt restructurings do not necessarily result in an increase in nonaccrual loans. Table 12 below summarizes the total number and amount of the Company’s troubled debt restructurings for the past five years ended December 31, 2011, 2010, 2009, 2008 and 2007.
| Table 12 - Loans classifed as TDRs | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Amount of TDRs | | $ | 9,043 | | | $ | 5,617 | | | $ | 5,481 | | | $ | 1,891 | | | $ | 1,020 | |
| Outstanding Contacts | | | 29 | | | | 16 | | | | 6 | | | | 3 | | | | 1 | |
Asset Classification. The OCC has adopted various regulations regarding problem assets of financial institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OCC examiners have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, we establish specific allowances for loan losses for the full amount of the portion of the asset classified as loss. All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful can be included in determining an institution’s regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated “special mention.” The Company’s portfolio of FDIC-covered loans was considered to be Pass rated loans at December 31, 2011 and December 31, 2010, as the loans were marked to fair value at acquisition and have FDIC loss-share agreements to cover at least 80% of any future losses.
The risk category of loans by type as of December 31, 2011 and 2010 is presented in the following table.
| Table 13 - Loans and Ratios | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | | | | Criticized Loans | | | | |
| December 31, 2011 | | Pass | | | Special Mention | | | Substandard | | | Doubtful | | | Total Outstanding | |
| | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 149,013 | | | $ | 562 | | | $ | 1,925 | | | $ | - | | | $ | 151,500 | |
| Multifamily residential | | | 19,685 | | | | - | | | | - | | | | - | | | | 19,685 | |
| Construction | | | 20,857 | | | | - | | | | - | | | | - | | | | 20,857 | |
| Commercial land | | | 30,202 | | | | 8,600 | | | | 2,990 | | | | - | | | | 41,792 | |
| Residential development | | | 15,806 | | | | 1,037 | | | | 7,696 | | | | - | | | | 24,539 | |
| Other commercial real estate | | | 269,970 | | | | 19,925 | | | | 12,400 | | | | - | | | | 302,295 | |
| Consumer real estate | | | 110,108 | | | | 1,248 | | | | 3,313 | | | | - | | | | 114,669 | |
| Total real estate | | | 615,641 | | | | 31,372 | | | | 28,324 | | | | - | | | | 675,337 | |
| Commercial business | | | 48,477 | | | | 254 | | | | 296 | | | | - | | | | 49,027 | |
| Other consumer | | | 9,147 | | | | 170 | | | | 107 | | | | - | | | | 9,424 | |
| Total loans | | $ | 673,265 | | | $ | 31,796 | | | $ | 28,727 | | | $ | - | | | $ | 733,788 | |
| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 131,072 | | | $ | 1,167 | | | $ | 1,530 | | | $ | - | | | $ | 133,769 | |
| Multifamily residential | | | 23,394 | | | | 273 | | | | - | | | | - | | | | 23,667 | |
| Construction | | | 18,488 | | | | 1,933 | | | | - | | | | - | | | | 20,421 | |
| Commercial land | | | 46,455 | | | | 5,138 | | | | 7,733 | | | | 75 | | | | 59,401 | |
| Residential development | | | 19,650 | | | | 5,395 | | | | 8,279 | | | | - | | | | 33,324 | |
| Other commercial real estate | | | 257,769 | | | | 7,882 | | | | 20,949 | | | | - | | | | 286,600 | |
| Consumer real estate | | | 113,036 | | | | 1,327 | | | | 3,523 | | | | 135 | | | | 118,021 | |
| Total real estate | | | 609,864 | | | | 23,115 | | | | 42,014 | | | | 210 | | | | 675,203 | |
| Commercial business | | | 47,423 | | | | 376 | | | | 254 | | | | - | | | | 48,053 | |
| Other consumer | | | 11,200 | | | | - | | | | 2,054 | | | | - | | | | 13,254 | |
| Total loans | | $ | 668,487 | | | $ | 23,491 | | | $ | 44,322 | | | $ | 210 | | | $ | 736,510 | |
Other Real Estate Owned. Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned. All foreclosed properties are written down to their estimated fair value (market value less estimated disposition costs) at acquisition. Management will continue to aggressively market foreclosed properties for a timely disposition.
A summary of the activity in the other real estate owned account at December 31 for the past three years is presented in Table 14 below.
| Table 14 - Other Real Estate Owned Rollforward | | | | | | | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | |
| Balance at beginning of year | | $ | 14,652 | | | $ | 5,067 | | | $ | 2,601 | |
| Additions to other real estate owned: | | | | | | | | | | | | |
| Acquisition of other real estate owned | | | 6,374 | | | | 1,076 | | | | - | |
| New foreclosed properties | | | 16,486 | | | | 16,293 | | | | 5,502 | |
| Reductions of other real estate owned: | | | | | | | | | | | | |
| Sales proceeds | | | (15,328 | ) | | | (5,955 | ) | | | (2,418 | ) |
| Loss on sale of OREO | | | (294 | ) | | | (447 | ) | | | (280 | ) |
| Writedowns | | | (4,319 | ) | | | (1,382 | ) | | | (338 | ) |
| Balance at end of year | | $ | 17,571 | | | $ | 14,652 | | | $ | 5,067 | |
Allowance for Loan Losses
Management has established a systematic methodology for evaluating the adequacy of the Company’s allowance for loan losses. The methodology is set forth in a formal policy and considers all loans in the portfolio. Specific allowances are established for certain individual loans that management considers impaired. The remainder of the portfolio is segmented into groups of loans with similar risk characteristics for evaluation and analysis. In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower, the term of the loan, general economic conditions, and in the case of a secured loan, the quality of the collateral. We increase our allowance for loan losses by charging provisions for loan losses against our current period income.�� Management’s periodic evaluation of the adequacy of the allowance is consistently applied and is based on our past loan loss experience, particular risks inherent in the different kinds of lending that we engage in, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions, and other relevant internal and external factors that affect loan collectability.
At December 31, 2011, we had an allowance for loan losses of $11.7 million compared to $11.9 million at December 31, 2010. Management believes that the current allowance meets the requirement for losses on loans that management considers to be impaired, for known losses, and for risks inherent in the remaining loan portfolios. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly adversely affected if circumstances differ substantially from the assumptions used in making the determinations. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination.
Table 15 below sets forth the breakdown of the allowance for loan losses by loan category at December 31 for the five years indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any other category
| Table 15 - Allocation of the Allowance for Loan Losses | | | | | | | | | | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | At and for the Year Ended December 31 | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | Amount | | | % of Total Loans | | Amount | | | % of Total Loans | | Amount | | | % of Total Loans | | Amount | | | % of Total Loans | | Amount | | | % of Total Loans | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 500 | | | | 20.6 | % | | $ | 500 | | | | 18.2 | % | | $ | 250 | | | | 14.8 | % | | $ | 275 | | | | 13.5 | % | | $ | 250 | | | | 14.0 | % |
| Multifamily residential | | | 150 | | | | 2.7 | % | | | 200 | | | | 3.2 | % | | | 200 | | | | 4.2 | % | | | 225 | | | | 3.7 | % | | | 200 | | | | 3.5 | % |
| Construction | | | 800 | | | | 2.8 | % | | | 1,000 | | | | 2.8 | % | | | 1,775 | | | | 3.7 | % | | | 1,500 | | | | 11.4 | % | | | 900 | | | | 16.2 | % |
| Nonresidential real estate | | | 6,163 | | | | 50.3 | % | | | 5,724 | | | | 51.5 | % | | | 3,964 | | | | 51.7 | % | | | 3,026 | | | | 47.7 | % | | | 2,494 | | | | 45.6 | % |
| Commercial business | | | 2,000 | | | | 6.7 | % | | | 2,500 | | | | 6.5 | % | | | 1,000 | | | | 6.3 | % | | | 1,250 | | | | 5.5 | % | | | 1,000 | | | | 6.0 | % |
| Consumer | | | 2,100 | | | | 16.9 | % | | | 2,000 | | | | 17.8 | % | | | 2,000 | | | | 19.3 | % | | | 1,750 | | | | 18.2 | % | | | 1,300 | | | | 14.7 | % |
| Total | | $ | 11,713 | | | | 100.0 | % | | $ | 11,924 | | | | 100.0 | % | | $ | 9,189 | | | | 100.0 | % | | $ | 8,026 | | | | 100.0 | % | | $ | 6,144 | | | | 100.0 | % |
Table 16 presents the changes in the allowance for loan losses over the past five years.
| Table 16 - Summary of Loan Loss and Recovery Experience | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | At and for the Year Ended December 31 | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | | | | |
| Allowances for loan losses at beginning of period | | $ | 11,924 | | | $ | 9,189 | | | $ | 8,026 | | | $ | 6,144 | | | $ | 5,764 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loan chargeoffs: | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | | (1,180 | ) | | | (324 | ) | | | (1 | ) | | | (185 | ) | | | (1 | ) |
| Construction | | | (42 | ) | | | (482 | ) | | | (1,352 | ) | | | (203 | ) | | | - | |
| Nonresidential real estate | | | (9,111 | ) | | | (8,260 | ) | | | (6,115 | ) | | | (319 | ) | | | (309 | ) |
| Commercial business | | | (974 | ) | | | (682 | ) | | | (235 | ) | | | (586 | ) | | | (861 | ) |
| Consumer | | | (544 | ) | | | (2,044 | ) | | | (2,268 | ) | | | (167 | ) | | | (83 | ) |
| Total loan chargeoffs | | | (11,851 | ) | | | (11,792 | ) | | | (9,971 | ) | | | (1,460 | ) | | | (1,254 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Loan recoveries: | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | | 17 | | | | 4 | | | | - | | | | - | | | | - | |
| Construction | | | 250 | | | | 48 | | | | - | | | | - | | | | - | |
| Nonresidential real estate | | | 410 | | | | 364 | | | | 137 | | | | 11 | | | | - | |
| Commercial business | | | 171 | | | | 4 | | | | 10 | | | | 46 | | | | 296 | |
| Consumer | | | 107 | | | | 57 | | | | 7 | | | | 10 | | | | 48 | |
| Total loan recoveries | | | 955 | | | | 477 | | | | 154 | | | | 67 | | | | 344 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loan chargeoffs | | | (10,896 | ) | | | (11,315 | ) | | | (9,817 | ) | | | (1,393 | ) | | | (910 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 10,685 | | | | 14,050 | | | | 10,980 | | | | 3,275 | | | | 1,290 | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses at end of period | | $ | 11,713 | | | $ | 11,924 | | | $ | 9,189 | | | $ | 8,026 | | | $ | 6,144 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratios: | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses to non-covered loans | | | 2.04 | % | | | 2.02 | % | | | 1.51 | % | | | 1.28 | % | | | 1.10 | % |
| Net chargeoffs to average non-covered loans | | | 1.88 | % | | | 1.88 | % | | | 1.58 | % | | | 0.23 | % | | | 0.17 | % |
FDIC Loss Share Receivable. The FDIC loss share receivable relates to agreements with the FDIC, whereby the FDIC has agreed to reimburse to the Company 80% of the losses related to covered loans and other real estate that the Company assumed in the acquisition of a failed bank. This loss share receivable is measured separately from the loan portfolio and other real estate because it is not contractually embedded in the loans and is not transferable with the loans should the Company choose to dispose of them. The carrying value of this receivable is the present value of the estimated amount of loan and other real estate losses covered by the agreements multiplied by the FDIC reimbursement percentage.
Table 17 presents the changes in the FDIC loss share receivable for the twelve months ended December 31, 2011 and 2010.
| Table 17 - FDIC Loss Share Rollforward | | | | | | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| | | 2011 | | | 2010 | |
| | | | | | | |
| Balance at beginning of period | | $ | 24,848 | | | $ | - | |
| Additional FDIC loss share receivable from acquisitions | | | 19,922 | | | | 36,301 | |
| Increase in expected losses on indemnified assets | | | 2,295 | | | | 2,184 | |
| Claimable (gains) losses on OREO covered under loss share agreements | | | 2,285 | | | | (14 | ) |
| Reimbursable expenses claimed | | | 810 | | | | 318 | |
| Accretion of discounts and premiums, net | | | (2,946 | ) | | | (2,597 | ) |
| Receipt of payments from FDIC | | | (8,593 | ) | | | (12,035 | ) |
| Other | | | 310 | | | | 691 | |
| Balance at end of period | | $ | 38,931 | | | $ | 24,848 | |
Deposits
The Company offers a wide array of deposit products for small businesses and consumers including demand deposit accounts, money market deposit accounts, savings accounts, and time deposits. During 2011, the Company’s total deposits increased by $25.3 million from $850.8 million at December 31, 2010, to $876.1 million at December 31, 2011. This increase in deposits was largely fueled by the $96.7 million in deposits assumed by New Horizons Bank during the second quarter of 2011. Excluding the New Horizons Bank deposits, interest-bearing and non-interest bearing demand deposits, or checking accounts, increased by $33.3 million, or 13.7%, to $287.5 million at December 31, 2011. Management is committed to increasing demand deposit accounts and building new and enhancing existing customer relationships through improving technology, expanding its branch network and focused marketing efforts. The Company continues to focus on promoting our remote deposit capture, which gives our commercial customers the ability to make deposits of checks remotely without physically visiting a branch office. This allows our commercial sales force the opportunity to solicit business from commercial customers that may not be located near an existing branch office. During 2011, money market deposit accounts increased by $12.7 million, or 8.9%, to $155.2 million at December 31, 2011. This growth was partly due to $7.7 million of deposits assumed from New Horizons Bank. The remaining increase was partly due to consumers moving money from other financial institutions and brokerage accounts due to concerns about the safety of their principal. Also, some consumers rolled their maturing time deposits into these accounts because they provide a higher degree of liquidity and provide a competitive interest rate. Savings accounts increased by $3.5 million, or 20.8%, to $20.5 million. This increase was partly due to the $1.1 million of savings accounts assumed from New Horizons Bank. Time deposits decreased $35.6 million, or 7.9%, to $412.8 million at December 31, 2011. In addition, the Bank assumed $38.5 million of time deposits from New Horizons Bank. Excluding these assumed deposits, then Company’s time deposits decreased by $74.1 million. This decrease was primarily due to the low level of short-term interest rates in 2011, which made alternative investments more attractive to customers. While management is committed to growing its deposit base from within the Company’s market area, we are focused on building relationships and we generally do not offer premium interest rates on time deposits to customers that do not have a banking relationship with our Company. From time to time, brokered time deposits may be used as an additional source of liquidity as needed. However, historically we have not needed to solicit such brokered relationships and as of December 31, 2011, we had no brokered time deposits.
Table 18 below summarizes the deposit portfolio composition for the past three year periods ended December 31.
| Table 18 - Deposit Portfolio Composition | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | Amount | | | % of Total Deposits | | Amount | | | % of Total Deposits | | Amount | | | % of Total Deposits | |
| Noninterest-bearing demand | | $ | 88,077 | | | | 10.1 | % | | $ | 70,389 | | | | 8.3 | % | | $ | 45,830 | | | | 7.5 | % |
| Interest-bearing demand | | | 199,390 | | | | 22.8 | % | | | 172,414 | | | | 20.3 | % | | | 113,564 | | | | 18.6 | % |
| Money market deposit | | | 155,228 | | | | 17.7 | % | | | 142,538 | | | | 16.8 | % | | | 118,687 | | | | 19.5 | % |
| Savings | | | 20,542 | | | | 2.3 | % | | | 17,004 | | | | 2.0 | % | | | 10,584 | | | | 1.7 | % |
Time deposits < $100,000 | | | 239,381 | | | | 27.3 | % | | | 253,812 | | | | 29.7 | % | | | 204,167 | | | | 33.6 | % |
| Time deposits > $100,000 | | | 173,438 | | | | 19.8 | % | | | 194,632 | | | | 22.9 | % | | | 116,513 | | | | 19.1 | % |
| Total deposits | | $ | 876,056 | | | | 100.0 | % | | $ | 850,789 | | | | 100.0 | % | | $ | 609,345 | | | | 100.0 | % |
Table 19 below provides a maturity distribution for all time deposits over $100,000 as of December 31.
| Table 19 - Maturity of Time Deposits Over $100,000 | | | | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| | | 2011 | | | 2010 | | | % Change | |
| Within three months | | $ | 40,670 | | | $ | 49,996 | | | | -18.7 | % |
| After three months through six months | | | 38,936 | | | | 36,799 | | | | 5.8 | % |
| After six months through twelve months | | | 53,446 | | | | 59,342 | | | | -9.9 | % |
| After twelve months | | | 40,386 | | | | 48,495 | | | | -16.7 | % |
| Total | | $ | 173,438 | | | $ | 194,632 | | | | -10.9 | % |
Borrowed Money
The Company’s borrowed money includes advances from the Federal Home Loan Bank of Atlanta (“FHLB”), repurchase agreements and subordinated debt. During 2011 our borrowed money decreased by $7.1 million from $85.8 million at December 31, 2010, to $78.7 million at December 31, 2011. This decrease was primarily due to normal maturities during the period. The Company plans to use excess liquidity to repay these borrowings as they mature. From time to time additional borrowed money may be used to fund additional loan growth, or to purchase investment securities. Table 20 summarizes the balance and average rate for borrowed money at December 31 for the past three years.
| Table 20 - Borrowed Money | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | Balance | | | Average Rate | | Balance | | | Average Rate | | Balance | | | Average Rate | |
| FHLB Advances | | $ | 60,688 | | | | 3.78 | % | | $ | 67,782 | | | | 3.64 | % | | $ | 56,165 | | | | 3.80 | % |
| Repurchase Agreements | | | 18,000 | | | | 3.28 | % | | | 18,000 | | | | 3.28 | % | | | 26,000 | | | | 3.38 | % |
| Total Borrowed Money | | $ | 78,688 | | | | 3.66 | % | | $ | 85,782 | | | | 3.56 | % | | $ | 82,165 | | | | 3.67 | % |
Borrowed money provides an additional source of funding for the Company to cover new loan growth, repay maturing deposits, purchase investment securities, or other operating purposes. The Company’s borrowed money includes unsecured federal funds lines of credit with correspondent banks, secured lines of credit with the Federal Home Loan Bank of Atlanta, reverse repurchase agreements with other financial institutions and subordinated debt. The interest rates on borrowed money ranged from 1.15% to 4.77% in 2011 and 2010 and ranged from 0.62% to 6.25% in 2009. The highest outstanding balance at any month-end for borrowed money was $85.8 million in 2011, $110.6 million in 2010, and $120.1 million in 2009. The average outstanding balance for FHLB advances was $62.8 million, $69.4 million and $58.8 million for 2011, 2010 and 2009, respectively. The average outstanding balance for repurchase agreements was $18.0 million, $21.7 million, and $26.0 million for 2011, 2010, and 2009, respectively.
Capital Resources
Funding for future growth is largely dependent upon the earnings of the Company and its subsidiaries. At December 31, 2011, the Company had a capital-to-assets ratio of 8.6%. As such, the Company fully expects to be able to meet future capital needs caused by growth and expansion as well as regulatory requirements.
Shareholders’ Equity. Total shareholders’ equity decreased by $784,000 from $93.4 million at December 31, 2010, to $92.7 million at December 31, 2011. This decrease was primarily due to the $1.4 million in cash dividends paid on preferred and common stock and the $584,000 accretion of the unamortized discount on preferred stock. These decreases were partly offset by net income of $241,000 during 2011.
Bank Regulatory Capital. OCC regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio and an 8% risk-based capital ratio. At December 31, 2011, Citizens South Bank’s capital exceeded all applicable requirements. Under prompt corrective action regulations, the OCC is required and authorized to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the bank’s capital: 1) well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital); 2) adequately capitalized (at least 4% leverage capital, 4% Tier 1 risk-based capital and 8% total risk-based capital); 3) undercapitalized (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 3% leverage capital); 4) significantly undercapitalized (less than 6% total risk-based capital, 3% Tier 1 risk-based capital or 3% leverage capital); and 5) critically undercapitalized (less than 2% tangible capital). As shown in Table 21 below, Citizens South Bank met the criteria for being considered “well-capitalized” at December 31, 2011 and 2010.
| Table 21 - Regulatory Capital Requirements | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | Well | | | At December 31 | |
| | | Capitalized | | | 2011 | | | 2010 | |
| Leverage capital | | | 5.00 | % | | | 9.44 | % | | | 9.74 | % |
| Tier 1 risk-based | | | 6.00 | % | | | 14.35 | % | | | 15.54 | % |
| Total risk-based | | | 10.00 | % | | | 15.60 | % | | | 16.80 | % |
Preferred Stock. On September 22, 2011, Citizens South Banking Corporation entered into a Securities Purchase Agreement with the Secretary of the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued and sold to the Treasury 20,500 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series C (“Series C Preferred Stock”), having a liquidation preference of $1,000 per share (the “Liquidation Amount”), for aggregate proceeds of $20,500,000. The Securities Purchase Agreement was entered into, and the Series C Preferred Stock was issued, pursuant to the Treasury’s Small Business Lending Fund program (“SBLF”), as established under the Small Business Jobs Act of 2010.
The Company’s rights and obligations with respect to the Series C Preferred Stock are set forth in the Securities Purchase Agreement and the Certificate of Designation to its Certificate of Incorporation filed by the Company with the Secretary State of the State of Delaware on September 6, 2011, and as amended on September 19, 2011 (collectively referred to as the “Certificate of Designation”). Those rights and obligations are summarized below.
The Series C Preferred Stock is entitled to receive non-cumulative dividends payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011. The dividend rate, which is calculated on the aggregate Liquidation Amount, was initially set at 4.84% per annum based upon the level of “Qualified Small Business Lending”, or “QSBL” (as defined in the Certificate of Designation) by the Company’s wholly owned subsidiary Citizens South Bank. The dividend rate for future dividend periods will be set based upon the “Percentage Change in QSBL” (as defined in the Certificate of Designation) between each dividend period and the “Baseline” QSBL level. Such dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods and from 1% per annum to 7% per annum for the eleventh through the first half of the nineteenth dividend periods. If the Series C Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%. Prior to that time, in general, the dividend rate decreases as the level of the Bank’s QSBL increases. The Company may only declare and pay dividends on its common stock (or any other equity securities junior to the Series C Preferred Stock) if it has declared and paid dividends for the current dividend period on the Series C Preferred Stock, and will be subject to other restrictions on its ability to repurchase or redeem other securities.
The Company may redeem the shares of Series C Preferred Stock, in whole or in part, at any time at a redemption price equal to the sum of the Liquidation Amount per share and the per-share amount of any unpaid dividends for the then-current period, subject to any required prior approval by the Company’s primary federal banking regulator.
The Series C Preferred Stock was issued in a private placement exempt from registration pursuant to the Securities Act of 1933, as amended. As part of the Securities Purchase Agreement, the Company has granted the Treasury (and any successor) holder certain rights to require the Series C Preferred Stock to be registered for resale under the Securities Act of 1933, as amended.
As a result of the Company’s participation in SBLF, the Company redeemed all 20,500 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) it sold to the Treasury on December 12, 2008, in connection with the Treasury’s Capital Purchase Program. The Company paid $20.6 million to the Treasury to redeem the Series A Preferred Stock, which includes the original investment of $20.5 million, plus accrued dividends.
Liquidity
The objectives of the Company’s liquidity management policy include providing adequate funds to meet the cash needs of both borrowers and depositors, to provide for the on-going operations of the Company, and to capitalize on opportunities for expansion. Liquidity management addresses the Company’s ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise. The primary sources of internally generated funds are principal and interest payments on loans receivable, increases in local deposits, cash flows generated from operations, and cash flows generated by investments. If the Company requires funds beyond its internal funding capabilities, it may rely upon external sources of funds such as brokered deposits and borrowings, including FHLB advances. At December 31, 2011, the Bank had approximately $103.1 million in additional borrowings available from its line of credit from the FHLB. The FHLB functions as a central reserve bank providing credit for member financial institutions. As a member of the FHLB, we are required to own capital stock in the FHLB and we are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities that are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. In addition, the Bank maintains a $16 million unsecured Fed funds line of credit with Pacific Coast Bankers Bank and a $6 million unsecured Fed funds line of credit with CenterState Bank of Florida. As of December 31, 2011, the balance on both of the Fed funds lines of credit was $0. The Company may also solicit brokered deposits for providing funds for asset growth.
Off-Balance Sheet Arrangements
In the normal course of business, various commitments are outstanding that are not reflected in the Company’s consolidated financial statements. Commitments to extend credit and undisbursed advances on customer lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The funding of these commitments and previously approved undisbursed lines of credit could affect the Company's liquidity position. The Company does not have any special purpose entities or other similar forms of off-balance sheet financing.
Table 22 details the Company’s off-balance sheet commitments at December 31, 2011 and December 31, 2010.
| Table 22 - Commitments | | | | | | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| | | 2011 | | | 2010 | |
| | | | | | | |
| Loan commitments: | | | | | | |
| Residential mortgage loans | | $ | 24,484 | | | $ | 14,530 | |
| | | | | | | | | |
| | | | | | | | | |
| Unused lines of credit: | | | | | | | | |
| Residential Construction | | $ | 7,390 | | | $ | 5,868 | |
| Commercial Real Estate | | | 18,593 | | | | 6,505 | |
| Commercial Business | | | 9,558 | | | | 8,775 | |
| Consumer | | | 74,930 | | | | 76,015 | |
| Total unused lines of credit | | $ | 110,471 | | | $ | 97,163 | |
| | | | | | | | | |
| Undisbursed Construction Loan Proceeds | | $ | 1,200 | | | $ | 524 | |
Contractual Obligations. Under existing contractual obligations, the Company will be required to make payments in future periods. The Company expects that a portion of the deposits will not be renewed upon maturity. If there is a higher than normal level of time deposits that are not renewed at maturity, then the Company may experience a decrease in liquidity. This may result in the Company offering higher than market interest rates to maintain deposits, which would increase interest expense. Transaction deposit accounts with indeterminate maturities have been classified as having payments due in one year or less. Table 23 following this discussion presents aggregated information about payments due under such contractual obligations at December 31, 2011.
| Table 23 - Contractual Obligations | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | Total | | | Less Than 1 year | | | Over 1 Year to 3 Years | | | Over 3 years to 5 Years | | | After 5 Years | |
| Deposits | | $ | 876,056 | | | $ | 780,688 | | | $ | 82,807 | | | $ | 12,561 | | | $ | - | |
| Securities sold under repurchase agreements | | | 9,787 | | | | 9,787 | | | | - | | | | - | | | | - | |
| Borrowings | | | 78,688 | | | | 17,954 | | | | 18,734 | | | | 42,000 | | | | - | |
| Subordinated debt | | | 15,464 | | | | - | | | | - | | | | - | | | | 15,464 | |
| Leases | | | 5,690 | | | | 641 | | | | 797 | | | | 837 | | | | 3,415 | |
| Total contractual cash obligations | | $ | 979,995 | | | $ | 809,070 | | | $ | 102,338 | | | $ | 55,398 | | | $ | 18,879 | |
Impact of Inflation and Changing Prices
The consolidated financial statements and related notes have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all the assets and liabilities of the Company are financial in nature. As a result, interest rates have a more significant impact on the Company’s performance than the effect of inflation. Interest rates do not necessarily change in the same magnitude as the price of goods and services.
| Quantitative and Qualitative Disclosures About Market Risk |
Management of Market Risk
Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates. The risk of loss can be reflected in diminished market values and/or reduced net interest income in future periods. The Company’s most significant form of market risk is interest rate risk, as the majority of the Company's assets and liabilities are sensitive to changes in interest rates. The structure of the Company's loan and deposit portfolios is such that significant changes in interest rates could adversely impact net interest income. The Company does not maintain a trading account, nor is it subject to currency exchange risk or commodity price risk. The Company's Asset/Liability Committee ("ALCO") is responsible for monitoring and managing exposure to interest rate risk. The Company's ALCO monitors the Company's level of interest rate sensitivity and ensures that the level of sensitivity of the Company's net portfolio value is maintained within limits established by the Board of Directors. Through such management, the ALCO seeks to reduce the vulnerability of the Company's operations to changes in interest rates. During the past year, the ALCO utilized the following strategies to manage interest rate risk: 1) emphasizing the origination and retention of short-term commercial business loans and nonresidential mortgage loans; 2) emphasizing the origination of adjustable-rate home equity lines of credit; 3) emphasizing the origination and retention of adjustable-rate one-to-four family residential mortgage loans; 4) originating most new fixed-rate mortgage loans as a broker for a third party; and 5) focusing on growing the Company’s core deposit portfolio.
Interest Rate Sensitivity. The OCC requires the computation of amounts by which the net present value of the Bank's cash flow from assets, liabilities, and off balance sheet items (the Bank’s net portfolio value or "NPV") and the net interest income (“NII”) of the Bank would change in the event of a range of assumed changes in market interest rates. These computations estimate the effect on a bank’s NPV and NII from instantaneous and permanent one hundred- to three hundred-basis point increases and decreases in market interest rates. Table 24, which follows this discussion, presents the Bank’s projected change in NPV and NII at December 31, 2011, as calculated by an independent third party, based upon information provided by the Bank. This table also details the Bank’s level of sensitivity, given a hypothetical, immediate, and sustained change in interest rates from + 300 basis points to – 300 basis points, and its range of acceptable sensitivity established by the Board of Directors.
| Table 24 - Interest Rate Risk | | | | | | | | | | | | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Hypothical, Immediate and Sustained Changes in | | Net Interest Income | | | Net Portfolio Value | |
| Interest Rates | | Amount | | | % Change | | | Amount | | | % Change | |
| | | | | | | | | | | | | |
| 300 basis point rise | | $ | 27,094 | | | | -5.32 | % | | $ | 118,316 | | | | -4.30 | % |
| 200 basis point rise | | | 27,343 | | | | -4.45 | % | | | 120,674 | | | | -2.39 | % |
| 100 basis point rise | | | 27,714 | | | | -3.16 | % | | | 122,626 | | | | -0.81 | % |
| No change | | | 28,617 | | | | 0.00 | % | | | 123,632 | | | | 0.00 | % |
| 100 basis point decline | | | 27,464 | | | | -4.03 | % | | | 123,665 | | | | 0.03 | % |
| 200 basis point decline | | | 26,149 | | | | -8.62 | % | | | 133,683 | | | | 8.13 | % |
| 300 basis point decline | | | 25,480 | | | | -10.96 | % | | | 151,171 | | | | 22.28 | % |
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in NPV require the making of certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV presented in Table 24 above assumes that the composition of the interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV on Table 24 provides an indication of the Bank’s interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Bank’s net interest income and will differ from actual results.
| Financial Statements and Supplemental Data |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Citizens South Banking Corporation and Subsidiaries
Gastonia, North Carolina
We have audited the accompanying consolidated statements of financial condition of Citizens South Banking Corporation and subsidiaries (the “Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2011. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinions.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Citizens South Banking Corporation and subsidiaries as of December 31, 2011 and 2010 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
/s/ Cherry, Bekaert & Holland, L.L.P.
Raleigh, North Carolina
March 30, 2012
| | | | | | |
| CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION | | | | | | |
| December 31, 2011 and 2010 | | | | | | |
| | | | | | | |
| | | 2011 | | | 2010 | |
| (Dollars in thousands, except share and per share data) | | | | | | |
| | | | | | | |
| ASSETS | | | | | | |
| Cash and cash equivalents: | | | | | | |
| Cash and due from banks | | $ | 13,296 | | | $ | 15,110 | |
| Interest bearing deposits | | | 75,048 | | | | 105,789 | |
| Cash and cash equivalents | | | 88,344 | | | | 120,899 | |
Investment securities available for sale, at fair value (amortized cost of $51,659 and $74,335 at December 31, 2011 and December 31, 2010, respectively) | | | 52,136 | | | | 74,308 | |
Investment securities held to maturity, at amortized cost (fair value of $98,115 and $37,278 at December 31, 2011, and December 31, 2010, respectively) | | | 95,763 | | | | 37,278 | |
| Federal Home Loan Bank stock, at cost | | | 5,067 | | | | 5,715 | |
| Presold loans in process of settlement | | | 2,146 | | | | 4,034 | |
| Loans: | | | | | | | | |
| Covered by FDIC loss-share agreements | | | 159,688 | | | | 147,576 | |
| Not covered by FDIC loss-share agreements | | | 574,100 | | | | 588,934 | |
| Loans, net of deferred fees and costs | | | 733,788 | | | | 736,510 | |
| Allowance for loan losses | | | (11,713 | ) | | | (11,924 | ) |
| Loans, net | | | 722,075 | | | | 724,586 | |
| Other real estate owned | | | 17,571 | | | | 14,652 | |
| Premises and equipment, net | | | 25,888 | | | | 23,785 | |
| FDIC loss share receivable | | | 38,931 | | | | 24,848 | |
| Accrued interest receivable | | | 2,773 | | | | 3,001 | |
| Bank-owned life insurance | | | 18,978 | | | | 18,230 | |
| Intangible assets | | | 1,373 | | | | 1,690 | |
| Other assets | | | 9,415 | | | | 11,461 | |
| Total assets | | $ | 1,080,460 | | | $ | 1,064,487 | |
| | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | |
| Deposits | | $ | 876,056 | | | $ | 850,789 | |
| Securities sold under repurchase agreements | | | 9,787 | | | | 9,432 | |
| Borrowed money | | | 78,688 | | | | 85,782 | |
| Subordinated debt | | | 15,464 | | | | 15,464 | |
| Other liabilities | | | 7,806 | | | | 9,577 | |
| Total liabilities | | | 987,801 | | | | 971,044 | |
| | | | | | | | | |
| Shareholders' Equity | | | | | | | | |
Preferred stock, $0.01 par value, Authorized: 1,000,000 shares; Issued and outstanding: 20,500 shares | | | 20,500 | | | | 20,672 | |
Common stock, $0.01 par value, Authorized: 20,000,000 shares; Issued: 12,393,126 shares; Outstanding: 11,506,324 shares at December 31, 2011, and 11,508,750 shares at December 31, 2010 | | | 124 | | | | 124 | |
| Additional paid-in-capital | | | 63,888 | | | | 63,000 | |
| Retained earnings, substantially restricted | | | 7,854 | | | | 9,663 | |
| Accumulated other comprehensive income (loss) | | | 293 | | | | (16 | ) |
| Total shareholders' equity | | | 92,659 | | | | 93,443 | |
| Total liabilities and shareholders' equity | | $ | 1,080,460 | | | $ | 1,064,487 | |
See accompanying notes to consolidated financial statements.
| | | | | | | | | |
| CONSOLIDATED STATEMENTS OF OPERATIONS | | | | | | | | | |
| For the Years Ended December 31, 2011, 2010, and 2009 | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands, except per share data) | | | | | | | | | |
| | | | | | | | | | |
| Interest Income: | | | | | | | | | |
| Interest and fees on loans | | $ | 40,158 | | | $ | 40,540 | | | $ | 33,676 | |
| Investment securities: | | | | | | | | | | | | |
| Taxable interest income | | | 3,412 | | | | 2,517 | | | | 3,397 | |
| Tax-exempt interest income | | | 304 | | | | 544 | | | | 1,127 | |
| Other interest income | | | 202 | | | | 314 | | | | 100 | |
| Total interest income | | | 44,076 | | | | 43,915 | | | | 38,300 | |
| Interest Expense: | | | | | | | | | | | | |
| Deposits | | | 7,128 | | | | 10,262 | | | | 11,918 | |
| Securities sold under repurchase agreements | | | 60 | | | | 107 | | | | 178 | |
| Borrowed money | | | 3,022 | | | | 3,395 | | | | 3,487 | |
| Subordinated debt | | | 328 | | | | 914 | | | | 943 | |
| Total interest expense | | | 10,538 | | | | 14,678 | | | | 16,526 | |
| | | | | | | | | | | | | |
| Net interest income | | | 33,538 | | | | 29,237 | | | | 21,774 | |
| Provision for loan losses | | | 10,685 | | | | 14,050 | | | | 10,980 | |
| Net interest income after provision for loan losses | | | 22,853 | | | | 15,187 | | | | 10,794 | |
| Noninterest Income: | | | | | | | | | | | | |
| Service charges on deposit accounts | | | 4,154 | | | | 3,932 | | | | 3,256 | |
| Mortgage banking income | | | 1,255 | | | | 1,525 | | | | 1,202 | |
| Commissions on sales of financial products | | | 267 | | | | 426 | | | | 191 | |
| Income from bank-owned life insurance | | | 777 | | | | 832 | | | | 770 | |
| Gain from acquisition | | | 4,140 | | | | 19,679 | | | | - | |
| Gain on sale of investments, available for sale | | | 111 | | | | 349 | | | | 2,198 | |
| Loss on sale of other assets | | | (342 | ) | | | (490 | ) | | | (285 | ) |
| Other | | | 979 | | | | 883 | | | | 640 | |
| Total noninterest income | | | 11,341 | | | | 27,136 | | | | 7,972 | |
| Noninterest Expense: | | | | | | | | | | | | |
| Compensation and benefits | | | 15,000 | | | | 13,598 | | | | 9,818 | |
| Occupancy and equipment | | | 3,421 | | | | 3,302 | | | | 2,571 | |
| Data processing and other technology | | | 1,063 | | | | 927 | | | | 672 | |
| Professional services | | | 1,003 | | | | 981 | | | | 1,059 | |
| Advertising and business development | | | 320 | | | | 333 | | | | 365 | |
| Loan collection and other expenses | | | 1,361 | | | | 447 | | | | 238 | |
| Deposit insurance | | | 1,535 | | | | 1,326 | | | | 1,076 | |
| Office supplies | | | 248 | | | | 240 | | | | 142 | |
| Telephone and communications | | | 442 | | | | 406 | | | | 274 | |
| Other real estate owned valuation adjustments | | | 4,319 | | | | 1,382 | | | | 338 | |
| Other real estate owned expenses | | | 1,302 | | | | 993 | | | | 341 | |
| Amortization of intangible assets | | | 538 | | | | 517 | | | | 314 | |
| Impairment of investment securities | | | - | | | | 435 | | | | 754 | |
| Impairment of goodwill | | | - | | | | - | | | | 29,641 | |
| Acquisition and integration expenses | | | 792 | | | | 1,064 | | | | - | |
| Other | | | 3,311 | | | | 3,384 | | | | 2,669 | |
| Total noninterest expense | | | 34,655 | | | | 29,335 | | | | 50,272 | |
| | | | | | | | | | | | | |
| Income (loss) before income tax expense (benefit) | | | (461 | ) | | | 12,988 | | | | (31,506 | ) |
| Income tax expense (benefit) | | | (702 | ) | | | 4,349 | | | | (1,499 | ) |
| Net income (loss) | | | 241 | | | | 8,639 | | | | (30,007 | ) |
| Dividends and accretion of discount on preferred stock | | | 1,526 | | | | 1,025 | | | | 1,034 | |
| | | | | | | | | | | | | |
| Net income (loss) available to common shareholders | | $ | (1,285 | ) | | $ | 7,614 | | | $ | (31,041 | ) |
| | | | | | | | | | | | | |
| Earnings (loss) per common share - basic | | $ | (0.11 | ) | | $ | 0.78 | | | $ | (4.19 | ) |
| Earnings (loss) per common share - diluted | | | (0.11 | ) | | | 0.78 | | | | (4.19 | ) |
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2011, 2010, and 2009
| | | Stock | | | Stock | | | Capital | | | Earnings Restricted | | | Income (Loss) | | | Equity | |
| (Dollars in thousands, except share and per share data) | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Balances, January 1, 2009 | | $ | 20,507 | | | $ | 91 | | | $ | 48,008 | | | $ | 36,089 | | | $ | 25 | | | $ | 104,720 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive results: | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | (30,007 | ) | | | - | | | | (30,007 | ) |
| Other comprehensive results, net of tax | | | - | | | | - | | | | - | | | | - | | | | (322 | ) | | | (322 | ) |
| Accretion of discount on preferred stock | | | 82 | | | | - | | | | - | | | | (82 | ) | | | - | | | | - | |
| Allocation from shares purchased with loan to ESOP | | | - | | | | - | | | | 63 | | | | - | | | | - | | | | 63 | |
| Vesting of Recognition and Retention Plan ("RRP") | | | - | | | | - | | | | 331 | | | | - | | | | - | | | | 331 | |
| Stock-based compensation | | | - | | | | - | | | | 106 | | | | - | | | | - | | | | 106 | |
| Stock options exercised | | | - | | | | - | | | | 20 | | | | (20 | ) | | | - | | | | - | |
| Cash dividends on preferred stock, net of accretion | | | - | | | | - | | | | - | | | | (1,034 | ) | | | - | | | | (1,034 | ) |
| Cash dividends on common stock | | | - | | | | - | | | | - | | | | (1,535 | ) | | | - | | | | (1,535 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | - | |
| Balances, December 31, 2009 | | $ | 20,589 | | | $ | 91 | | | $ | 48,528 | | | $ | 3,411 | | | $ | (297 | ) | | $ | 72,322 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | 8,639 | | | | - | | | | 8,639 | |
| Other comprehensive results, net of tax | | | - | | | | - | | | | - | | | | - | | | | 281 | | | | 281 | |
| Issuance of 1,490,400 shares of common stock | | | - | | | | 33 | | | | 14,007 | | | | - | | | | - | | | | 14,040 | |
| Accretion of discount on preferred stock | | | 83 | | | | - | | | | - | | | | (83 | ) | | | - | | | | - | |
| Allocation from shares purchased with loan to ESOP | | | - | | | | - | | | | 50 | | | | - | | | | - | | | | 50 | |
| Vesting of RRP | | | - | | | | - | | | | 316 | | | | - | | | | - | | | | 316 | |
| Stock-based compensation | | | - | | | | - | | | | 99 | | | | - | | | | - | | | | 99 | |
| Cash dividends on preferred stock, net of accretion | | | - | | | | - | | | | - | | | | (1,025 | ) | | | - | | | | (1,025 | ) |
| Cash dividends on common stock | | | - | | | | - | | | | - | | | | (1,279 | ) | | | - | | | | (1,279 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | - | |
| Balances, December 31, 2010 | | $ | 20,672 | | | $ | 124 | | | $ | 63,000 | | | $ | 9,663 | | | $ | (16 | ) | | $ | 93,443 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | 241 | | | | - | | | | 241 | |
| Other comprehensive results, net of tax | | | - | | | | - | | | | - | | | | - | | | | 309 | | | | 309 | |
| Redemption of 20,500 shares of preferred stock issued to the U.S. Treasury under the Capital Purchase Program, a part of the Troubled Asset Relief Program ("TARP") | | | (20,500 | ) | | | - | | | | - | | | | - | | | | - | | | | (20,500 | ) |
| Issuance of 20,500 shares of preferred stock issued to the U.S. Treasury under the Small Business Lending Fund ("SBLF") | | | 20,500 | | | | - | | | | - | | | | - | | | | - | | | | 20,500 | |
| Accretion of discount on preferred stock | | | 68 | | | | - | | | | - | | | | (68 | ) | | | - | | | | - | |
| Repurchase of warrants | | | (240 | ) | | | - | | | | 599 | | | | - | | | | - | | | | 359 | |
| Allocation from shares purchased with loan to ESOP | | | - | | | | - | | | | 35 | | | | - | | | | - | | | | 35 | |
| Issuance of shares under RRP | | | - | | | | - | | | | (10 | ) | | | - | | | | - | | | | (10 | ) |
| Vesting of RRP | | | - | | | | - | | | | 163 | | | | - | | | | - | | | | 163 | |
| Stock-based compensation | | | - | | | | - | | | | 101 | | | | - | | | | - | | | | 101 | |
| Cash dividends on preferred stock, net of accretion | | | - | | | | - | | | | - | | | | (1,526 | ) | | | - | | | | (1,526 | ) |
| Cash dividends on common stock | | | - | | | | - | | | | - | | | | (456 | ) | | | - | | | | (456 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | - | |
| Balances, December 31, 2011 | | $ | 20,500 | | | $ | 124 | | | $ | 63,888 | | | $ | 7,854 | | | $ | 293 | | | $ | 92,659 | |
See accompanying notes to consolidated financial statements.
| | | | | | | | | |
| For the Years Ended December 31, 2011, 2010, and 2009 | | | | | | | |
| | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | |
| Net income (loss) | | $ | 241 | | | $ | 8,639 | | | $ | (30,007 | ) |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | |
| Provision for loan losses | | | 10,685 | | | | 14,050 | | | | 10,980 | |
| Depreciation of premises and equipment | | | 1,244 | | | | 1,254 | | | | 1,026 | |
| Goodwill impairment charge | | | - | | | | - | | | | 29,641 | |
| Impairment of securities | | | - | | | | 435 | | | | 754 | |
| Deferred income tax expense (benefit) | | | (2,232 | ) | | | 4,058 | | | | (1,273 | ) |
| Gain on acquisition | | | (4,140 | ) | | | (19,679 | ) | | | - | |
| Gain on sale of investment securities available for sale | | | (111 | ) | | | (349 | ) | | | (2,198 | ) |
| Loss on sale of other real estate owned | | | 294 | | | | 447 | | | | 280 | |
| Loss on sale of other assets | | | 48 | | | | 43 | | | | 5 | |
| Valuation adjustment on other real estate owned | | | 4,319 | | | | 1,382 | | | | 338 | |
| Net purchase accounting adjustments | | | 13,384 | | | | 20,299 | | | | - | |
| Net (increase) decrease in loans available for sale | | | 1,888 | | | | (4,034 | ) | | | - | |
| Deferred loan origination fees | | | 232 | | | | 81 | | | | 41 | |
| Amortization of intangible assets | | | 538 | | | | 517 | | | | 314 | |
| Allocation of shares to the ESOP | | | 35 | | | | 50 | | | | 63 | |
| Stock-based compensation expense | | | 101 | | | | 99 | | | | 106 | |
| Vesting of shares issued for the RRP | | | 153 | | | | 316 | | | | 331 | |
| Decrease in accrued interest receivable | | | 527 | | | | 610 | | | | 179 | |
| (Increase) decrease in other assets | | | 10,564 | | | | (4,216 | ) | | | (8,397 | ) |
| Decrease in other liabilities | | | (3,343 | ) | | | (1,425 | ) | | | (3,399 | ) |
| Net cash provided by (used in) operating activities | | | 34,427 | | | | 22,577 | | | | (1,216 | ) |
| | | | | | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | | | | | |
| Net decrease in loans made to customers | | | 10,984 | | | | 25,203 | | | | 6,630 | |
| Proceeds from sales of investment securities available for sale | | | 10,111 | | | | 43,302 | | | | 69,349 | |
| Proceeds from sales of premises and equipment | | | - | | | | 1 | | | | 815 | |
| Proceeds from sales of other real estate owned | | | 15,328 | | | | 5,955 | | | | 2,418 | |
| Proceeds from maturities/issuer calls of investment securities available for sale | | | 22,378 | | | | 12,198 | | | | 23,352 | |
| Proceeds from maturities/issuer calls of investment securities held to maturity | | | 14,637 | | | | 43,874 | | | | 36 | |
| Purchases of investment securities available for sale | | | - | | | | (56,139 | ) | | | (33,591 | ) |
| Purchases of investment securities held to maturity | | | (73,122 | ) | | | (48,773 | ) | | | (32,415 | ) |
| Net cash received in acquisition | | | 18,951 | | | | 95,058 | | | | - | |
| Redemption of FHLB stock | | | 1,075 | | | | 682 | | | | 644 | |
| Purchases of premises and equipment | | | (3,315 | ) | | | (9,396 | ) | | | (445 | ) |
| Net cash provided by investment activities | | | 17,027 | | | | 111,965 | | | | 36,793 | |
| | | | | | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | | | | | |
| Net increase (decrease) in deposits | | | (71,460 | ) | | | (51,109 | ) | | | 27,857 | |
| Dividends paid to common stockholders | | | (456 | ) | | | (1,279 | ) | | | (1,535 | ) |
| Dividends paid and accretion of discount on preferred stock | | | (1,526 | ) | | | (1,025 | ) | | | (1,034 | ) |
| Repurchase of warrants on preferred stock | | | 359 | | | | - | | | | - | |
| Issuance of common stock | | | - | | | | 14,040 | | | | - | |
| Net decrease in borrowed money and repurchase agreements | | | (10,954 | ) | | | (27,504 | ) | | | (17,766 | ) |
| Increase in advances from borrowers for insurance and taxes | | | 28 | | | | 54 | | | | 24 | |
| Net cash provided by (used in) financing activities | | | (84,009 | ) | | | (66,823 | ) | | | 7,546 | |
| | | | | | | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | (32,555 | ) | | | 67,719 | | | | 43,123 | |
| Cash and cash equivalents at beginning of year | | | 120,899 | | | | 53,180 | | | | 10,057 | |
| Cash and cash equivalents at end of year | | $ | 88,344 | | | $ | 120,899 | | | $ | 53,180 | |
| | | | | | | | | | | | | |
| Supplemental non-cash investing activity: | | | | | | | | | | | | |
| Foreclosed loans transferred to other real estate owned | | $ | 16,486 | | | $ | 16,293 | | | $ | 5,502 | |
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Organization and Summary of Significant Accounting Policies
Organization - Citizens South Banking Corporation (also referred to as the “Company”, the “Registrant”, “We”, “Us”, or “Our”) is a Delaware corporation that owns all of the outstanding shares of common stock of Citizens South Bank (the “Bank”). The shares of common stock of the Company trade on the Nasdaq Global Market under the ticker symbol “CSBC.” The Company’s principal business activities are overseeing and directing the business of the Bank. The Company’s assets consist primarily of the outstanding capital stock of the Bank, deposits held at the Bank, and investment securities. The Company became the holding company for the Bank in 2002, in connection with the mutual-to-stock conversion of Citizens South Holdings, MHC, the mutual holding company of Citizens South Banking Corporation, a federal corporation, formerly named Gaston Federal Bancorp, Inc., which was originally formed in 1998 for the purpose of acting as the holding company for the Bank.
Citizens South Bank, which was chartered in 1904, is a federally chartered savings bank headquartered in Gastonia, North Carolina. The Bank’s principal business activity is offering FDIC-insured deposits to local customers through its 21 branch offices and investing those deposits, together with funds generated from operations and borrowings, in residential and nonresidential real estate loans, construction loans, commercial business loans, consumer loans and investment securities. The Bank also acts as a broker in both the origination of loans secured by one-to-four family dwellings and in the sale of uninsured financial products. The Bank’s results of operations are heavily dependent on net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. The Bank’s results of operations are heavily dependent on net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. Results of operations are also materially affected by the Bank’s provision for loan losses, noninterest income, and noninterest expense. Noninterest income primarily consists of fee income generated from deposit accounts, mortgage banking fees, commissions earned from the sale of uninsured investment products, increases in the cash value of bank-owned life insurance policies, net gains from the sale of assets and other noninterest income items. The Bank’s noninterest expense primarily consists of compensation and employee benefits, occupancy expense, professional services, advertising, deposit insurance, loan collection expenses, other real estate owned value adjustments and expenses, amortization of intangible assets, impairment of investments, and other noninterest expenses. Results of operations are also significantly affected by local economic and competitive conditions, changes in interest rates, and actions of regulatory and governmental authorities. The Bank has two subsidiaries, Citizens South Financial Services, Inc, and Citizens Properties, LLC. Citizens South Financial Services, Inc. primarily owns stock in a title insurance company which is used by the Bank for certain real estate transactions. Citizens Properties, LLC was formed in January 2012 for the purpose of holding title to certain real estate that was acquired by the Bank through foreclosure.
The Company operates 21 full-service branch offices in the North Carolina Counties of Gaston (7), Union (3), Rowan (2), Mecklenburg (1), and Iredell (2), the South Carolina County of York (1) and the Georgia Counties of Fannin (1), Union (1), Gilmer (1) and Towns (2). The Company’s corporate headquarters is located at 519 South New Hope Road in Gastonia, North Carolina.
Consolidation – The accompanying consolidated financial statements include the accounts of Citizens South Banking Corporation, its wholly-owned subsidiary, Citizens South Bank, and the Bank’s wholly-owned subsidiaries, Citizens South Financial Services, Inc. and Citizens Properties, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain of the prior year amounts have been reclassified to conform to current year presentation. Such reclassifications are immaterial to the financial statements.
Use of Estimates – The consolidated financial statements are prepared in accordance with GAAP which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The more significant estimates that are particularly susceptible to change in the near future relate to the calculation of the allowance for loan losses, the determination of other-than-temporary impairment on investment securities and the estimate of the fair value of assets acquired in FDIC-assisted transactions, including loans, other real estate owned and FDIC loss-share receivable. Actual results could differ from those estimates.
Business Combinations and Method of Accounting for Loans Acquired - The Company accounts for its acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. There is no allowance for loan losses related to the acquired loans recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in FASB ASC Topic 820, Fair Value Measurements and Disclosures, exclusive of the loss share agreements with the FDIC. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.
Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality, formerly American Institute of Certified Public Accountants ("AICPA") Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer , and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of purchase dates may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. The Company considers expected prepayments and estimates the amount and timing of expected principal, interest and other cash flows for each loan or pool of loans meeting the criteria above, and determines the excess of the loan's scheduled contractual principal and contractual interest payments over all cash flows expected to be collected at acquisition as an amount that should not be accreted (nonaccretable difference). The remaining amount, representing the excess of the loan's or pool's cash flows expected to be collected over the fair value for the loan or pool of loans, is accreted into interest income over the remaining life of the loan or pool (accretable yield).
Subsequent to the acquisition date, FASB ASC Topic 310-30 requires that increases in cash flows expected to be received in excess of the Company's initial estimates are to be reclassified from nonaccretable difference to accretable yield and are to then be accreted into interest income on a level-yield basis over the remaining life of the loan. Decreases in cash flows expected to be collected are to be recognized as impairment through the provision for loan losses. For acquired loans subject to a loss sharing agreement with the FDIC, the FDIC indemnification asset will be adjusted prospectively in a similar, consistent manner with increases and decreases in expected cash flows. However, the Company’s methodology does not conform to FASB ASC Topic 310-30 in that adjustments to both the nonaccretable difference and in some cases the accretable yield, have been based upon actual cash flows since acquisition versus expected cash flows. With regards to the Company’s loans acquired from the Bank of Hiawassee in March 2010 that are subject to FASB ASC Topic 310-30, management has determined that actual cash flows since acquisition have been materially consistent with the expected cash flows as of the acquisition date and that as of December 31, 2011 the nonaccretable difference allocable to the remaining loans in this acquired portfolio represents a materially correct proxy for the difference between remaining contractual cash flows and expected future cash flows. With regards to the Company’s loans acquired from New Horizons Bank in April 2011 that are subject to FASB ASC Topic 310-30, no events have occurred since the acquisition date through December 31, 2011 that cause management to believe that the initial expected future cash flows have changed materially. Based upon these considerations as well as managements continued evaluation of the performance of both acquired loan portfolios, management has determined that its current methodology does not provide a materially different result than that which would be expected had the guidance in FASB ASC Topic 310-30 been adhered to.
Cash and Cash Equivalents – Cash and cash equivalents include cash on hand, amounts due from banks, short-term interest-bearing deposits, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Investment Securities – Investment securities are classified in one of three categories on the date of purchase as follows: 1) available for sale; 2) held to maturity; or 3) trading. Investment securities classified as available for sale are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of consolidated shareholders’ equity and as an item of other comprehensive income. Investment securities classified as held to maturity are carried at book value. The Company did not classify any securities as trading at December 31, 2011 or 2010. Purchases and sales of securities are recorded on a trade-date basis. Gains and losses are recognized on a trade-date basis at the time of the sale using the specific identification method. Declines in the fair value of individual securities below their cost that are considered “other-than-temporary” result in write-downs of the individual securities to their fair value. The related write-downs are included in the consolidated earnings of the Company. Amortization of premiums and accretion of discounts are included in interest income over the life of the related security, or in the case of mortgage-backed and related securities, the estimated life of the security. Additional details may be found later in this Report under Note 4 – Investment Securities.
Loans - Loans that management has the intent and ability to hold for the foreseeable future are carried at their principal balance adjusted for any deferred loan fees or expenses. Interest income is earned on the level yield method based on the daily outstanding balance. Generally, loans are classified as nonaccrual, and the accrual of interest is discontinued, when the contractual payment of principal and interest has become 90 days past due or when, in management’s judgment, principal or interest is not collectible in accordance with the terms of the obligation. Cash receipts on nonaccrual loans are applied to principal. The accrual of interest resumes when the loan returns to performing status. The Company evaluates impairment of its residential mortgage and consumer loans on a collective basis. Commercial loans are considered to be impaired when, based on current information, it is probable that the Company will not collect all amounts when due in accordance with the contractual terms of the loan agreement. Management monitors internally generated reports, including past due reports, payment histories, criticized asset reports, which include loans with historical payment problems or borrowers in troubled industries, as well as other sources of information, such as borrower financial statements, the value of the collateral, etc., to identify impaired loans. Discounted cash flow analysis or the estimated fair value of collateral are used in determining the fair value of impaired loans. When the ultimate collectability of the principal balance of an impaired loan is in doubt, cash receipts are applied to principal. The Company had presold loans in process of settlement of $2.1 million at December 31, 2011 and $4.0 million at December 31, 2010. Additional details may be found later in this Report under Note 5 – Loans.
Impaired Loans – Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected to come from the sale of the collateral. Collateral values are estimated using Level 3 inputs based on observable market data. During 2011 and 2010, certain impaired loans were identified and reported at fair value through a direct write-down against the principal balance. Future interest income on impaired loans will be recognized only if the loan is not in excess of 90 days delinquent and the loan is not on nonaccrual status. Payments received on those loans that are on nonaccrual status will be applied directly to principal and no income will be recognized until the loan has been repaid or has been placed back on accrual status. Additional details may be found later in this Report under Note 6 – Credit Quality of Loans.
Concentrations of Credit Risk – The Company makes loans to individuals as well as small and medium sized businesses primarily in the Company’s normal lending area which includes the North Carolina Counties of Gaston, Rowan, Union, Mecklenburg, Cabarrus, Lincoln, Cleveland, and Iredell Counties, along with York County in South Carolina and the Georgia Counties of Fannin, Union and Towns. The Company has a diversified loan portfolio, and the borrowers' ability to repay their loans is not dependent upon any specific economic segment. A large portion of the Company’s loans are secured by real estate in our normal lending area. As a result, significant decreases in real estate values in the Company’s normal lending area could increase loan losses and have an adverse effect on future earnings.
Allowance for Loan Losses - Management has established a systematic methodology for evaluating the adequacy of the Company’s allowance for loan losses. The methodology is set forth in a formal policy and considers all loans in the portfolio. Specific allowances are established for certain individual loans that management considers impaired. The remainder of the portfolio is segmented into groups of loans with similar risk characteristics for evaluation and analysis. In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower, the term of the loan, general economic conditions, and in the case of a secured loan, the quality of the collateral. We increase our allowance for loan losses by charging the provisions for loan losses against our current period income. Management’s periodic evaluation of the adequacy of the allowance is consistently applied and is based on our past loan loss experience, particular risks inherent in the different kinds of lending that we engage in, adverse situations that may affect the borrower’s ability to repay the debt, the estimated value of any underlying collateral, current economic conditions, as well as other relevant internal and external factors that could impact loan collectability. The evaluation of the allowance for loan losses is inherently subjective. As such, if factors, such as economic conditions, differ substantially from the assumptions, then future adjustments to the allowance for loan losses may be necessary. Additional details may be found in later in this Report under Note 7 – Allowance for Loan Losses.
FDIC Loss Share Receivable – The FDIC loss share receivable relates to agreements with the FDIC, whereby the FDIC has agreed to reimburse to the Company a percentage of the losses related to loans and other real estate that the Company assumed in the acquisition of a failed bank. This loss share receivable is measured separately from the loan portfolio and other real estate because it is not contractually embedded in the loans and is not transferable with the loans should the Company choose to dispose of them. The carrying value of this receivable is determined at each period end by multiplying the estimated amount of loan and other real estate losses covered by the agreements by the FDIC reimbursement percentage. Additional details may be found in later in this Report under Note 8 – FDIC Loss Share Receivable.
Other Real Estate Owned – Other real estate owned (“OREO”) is comprised of real estate properties acquired in partial or total satisfaction of problem loans. OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Losses arising at the time of acquisition of such properties are charged against the allowance for loan losses. Subsequent write-downs that may be required to the carrying value of these properties are charged to current operations. Gains and losses realized from the sale of other real estate owned are included in current operations. Additional details may be found in later in this Report under Note 9 – Other Real Estate Owned.
Premises and Equipment – Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed over the estimated useful lives of the assets (from three to 40 years) based on the straight-line method. Maintenance and repairs are charged to operations in the period incurred. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life of the improvement or the lease term. Gains and losses on dispositions of fixed assets are included in current operations. Additional details may be found in later in this Report under Note 10 – Premises and Equipment.
Bank-owned life insurance – The Company has purchased life insurance on certain key employees and directors. These policies are recorded at their cash surrender value. Income generated from polices is recorded as noninterest income.
Goodwill and Other Intangible Assets – Goodwill represents the cost in excess of fair value of net assets acquired in transactions accounted for as purchases. In accordance with accounting guidelines, goodwill is not amortized over an estimated useful life, but rather is tested annually for impairment. Performing a goodwill impairment test is a two-step process. In performing the first step, the Company estimates the fair value of the reporting unit (which was determined to be the Company) using a market value approach that utilizes the Company’s current stock price as the primary indicator of fair market value. As of December 31, 2009, the results of the first step indicated that the fair value of the Company was less than the book value of the Company. As such, the Company performed the second step of the goodwill impairment test. The results of the second step indicated that the goodwill was fully impaired and had a fair value of $0. The primary determining factors in the determination of the goodwill impairment was the relatively low stock price of the Company and the resulting low market valuation. These factors were largely attributed to the low market-wide valuations for financial institutions which impacted the Company’s market valuation. The goodwill impairment was a non-cash expense and did not impact future operating performance.
In accordance with accounting guidelines, the Company’s core deposit intangible is amortized over its estimated useful life of eight years on an accelerated basis. Additional details may be found in later in this Report under Note 11 – Intangible Assets.
Income Taxes – Provisions for income taxes are based on amounts reported in the consolidated statements of income, excluding non-taxable income, and including changes in deferred income taxes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes. Amounts provided for deferred income taxes relate primarily to differences between tax and financial reporting for unrealized gains and losses on securities available-for-sale, allowances for loan losses, depreciation, and deferred compensation. Additional details may be found in later in this Report under Note 16 – Income Taxes.
Income and Expenses – The Company uses the accrual method of accounting for all material income and expense items. Loan origination fees received and direct costs incurred are deferred and amortized to interest income over the contractual lives of the loans, using the level yield method. Current period expenses, such as advertising costs, are expensed as incurred.
Stock-Based Compensation – The Company offers a stock-based compensation incentive program which includes certain officers and directors. Under this program, the Company may grant stock options for a fixed number of shares with an exercise price equal to the market value of the stock at the date of grant. The fair value of each option is then estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used: 2011 - dividend yield of 0.82%, expected volatility of 50%, a risk-free interest rate of 2.08%, and expected lives of six years for the options; 2010 - dividend yield of 2.9%, expected volatility of 47%, a risk-free interest rate of 2.1%, and expected lives of six years for the options. Based on these assumptions, the Company recognized compensation expense totaling $101,000 for the year ended December 31, 2011, and $99,000 for the year ended December 31, 2010, for its stock-based compensation program.
Earnings per Share – The Company has presented both basic and diluted earnings per common share (“EPS”). Basic EPS is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period, without considering any dilutive items. Diluted EPS is calculated by dividing net income (loss) available to common shareholders by the sum of the weighted average number of common shares outstanding for the period and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury method.
The potential common stock of the Company includes stock options and unvested shares issued for the Recognition and Retention Plan granted to various directors and officers. At December 31, 2011, the Company excluded all of the 739,302 outstanding options from the calculation of diluted earnings per share since these options had a strike price in excess of the market value of the stock at December 31, 2011. Also, at December 31, 2010, the Company excluded 753,925 of 861,180 outstanding options from the calculation of diluted earnings per share and at December 31, 2009, the Company excluded 795,967 of 798,079 outstanding options from the calculation of diluted earnings per share. These outstanding options were excluded in 2010 and 2009 because the options had a strike price that was in excess of the market value of the stock at December 31 of each of the respective years. The following is a summary of the computation of basic and diluted earnings per share calculation for the years ended December 31:
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands, except per share amounts) | | | | | | | | | |
| | | | | | | | | | |
| Net income (loss) available to common shareholders | | $ | (1,285 | ) | | $ | 7,614 | | | $ | (31,041 | ) |
| Weighted average number of shares outstanding | | | 11,495,866 | | | | 9,811,701 | | | | 7,507,903 | |
| Less: Unallocated ESOP shares | | | (36,820 | ) | | | (69,371 | ) | | | (97,211 | ) |
| Weighted average number of shares outstanding for EPS | | | 11,459,046 | | | | 9,742,330 | | | | 7,410,692 | |
| | | | | | | | | | | | | |
| Basic earnings (loss) per share | | $ | (0.11 | ) | | $ | 0.78 | | | $ | (4.19 | ) |
| | | | | | | | | | | | | |
| Net income (loss) available to common shareholders | | $ | (1,285 | ) | | $ | 7,614 | | | $ | (31,041 | ) |
| Weighted average number of shares outstanding for EPS | | | 11,459,046 | | | | 9,742,330 | | | | 7,410,692 | |
| Incremental shares from assumed exercise of stock options and restricted stock | | | - | | | | - | | | | - | |
| Weighted average number of shares outstanding - diluted | | | 11,459,046 | | | | 9,742,330 | | | | 7,410,692 | |
| | | | | | | | | | | | | |
| Diluted earnings (loss) per share | | $ | (0.11 | ) | | $ | 0.78 | | | $ | (4.19 | ) |
Comprehensive Income (Loss) – Comprehensive income (loss) is the change in the Company’s equity during the period from transactions and other events and circumstances from non-owner sources. Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). The Company’s other comprehensive income (loss) and accumulated other comprehensive income (loss) are comprised of unrealized gains and losses on certain investments. Information concerning the Company’s other comprehensive income (loss) for the years ended December 31 is as follows:
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Net income (loss) | | $ | 241 | | | $ | 8,639 | | | $ | (30,007 | ) |
| Other comprehensive income (loss): | | | | | | | | | | | | |
| Investment securities, available for sale: | | | | | | | | | | | | |
| Unrealized holding gains arising during period | | | 615 | | | | 806 | | | | 1,674 | |
| Tax expense | | | (237 | ) | | | (311 | ) | | | (645 | ) |
| Reclassification for realized gains included in net income | | | (111 | ) | | | (349 | ) | | | (2,198 | ) |
| Tax benefit | | | 43 | | | | 135 | | | | 847 | |
| Other comprehensive income (loss) | | | 309 | | | | 281 | | | | (322 | ) |
| Total comprehensive income (loss) | | $ | 550 | | | $ | 8,920 | | | $ | (30,329 | ) |
Recent Accounting Pronouncements - The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company.
In January 2011, the FASB issued guidance on the “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (“ASU 2010-20”).” The provisions of this guidance require the disclosure of more granular information on the nature and extent of troubled debt restructurings and their effect on the allowance for loan and lease losses. The amendments in this guidance defer the effective date related to these disclosures, enabling creditors to provide such disclosures after the FASB completes their project clarifying the guidance for determining what constitutes a troubled debt restructuring. As the provisions of this Accounting Standards Update “ASU” only defer the effective date of disclosure requirements related to troubled debt restructurings, the adoption of this ASU had no impact on the Company's statements of income and condition. The deferred requirements of ASU 2010-20 were adopted by the Company in the third quarter of 2011. The adoption of the requirements has resulted in additional disclosures related to its troubled debt restructured loans in Note 6 of the Consolidated Financial Statements.
In April 2011, the FASB issued guidance regarding “A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring.” The provisions of this new standard provide additional guidance related to determining whether a creditor has granted a concession, including factors and examples for creditors to consider in evaluating whether a restructuring results in a delay in payment that is insignificant, prohibiting creditors from using the borrower's effective rate test to evaluate whether a concession has been granted to the borrower, and adding factors for creditors to use in determining whether a borrower is experiencing financial difficulties. A provision in the standard also ends the FASB's deferral of the additional disclosures about troubled debt restructurings as required by previously released standards. The provisions of this guidance are effective for the Company's reporting periods ending September 30, 2011 and after and are retrospective to January 1, 2011. The adoption of the standard did not have a material impact on the Company's statements of income and financial condition; however, adoption of this guidance did result in an increase in troubled debt restructured loans.
In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. FASB ACS Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets. The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently in the process of evaluating the impact that this ASU may have on the consolidated financial statements.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the International Accounting Standards Board (the “Boards”) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the FASB ASC in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Management does not believe the guidance will have a material impact on the consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the FASB ASC to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The Company has adopted the standard and the adoption of ASU 2011-05 did not have an impact on the Company's financial condition, results of operations, or cash flows.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company has determined that the adoption of this ASU will not have a material effect on its consolidated financial statements, given that the Company has no recorded goodwill at December 2011.
Several other new accounting standards became effective during the periods presented or will be effective subsequent to December 31, 2011. None of these new standards had or is expected to have a material impact on the Company’s consolidated financial statements.
Note 2 - Participation in the Small Business Lending Fund
On September 22, 2011, Citizens South Banking Corporation entered into a Securities Purchase Agreement with the Secretary of the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued and sold to the Treasury 20,500 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series C (“Series C Preferred Stock”), having a liquidation preference of $1,000 per share (the “Liquidation Amount”), for aggregate proceeds of $20.5 million. The Securities Purchase Agreement was entered into, and the Series C Preferred Stock was issued, pursuant to the Treasury’s Small Business Lending Fund program (“SBLF”), as established under the Small Business Jobs Act of 2010. The Company’s rights and obligations with respect to the Series C Preferred Stock are set forth in the Securities Purchase Agreement and the Certificate of Designation to its Certificate of Incorporation filed by the Company with the Secretary State of the State of Delaware on September 6, 2011, and as amended on September 19, 2011 (collectively referred to as the “Certificate of Designation”). Those rights and obligations are summarized below.
The Series C Preferred Stock is entitled to receive non-cumulative dividends payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011. The dividend rate, which is calculated on the aggregate Liquidation Amount, was initially set at 4.84% per annum based upon the current level of “Qualified Small Business Lending”, or “QSBL” (as defined in the Certificate of Designation) by the Company’s wholly owned subsidiary Citizens South Bank. The dividend rate for future dividend periods will be set based upon the “Percentage Change in QSBL” (as defined in the Certificate of Designation) between each dividend period and the “Baseline” QSBL level. Such dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods and from 1% per annum to 7% per annum for the eleventh through the first half of the nineteenth dividend periods. If the Series C Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%. Prior to that time, in general, the dividend rate decreases as the level of the Bank’s QSBL increases. As of December 31, 2011, the dividend rate was 3.30%. The Company may only declare and pay dividends on its common stock if it has declared and paid dividends for the current dividend period on the Series C Preferred Stock, and will be subject to other restrictions on its ability to repurchase or redeem other securities. The Company may redeem the shares of Series C Preferred Stock, in whole or in part, at any time at a redemption price equal to the sum of the Liquidation Amount per share and the per-share amount of any unpaid dividends for the then-current period, subject to any required prior approval by the Company’s primary federal banking regulator. The Series C Preferred Stock was issued in a private placement exempt from registration pursuant to the Securities Act of 1933, as amended. As part of the Securities Purchase Agreement, the Company has granted the Treasury certain rights to require the Series C Preferred Stock to be registered for resale under the Securities Act of 1933, as amended.
As a result of the Company’s participation in SBLF, the Company redeemed all 20,500 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A it sold to the Treasury on December 12, 2008, in connection with the Treasury’s Capital Purchase Program. The Company paid $20.6 million to the Treasury to redeem the Series A Preferred Stock, which includes the original investment of $20.5 million, plus accrued dividends.
Note 3 – FDIC-Assisted Acquisitions
New Horizons Bank, East Ellijay, GA
On April 15, 2011, the Bank entered into a purchase and assumption agreement (the “Agreement”) with the FDIC, as receiver for New Horizons Bank, to acquire substantially all of the assets and assume substantially all of the liabilities of New Horizons Bank (“NHB”) from the FDIC, as receiver. NHB was established in 2004 and operated from one location in East Ellijay, Georgia. The NHB office, which is located on the Highway 515 corridor in the north Georgia area, now operates under the name of Citizens South Bank.
The acquisition was accounted for under the purchase method of accounting in accordance with ASC 805, “Business Combinations.” Both the purchased assets and assumed liabilities were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, especially nonperforming loans and foreclosed properties, is a difficult process and involves significant judgment regarding estimates and assumptions used to calculate estimated fair values. Management engaged an experienced independent third party to assist in determining the fair value of these financial instruments. These fair value determinations are considered preliminary and may be adjusted for a period of one year after the acquisition as relevant information becomes available regarding the estimated fair value on the date of acquisition. After applying purchase accounting adjustments to the acquired assets and liabilities, the Company recognized an initial $4.4 million pre-tax gain from the acquisition which was included as a component of noninterest income.
In connection with the acquisition, the Bank entered into two loss-sharing agreements with the FDIC that covered approximately $69.3 million of the $71.2 million of loans that were acquired from the FDIC (the “covered loans”) and all of the $11.4 million of OREO that was acquired from the FDIC (collectively referred to as “covered assets”). The amount of the covered assets represents the legal balance of the assets prior to any fair value adjustments. One loss-share agreement covers certain residential loans and OREO for a period of ten years. The other loss-share agreement covers all remaining covered assets for a period of five years. Pursuant to the terms of the loss-share agreements, the FDIC is obligated to reimburse the Bank for 80% of all eligible losses, which begins with the first dollar of loss occurred, and certain collection and disposition expenses with respect to covered assets. The Bank has a corresponding obligation to reimburse the FDIC for 80% of eligible recoveries with respect to covered assets for a period of ten years for residential properties and eight years for all other covered assets. The Banks recorded an estimated receivable from the FDIC in the amount of $19.9 million, which represents the discounted value of the FDIC’s estimated portion of future loan losses. Any losses incurred on the $1.9 million in loans not covered under shared-loss agreements will be the sole responsibility of the Bank. New loans made after the acquisition date are not covered by the FDIC loss-share agreements.
A statement of net assets received from the FDIC in the New Horizons Bank transaction, including the fair value adjustments and resulting gain are presented in the following table.
| | | As Recorded by New Horizons Bank | | | Fair Value Adjustments | | As Recorded by the Company | |
| (Dollars in thousands) | | | | | | | | | | |
| | | | | | | | | | | |
| Assets Acquired | | | | | | | | | | |
| Cash and due from banks | | $ | 7,913 | | | $ | - | | | | $ | 7,913 | |
| Investment securities, available for sale | | | 9,703 | | | | - | | | | | 9,703 | |
| Loans | | | 71,210 | | | | (21,950 | ) | (a) | | | 49,260 | |
| FDIC indemnification asset | | | - | | | | 19,922 | | (b) | | | 19,922 | |
| Other real estate owned | | | 11,422 | | | | (5,211 | ) | (c) | | | 6,211 | |
| Core deposit intangible | | | - | | | | 221 | | (d) | | | 221 | |
| Other assets | | | 1,123 | | | | - | | | | | 1,123 | |
| Total assets acquired | | $ | 101,371 | | | $ | (7,018 | ) | | | $ | 94,353 | |
| | | | | | | | | | | | | | |
| Liabilities Assumed | | | | | | | | | | | | | |
| Deposits | | $ | 96,216 | | | $ | 414 | | (c) | | $ | 96,630 | |
| Borrowings | | | 4,005 | | | | 212 | | (c) | | | 4,217 | |
| Deferred tax liabilities | | | - | | | | 1,694 | | (e) | | | 1,694 | |
| Other liabilities | | | 151 | | | | 261 | | (c) | | | 412 | |
| Total liabilities assumed | | $ | 100,372 | | | $ | 2,581 | | | | $ | 102,953 | |
| | | | | | | | | | | | | | |
| Excess of assets acquired over liabilities assumed | | | 999 | | | | (9,599 | ) | | | | (8,600 | ) |
| Less: Net asset discount received from FDIC | | | (12,299 | ) | | | | | | | | | |
| Cash received from FDIC at closing | | | 11,300 | | | | | | | | | 11,300 | |
| | | | | | | | | | | | | | |
| Total gain recorded | | | | | | | | | | | $ | 2,700 | |
Explanation of Fair Value Adjustments:
| a. | The fair value adjustment on loans represents the estimated amount of future loan losses expected in the New Horizons Bank loan portfolio at the acquisition date. This estimate was based on a review of a sample of the acquired loan files, a review of various appraisal reports and other relevant local real estate market data, and discussions with loan officers and other personnel familiar with the local market. |
| b. | The FDIC indemnification asset represents the estimated funds to be received from the FDIC under the loss share agreements discounted back to the acquisition date. |
| c. | These fair value adjustments represent the amount necessary to write down NHB’s book value to its estimated fair value at the acquisition date based on market information available at the time of the acquisition. |
| d. | The core deposit intangible represents the estimated fair value of NHB’s core deposits based on an evaluation prepared by an experienced independent third party. This core deposit intangible is being amortized over an eight year period on an accelerated basis. |
e. | The deferred tax liability represents 38.55% of the amount of the initial $4.4 million acquisition date gain. |
The operating results of the Company for the year ended December 31, 2011, include the operating results of the acquired assets and assumed liabilities from New Horizons Bank. Due primarily to the significant amount of fair value adjustments and the outstanding FDIC loss share agreements that are in place, historical results of New Horizons Bank are not believed to be relevant to the Company’s results. Therefore, no pro forma financial information is presented on this acquisition.
Bank of Hiawassee, Hiawassee, GA
On March 19, 2010, Citizens South Bank, the Bank entered into a purchase and assumption agreement with the FDIC, as receiver for Bank of Hiawassee, to acquire substantially all of the assets and assume substantially all of the liabilities of Bank of Hiawassee (the “acquisition”). The Bank of Hiawassee was a Georgia state-chartered bank headquartered in Hiawassee, Georgia, and operated five full-service offices in the North Georgia area. This acquisition extended the Bank’s geographic footprint outside of the Charlotte metropolitan area, providing geographic diversification for future loan and deposit growth.
The acquisition was accounted for under the purchase method of accounting in accordance with ASC 805, “Business Combinations.” Both the purchased assets and assumed liabilities were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, especially nonperforming loans and foreclosed properties, is a difficult process and involves significant judgment regarding estimates and assumptions used to calculate estimated fair values. Management engaged an experienced independent third party to assist in determining the fair value of these financial instruments. After applying purchase accounting adjustments to the acquired assets and liabilities, the Company recognized an initial $18.7 million pre-tax gain from the acquisition which was included as a component of noninterest income. This amount was later adjusted to $19.7 million.
The acquired loans, also referred to as “covered loans,” are covered by two loss-share agreements between the FDIC and the Bank, which afford the Bank significant protection against future loan losses. Under these loss-share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans, five years for losses on all other loans and eight years for recoveries on all other loans. The Bank recorded an estimated receivable from the FDIC in the amount of $36.3 million, which represents the discounted value of the FDIC’s estimated portion of the expected future loan losses. New loans made after the acquisition date are not covered by the FDIC loss-share agreements.
A statement of net assets received from the FDIC in the Bank of Hiawassee transaction, including the fair value adjustments and resulting gain are presented in the following table.
| | | As Recorded by Bank of Hiawassee | | | Fair Value Adjustments | | As Recorded by the Company | |
| (Dollars in thousands) | | | | | | | | | | |
| | | | | | | | | | | |
| Assets Acquired | | | | | | | | | | |
| Cash and due from banks | | $ | 28,658 | | | $ | - | | | | $ | 28,658 | |
| Investment securities, available for sale | | | 22,309 | | | | - | | | | | 22,309 | |
| Loans | | | 229,909 | | | | (46,702 | ) | (a) | | | 183,207 | |
| FDIC indemnification asset | | | - | | | | 36,301 | | (b) | | | 36,301 | |
| Other real estate owned | | | 1,159 | | | | (83 | ) | (c) | | | 1,076 | |
| Core deposit intangible | | | - | | | | 1,637 | | (d) | | | 1,637 | |
| Other assets | | | 3,741 | | | | - | | | | | 3,741 | |
| Total assets acquired | | $ | 285,776 | | | $ | (8,847 | ) | | | $ | 276,929 | |
| | | | | | | | | | | | | | |
| Liabilities Assumed | | | | | | | | | | | | | |
| Deposits | | $ | 291,451 | | | $ | 768 | | (c) | | $ | 292,219 | |
| Borrowings | | | 30,000 | | | | 1,582 | | (c) | | | 31,582 | |
| Deferred tax liabilities | | | - | | | | 7,222 | | (e) | | | 7,222 | |
| Other liabilities | | | (423 | ) | | | 1,218 | | (c) | | | 795 | |
| Total liabilities assumed | | $ | 321,028 | | | $ | 10,790 | | | | $ | 331,818 | |
| Excess of assets acquired over liabilities assumed | | | (35,252 | ) | | | (19,637 | ) | | | | (54,889 | ) |
| Less: Net asset discount received from FDIC | | | (31,148 | ) | | | | | | | | | |
| Cash received from FDIC at closing | | | 66,400 | | | | | | | | | 66,400 | |
| | | | | | | | | | | | | | |
| Total gain recorded | | | | | | | | | | | $ | 11,511 | |
Explanation of Fair Value Adjustments:
| a. | The fair value adjustment on loans represents the estimated amount of future loan losses expected in the Bank of Hiawassee loan portfolio at the acquisition date. This estimate was based on a review of a sample of the acquired loan files, a review of various appraisal reports and other relevant local real estate market data, and discussions with loan officers and other personnel familiar with the local market. |
| b. | The FDIC indemnification asset represents the estimated funds to be received from the FDIC under the loss share agreements discounted back to the acquisition date. |
| c. | These fair value adjustments represent the estimated amount necessary to write down Bank of Hiawassee’s book value to its estimated fair value at the acquisition date based on market information available at the time of the acquisition. |
| d. | The core deposit intangible represents the estimated fair value of the Bank of Hiawassee’s core deposits based on an evaluation prepared by an experienced independent third party. This core deposit intangible is being amortized over an eight year period on an accelerated basis. |
| e. | The deferred tax liability represents 38.55% of the amount of the initial $18.7 million acquisition date gain. |
The operating results of the Company for the year ended December 31, 2011, include the operating results of the acquired assets and assumed liabilities from Bank of Hiawassee. Due primarily to the significant amount of fair value adjustments and the outstanding FDIC loss share agreements that are in place, historical results of Bank of Hiawassee are not believed to be relevant to the Company’s results. Therefore, no pro forma financial information is presented on this acquisition.
Note 4 – Investment Securities
The following is a summary of the investment securities portfolio by major classification:
| | | Amortized Cost | | | Gains | | | Losses | | | Fair Value | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| 2011 | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | |
| U.S. Government Agency obligations | | $ | 7,168 | | | $ | 73 | | | $ | - | | | $ | 7,241 | |
| Municipal bonds | | | 6,578 | | | | 133 | | | | - | | | | 6,711 | |
| Mortgage-backed securities | | | 35,170 | | | | 330 | | | | 8 | | | | 35,492 | |
| SBA securities | | | 1,255 | | | | 71 | | | | - | | | | 1,326 | |
| Other securities | | | 1,488 | | | | 44 | | | | 166 | | | | 1,366 | |
| Subtotal | | | 51,659 | | | | 651 | | | | 174 | | | | 52,136 | |
| | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | |
| U.S. Treasury obligations | | | 9,972 | | | | 61 | | | | - | | | | 10,033 | |
| U.S. Government Agency obligations | | | 25,989 | | | | 74 | | | | 4 | | | | 26,059 | |
| Municipal bonds | | | 3,300 | | | | 99 | | | | - | | | | 3,399 | |
| Mortgage-backed securities | | | 52,502 | | | | 2,277 | | | | - | | | | 54,779 | |
| Other securities | | | 4,000 | | | | - | | | | 155 | | | | 3,845 | |
| Subtotal | | | 95,763 | | | | 2,511 | | | | 159 | | | | 98,115 | |
| | | | | | | | | | | | | | | | | |
| Total at December 31, 2011 | | $ | 147,422 | | | $ | 3,162 | | | $ | 333 | | | $ | 150,251 | |
| | | | | | | | | | | | | | | | | |
| 2010 | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | |
| U.S. Government Agency obligations | | $ | 19,297 | | | $ | 23 | | | $ | 122 | | | $ | 19,198 | |
| Municipal bonds | | | 11,602 | | | | 40 | | | | 128 | | | | 11,514 | |
| Mortgage-backed securities | | | 40,655 | | | | 293 | | | | 175 | | | | 40,773 | |
| Other securities | | | 2,781 | | | | 110 | | | | 68 | | | | 2,823 | |
| Subtotal | | | 74,335 | | | | 466 | | | | 493 | | | | 74,308 | |
| | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | |
| U.S. Treasury obligations | | | 9,955 | | | | - | | | | 38 | | | | 9,917 | |
| U.S. Government Agency obligations | | | 8,509 | | | | 4 | | | | 129 | | | | 8,384 | |
| Mortgage-backed securities | | | 14,814 | | | | 641 | | | | 37 | | | | 15,418 | |
| Other securities | | | 4,000 | | | | - | | | | 81 | | | | 3,919 | |
| Subtotal | | | 37,278 | | | | 645 | | | | 285 | | | | 37,638 | |
| | | | | | | | | | | | | | | | | |
| Total at December 31, 2010 | | $ | 111,613 | | | $ | 1,111 | | | $ | 778 | | | $ | 111,946 | |
The book values and estimated fair values of investment securities available for sale and held to maturity at December 31, 2011, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.
| | | Book Value | | | Estimated Fair Value | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Available for sale: | | | | | | |
| Due in one year or less | | $ | 10,301 | | | $ | 10,359 | |
| Due after one year through five years | | | 25,296 | | | | 25,567 | |
| Due after five years through ten years | | | 7,679 | | | | 7,837 | |
| Due after ten years | | | 6,908 | | | | 7,064 | |
| Equities | | | 1,475 | | | | 1,309 | |
| Total | | $ | 51,659 | | | $ | 52,136 | |
| | | | | | | | | |
| Held to Maturity: | | | | | | | | |
| Due in one year or less | | $ | 16,414 | | | $ | 16,709 | |
| Due after one year through five years | | | 38,436 | | | | 38,932 | |
| Due after five years through ten years | | | 28,663 | | | | 29,068 | |
| Due after ten years | | | 12,250 | | | | 13,406 | |
| Total | | $ | 95,763 | | | $ | 98,115 | |
The following tables set forth the amount of the unrealized losses and fair values of the investment securities by investment types segregated between those that have been in a continuous unrealized-loss position for less than twelve months and those investments that have been in a continuous unrealized-loss position for more than twelve months at December 31, 2011 and December 31, 2010. At December 31, 2011, the unrealized losses related to one U.S. Government Agency obligation, six mortgage-backed securities, and six other securities. Of these 13 securities, five had been in a continuous-loss position for more than 12 months. At December 31, 2010, the unrealized losses related to two U.S. Treasury obligations, ten U.S. Government Agency obligations, fifteen municipal bonds, seven mortgage-backed securities, and six other securities. Of these 40 securities, three had been in a continuous-loss position for more than 12 months. As of December 31, 2011, and December 31, 2010, management concluded that the unrealized losses presented above were temporary in nature since the unrealized losses were attributable to changes in interest rates and not a deterioration of the credit quality of the issuers. The Company does not have the intent to sell securities in a temporary loss position at December 31, 2011, and it is not more likely than not that the Company will be required to sell the securities before anticipated recovery.
| | | Less than 12 months | | | 12 months or more | | | Total | |
| | | Estimated Fair Value | | | Loss | | | Estimated Fair Value | | | Loss | | | Estimated Fair Value | | | Loss | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| 2011 | | | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities | | $ | 4,619 | | | $ | 8 | | | $ | 88 | | | $ | - | | | $ | 4,707 | | | $ | 8 | |
| Other securities | | | 165 | | | | 93 | | | | 29 | | | | 73 | | | | 194 | | | | 166 | |
| Subtotal | | | 4,784 | | | | 101 | | | | 117 | | | | 73 | | | | 4,901 | | | | 174 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Government Agency obligations | | | 1,996 | | | | 4 | | | | - | | | | - | | | | 1,996 | | | | 4 | |
| Other securities | | | 997 | | | | 3 | | | | 2,848 | | | | 152 | | | | 3,845 | | | | 155 | |
| Subtotal | | | 2,993 | | | | 7 | | | | 2,848 | | | | 152 | | | | 5,841 | | | | 159 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total at December 30, 2011 | | $ | 7,777 | | | $ | 108 | | | $ | 2,965 | | | $ | 225 | | | $ | 10,742 | | | $ | 333 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| 2010 | | | | | | | | | | | | | | | | | | | | | | | | |
| Available for sale: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Government Agency obligations | | $ | 18,113 | | | $ | 122 | | | $ | - | | | $ | - | | | $ | 18,113 | | | $ | 122 | |
| Municipals bonds | | | 8,376 | | | | 128 | | | | - | | | | - | | | | 8,376 | | | | 128 | |
| Mortgage-backed securities | | | 9,395 | | | | 174 | | | | 108 | | | | 1 | | | | 9,503 | | | | 175 | |
| Other securities | | | - | | | | - | | | | 104 | | | | 68 | | | | 104 | | | | 68 | |
| Subtotal | | | 35,884 | | | | 424 | | | | 212 | | | | 69 | | | | 36,096 | | | | 493 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury obligations | | | 9,917 | | | | 38 | | | | - | | | | - | | | | 9,917 | | | | 38 | |
| U.S. Government Agency obligations | | | 5,881 | | | | 129 | | | | - | | | | - | | | | 5,881 | | | | 129 | |
| Mortgage-backed securities | | | 3,049 | | | | 37 | | | | - | | | | - | | | | 3,049 | | | | 37 | |
| Other securities | | | 3,919 | | | | 81 | | | | - | | | | - | | | | 3,919 | | | | 81 | |
| Subtotal | | | 22,766 | | | | 285 | | | | - | | | | - | | | | 22,766 | | | | 285 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total at December 30, 2010 | | $ | 58,650 | | | $ | 709 | | | $ | 212 | | | $ | 69 | | | $ | 58,862 | | | $ | 778 | |
From time to time the Company will pledge investment securities as collateral to secure public deposits and for other purposes as required or allowed by law. The amortized cost of these pledged investment securities was $82.1 million at December 31, 2011, and $68.9 million at December 31, 2010.
Note 5 - Loans
The Company makes various business and consumer loans in the normal course of business. A brief description of these types of loans is as follows:
One-to-four family residential – This portfolio primarily consists of loans secured by properties in the Company’s normal lending area. The Company originates fixed and adjustable rate loans for terms of 10 to 30 years, including conventional and jumbo loans. These loans generally have an original loan-to-value ratio (“LTV”) of 80% or less. Those loans with an initial LTV of more than 80% typically have private mortgage insurance to protect the Bank. This type of loan has historically possessed a lower than average level of loss to the Bank compared to the total loan portfolio.
Multifamily residential – This portfolio is moderately seasoned and is generally secured by properties in the Bank’s normal lending area. These loans generally have an initial LTV of 75% and an initial debt service coverage ratio of 1.2x to 1.0x. This Bank has not experienced any significant losses in this loan portfolio over the past 24 months.
Construction – This portfolio has decreased significantly over the past several years as fewer construction loans have been made during the economic downturn. These loans are located in the Company’s normal lending area and had an initial LTV of 80%. Approximately 57% of these loans are secured by residential properties and 43% are secured by commercial properties. This type of loan has historically possessed a lower than average level of loss to the Bank.
Commercial land and residential development – These categories include raw undeveloped land and developed residential lots held by builders and developers. Generally, the initial LTV for raw land is 65% and the initial LTV for developed lots is 90%. Given the significant decline in value for both developed and undeveloped land due to reduced demand, these loan portfolios have historically possessed a much higher level of risk compared to other loan categories.
Other commercial real estate – This portfolio consists of nonresidential improved real estate which includes churches, shopping centers, office buildings, etc. These loans typically have an initial LTV of 75% and an initial debt service ratio of 1.2x to 1.0x. These properties are generally located in the Company’s normal lending area. Decreased rental income due to the economic slowdown has caused some deterioration in values. However, this loan portfolio has historically possessed a slightly lower than average loss history compared to the Bank’s entire loan portfolio.
Consumer real estate – This category includes home equity lines of credit (“HELOCs”) and loans secured by residential lots purchased by consumers. The HELOCs generally had an adjustable rate tied to prime rate and a term of 15 years. The HELOCs initially had an LTV of up to 85%. The residential lot loans typically have a term of five years or less and are made at an initial LTV of up to 90%. Many of these properties have declined in value over the past several years. However, the loss history for these types of loans has been slightly lower than average compared to the Bank’s entire loan portfolio.
Commercial business – These loans include loans to businesses that are not secured by real estate. These loans are typically secured by accounts receivable, inventory, equipment, etc. Commercial loans are typically granted to local businesses that have a strong track record of profitability and performance. This category of loans incurred slightly higher than average losses over the past 24 months for the Bank’s entire loan portfolio.
Other consumer - These loans are either unsecured or secured by automobiles, marketable securities, etc. They are generally granted to local customers that have a banking relationship with our Bank. The loss history for this category of loans has been slightly lower than the Bank average over the past 24 months.
The following is a summary of loans outstanding by category at the periods presented:
| | | December 31, 2011 | | | December 31, 2010 | |
| | | Loans covered by FDIC-loss share agreements | | | Loans not covered by FDIC-loss share agreements | | | Total | | | Loans covered by FDIC-loss share agreements | | | Loans not covered by FDIC-loss share agreements | | | Total | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 34,641 | | | $ | 116,859 | | | $ | 151,500 | | | $ | 32,755 | | | $ | 101,014 | | | $ | 133,769 | |
| Multifamily residential | | | 2,926 | | | | 16,759 | | | | 19,685 | | | | 2,993 | | | | 20,674 | | | | 23,667 | |
| Construction | | | 1,255 | | | | 19,602 | | | | 20,857 | | | | 207 | | | | 20,214 | | | | 20,421 | |
| Commercial land | | | 13,670 | | | | 28,122 | | | | 41,792 | | | | 21,599 | | | | 37,802 | | | | 59,401 | |
| Residential development | | | 8,095 | | | | 16,444 | | | | 24,539 | | | | 8,239 | | | | 25,085 | | | | 33,324 | |
| Other commercial real estate | | | 76,312 | | | | 225,983 | | | | 302,295 | | | | 52,117 | | | | 234,483 | | | | 286,600 | |
| Consumer real estate | | | 11,148 | | | | 103,521 | | | | 114,669 | | | | 8,827 | | | | 109,194 | | | | 118,021 | |
| Total real estate | | | 148,047 | | | | 527,290 | | | | 675,337 | | | | 126,737 | | | | 548,466 | | | | 675,203 | |
| Commercial business | | | 7,866 | | | | 41,161 | | | | 49,027 | | | | 13,060 | | | | 34,993 | | | | 48,053 | |
| Other consumer | | | 3,775 | | | | 5,649 | | | | 9,424 | | | | 7,779 | | | | 5,475 | | | | 13,254 | |
| Total loans | | $ | 159,688 | | | $ | 574,100 | | | | 733,788 | | | $ | 147,576 | | | $ | 588,934 | | | | 736,510 | |
| Less: Allowance for loan losses | | | | | | | | | | | 11,713 | | | | | | | | | | | | 11,924 | |
| Total net loans | | | | | | | | | | $ | 722,075 | | | | | | | | | | | $ | 724,586 | |
The Company, through its normal lending activity, originates substantially all of its loans to borrowers that are located in the Piedmont (central) Region of North and South Carolina and the North Georgia Region. The Company also has presold loans in process of settlement which totaled $2.1 million at December 31, 2011, and $4.0 million at December 31, 2010. These presold loans in process of settlement were not included in the table above.
As of December 31, 2011, the Company had $159.7 million in loans covered by FDIC loss-share agreements as a result of the acquisition of loans from Bank of Hiawassee and New Horizons Bank in separate FDIC-assisted transactions (referred to as “covered loans”). The loans acquired in the Bank of Hiawassee transaction in March 2010 are covered by two loss-share agreements between the FDIC and the Bank, which afford the Bank significant protection against future loan losses. Under these loss-share agreements, the FDIC will cover 80% of net loan losses up to $102 million and 95% of net loan losses that exceed $102 million. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans and five years for losses and eight years on recoveries on nonresidential loans. At acquisition, the Bank recorded an estimated receivable from the FDIC in the amount of $36.3 million, which represented the discounted value of the FDIC’s estimated portion of the expected future loan losses. New loans made after the acquisition date are not covered by the FDIC loss-share agreements. These covered loans totaled $118.5 million at December 31, 2011.
In April 2011 the Company acquired New Horizons Bank in an FDIC-assisted transaction. As part of this transaction, the Company acquired $49.3 million in loans at fair value. Of the acquired loans, $47.6 million are covered by two loss-share agreements between the FDIC and the Bank. Under these loss-share agreements, the FDIC will cover 80% of net loan losses and qualified expenses. The term of the loss-share agreements is ten years for losses and recoveries on residential real estate loans and five years for losses and eight years on recoveries on nonresidential loans. At acquisition, the Bank recorded an estimated receivable from the FDIC in the amount of $19.9 million, which represented the discounted value of the FDIC’s estimated portion of the expected future loan losses. The remaining $1.6 million in loans acquired in the New Horizons Bank transaction were not covered by FDIC loss-share agreements. As such, any losses incurred on these non-covered loans will be the sole responsibility of the Bank. New loans made after the acquisition date are not covered by the FDIC loss-share agreements. These covered loans totaled $41.2 million at December 31, 2011.
A portion of the fair value discount on the acquired loans has an accretable yield associated with those loans that is accreted into interest income over the estimated remaining life of the loans. The remaining nonaccretable difference represents cash flows not expected to be collected. The changes in the accretable yield and the carrying amounts of the covered loans for the twelve-month periods ended December 31, 2011 and 2010 are presented in the following table.
| | | 2011 | | | 2010 | |
| | | Accretable Yield | | | Carrying Amount | | | Accretable Yield | | | Carrying Amount | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Balance at beginning of period | | $ | 1,050 | | | $ | 147,576 | | | $ | - | | | $ | - | |
| Changes due to acquisition | | | (1,813 | ) | | | 49,260 | | | | 759 | | | | 183,207 | |
| Reductions from payments and foreclosures, net | | | (286 | ) | | | (37,977 | ) | | | - | | | | (35,922 | ) |
| Accretion | | | 829 | | | | 829 | | | | 291 | | | | 291 | |
| Balance at end of period | | $ | (220 | ) | | $ | 159,688 | | | $ | 1,050 | | | $ | 147,576 | |
Directors, executive officers, and associates of such persons are customers of and had transactions with the Bank in the ordinary course of business. As a matter of policy, these loans and lines of credit are approved by the Board of Directors and are made with interest rates, terms, and collateral requirements available to the general public. The aggregate amounts of these loans were $3.9 million and $8.0 million at December 31, 2011 and 2010, respectively. During the year ended December 31, 2011, new loans of $143,000 were made and payments totaled $3.9 million. During the year ended December 31, 2010, new loans of $128,000 were made and payments totaled $2.5 million.
Note 6 – Credit Quality of Loans
Loan Payment Status. The following tables present an aging analysis of the Company’s loans by category for 1) loans not covered by FDIC loss-share agreements, 2) loans covered by FDIC loss-share agreements and 3) total loans at December 31, 2011.
| December 31, 2011 | | 30 - 59 Days Past Due | | 60 - 89 Days Past Due | | 90 Days or More Past Due and Accruing | | | Nonaccrual | | | Total Past Due | | | Current | | | Total Loans | | | Recorded Investment 90 Days or More and Accruing | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Not covered by FDIC loss-share agreements: | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 80 | | | $ | 1,634 | | | $ | - | | | $ | 2,407 | | | $ | 4,121 | | | $ | 112,738 | | | $ | 116,859 | | | $ | - | |
| Multifamily residential | | | - | | | | - | | | | - | | | | - | | | | - | | | | 16,759 | | | | 16,759 | | | | - | |
| Construction | | | - | | | | 93 | | | | - | | | | - | | | | 93 | | | | 19,509 | | | | 19,602 | | | | - | |
| Commercial land | | | - | | | | - | | | | - | | | | 2,631 | | | | 2,631 | | | | 25,491 | | | | 28,122 | | | | - | |
| Residential development | | | - | | | | - | | | | - | | | | 6,474 | | | | 6,474 | | | | 9,970 | | | | 16,444 | | | | - | |
| Other commercial real estate | | | 81 | | | | 1,873 | | | | - | | | | 4,173 | | | | 6,127 | | | | 219,856 | | | | 225,983 | | | | - | |
| Consumer real estate | | | 761 | | | | 388 | | | | 335 | | | | 2,543 | | | | 4,027 | | | | 99,494 | | | | 103,521 | | | | 338 | |
| Total real estate | | | 922 | | | | 3,988 | | | | 335 | | | | 18,228 | | | | 23,473 | | | | 503,817 | | | | 527,290 | | | | 338 | |
| Commercial business | | | 7 | | | | - | | | | - | | | | 168 | | | | 175 | | | | 40,986 | | | | 41,161 | | | | - | |
| Other consumer | | | 13 | | | | 3 | | | | - | | | | 80 | | | | 96 | | | | 5,553 | | | | 5,649 | | | | - | |
| Total | | $ | 942 | | | $ | 3,991 | | | $ | 335 | | | $ | 18,476 | | | $ | 23,744 | | | $ | 550,356 | | | $ | 574,100 | | | $ | 338 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Covered by FDIC loss-share agreements: | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 1,530 | | | $ | 2,220 | | | $ | 215 | | | $ | 8,441 | | | $ | 12,406 | | | $ | 22,235 | | | $ | 34,641 | | | $ | 219 | |
| Multifamily residential | | | - | | | | - | | | | - | | | | 216 | | | | 216 | | | | 2,710 | | | | 2,926 | | | | - | |
| Construction | | | - | | | | - | | | | - | | | | 1,191 | | | | 1,191 | | | | 64 | | | | 1,255 | | | | - | |
| Commercial land | | | 140 | | | | 11 | | | | 10 | | | | 6,704 | | | | 6,865 | | | | 6,805 | | | | 13,670 | | | | 11 | |
| Residential development | | | - | | | | - | | | | - | | | | 4,578 | | | | 4,578 | | | | 3,517 | | | | 8,095 | | | | - | |
| Other commercial real estate | | | 351 | | | | 466 | | | | 495 | | | | 17,454 | | | | 18,766 | | | | 57,546 | | | | 76,312 | | | | 511 | |
| Consumer real estate | | | 236 | | | | 15 | | | | - | | | | 634 | | | | 885 | | | | 10,263 | | | | 11,148 | | | | - | |
| Total real estate | | | 2,257 | | | | 2,712 | | | | 720 | | | | 39,218 | | | | 44,907 | | | | 103,140 | | | | 148,047 | | | | 741 | |
| Commercial business | | | 90 | | | | 39 | | | | 23 | | | | 3,484 | | | | 3,636 | | | | 4,230 | | | | 7,866 | | | | 24 | |
| Other consumer | | | 141 | | | | 133 | | | | 57 | | | | 554 | | | | 885 | | | | 2,890 | | | | 3,775 | | | | 58 | |
| Total | | $ | 2,488 | | | $ | 2,884 | | | $ | 800 | | | $ | 43,256 | | | $ | 49,428 | | | $ | 110,260 | | | $ | 159,688 | | | $ | 823 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total at December 31, 2011: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 1,610 | | | $ | 3,854 | | | $ | 215 | | | $ | 10,848 | | | $ | 16,527 | | | $ | 134,973 | | | $ | 151,500 | | | $ | 219 | |
| Multifamily residential | | | - | | | | - | | | | - | | | | 216 | | | | 216 | | | | 19,469 | | | | 19,685 | | | | - | |
| Construction | | | - | | | | 93 | | | | - | | | | 1,191 | | | | 1,284 | | | | 19,573 | | | | 20,857 | | | | - | |
| Commercial land | | | 140 | | | | 11 | | | | 10 | | | | 9,335 | | | | 9,496 | | | | 32,296 | | | | 41,792 | | | | 11 | |
| Residential development | | | - | | | | - | | | | - | | | | 11,052 | | | | 11,052 | | | | 13,487 | | | | 24,539 | | | | - | |
| Other commercial real estate | | | 432 | | | | 2,339 | | | | 495 | | | | 21,627 | | | | 24,893 | | | | 277,402 | | | | 302,295 | | | | 511 | |
| Consumer real estate | | | 997 | | | | 403 | | | | 335 | | | | 3,177 | | | | 4,912 | | | | 109,757 | | | | 114,669 | | | | 338 | |
| Total real estate | | | 3,179 | | | | 6,700 | | | | 1,055 | | | | 57,446 | | | | 68,380 | | | | 606,957 | | | | 675,337 | | | | 1,079 | |
| Commercial business | | | 97 | | | | 39 | | | | 23 | | | | 3,652 | | | | 3,811 | | | | 45,216 | | | | 49,027 | | | | 24 | |
| Other consumer | | | 154 | | | | 136 | | | | 57 | | | | 634 | | | | 981 | | | | 8,443 | | | | 9,424 | | | | 58 | |
| Total | | $ | 3,430 | | | $ | 6,875 | | | $ | 1,135 | | | $ | 61,732 | | | $ | 73,172 | | | $ | 660,616 | | | $ | 733,788 | | | $ | 1,161 | |
The following tables present an aging analysis of the Company’s loans by category for 1) loans not covered by FDIC loss-share agreements, 2) loans covered by FDIC loss-share agreements and 3) total loans at December 31, 2010.
| December 31, 2010 | | 30 - 59 Days Past Due | | | 60 - 89 Days Past Due | | | 90 Days or More Past Due and Accruing | | | Nonaccrual | | | Total Past Due | | | Current | | | Total Loans | | | Recorded Investment > 90 Days and Accruing | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Not covered by FDIC loss-share agreements: | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | - | | | $ | 1,299 | | | $ | - | | | $ | 1,864 | | | $ | 3,163 | | | $ | 107,901 | | | $ | 111,064 | | | $ | - | |
| Multifamily residential | | | - | | | | - | | | | - | | | | - | | | | - | | | | 19,496 | | | | 19,496 | | | | - | |
| Construction | | | 240 | | | | 391 | | | | - | | | | 14 | | | | 645 | | | | 9,517 | | | | 10,162 | | | | - | |
| Commercial land | | | 1,200 | | | | 1,531 | | | | - | | | | - | | | | 2,731 | | | | 57,527 | | | | 60,258 | | | | - | |
| Residential development | | | 1,892 | | | | 909 | | | | 2,000 | | | | 559 | | | | 5,360 | | | | - | | | | 5,360 | | | | 2,027 | |
| Other commercial real estate | | | 2,089 | | | | 3,079 | | | | - | | | | 9,161 | | | | 14,329 | | | | 218,601 | | | | 232,930 | | | | - | |
| Consumer real estate | | | 628 | | | | 419 | | | | - | | | | 2,513 | | | | 3,560 | | | | 105,634 | | | | 109,194 | | | | - | |
| Total real estate | | | 6,049 | | | | 7,628 | | | | 2,000 | | | | 14,111 | | | | 29,788 | | | | 518,676 | | | | 548,464 | | | | 2,027 | |
| Commercial business | | | 61 | | | | - | | | | - | | | | 287 | | | | 348 | | | | 34,645 | | | | 34,993 | | | | - | |
| Other consumer | | | 15 | | | | 35 | | | | - | | | | 16 | | | | 66 | | | | 5,411 | | | | 5,477 | | | | - | |
| Total | | $ | 6,125 | | | $ | 7,663 | | | $ | 2,000 | | | $ | 14,414 | | | $ | 30,202 | | | $ | 558,732 | | | | 588,934 | | | $ | 2,027 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Covered by FDIC loss-share agreements: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 1,512 | | | $ | 461 | | | $ | - | | | $ | 3,468 | | | $ | 5,441 | | | $ | 27,314 | | | $ | 32,755 | | | $ | - | |
| Multifamily residential | | | - | | | | - | | | | - | | | | - | | | | - | | | | 2,993 | | | | 2,993 | | | | - | |
| Construction | | | - | | | | - | | | | - | | | | 49 | | | | 49 | | | | 158 | | | | 207 | | | | - | |
| Commercial land | | | 24 | | | | 525 | | | | - | | | | 6,338 | | | | 6,887 | | | | 19,385 | | | | 26,272 | | | | - | |
| Residential development | | | - | | | | - | | | | - | | | | 3,565 | | | | 3,565 | | | | - | | | | 3,565 | | | | - | |
| Other commercial real estate | | | 1,213 | | | | 877 | | | | 472 | | | | 9,471 | | | | 12,033 | | | | 40,084 | | | | 52,117 | | | | 482 | |
| Consumer real estate | | | 51 | | | | - | | | | 37 | | | | 213 | | | | 301 | | | | 8,526 | | | | 8,827 | | | | 37 | |
| Total real estate | | | 2,800 | | | | 1,863 | | | | 509 | | | | 23,104 | | | | 28,276 | | | | 98,460 | | | | 126,736 | | | | 519 | |
| Commercial business | | | 175 | | | | 201 | | | | 17 | | | | 1,051 | | | | 1,444 | | | | 11,616 | | | | 13,060 | | | | 18 | |
| Other consumer | | | 524 | | | | 204 | | | | - | | | | 861 | | | | 1,589 | | | | 6,191 | | | | 7,780 | | | | - | |
| Total loans covered by FDIC loss-share agreements | | $ | 3,499 | | | $ | 2,268 | | | $ | 526 | | | $ | 25,016 | | | $ | 31,309 | | | $ | 116,267 | | | $ | 147,576 | | | $ | 537 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total at December 31, 2010: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 1,512 | | | $ | 1,760 | | | $ | - | | | $ | 5,332 | | | $ | 8,604 | | | $ | 135,215 | | | $ | 143,819 | | | $ | - | |
| Multifamily residential | | | - | | | | - | | | | - | | | | - | | | | - | | | | 22,489 | | | | 22,489 | | | | - | |
| Construction | | | 240 | | | | 391 | | | | - | | | | 63 | | | | 694 | | | | 9,675 | | | | 10,369 | | | | - | |
| Commercial land | | | 1,224 | | | | 2,056 | | | | - | | | | 6,338 | | | | 9,618 | | | | 76,912 | | | | 86,530 | | | | - | |
| Residential development | | | 1,892 | | | | 909 | | | | 2,000 | | | | 4,124 | | | | 8,925 | | | | - | | | | 8,925 | | | | 2,027 | |
| Other commercial real estate | | | 3,302 | | | | 3,956 | | | | 472 | | | | 18,632 | | | | 26,362 | | | | 258,685 | | | | 285,047 | | | | 482 | |
| Consumer real estate | | | 679 | | | | 419 | | | | 37 | | | | 2,726 | | | | 3,861 | | | | 114,160 | | | | 118,021 | | | | 37 | |
| Total real estate | | | 8,849 | | | | 9,491 | | | | 2,509 | | | | 37,215 | | | | 58,064 | | | | 617,136 | | | | 675,200 | | | | 2,546 | |
| Commercial business | | | 236 | | | | 201 | | | | 17 | | | | 1,338 | | | | 1,792 | | | | 46,261 | | | | 48,053 | | | | 18 | |
| Other consumer | | | 539 | | | | 239 | | | | - | | | | 877 | | | | 1,655 | | | | 11,602 | | | | 13,257 | | | | - | |
| Total loans | | $ | 9,624 | | | $ | 9,931 | | | $ | 2,526 | | | $ | 39,430 | | | $ | 61,511 | | | $ | 674,999 | | | $ | 736,510 | | | $ | 2,564 | |
Impaired Loans. The Company evaluates impairment of its non-covered residential mortgage and consumer loans on a collective basis, while non-covered commercial and construction loans are evaluated individually for impairment. The Company identifies a non-covered loan as impaired when it is probable that principal and interest will not be collected according to the contractual terms of the loan agreement. Specific allowances or principal write-downs are established for certain individual non-covered loans that management considers impaired. The remainder of the portfolio of non-covered loans is segmented into groups of loans with similar risk characteristics for evaluation and analysis.
The following table details the Company’s non-covered impaired loans at December 31, 2011 and 2010:
| | | Recorded Investment | | | Unpaid Principal Balance | | | Principal Write-down | | | Net Principal Balance | | | Specific Allowance | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 2,781 | | | $ | 2,739 | | | $ | - | | | $ | 2,739 | | | $ | - | |
| Commercial land | | | 3,062 | | | | 4,523 | | | | 1,697 | | | | 2,826 | | | | - | |
| Residential development | | | 8,428 | | | | 10,173 | | | | 1,911 | | | | 8,262 | | | | - | |
| Commercial real estate - office | | | 6,322 | | | | 7,573 | | | | 1,268 | | | | 6,305 | | | | - | |
| Commercial real estate - residential rental | | | 4,076 | | | | 4,808 | | | | 779 | | | | 4,029 | | | | - | |
| Commercial real estate - other | | | 2,426 | | | | 2,945 | | | | 622 | | | | 2,323 | | | | - | |
| Consumer real estate | | | 2,689 | | | | 2,801 | | | | 171 | | | | 2,630 | | | | - | |
| Commercial business | | | 169 | | | | 169 | | | | - | | | | 169 | | | | - | |
| Other consumer | | | 89 | | | | 90 | | | | 1 | | | | 89 | | | | - | |
| Total | | $ | 30,042 | | | $ | 35,821 | | | $ | 6,449 | | | $ | 29,372 | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 2,668 | | | $ | 2,828 | | | $ | 200 | | | $ | 2,628 | | | $ | - | |
| Construction | | | 14 | | | | 14 | | | | | | | | 14 | | | | - | |
| Commercial land | | | 4,702 | | | | 5,312 | | | | 773 | | | | 4,539 | | | | - | |
| Residential development | | | 6,792 | | | | 8,556 | | | | 1,389 | | | | 6,751 | | | | 416 | |
| Commercial real estate - office | | | 4,836 | | | | 5,356 | | | | 540 | | | | 4,816 | | | | - | |
| Commercial real estate - residential rental | | | 2,085 | | | | 2,085 | | | | - | | | | 2,085 | | | | - | |
| Commercial real estate - retail | | | 1,863 | | | | 4,009 | | | | 2,186 | | | | 1,823 | | | | - | |
| Commercial real estate - other | | | 983 | | | | 1,254 | | | | 298 | | | | 956 | | | | - | |
| Consumer real estate | | | 2,544 | | | | 3,001 | | | | 487 | | | | 2,514 | | | | - | |
| Commercial business | | | - | | | | - | | | | - | | | | 287 | | | | - | |
| Other consumer | | | - | | | | - | | | | - | | | | 16 | | | | - | |
| Total | | $ | 26,487 | | | $ | 32,415 | | | $ | 5,873 | | | $ | 26,429 | | | $ | 416 | |
Loan Classification. We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debts such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis is performed on at least a quarterly basis. We use the following definitions for risk ratings: Special Mention - Loans designated as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of our credit position at some future date. Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have one or more well-defined weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable. Loans not meeting the criteria above as part of the above described process are considered to be Pass rated loans. The Company’s portfolio of FDIC-covered loans was considered to be Pass rated loans at December 31, 2011 and December 31, 2010, as the loans were marked to fair value at acquisition and have FDIC loss-share agreements to cover at least 80% of any future losses.
As of December 31, 2011 and 2010, the risk category of loans by type is as follows:
| | | | | | Criticized Loans | | | | |
| | | Pass | | | Special Mention | | | Substandard | | | Doubtful | | | Total Outstanding | |
| (Dollars in thousands) | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 149,013 | | | $ | 562 | | | $ | 1,925 | | | $ | - | | | $ | 151,500 | |
| Multifamily residential | | | 19,685 | | | | - | | | | - | | | | - | | | | 19,685 | |
| Construction | | | 20,857 | | | | - | | | | - | | | | - | | | | 20,857 | |
| Commercial land | | | 30,202 | | | | 8,600 | | | | 2,990 | | | | - | | | | 41,792 | |
| Residential development | | | 15,806 | | | | 1,037 | | | | 7,696 | | | | - | | | | 24,539 | |
| Other commercial real estate | | | 269,970 | | | | 19,925 | | | | 12,400 | | | | - | | | | 302,295 | |
| Consumer land | | | 17,356 | | | | 458 | | | | 1,560 | | | | - | | | | 19,374 | |
| Home equity lines of credit | | | 92,752 | | | | 790 | | | | 1,753 | | | | - | | | | 95,295 | |
| Total real estate | | | 615,641 | | | | 31,372 | | | | 28,324 | | | | - | | | | 675,337 | |
| Commercial business | | | 48,477 | | | | 254 | | | | 296 | | | | - | | | | 49,027 | |
| Other consumer | | | 9,147 | | | | 170 | | | | 107 | | | | - | | | | 9,424 | |
| Total loans | | $ | 673,265 | | | $ | 31,796 | | | $ | 28,727 | | | $ | - | | | $ | 733,788 | |
| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | 131,072 | | | $ | 1,167 | | | $ | 1,530 | | | $ | - | | | $ | 133,769 | |
| Multifamily residential | | | 23,394 | | | | 273 | | | | - | | | | - | | | | 23,667 | |
| Construction | | | 18,488 | | | | 1,933 | | | | - | | | | - | | | | 20,421 | |
| Commercial land | | | 46,455 | | | | 5,138 | | | | 7,733 | | | | 75 | | | | 59,401 | |
| Residential development | | | 19,650 | | | | 5,395 | | | | 8,279 | | | | - | | | | 33,324 | |
| Other commercial real estate | | | 257,769 | | | | 7,882 | | | | 20,949 | | | | - | | | | 286,600 | |
| Consumer land | | | 13,153 | | | | 1,327 | | | | 2,815 | | | | 81 | | | | 17,376 | |
| Home equity lines of credit | | | 99,883 | | | | - | | | | 708 | | | | 54 | | | | 100,645 | |
| Total real estate | | | 609,864 | | | | 23,115 | | | | 42,014 | | | | 210 | | | | 675,203 | |
| Commercial business | | | 47,423 | | | | 376 | | | | 254 | | | | - | | | | 48,053 | |
| Other consumer | | | 11,200 | | | | - | | | | 2,054 | | | | - | | | | 13,254 | |
| Total loans | | $ | 668,487 | | | $ | 23,491 | | | $ | 44,322 | | | $ | 210 | | | $ | 736,510 | |
Troubled Debt Restructurings. The Company adopted the amendments in ASU No. 2011-02, during the current period ended September 30, 2011, and has reassessed all restructurings that occurred on or after the beginning of the current fiscal year for identification as TDRs. The Company identified as TDRs certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology (ASC 450-20). Upon identifying the reassessed receivables as TDRs, the Company also identified them as impaired under the new guidance in ASC 310-10-35. The amendments in ASU No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of the first interim period of adoption for the Company, the recorded investment in the receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $1.3 million (310-40-65-1(b)), and there was no allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss (310-40-65-1(b)).
The modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrowers that we would not otherwise consider. Some examples of modifications are described below:
Rate modification – A modification in which only the interest rate is changed.
Term modification – A modification in which the maturity date, timing of payments, or frequency of payments is changed.
Interest only modification – A modification in which the loan is converted to interest only payments for a period of time.
Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.
Debt Reduction Modification – A modification in which a portion of the debt is reduced.
Transfer of Assets Modification – A modification in which a transfer of assets has occurred to partially satisfy debt, including foreclosure and repossession.
Combination Modification – Any other type of modification, including the use of multiple categories above.
The following tables present the Bank’s loans classified as TDRs by loan type at December 31, 2011 and December 31, 2010:
| | | Accrual Status | | | Non-accrual Status | | | Total Contracts | | | Total TDRs | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| December 31, 2011: | | | | | | | | | | | | |
| One-to-four family residential | | $ | 12 | | | $ | - | | | | 1 | | | $ | 12 | |
| Commercial land | | | 195 | | | | 89 | | | | 2 | | | | 284 | |
| Residential development | | | 633 | | | | - | | | | 2 | | | | 633 | |
| Other commercial real estate | | | 6,955 | | | | 1,159 | | | | 24 | | | | 8,114 | |
| Total | | $ | 7,795 | | | $ | 1,248 | | | | 29 | | | $ | 9,043 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| December 31, 2010: | | | | | | | | | | | | | | | | |
| One-to-four family residential | | $ | - | | | $ | 1,084 | | | | 1 | | | $ | 1,084 | |
| Commercial land | | | - | | | | 471 | | | | 1 | | | | 471 | |
| Other commercial real estate | | | 1,882 | | | | 2,163 | | | | 13 | | | | 4,045 | |
| Other consumer | | | 17 | | | | - | | | | 1 | | | | 17 | |
| Total | | $ | 1,899 | | | $ | 3,718 | | | | 16 | | | $ | 5,617 | |
The following table presents newly restructured loans that occurred during the twelve months ended December 31, 2011 and 2010:
| | | December 31, 2011 | | | December 31, 2010 | |
| | | Total Number of Contracts | | | Pre-modification Outstanding Recorded Investment | | | Post-modification Outstanding Recorded Investment | | | Total Number of Contracts | | | Pre-modification Outstanding Recorded Investment | | | Post-modification Outstanding Recorded Investment | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Below market interest rate: | | | | | | | | | | | | | | | | | | |
| Commercial land | | | 1 | | | $ | 195 | | | $ | 195 | | | | - | | | $ | - | | | $ | - | |
| Residential development | | | 2 | | | | 633 | | | | 633 | | | | - | | | | - | | | | - | |
| Commercial real estate | | | 5 | | | | 1,612 | | | | 1,612 | | | | 3 | | | | 695 | | | | 695 | |
| Subtotal | | | 8 | | | $ | 2,440 | | | $ | 2,440 | | | | 3 | | | $ | 695 | | | $ | 695 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Extended payment terms: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential real estate | | | 1 | | | $ | 12 | | | $ | 12 | | | | - | | | $ | - | | | $ | - | |
| Commercial land | | | - | | | | - | | | | - | | | | 1 | | | | 471 | | | | 471 | |
| Commercial real estate | | | 6 | | | | 2,170 | | | | 2,170 | | | | 6 | | | | 853 | | | | 853 | |
| Consumer | | | - | | | | - | | | | - | | | | 1 | | | | 17 | | | | 17 | |
| Subtotal | | | 7 | | | $ | 2,182 | | | $ | 2,182 | | | | 8 | | | $ | 1,341 | | | $ | 1,341 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Principal payment reduction: | | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate | | | 3 | | | $ | 1,851 | | | $ | 1,341 | | | | - | | | $ | - | | | $ | - | |
| Subtotal | | | 3 | | | $ | 1,851 | | | $ | 1,341 | | | | - | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | | 18 | | | $ | 6,473 | | | $ | 5,963 | | | | 11 | | | $ | 2,036 | | | $ | 2,036 | |
All TDRs are not automatically placed on nonaccrual status. Generally, those TDRs that are placed on non-accrual status may return to accrual status when the borrower has sustained repayment performance in accordance with the modified terms. The number of payments needed to meet these criteria varies from loan to loan. However, as a general rule, most non-accrual loans should be able to return to accrual status after the payment of six consecutive regular scheduled payments.
During the year ended December 31, 2011, there was one payment default on a residential TDR. The collateral for this residential loan was acquired through foreclosure and was sold during the third quarter of 2011. The loan had an original principal balance of $1.1 million and the resulting loss from the disposition of the collateral was approximately $335,000. There were no payment defaults of any restructured loans during the year ended December 31, 2010.
Also, in the normal course of business, the Company will make loan restructurings or modifications to borrowers for reasons unrelated to the borrower’s financial condition. These restructurings or modifications are made based on the prevailing interest rates and terms offered to other borrowers for similar types of loans at the time of the modification. These types of debt restructurings or loan modifications would not be considered troubled debt restructurings.
Note 7 - Allowance for Loan Losses
The Company has established a systematic methodology for determining the allowance for loan losses. This methodology is set forth in a formal policy and considers all non-covered loans in the portfolio. Loans totaling $159.7 million that were covered under the FDIC loss-share agreements were not included in the Company’s evaluation of the adequacy of loan loss allowances since potential losses are covered up to at least 80% by the FDIC. These covered loans were recorded at their estimated fair value at the time of the acquisition. Management’s periodic evaluation of the allowance is consistently applied and based on inherent losses in the portfolio, past loan loss experience, risks inherent in the different types of loans, the estimated value of any underlying collateral, current economic conditions, the borrower’s financial position, and other relevant internal and external factors that may affect loan collectability. The allowance for loan losses is increased by charging provisions for loan losses against income. As of December 31, 2011, the allowance for loan losses was $11.7 million, or 2.04% of total non-covered loans. Management believes that this amount meets the requirement for losses on loans that management considers to be impaired, for known losses, and for losses inherent in the remaining non-covered loan portfolio. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly adversely affected if circumstances differ substantially from the assumptions used in making the determinations.
A reconciliation of the allowance for loan losses is as follows:
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Balance at beginning of year | | $ | 11,924 | | | $ | 9,189 | | | $ | 8,026 | |
| Loans charged-off: | | | | | | | | | | | | |
| One-to-four residential | | | (1,180 | ) | | | (324 | ) | | | (1 | ) |
| Construction | | | (42 | ) | | | (482 | ) | | | (1,352 | ) |
| Commercial land | | | (2,895 | ) | | | (2,337 | ) | | | (3,172 | ) |
| Residential development | | | (2,826 | ) | | | (1,041 | ) | | | (967 | ) |
| Other commercial real estate | | | (3,390 | ) | | | (4,882 | ) | | | (1,976 | ) |
| Consumer real estate | | | (479 | ) | | | (1,860 | ) | | | (2,143 | ) |
| Commercial business | | | (974 | ) | | | (682 | ) | | | (235 | ) |
| Other consumer | | | (65 | ) | | | (184 | ) | | | (125 | ) |
| Total loan charge-offs | | | (11,851 | ) | | | (11,792 | ) | | | (9,971 | ) |
| Recoveries on loans previously charged-off: | | | | | | | | | | | | |
| One-to-four residential | | | 17 | | | | 4 | | | | - | |
| Construction | | | 250 | | | | 48 | | | | - | |
| Commercial land | | | 66 | | | | - | | | | 135 | |
| Residential development | | | 85 | | | | - | | | | - | |
| Other commercial real estate | | | 259 | | | | 364 | | | | 2 | |
| Consumer real estate | | | 93 | | | | 30 | | | | - | |
| Commercial business | | | 171 | | | | 4 | | | | 10 | |
| Other consumer | | | 14 | | | | 27 | | | | 7 | |
| Total loan recoveries | | | 955 | | | | 477 | | | | 154 | |
| Provision for loan losses | | | 10,685 | | | | 14,050 | | | | 10,980 | |
| Balance at end of year | | $ | 11,713 | | | $ | 11,924 | | | $ | 9,189 | |
The following tables present a disaggregated analysis of the activity in the allowance for loan losses and loan balances for non-covered loans for the twelve months ended December 31, 2011 and 2010.
| | | One-to-four family residential | | | Multifamily residential | | | Construction | | | Commercial land | | | Residential development | | | Other commercial real estate | | | Consumer real estate | | | Commercial business | | | Other consumer | | | Total | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance - January 1, 2011 | | $ | 500 | | | $ | 200 | | | $ | 1,000 | | | $ | 2,163 | | | $ | 2,000 | | | $ | 1,561 | | | $ | 1,500 | | | $ | 2,500 | | | $ | 500 | | | $ | 11,924 | |
| Loan charge-offs | | | (1,180 | ) | | | - | | | | (42 | ) | | | (2,895 | ) | | | (2,826 | ) | | | (3,390 | ) | | | (479 | ) | | | (974 | ) | | | (65 | ) | | | (11,851 | ) |
| Loan recoveries | | | 17 | | | | - | | | | 250 | | | | 66 | | | | 85 | | | | 259 | | | | 93 | | | | 171 | | | | 14 | | | | 955 | |
| Provision for loan losses | | | 1,163 | | | | (50 | ) | | | (408 | ) | | | 3,000 | | | | 2,740 | | | | 3,400 | | | | 486 | | | | 303 | | | | 51 | | | | 10,685 | |
| Balance - Decmber 31, 2011 | | $ | 500 | | | $ | 150 | | | $ | 800 | | | $ | 2,334 | | | $ | 1,999 | | | $ | 1,830 | | | $ | 1,600 | | | $ | 2,000 | | | $ | 500 | | | $ | 11,713 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Loans collectively evaluated for impairment | | $ | 500 | | | $ | 150 | | | $ | 800 | | | $ | 2,334 | | | $ | 1,999 | | | $ | 1,830 | | | $ | 1,600 | | | $ | 2,000 | | | $ | 500 | | | $ | 11,713 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | 1,526 | | | $ | - | | | $ | - | | | $ | 2,388 | | | $ | 4,014 | | | $ | 10,431 | | | $ | 439 | | | $ | 1 | | | $ | 34 | | | $ | 18,833 | |
| Loans collectively evaluated for impairment | | | 116,859 | | | | 16,759 | | | | 19,602 | | | | 26,632 | | | | 12,256 | | | | 218,180 | | | | 103,486 | | | | 41,161 | | | | 5,649 | | | | 560,584 | |
| Total non-covered loans | | $ | 118,385 | | | $ | 16,759 | | | $ | 19,602 | | | $ | 29,020 | | | $ | 16,270 | | | $ | 228,611 | | | $ | 103,925 | | | $ | 41,162 | | | $ | 5,683 | | | $ | 579,417 | |
| | | One-to-four family residential | | | Multifamily residential | | | Construction | | | Commercial land | | | Residential development | | | Other commercial real estate | | | Consumer real estate | | | Commercial business | | | Other consumer | | | Total | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance - January 1, 2010 | | $ | 250 | | | $ | 200 | | | $ | 1,775 | | | $ | 1,000 | | | $ | 1,000 | | | $ | 1,964 | | | $ | 1,500 | | | $ | 1,000 | | | $ | 500 | | | $ | 9,189 | |
| Loan charge-offs | | | (324 | ) | | | - | | | | (482 | ) | | | (2,337 | ) | | | (1,041 | ) | | | (4,882 | ) | | | (1,860 | ) | | | (682 | ) | | | (184 | ) | | | (11,792 | ) |
| Loan recoveries | | | 4 | | | | - | | | | 48 | | | | - | | | | - | | | | 364 | | | | 30 | | | | 4 | | | | 27 | | | | 477 | |
| Provision for loan losses | | | 570 | | | | - | | | | (341 | ) | | | 3,500 | | | | 2,041 | | | | 4,115 | | | | 1,830 | | | | 2,178 | | | | 157 | | | | 14,050 | |
| Balance - December 31, 2010 | | $ | 500 | | | $ | 200 | | | $ | 1,000 | | | $ | 2,163 | | | $ | 2,000 | | | $ | 1,561 | | | $ | 1,500 | | | $ | 2,500 | | | $ | 500 | | | $ | 11,924 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 416 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 416 | |
| Loans collectively evaluated for impairment | | $ | 500 | | | $ | 200 | | | $ | 1,000 | | | $ | 2,163 | | | $ | 2,000 | | | $ | 1,561 | | | $ | 1,500 | | | $ | 2,500 | | | $ | 500 | | | $ | 11,924 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans individually evaluated for impairment | | $ | 764 | | | $ | - | | | $ | - | | | $ | 2,630 | | | $ | 6,192 | | | $ | 6,123 | | | $ | 205 | | | $ | - | | | $ | - | | | $ | 15,914 | |
| Loans collectively evaluated for impairment | | | 100,250 | | | | 20,674 | | | | 20,214 | | | | 35,173 | | | | 18,894 | | | | 228,358 | | | | 108,989 | | | | 34,993 | | | | 5,475 | | | | 573,020 | |
| Total non-covered loans | | $ | 101,014 | | | $ | 20,674 | | | $ | 20,214 | | | $ | 37,803 | | | $ | 25,086 | | | $ | 234,481 | | | $ | 109,194 | | | $ | 34,993 | | | $ | 5,475 | | | $ | 588,934 | |
Note 8 – FDIC Loss Share Receivable
The following table provides changes in the loss share receivable from the FDIC for the twelve months ended December 31, 2011 and 2010.
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Balance at beginning of period | | $ | 24,848 | | | $ | - | |
| Additional FDIC loss share receivable from acquisitions | | | 19,922 | | | | 36,301 | |
| Increase in expected losses on indemnified assets | | | 2,295 | | | | 2,184 | |
| Claimable (gains) losses on OREO covered under loss share agreements | | | 2,285 | | | | (14 | ) |
| Reimbursable expenses claimed | | | 810 | | | | 318 | |
| Accretion of discounts and premiums, net | | | (2,946 | ) | | | (2,597 | ) |
| Receipt of payments from FDIC | | | (8,593 | ) | | | (12,035 | ) |
| Other | | | 310 | | | | 691 | |
| Balance at end of period | | $ | 38,931 | | | $ | 24,848 | |
Note 9 – Other Real Estate Owned
The following table details the other real estate owned (“OREO”) by property type at December 31 for the past two years.
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Non-covered OREO: | | | | | | |
| Residential properties | | $ | 1,737 | | | $ | 1,389 | |
| Undeveloped land and residential lots | | | 6,577 | | | | 5,367 | |
| Other commercial real estate | | | 622 | | | | 894 | |
| OREO covered by FDIC loss share agreements | | | 8,635 | | | | 7,002 | |
| Other real estate owned | | $ | 17,571 | | | $ | 14,652 | |
A reconciliation of OREO for the past two years is as follows:
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Balance at beginning of year | | $ | 14,652 | | | $ | 5,067 | |
| Additions to other real estate owned: | | | | | | | | |
| Acquisition of other real estate owned | | | 6,374 | | | | 1,076 | |
| New foreclosed properties | | | 16,486 | | | | 16,293 | |
| Reductions of other real estate owned: | | | | | | | | |
| Sales proceeds | | | (15,328 | ) | | | (5,955 | ) |
| Loss on sale of other real estate owned | | | (294 | ) | | | (447 | ) |
| Writedowns | | | (4,319 | ) | | | (1,382 | ) |
| Balance at end of year | | $ | 17,571 | | | $ | 14,652 | |
Note 10 – Premises and Equipment
Premises and equipment at December 31 are summarized below.
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Land | | $ | 7,676 | | | $ | 6,023 | |
| Buildings | | | 21,283 | | | | 20,103 | |
| Leasehold improvements | | | 342 | | | | 344 | |
| Land improvements | | | 463 | | | | 387 | |
| Furniture and equipment | | | 6,661 | | | | 6,274 | |
| Premises and equipment, gross | | | 36,425 | | | | 33,131 | |
| Less: Accumulated depreciation | | | (10,537 | ) | | | (9,346 | ) |
| Premises and equipment, net | | $ | 25,888 | | | $ | 23,785 | |
Note 11 – Intangible Assets
The following is a summary of intangible assets at December 31, 2011 and 2010.
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Core deposit intangible | | $ | 6,628 | | | $ | 6,404 | |
| Less: Accumulated amortization | | | (5,255 | ) | | | (4,714 | ) |
| Intangible assets, net | | $ | 1,373 | | | $ | 1,690 | |
Amortization expense for intangible assets subject to amortization was $538,000, $517,000, and $314,000 for the twelve months ended December 31, 2011, 2010 and 2009, respectively. Estimated amortization expense for the next five succeeding years is as follows:
| | 2012 | $ | 440,000 | |
| | 2013 | | 318,000 | |
| | 2014 | | 226,000 | |
| | 2015 | | 175,000 | |
| | 2016 | | 122,000 | |
Note 12 – Deposits
The Company’s deposit balances and weighted average interest rates at December 31 are detailed by category as follows for the past two years:
| | | 2011 | | | 2010 | |
| | | Amount | | | Average Rate | | | Amount | | | Average Rate | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Noninterest-bearing demand | | $ | 88,077 | | | | - | | | $ | 70,389 | | | | - | |
| Interest-bearing demand | | | 199,390 | | | | 0.41 | % | | | 172,414 | | | | 0.81 | % |
| Money market deposit | | | 155,228 | | | | 0.52 | % | | | 142,538 | | | | 1.00 | % |
| Savings | | | 20,542 | | | | 0.17 | % | | | 17,004 | | | | 0.24 | % |
| Time deposits | | | 412,819 | | | | 1.26 | % | | | 448,444 | | | | 1.78 | % |
| Total deposits | | $ | 876,056 | | | | 0.81 | % | | $ | 850,789 | | | | 1.28 | % |
Contractual maturities of time deposits at December 31 for the past two years are as follows:
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Under 1 year | | $ | 317,451 | | | $ | 326,087 | |
| Over 1 year to 2 years | | | 69,283 | | | | 113,103 | |
| Over 2 years to 3 years | | | 13,524 | | | | 3,279 | |
| Over 3 years to 4 years | | | 4,900 | | | | 3,079 | |
| Over 4 years | | | 7,661 | | | | 2,896 | |
| Total time deposits | | $ | 412,819 | | | $ | 448,444 | |
Time deposits in excess of $100,000 totaled $173.4 million and $194.7 million at December 31, 2011 and 2010, respectively. Interest paid on deposits and other borrowings was $10.9 million, $14.9 million, and $17.6 million for the years ending December 31, 2011, 2010 and 2009, respectively.
Directors, executive officers, and associates of such persons are customers of and have had transactions with the Bank in the ordinary course of business. Included in such transactions are deposit accounts, all of which were made under normal terms. The aggregate amount of these deposit accounts was $6.3 million and $7.5 million at December 31, 2011 and 2010, respectively.
Note 13 – Borrowed Money
As of December 31, 2011, the Company had $60.7 million in advances from the FHLB of Atlanta that were obtained pursuant to a line of credit. These advances are collateralized by a lien on qualifying first mortgage loans in an amount necessary to satisfy outstanding indebtedness plus accrued interest. The total amount available on the line of credit is approximately $163 million. The unused portion of the line of credit available to the Company at December 31, 2011, was approximately $103 million. These advances had interest rates ranging from 1.15% to 4.77% during 2011 and 2010. Interest rates on certain FHLB convertible advances may be reset on certain dates at the option of the FHLB in accordance with the terms of the note. The Bank has the option of repaying the outstanding advance or converting the interest rate from a fixed rate to a floating rate at the time the advance is called by the FHLB. These convertible advances totaled $15.0 million at December 31, 2011, and $20.0 million at December 31, 2010.
The Company also had $18.0 million in repurchase agreements (“repos”) from JP Morgan Chase Bank, NA (“JP Morgan”) and Citigroup Global Markets, Inc. (“Citigroup”) at December 31, 2011. These borrowings are collateralized by various U.S. Government agency investment securities in an amount equal to at least 105% of the outstanding amount of the repurchase agreement. The Company had $3.0 million in repos from JP Morgan and $15.0 million from Citigroup. The interest rates on these repos range from 2.99% to 3.66%. Three repos totaling $13.0 million have fixed rates and fixed maturities. The remaining repo, which totaled $5.0 million, may be called at the option of the issuer in accordance of the terms of the agreement.
A summary of the Company’s borrowed money balances and average interest rates for the periods ended December 31, 2011 and 2010 is as follows:
| | | 2011 | | | 2010 | |
| | | Balance | | | Average Rate | | | Balance | | | Average Rate | |
| (Dollars in thousands) | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| FHLB Advances | | $ | 60,688 | | | | 3.78 | % | | $ | 67,782 | | | | 3.64 | % |
| Repurchase Agreements | | | 18,000 | | | | 3.28 | % | | | 18,000 | | | | 3.28 | % |
| Total Borrowed Money | | $ | 78,688 | | | | 3.66 | % | | $ | 85,782 | | | | 3.56 | % |
Maturities of borrowed money at December 31 are as follows:
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Borrowed money due: | | | | | | |
| | | | | | | |
| Less than one year | | $ | 17,907 | | | $ | 1,972 | |
| 1 to 2 years | | | 12,781 | | | | 17,814 | |
| 2 to 3 years | | | 3,000 | | | | 12,996 | |
| 3 to 4 years | | | 3,000 | | | | 3,000 | |
| 4 to 5 years | | | - | | | | 3,000 | |
| 5 to 10 years | | | 42,000 | | | | 47,000 | |
| Total borrowed money | | $ | 78,688 | | | $ | 85,782 | |
Note 14 – Subordinated Debt
On October 28, 2005, CSBC Statutory Trust I issued an aggregate of $15,000,000 in trust preferred securities, liquidation amount $1,000 per security. The Preferred Securities mature on December 15, 2035, but may be redeemed beginning December 15, 2010, if the Company exercises its right to redeem the Debentures, as described below. The Preferred Securities require quarterly distributions by the Trust to the holders of the Preferred Securities, initially at a fixed rate of 6.095% per annum through the interest payment date in December 2010, and thereafter at a variable rate of three-month LIBOR plus 1.57% per annum, reset quarterly. Distributions are cumulative and will accrue from the date of original issuance but may be deferred for a period of up to twenty consecutive quarterly interest payment periods if the Company exercises its right under the Indenture to defer the payment of interest on the Debentures, as described below. In accordance with ASC 810, formerly referred to as FIN No. 46(R), “Consolidation of Variable Interest Entities”, the trust is not consolidated with the financial statements of the Company.
The proceeds from the sale of the Preferred Securities received by the Trust, combined with the proceeds of $464,000 received by the Trust from the issuance of common securities (the "Common Securities") by the Trust to the Company, were used to purchase $15,464,000 in principal amount of unsecured junior subordinated deferrable interest debentures (the "Debentures") of the Company, issued pursuant to the Indenture.
The issuance of the Preferred Securities and the Common Securities are provided for in the Trust Agreement dated October 28, 2005, by and among the Trustee, the Company, and the administrative trustees of the Trust. The administrative trustees are the President and Chief Executive Officer, Executive Vice President and Secretary, and Executive Vice President and Chief Financial Officer.
The Debentures mature on December 15, 2035, but the Company may at its option redeem the Debentures, in whole or in part, beginning on December 15, 2010, in accordance with the provisions of the Indenture. The Debentures bear interest at a fixed rate equal to 6.095% per annum through the interest payment date in December 2010, and thereafter at a variable rate, reset quarterly, of three-month LIBOR plus 1.57% per annum. Interest is cumulative and will accrue from the date of original issuance. However, so long as there is no event of default, interest payments may be deferred by the Company at its option at any time for a period of up to twenty consecutive quarterly interest payment periods, but not beyond December 15, 2035 (each such extended interest payment period, an "Extension Period"). No interest shall be due and payable during an Extension Period, but each installment of interest that would otherwise have been due and payable during such Extension Period shall bear additional interest at an annual rate equal to the interest rate in effect for each Extension Period. Furthermore, during any Extension Period, the Company may not declare or pay any dividends on its capital stock, which includes its Common Stock, nor make any payment or redeem debt securities that rank pari passu with the Debentures. The Company has not deferred any interest payments on the Debentures as of December 31, 2010.
The Debentures may be redeemed at par at the option of the Company beginning on December 15, 2010. The Trust will be required to redeem a like amount of Preferred Securities if the Company exercises its right to redeem all or a portion of the Debentures.
Either the Trustee or the holders of at least 25% of the aggregate principal amount of the outstanding Debentures may declare the principal amount of, and all accrued interest on, all the Debentures to be due and payable immediately, or if the holders of the Debentures fail to make such declaration, the holders of at least a majority in aggregate liquidation amount of the Preferred Securities outstanding shall have a right to make such declaration, if an Event of Default occurs. An Event of Default generally includes a default in payment of any interest for 30 days, a default in payment upon maturity, a default in performance, or breach of any covenant or representation, bankruptcy or insolvency of the Company or liquidation or dissolution of the Trust. Any holder of the Preferred Securities has the right, upon the occurrence of an Event of Default related to payment of interest of principal, to institute suit directly against the Company for enforcement of payment to such holder of principal of and any premium and interest, including additional interest, on the Debentures having a principal amount equal to the aggregate liquidation amount of the Preferred Securities held by such holder.
Note 15 – Preferred Stock
On September 22, 2011, the Company entered into a Securities Purchase Agreement with the Secretary of the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued and sold to the Treasury 20,500 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series C (“Series C Preferred Stock”), having a liquidation preference of $1,000 per share, for aggregate proceeds of $20,500,000. The Securities Purchase Agreement was entered into, and the Series C Preferred Stock was issued, pursuant to the Treasury’s Small Business Lending Fund program (“SBLF”), as established under the Small Business Jobs Act of 2010. The Company’s rights and obligations with respect to the Series C Preferred Stock are set forth in the Securities Purchase Agreement and the Certificate of Designation to its Certificate of Incorporation filed by the Company with the Secretary State of the State of Delaware. The Series C Preferred Stock is entitled to receive non-cumulative dividends payable quarterly. The dividend rate was initially set at 4.84% per annum based upon the initial level of qualified small business lending (“QSBL”) by the Bank. The dividend rate for future dividend periods will be set based upon the percentage change in the QSBL between each dividend period and the baseline QSBL level. This dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods, from 1% per annum to 7% per annum for the eleventh through the first half of the nineteenth dividend periods. The current dividend rate is 3.30%. If the Series C Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%. Prior to that time the dividend rate decreases as the level of the Bank’s QSBL increases. Also, the Company may redeem the shares of Series C Preferred Stock, in whole or in part, at any time subject to prior approval by the Company’s primary federal banking regulator.
As a result of the Company’s participation in SBLF, the Company redeemed all 20,500 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A it sold to the Treasury on December 12, 2008, in connection with the Treasury’s Capital Purchase Program. The Company paid $20.6 million to the Treasury to redeem the Series A Preferred Stock, which includes the original investment of $20.5 million, plus accrued dividends.
Note 16 – Income Taxes
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Currently payable: | | | | | | | | | |
| Federal | | $ | 1,151 | | | $ | 226 | | | $ | (189 | ) |
| State | | | 379 | | | | 65 | | | | (37 | ) |
| Total current | | | 1,530 | | | | 291 | | | | (226 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Deferred: | | | | | | | | | | | | |
| Federal | | | (1,785 | ) | | | 3,308 | | | | (1,080 | ) |
| State | | | (447 | ) | | | 750 | | | | (193 | ) |
| Total deferred | | | (2,232 | ) | | | 4,058 | | | | (1,273 | ) |
| | | | | | | | | | | | | |
| Total income taxes | | $ | (702 | ) | | $ | 4,349 | | | $ | (1,499 | ) |
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Federal income taxes at statutory rate | | $ | (676 | ) | | $ | 4,067 | | | $ | (11,063 | ) |
| | | | | | | | | | | | | |
| Effect of federal tax exempt interest | | | (223 | ) | | | (326 | ) | | | (475 | ) |
| State income taxes, net of federal benefit | | | (45 | ) | | | 538 | | | | (152 | ) |
| Non deductible preferred dividends | | | 320 | | | | 349 | | | | 351 | |
| Goodwill impairment | | | - | | | | - | | | | 10,078 | |
| Non deductible merger expenses | | | 95 | | | | - | | | | - | |
| Increase in cash value of life insurance | | | (228 | ) | | | (259 | ) | | | (238 | ) |
| Other | | | 55 | | | | (20 | ) | | | - | |
| | | $ | (702 | ) | | $ | 4,349 | | | $ | (1,499 | ) |
| | | | | | | | | | | | | |
| Effective tax rate | | | 35.3 | % | | | 36.3 | % | | | 4.6 | % |
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Deferred tax assets: | | | | | | |
| Deferred compensation | | $ | 1,316 | | | $ | 1,179 | |
| Unrealized (gain) loss on securities available for sale | | | (169 | ) | | | 12 | |
| Allowance for loan losses | | | 4,116 | | | | 4,334 | |
| Alternative minimum tax credits | | | 306 | | | | 272 | |
| Capital loss carryforward | | | 47 | | | | 27 | |
| Other | | | 5,423 | | | | 2,984 | |
| Gross deferred tax assets | | | 11,039 | | | | 8,808 | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| Excess carrying value of assets acquired over tax basis | | | 742 | | | | 526 | |
| FDIC assisted book gain | | | 7,106 | | | | 7,065 | |
| Deferred loan fees | | | (60 | ) | | | 33 | |
| Other | | | 4 | | | | 2 | |
| Gross deferred tax liabilities | | | 7,792 | | | | 7,626 | |
| | | | | | | | | |
| Net deferred tax asset | | $ | 3,247 | | | $ | 1,182 | |
Note 17 – Commitments
Commitments to extend credit are agreements to lend as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These commitments represent no more than normal lending risk that the Bank commits to its borrowers and management believes that these commitments can be funded through normal operations.
Commitments to extend credit at December 31, 2011 and 2010 are detailed below:
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Loan commitments | | | | | | |
| Residential mortgage loans | | $ | 24,704 | | | $ | 14,530 | |
| Total loan commitments | | $ | 24,704 | | | $ | 14,530 | |
| | | | | | | | | |
| Unused lines of credit | | | | | | | | |
| Residential construction | | $ | 7,390 | | | $ | 5,868 | |
| Commercial real estate | | | 18,593 | | | | 6,505 | |
| Commercial business | | | 9,558 | | | | 8,775 | |
| Consumer | | | 74,930 | | | | 76,015 | |
| Total unused lines of credit | | $ | 110,471 | | | $ | 97,163 | |
| | | | | | | | | |
| Undisbursed Construction Loan Proceeds | | $ | 1,200 | | | $ | 524 | |
Note 18 – Regulatory Capital Requirements
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain commitments as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.
The Bank is required to maintain: tangible capital of at least 1.5% of adjusted total assets; core capital of at least 4.0% of adjusted total assets; and total capital of at least 8.0% of risk weighted assets. The Bank’s primary regulator confirmed that the Bank was in the “well-capitalized” category as of the most recent regulatory examination, and management is not aware of any events that have occurred since that would have changed its classification. The Bank’s regulatory capital ratios and regulatory requirements are presented in the following table.
| | | Actual | | | Minimum for capital adequacy purposes | | | Minimum to be well capitalized under prompt corrective action provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| (Dollars in thousands) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| As of December 31, 2011: | | | | | | | | | | | | | | | | | | |
| Total risk-based capital (to risk-weighted assets) | | $ | 111,508 | | | | 15.60 | % | | $ | 57,184 | | | | 8.00 | % | | $ | 71,481 | | | | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) | | | 102,539 | | | | 14.35 | % | | | 28,592 | | | | 4.00 | % | | | 42,888 | | | | 6.00 | % |
| Tier 1 capital (to adjusted total assets) | | | 102,539 | | | | 9.44 | % | | | 43,433 | | | | 4.00 | % | | | 54,292 | | | | 5.00 | % |
| Tangible capital (to adjusted total assets) | | | 102,539 | | | | 9.44 | % | | | 16,287 | | | | 1.50 | % | | | 32,575 | | | | 3.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2010: | | | | | | | | | | | | | | | | | | | | | | | | |
| Total risk-based capital (to risk-weighted assets) | | $ | 111,623 | | | | 16.80 | % | | $ | 53,139 | | | | 8.00 | % | | $ | 66,424 | | | | 10.00 | % |
| Tier 1 capital (to risk-weighted assets) | | | 103,233 | | | | 15.54 | % | | | 26,570 | | | | 4.00 | % | | | 39,855 | | | | 6.00 | % |
| Tier 1 capital (to adjusted total assets) | | | 103,233 | | | | 9.74 | % | | | 42,383 | | | | 4.00 | % | | | 52,979 | | | | 5.00 | % |
| Tangible capital (to adjusted total assets) | | | 103,233 | | | | 9.74 | % | | | 15,894 | | | | 1.50 | % | | | 31,787 | | | | 3.00 | % |
On May 23, 2002, Citizens South Holdings, MHC approved a Plan of Conversion and Reorganization. As a result of the conversion, the Bank established a memo liquidation account in an amount equal to its equity at the time of the Conversion of approximately $44 million for the benefit of eligible account holders and supplemental eligible account holders who continue to maintain their accounts at the Bank after the conversion. In the event of a complete liquidation of the Bank, each eligible account holder and supplemental eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. As a result, retained earnings are substantially restricted at December 31, 2011 and 2010.
Note 19 – Employee Benefits
Employee 401(k) Savings Plan – The Bank provides supplemental benefits to substantially all employees through a 401(k) savings plan. Eligible participants may contribute up to 75% of eligible compensation. Prior to 2009 the Bank provided matching contributions of 50% of employee contributions up to 6% of eligible compensation. Total expense relating to the employer match on the 401(k) savings plan was $76,000, $0, and $44,000 for the years ended December 31, 2011, 2010 and 2009, respectively. The reason for the decrease in 2010 was that the Board of Directors suspended the employer match for the 401(k) savings plan effective March 1, 2009. In 2011, the Board of Directors partially reinstated the employer match to provide for matching contributions of 25% of employee contributions up to 6% of eligible compensation beginning April 1, 2011. Participants will vest in the employer matching contributions allocated to their respective accounts over a period not to exceed three years. The amount of the employer match to the 401(k) savings plan will be evaluated by the Compensation Committee and the Board of Directors on an on-going basis.
Employee Stock Ownership Plan - The Bank established an Employee Stock Ownership Plan (“ESOP”) in 1998. The ESOP is a tax-qualified retirement plan designed to invest primarily in the Company’s common stock. All full-time employees of the Bank who have completed one year of service with the Bank are eligible to participate in the ESOP. The ESOP utilized funds borrowed from the Company totaling $1.7 million, to purchase approximately 8%, or 380,038 shares of the Company’s common stock (adjusted for stock splits and stock dividends) issued in the 1998 Conversion. The ESOP utilized funds borrowed from the Company totaling $1.1 million to purchase 110,457 additional shares of the Company’s common stock issued in the 2002 Conversion. The loans to the ESOP will be primarily repaid with contributions from the Bank to the ESOP over a period not to exceed 15 years for each loan. Under the terms of the ESOP, the Bank makes contributions to the ESOP sufficient to cover all payments of principal and interest as they become due. The interest rate on each of the loans is based on the Bank’s prime rate at the end of each calendar year. The 1998 loan had an outstanding balance of $113,000 with an interest rate of 3.25% at December 31, 2011 and a balance of $225,000 with an interest rate of 3.25% at December 31, 2010, respectively. The 2002 loan had an outstanding balance of $351,000 with an interest rate of 3.25% at December 31, 2011 and a balance of $421,000 with an interest rate of 3.25% at December 31, 2010. Unallocated shares, totaling 49,572 shares at December 31, 2011, are excluded for the calculation of earnings per share.
Shares purchased with the loan proceeds are held in a suspense account by the third-party trustee of the plan for future allocation among participants as the loan is repaid. Contributions to the ESOP and shares released from the suspense account are allocated among participants on the basis of compensation as described in the plan. The number of shares released to participants will be determined based upon the percentage of principal and interest payments made during the year divided by the total remaining principal and interest payments including the current year’s payment. Participants will vest in the shares allocated to their respective accounts over a period not to exceed three years. Any forfeited shares are allocated to the then-remaining participants in the same proportion as contributions. As of December 31, 2011, 441,000 shares have been allocated to participants and 49,572 shares remain unallocated. The fair value of the 49,572 unallocated shares was $173,502 based on the closing price of $3.50 at December 31, 2011. The Company recognizes compensation expense attributable to the ESOP ratably over the fiscal year based upon the estimated number of ESOP shares to be allocated each December 31st. The Company recognized $41,000, $48,000, and $51,000 as compensation expense in the years ended December 31, 2011, December 31, 2010, and December 31, 2009, respectively.
The trustee for the ESOP must vote all allocated shares held in the ESOP trust in accordance with the instructions of the participants. Unallocated shares held by the ESOP trust are voted by the trustee in a manner calculated to most accurately reflect the results of the allocated ESOP shares voted, subject to the requirements of the Employee Retirement Income Security Act of 1974, as amended.
Nonqualified Deferred Compensation – The Bank maintains nonqualified deferred compensation and supplemental retirement plans for certain of the Company’s directors and executive officers of the Bank. Total expense for all of these plans was $615,000 for the year ended December 31, 2011, $426,000 for the year ended December 31, 2010, and $513,000 for the year ended December 31, 2009.
The Bank also adopted nonqualified deferred compensation plans for key employees and directors of Citizens Bank, a wholly-owned subsidiary of Innes Street Financial Corporation, which was acquired by the Company on December 31, 2001. The deferred assets related to these plans are maintained in rabbi trusts, which are included in other assets of the Company. The assets are accounted for at market value in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“ASC 320”) with the resulting gains or losses in value recorded in income. The corresponding change in fair value of the deferred compensation obligation is recorded as compensation expense. As a result, there is no impact on net income as a result of this benefit.
2003 Recognition and Retention Plan (“2003 RRP”) – On October 23, 2003 the Company’s stockholders approved the Citizens South Banking Corporation 2003 Recognition and Retention Plan that provided for the issuance of a total of 220,917 shares (adjusted for stock dividends) to be granted to certain directors and officers. On November 3, 2003, grants of 206,388 shares of restricted stock were made under the 2003 RRP. All of these shares vested over a seven-year period commencing on the date of the award, at the rate of 30% on November 3, 2003, 10% on January 2, 2004, 10% on November 3, 2005, and 10% per year on November 3 of each year thereafter. Adjusted for stock dividends, the fair market value of the restricted stock at the time of the grant was $14.32 per share. During 2011, 4,765 restricted shares vested, 525 shares were forfeited and 525 shares were granted from the 2003 RRP. No shares remained unissued and available for grants under the 2003 RRP. Total expense for the 2003 RRP amounted to $163,000 in 2011, $342,000 in 2010, and $331,000 in 2009.
1999 Stock Option Plan - On April 12, 1999, the Company’s stockholders approved the Citizens South Bank 1999 Stock Option Plan that provided the issuance of 475,047 options (adjusted for stock splits and stock dividends) for directors and officers to purchase the Company’s common stock, of which 1,481 option shares remain outstanding, of which 590 are vested and 891 are not vested. During 2011, there were no incentive options granted, no reload options issued, no options exercised, 295 shares vested, and 211 shares were forfeited but are expired. No incentive option grants have been made under the 1999 Stock Option Plan since March 16, 2009, and no options remain unissued and available for grants under the 1999 Stock Option Plan because the Plan expired on April 12, 2009.
2003 Stock Option Plan – On October 23, 2003, the Company’s stockholders approved the Citizens South Banking Corporation 2003 Stock Option Plan that provided for the issuance of 552,294 options (adjusted for stock dividends) for directors and officers to purchase the Company’s common stock. During 2011, there were no incentive options granted, no reload options issued, no options exercised, and 27,300 options were forfeited. At December 31, 2011, 33,698 options remained unissued and available for grants under the 2003 Stock Option Plan.
2008 Equity Incentive Plan – On May 12, 2008, the Company’s stockholders approved the Citizens South Banking Corporation 2008 Equity Incentive Plan that provided for a total of 315,000 shares (adjusted for stock dividends) of common stock available for award pursuant to grants of incentive stock options, non-statutory stock options, and restricted stock awards. Under the plan, no more than 105,000 shares may be issued as restricted stock awards and all shares may be issued as incentive stock options. During 2011, there were 6,300 restricted shares forfeited, 19,075 restricted shares vested, and 6,300 restricted shares granted with cliff vesting on February 19, 2013. During 2011, there were also 10,000 incentive stock options granted which vest in five equal annual installments, 10,500 stock options were forfeited, and no options were exercised. At December 31, 2011, 18,875 incentive option shares remained unissued and available for grants under the 2008 Equity Incentive Plan, of which no shares may be issued as restricted stock awards and 18,875 shares may be issued as incentive stock options.
The following is a summary of stock option activity and related information for the years ended December 31, 2011, 2010 and 2009. All balances have been adjusted for a 5% stock dividend paid on November 15, 2010.
| | | 2011 | | | 2010 | | | 2009 | |
| | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | |
| Outstanding at January 1 | | | 769,938 | | | $ | 11.97 | | | | 738,038 | | | $ | 12.25 | | | | 922,024 | | | $ | 11.51 | |
| Granted | | | 10,000 | | | | 4.80 | | | | 36,625 | | | | 4.92 | | | | 2,217 | | | | 4.75 | |
| Exercised | | | - | | | | - | | | | - | | | | - | | | | (24,702 | ) | | | 5.33 | |
| Forfeited | | | (40,636 | ) | | | 12.16 | | | | (4,725 | ) | | | 7.62 | | | | (12,600 | ) | | | 12.92 | |
| Expired | | | - | | | | - | | | | - | | | | - | | | | (148,901 | ) | | | 8.68 | |
| Outstanding at December 31 | | | 739,302 | | | | 11.85 | | | | 769,938 | | | | 11.97 | | | | 738,038 | | | | 12.25 | |
| Exercisable at December 31 | | | 638,802 | | | | 12.76 | | | | 623,021 | | | | 13.17 | | | | 584,722 | | | | 13.47 | |
| Weighted average fair value of options granted during the year | | | | | | $ | 2.19 | | | | | | | $ | 1.83 | | | | | | | $ | 1.65 | |
Exercise prices for options outstanding ranged from $4.50 to $14.32 at December 31, 2011 and December 31, 2010, adjusted for stock dividends. The weighted average remaining contractual life of those options was approximately two years at December 31, 2011, and three years at December 31, 2010.
Note 20 – Fair Value Measurements
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company has not elected the fair value option for liabilities. Investment securities, available for sale, are recorded at fair value on a recurring basis. Additionally, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans and other real estate owned. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting for these other assets.
In accordance with ASC 825-10, when measuring fair value, the Company uses valuation techniques that are appropriate and consistently applied. A fair value hierarchy is used based on the markets in which the assets are traded and the reliability of the assumptions used to determine the fair value. These levels are as follows:
Level 1: Inputs to the valuation methodology are based on quoted prices in active markets for identical instruments.
Level 2: Inputs to the valuation methodology are derived from readily available pricing sources for market transactions involving similar types of instruments in active markets.
Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. The following is a description of valuation methodologies used for assets recorded at fair value. The determination of where an instrument falls in the hierarchy requires significant judgment.
Investment Securities – Investment securities available for sale are recorded at fair value on at least a monthly 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 fair value is used for those securities traded on an active exchange, U.S. Treasury securities that are traded by brokers or dealers in an active over-the-counter market, and money market funds. Level 2 securities include mortgage-backed securities issued by government-sponsored enterprises, municipal bonds, and corporate debt securities. These Level 2 securities are valued using an independent third party. This independent third party uses multiple pricing vendors and matrix pricing methods developed in accordance with the Securities Industry and Financial Markets Association’s industry-standard methods. Level 3 investment securities include equity securities that are not traded on an active exchange, investments in closely held subsidiaries, and asset-backed securities traded in less liquid markets. The $258,000 of transfers into Level 3 investment securities during 2011 include equity securities that were pledged as collateral on a loan that defaulted. A reconciliation of the Company’s Level 3 securities for the twelve months ended December 31, 2011 and 2010 is shown in the following table:
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Beginning balance, January 1 | | $ | 3,023 | | | $ | 2,941 | |
| Total net gains (losses) for the year included in: | | | | | | | | |
| Net income | | | - | | | | 35 | |
| Other comprehensive income | | | (163 | ) | | | 399 | |
| Purchases, sales, issuances and settlements, net | | | (1,551 | ) | | | 83 | |
| Impairments | | | - | | | | (435 | ) |
| Transfers in and/or out of Level 3 | | | 258 | | | | - | |
| Ending balance, December 31 | | $ | 1,567 | | | $ | 3,023 | |
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 a specific allowance 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 being impaired, management measures the impairment in accordance with ASC 310-10-35. The fair value of impaired loans is estimated using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2011 and December 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with ASC 825-10, impaired loans where an allowance was established based on the fair value of collateral required classification in the fair value hierarchy. When the fair value of the collateral was based on an observable market price, the Company recorded the impaired loan as nonrecurring Level 2. When an observable market price was not available or when management made assumptions that impact the fair value of the collateral, such as estimated disposition or holding costs, the Company recorded the impaired loan as nonrecurring Level 3.
Other Real Estate Owned – Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price, the Company records the OREO as nonrecurring Level 2. When an observable market price is not available, or when management makes assumptions that impact the fair value of the collateral, such as estimated disposition or holding costs, the Company records the OREO as nonrecurring Level 3.
Assets Recorded at Fair Value on a Recurring Basis:
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | | (Dollars in thousands) | |
| December 31, 2011 | | | | | | | | | | | | |
| Investment securities, available for sale | | $ | - | | | $ | 94,196 | | | $ | 1,567 | | | $ | 95,763 | |
| Investment securities, rabbi trusts | | | - | | | | 213 | | | | - | | | | 213 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | |
| Investment securities, available for sale | | $ | - | | | $ | 71,285 | | | $ | 3,023 | | | $ | 74,308 | |
| Investment securities, rabbi trusts | | | - | | | | 731 | | | | - | | | | 731 | |
| | | | | | | | | | | | | | | | | |
| Assets Recorded at Fair Value on a Nonrecurring Basis: | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| December 31, 2011 | | | | | | | | | | | | | | | | |
| Presold loans in process of settlement | | $ | - | | | $ | 2,146 | | | $ | - | | | $ | 2,146 | |
| Impaired loans | | | - | | | | - | | | | 29,654 | | | | 29,654 | |
| Other real estate owned | | | - | | | | - | | | | 17,571 | | | | 17,571 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2010 | | | | | | | | | | | | | | | | |
| Presold loans in process of settlement | | $ | - | | | $ | 4,034 | | | $ | - | | | $ | 4,034 | |
| Impaired loans | | | - | | | | - | | | | 26,429 | | | | 26,429 | |
| Other real estate owned | | | - | | | | - | | | | 14,652 | | | | 14,652 | |
Estimated fair values of financial instruments have been estimated by the Company using the provisions of ASC Topic 825, Financial Instruments “ASC 825”, which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used to estimate the fair value of financial instruments:
Cash and noninterest-bearing deposits - The carrying amounts reported in the balance sheets for cash and noninterest-bearing deposits approximate the fair value of those assets.
Interest-earning deposits - The carrying amounts reported in the balance sheets for interest-earning deposits approximate the fair value of those assets.
Investment securities - Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on readily available pricing sources for market transactions involving comparable types of investments in active markets.
Federal Home Loan Bank stock - The fair values for FHLB stock are its carrying value since this is the amount for which it could be redeemed. There is no active market for this stock and the Company, in order to be a member of the FHLB, is required to maintain a minimum investment.
Presold loans in process of settlement – The fair values of presold loans in process of settlement are its carrying value since these loans have a firm commitment to be purchased by an independent third party.
Loans receivable, net - The fair values for fixed rate loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms and credit ratings for the same remaining maturities. The fair value of variable rate loans that reprice frequently is based on the carrying value. The resulting fair value for fixed and variable rate loans is adjusted for the allowance for loan losses.
FDIC indemnification asset - The fair values for the FDIC indemnification asset are estimated based on discounted future cash flows using current discount rates.
Accrued interest receivable and Accrued interest payable - The carrying values of accrued interest receivable and accrued interest payable are assumed to approximate fair value.
Bank-owned 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.
Demand deposits, money market accounts and savings - The fair values of demand deposits, money market accounts and savings accounts are equal to the amount payable on demand at the reporting date.
Time deposits – The fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on these accounts to a schedule of aggregated expected monthly maturities on time deposits.
Securities sold under repurchase agreements - The fair values of securities sold under repurchase agreements are equal to the carrying value due to the short-term nature of these instruments.
Borrowed Money - The fair values for borrowed money are estimated based on discounted future cash flows using current discount rates for similar borrowings.
Subordinated debt - The fair values for subordinated debt are estimated based on a broker indication of fair value at the respective dates.
At December 31, 2011 and December 31, 2010, the Company had outstanding unfunded commitments to extend credit offered in the normal course of business. Fair values of these commitments are based on fees currently charged for similar instruments. At December 31, 2011 and December 31, 2010, the carrying amounts and fair values of these off-balance sheet financial instruments were considered immaterial.
The carrying amounts and estimated fair values of financial instruments at the respective dates were as follows:
| | | 2011 | | | 2010 | |
| | | Amount | | | Fair Value | | | Amount | | | Fair Value | |
| Financial Assets: | | | | | | | | | | | | |
| Cash and non-interest bearing deposits | | $ | 13,296 | | | $ | 13,296 | | | $ | 15,110 | | | $ | 15,110 | |
| Interest-earning bank balances | | | 75,048 | | | | 75,048 | | | | 105,789 | | | | 105,789 | |
| Investment securities | | | 147,899 | | | | 150,251 | | | | 111,586 | | | | 111,946 | |
| Federal Home Loan Bank stock | | | 5,067 | | | | 5,067 | | | | 5,715 | | | | 5,715 | |
| Presold loans in process of settlement | | | 2,146 | | | | 2,146 | | | | 4,034 | | | | 4,034 | |
| Loans receivable, net | | | 722,075 | | | | 735,685 | | | | 724,586 | | | | 739,295 | |
| FDIC loss share receivable | | | 38,931 | | | | 38,931 | | | | 24,848 | | | | 24,848 | |
| Accrued interest receivable | | | 2,773 | | | | 2,773 | | | | 3,001 | | | | 3,001 | |
| Bank-owned life insurance | | | 18,978 | | | | 18,978 | | | | 18,230 | | | | 18,230 | |
| | | | | | | | | | | | | | | | | |
| Financial Liabiliities: | | | | | | | | | | | | | | | | |
| Demand deposits | | $ | 287,466 | | | $ | 287,466 | | | $ | 242,470 | | | $ | 242,470 | |
| Money market accounts | | | 155,229 | | | | 155,229 | | | | 142,538 | | | | 142,538 | |
| Savings accounts | | | 20,542 | | | | 20,542 | | | | 17,004 | | | | 17,004 | |
| Time deposits | | | 412,819 | | | | 415,145 | | | | 448,444 | | | | 451,853 | |
| Securities sold under repurchase agreements | | | 9,787 | | | | 9,787 | | | | 9,432 | | | | 9,432 | |
| Borrowed money | | | 78,688 | | | | 87,697 | | | | 85,782 | | | | 109,092 | |
| Subordinated debt | | | 15,464 | | | | 7,732 | | | | 15,464 | | | | 6,959 | |
| Accrued interest payable | | | 981 | | | | 981 | | | | 1,263 | | | | 1,263 | |
Note 22 – Subsequent Events
The Company has evaluated subsequent events for accounting and disclosure purposes through the date the financial statements are issued.
Dividend Declaration. On January 23, 2012, the Board of Directors of the Company approved and declared a regular cash dividend of one cent ($0.01) per share of common stock to shareholders of record as of February 3, 2012, payable on February 17, 2012. The Company has paid cash dividends in each of the 55 quarters since the Company’s conversion to public ownership.
Note 23 – Parent Only Financial Information
| Condensed Statements of Financial Condition | | | | | | |
| | | | | | | |
| | | 2011 | | | 2010 | |
| (Dollars in thousands) | | | | | | |
| | | | | | | |
| Assets | | | | | | |
| | | | | | | |
| Cash and cash equivalents | | $ | 2,131 | | | $ | 1,901 | |
| Investment securities, available for sale | | | 263 | | | | 1,369 | |
| Investment in subsidiary | | | 104,771 | | | | 104,759 | |
| Other assets | | | 1,423 | | | | 1,689 | |
| Total assets | | $ | 108,588 | | | $ | 109,718 | |
| | | | | | | | | |
| Liabilities and Shareholders' Equity | | | | | | | | |
| | | | | | | | | |
| Liabilities | | $ | 15,929 | | | $ | 16,275 | |
| Shareholders' equity | | | 92,659 | | | | 93,443 | |
| Total liabilities and shareholders' equity | | $ | 108,588 | | | $ | 109,718 | |
| Condensed Statements of Operations | | | | | | | | | |
| | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Interest income | | $ | 28 | | | $ | 148 | | | $ | 233 | |
| Interest expense | | | (328 | ) | | | (914 | ) | | | (952 | ) |
| Other noninterest income | | | - | | | | 35 | | | | 54 | |
| Other noninterest expense | | | (959 | ) | | | (1,625 | ) | | | (1,366 | ) |
| Loss before income taxes and earnings from subsidiaries | | | (1,259 | ) | | | (2,356 | ) | | | (2,031 | ) |
| Income tax benefit | | | 488 | | | | 926 | | | | 794 | |
| Loss before earnings from subsidiaries | | | (771 | ) | | | (1,430 | ) | | | (1,237 | ) |
| Equity in undistributed earnings (loss) of subsidiaries | | | 1,012 | | | | 10,069 | | | | (28,770 | ) |
| Net income (loss) | | | 241 | | | | 8,639 | | | | (30,007 | ) |
| Dividends and accretion of discount on preferred stock | | | (1,526 | ) | | | (1,025 | ) | | | (1,034 | ) |
| Net income (loss) available to common shareholders | | $ | (1,285 | ) | | $ | 7,614 | | | $ | (31,041 | ) |
| Condensed Statements of Cash Flows | | | | | | | | | |
| | | | | | | | | | |
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | | | | | | | | |
| | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | |
| Net income (loss) | | $ | 241 | | | $ | 8,639 | | | $ | (30,007 | ) |
| Adjustments to reconcile net income to net cash used in operating activities: | | | | | |
| Gain on sale of investments | | | - | | | | (35 | ) | | | (54 | ) |
| Impairment of investment securities | | | - | | | | 435 | | | | 52 | |
| Equity in undistributed earnings (losses) of subsidiaries | | | (1,012 | ) | | | (10,069 | ) | | | 28,770 | |
| Allocation of shares to ESOP | | | 35 | | | | 50 | | | | 63 | |
| Stock option expense | | | 101 | | | | 99 | | | | 106 | |
| Vesting of shares issued for the RRP | | | 153 | | | | 316 | | | | 331 | |
| Increase (decrease) in other operating liabilities | | | (69 | ) | | | (1,154 | ) | | | 129 | |
| Net cash used in operating activities | | | (551 | ) | | | (1,719 | ) | | | (610 | ) |
| | | | | | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | | | | | |
| Proceeds from the sale of investments | | | 1,101 | | | | 517 | | | | 983 | |
| Maturities and prepayments of investments | | | - | | | | - | | | | 111 | |
| Purchase of investment securities | | | - | | | | - | | | | (1,500 | ) |
| Net cash provided by investing activities | | | 1,101 | | | | 517 | | | | (406 | ) |
| | | | | | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | | | | | |
| Issuance of common stock | | | - | | | | 14,040 | | | | - | |
| Contributed capital to bank subsidiary | | | - | | | | (11,088 | ) | | | - | |
| Dividends received from bank subsidiary | | | 1,304 | | | | - | | | | - | |
| Repurchase of warrants on preferred stock | | | 359 | | | | - | | | | - | |
| Dividends and accretion of discount on preferred stock | | | (1,526 | ) | | | (1,025 | ) | | | (1,034 | ) |
| Dividends to common stockholders | | | (457 | ) | | | (1,279 | ) | | | (1,535 | ) |
| Net cash provided by (used in) financing activities | | | (320 | ) | | | 648 | | | | (2,569 | ) |
| | | | | | | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | 230 | | | | (554 | ) | | | (3,585 | ) |
| Cash and cash equivalents, beginning of year | | | 1,901 | | | | 2,455 | | | | 6,040 | |
| Cash and cash equivalents, end of year | | $ | 2,131 | | | $ | 1,901 | | | $ | 2,455 | |
| CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of the Company’s management, including the Company’s Principal Executive Officer and Principal Financial Officer, the Company has evaluated the effectiveness of the design and operation of its 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 report.
Based upon that evaluation, and for the reasons discussed below under Item (b), “Management’s Annual Report on Internal Control over Financial Reporting,” the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective.
(b) Management’s Annual Report on Internal Control over Financial Reporting
Management of Citizens South Banking Corporation is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
The Company’s internal control over financial reporting includes those policies and procedures that:
| · | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; |
| · | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that material receipts and expenditures of the Company are being made only in accordance with the authorizations of management and directors of the Company; and |
| · | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements of the Company. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. As a result of this assessment, a deficiency that existed in our internal control over financial reporting that we considered to represent a “material weakness” was identified. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The material weakness in our internal control over financial reporting related to a lack of controls to ensure that all impaired loans were properly identified as such and individually evaluated for impairment as part of management’s estimate of the allowance for loan losses.
Based upon management’s assessment, with input from our independent registered public accounting firm, and as a result of the material weakness discussed above, management concluded that the Company’s internal control over financial reporting as of December 31, 2011 was not effective using these criteria.
The Company has taken numerous steps subsequent to December 31, 2011, to address the material weakness described above, including, but not limited to, the following:
| · | The Company has appointed a new Chief Risk Officer. |
| · | All charge-offs or write downs in excess of $5,000 must now be approved by the Principal Executive Officer. |
| · | Loan reviews have been completed on all loan relationships of $750,000 or greater, as compared to the prior loan review exposure level of $1,500,000 or greater. |
| · | We are completing a quarterly Classified Loan Asset Report on all troubled relationships of $250,000 or greater, as compared to the prior level of $500,000 or greater. |
| · | Various additional reports are being prepared and reviewed by the Chief Financial Officer and the Chief Risk Officer to ensure the proper classification of loans as “impaired.” |
| · | The Bank’s Troubled Asset Officers are managing a larger amount of loans, which, in the past, were handled by lower-level Bank officers. |
| · | Additional Bank employees will be involved in periodic discussions regarding past-due loans and additional discussions are being held relating to various items, including the risk grading, classification and impairment of loans. |
| · | One employee has been appointed Real Estate Appraisal Assistant to better organize the appraisal process to ensure timely ordering, receipt and review of appraisals. |
| · | Additional internal system reminders and reviews have been established with respect to the monitoring of certain servicing issues. |
(c) Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting identified in connection with the quarterly evaluation that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
None.
| DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
Information required by Item 10. is included in the “Proposal I – Election of Directors” section of the Registrant’s Definitive Proxy Statement (the “Proxy Statement”) to be filed pursuant to Section 14 of the Securities Exchange Act of 1934 in connection with the 2011 Annual Meeting of Stockholders which is incorporated herein by reference. In addition, the Item 1. “Executive Officers of the Registrant” section of the Proxy Statement is incorporated herein by reference.
The information required by Item 11. is included in the “Proposal I – Election of Directors” section of the Registrant’s Proxy Statement which is incorporated herein by reference.
| SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required by Item 12. is included in the “Proposal I – Election of Directors” section of the Registrant’s Proxy Statement which is incorporated herein by reference.
| CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPNDENCE |
The information required by Item 13. is included in the “Proposal I – Election of Directors” section of the Registrant’s Proxy Statement which is incorporated herein by reference.
| PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The information required by Item 14. is included in the “Proposal II – Ratification of Appointment of the Independent Registered Public Accounting Firm” section of the Registrant’s Proxy Statement which is incorporated herein by reference.
| EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
| (a)(1) | Financial Statements The following documents are filed as Item 8. of this Annual Report on Form 10-K. |
| (A) | Report of Independent Registered Public Accounting Firm |
| (B) | Consolidated Statements of Financial Condition - at December 31, 2011 and 2010 |
| (C) | Consolidated Statements of Income - Years Ended December 31, 2011, 2010 and 2009 |
| (D) | Consolidated Statements of Comprehensive Income - Years Ended December 31, 2011, 2010 and 2009 |
| (E) | Consolidated Statements of Changes in Shareholders’ Equity - Years Ended December 31, 2011, 2010 and 2009 |
| (F) | Consolidated Statements of Cash Flows - Years ended December 31, 2011, 2010 and 2009 |
| (G) | Notes to Consolidated Financial Statements. |
| (a)(2) | Financial Statement Schedules None. |
| (b) | Exhibits – set forth below. |
Exhibits
| 3.1 | Certificate of Incorporation of Citizens South Banking Corporation (incorporated herein by reference to the Registration Statement on Form S-1 (File No. 333-91498), originally filed with the Commission on June 28, 2002) |
| 3.2 | Amended Bylaws of Citizens South Banking Corporation (incorporated herein by reference to the Current Report on Form 8-K filed with the Commission on October 20, 2008) |
| 4.1 | Form of Common Stock Certificate of Citizens South Banking Corporation (incorporated herein by reference to the Registration Statement on Form S-1 (File No. 333-91498), originally filed with the Commission on June 28, 2002) |
| 4.2 | Indenture between Citizens South Banking Corporation and Wilmington Trust Company, as trustee, dated October 28, 2005. (Incorporated by reference to the Current Report on Form 8-K (File No. 0-23971), filed with the Commission on November 3, 2005) |
| 4.3 | Certificate of Designations of Fixed-Rate Cumulative Perpetual Preferred Stock (incorporated herein by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on December 16, 2011) |
| 10.1 | Amended and Restated Employment Agreement with Kim S. Price dated November 17, 2008 (incorporated herein by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.2 | Deferred Compensation and Income Continuation Agreement (incorporated by reference to the Registration Statement on Form SB-2 (File No. 333-42951), originally filed with the Commission on December 22, 1997) |
| 10.3 | Employee Stock Option Plan (incorporated by reference to the Registration Statement on Form SB-2 (File No. 333-42951), originally filed with the Commission on December 22, 1997) |
| 10.4 | Supplemental Executive Retirement Plan (incorporated by reference to the Registration Statement on Form SB-2 (File No. 333-42951) filed with the Commission on December 22, 1997) |
| 10.5 | Amended and Restated Severance Agreement with Gary F. Hoskins dated November 17, 2008 (incorporated by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.6 | Amended and Restated Severance Agreement with Paul L. Teem, Jr. dated November 17, 2008 (incorporated by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.7 | Amended and Restated Severance Agreement with Daniel M. Boyd, IV dated November 17, 2008 (incorporated by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.8 | Salary Continuation Agreement with Kim S. Price dated January 1, 2004, as amended (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971), filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.9 | Salary Continuation Agreement with Gary F. Hoskins dated January 1, 2004, as amended (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971), filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.10 | Salary Continuation Agreement with Paul L. Teem, Jr. dated January 1, 2004, as amended (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.11 | Salary Continuation Agreement with Daniel M. Boyd, IV dated January 1, 2004, as amended (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.12 | Endorsement Split Dollar Agreement with Kim S. Price dated January 1, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005) |
| 10.13 | Endorsement Split Dollar Agreement with Gary F. Hoskins dated January 1, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005) |
| 10.14 | Endorsement Split Dollar Agreement with Paul L. Teem, Jr. dated January 1, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005) |
| 10.15 | Endorsement Split Dollar Agreement with Daniel M. Boyd, IV dated January 1, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005) |
| 10.16 | Amended Deferred Compensation and Income Continuation Agreement with David W. Hoyle, Sr. dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.17 | Amended Deferred Compensation and Income Continuation Agreement with Ben R. Rudisill, II dated March 15, 2005 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.18 | Amended Deferred Compensation and Income Continuation Agreement with James J. Fuller dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.19 | Amended Deferred Compensation and Income Continuation Agreement with Charles D. Massey dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.20 | Amended Director Retirement Agreement with David W. Hoyle, Sr. dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.21 | Amended Director Retirement Agreement with Ben R. Rudisill, II dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971, filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.22 | Amended Director Retirement Agreement with James J. Fuller dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.23 | Amended Director Retirement Agreement with Charles D. Massey dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971), filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.24 | Amended Director Retirement Agreement with Eugene R. Matthews, II dated March 15, 2004 (incorporated by reference to the Annual Report on Form 10-K (File No. 0-23971) filed with the Commission on March 16, 2005 and the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 20, 2008) |
| 10.31 | Amended and Restated Declaration of Trust among Citizens South Banking Corporation, Wilmington Trust Company, as Delaware and Institutional Trustee, and the Administrative Trustees named therein, dated October 28, 2005 (incorporated by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on November 3, 2005) |
| 10.32 | Citizens South Banking Corporation 2008 Equity Incentive Plan (incorporated herein by reference to the Appendix A of the Definitive Proxy Statement for the 2008 Annual Meeting of Stockholders, filed with the Commission on April 10, 2008) |
| 10.33 | Letter Agreement, dated December 12, 2008, between Citizens South Banking Corporation and the United States Department of the Treasury, which includes the Securities Purchase Agreement-Standard Terms attached thereto, with respect to the issuance and sale of the Series A Preferred Stock and the Warrant (incorporated herein by reference to the Current Report on Form 8-K (File No. 0-23971) filed with the Commission on December 16, 2008) |
| 14 | Code of Ethics Policy (incorporated herein by reference to the policy maintained on Company’s website which is located at www.citizenssouth.com) |
| 21 | Subsidiaries of Registrant (incorporated herein by reference to the Registration Statement on Form S-1 (File No. 333-91498), originally filed with the Commission on June 28, 2002) |
| 23 | Consent of Cherry, Bekaert & Holland, L.L.P. |
| 24 | Power of Attorney (set forth on signature page) |
| 31 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32 | Statement of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 99.1 | Certification of Principal Executive Officer Pursuant to Section III(b)(4) of the Emergency Stabilization Act of 2008. |
| 99.2 | Certification of Principal Financial Officer Pursuant to Section III(b)(4) of the Emergency Stabilization Act of 2008. |
| 101 | Financial statements and related notes formatted in XBRL. |
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Citizens South Banking Corporation
| Date: | March 30, 2012 | | By: | /s/ Kim S. Price |
| | | | | Kim S. Price |
| | | | | President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| By: | /s/ Kim S. Price | | By: | /s/ Gary F. Hoskins |
| | Kim S. Price | | | Gary F. Hoskins |
| | President, Chief Executive Officer and | | | Executive Vice President, Treasurer and |
| | Director (Principal Executive Officer) | | | Chief Financial Officer |
| | | | | (Principal Financial and Accounting Officer) |
| | | | | |
| Date: | March 30, 2012 | | Date: | March 30, 2012 |
| | | | | |
| | | | | |
| | | | | |
| By: | /s/ David W. Hoyle | | By: | /s/ Ben R. Rudisill, II |
| | David W. Hoyle | | | Ben R. Rudisill, II |
| | Chairman | | | Vice Chairman |
| | | | | |
| | | | | |
| Date: | March 30, 2012 | | Date: | March 30, 2012 |
| | | | | |
| | | | | |
| | | | | |
| By: | /s/ Eugene R. Matthews, II | | By: | /s/ Richard K. Craig |
| | Eugene R. Matthews, II | | | Richard K. Craig |
| | Director | | | Director |
| | | | | |
| | | | | |
| Date: | March 30, 2012 | | Date: | March 30, 2012 |
| | | | | |
| | | | | |
| | | | | |
| By: | /s/ James J. Fuller | | | |
| | James J. Fuller | | | |
| | Director | | | |
| | | | | |
| Date: | March 30, 2012 | | | |
104
