loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;
changes in access to funding or increased regulatory requirements with regard to funding;
other risks and uncertainties detailed in this report and, from time to time, in our other filings with the SEC.
All forward-looking statements in this report are based on information available to us as of the date of this report. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2013, as filed in our 2013 Form 10-K.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.
Real estate and other property acquired in settlement of loans is recorded at the lower of cost or fair value less estimated selling costs, establishing a new cost basis when acquired. Fair value of such property is reviewed regularly and write-downs are recorded when it is determined that the carrying value of the property exceeds the fair value less estimated costs to sell. Recoveries of value are recorded only to the extent of previous write-downs on the property in accordance with FASB ASC Topic 360 “Property, Plant, and Equipment”. Write-downs or recoveries of value resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are charged against income. Costs relating to the development and improvement of such properties are capitalized.
We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our consolidated financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and
interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.
Research and Development
All costs incurred to establish the technological feasibility of computer software to be sold, leased or otherwise marketed as research and development are expensed as incurred. Once technological feasibility has been established, the subsequent costs of producing, coding and testing the products should be capitalized. The expensing of computer software costs is discontinued when the product is available for general release to customers. Currently, the Company has not achieved technological feasibility and is expensing all computer software purchases related to research and development. Once technological feasibility is reached, the Company will capitalize costs as incurred.
Overview
The following discussion describes our results of operations for the three and nine month periods ended September 30, 2014 and 2013 and also analyzes our financial condition as of September 30, 2014.
The Consolidated Company
At September 30, 2014, we had total assets of $102.3 million, a decrease of $2.0 million, or 1.9%, from total assets of $104.3 million at December 31, 2013. The largest components of our total assets are net loans, investment securities available for sale, other real estate owned, federal funds sold and cash and due from banks, which were $65.8 million, $19.8 million, $2.7 million, $4.1 million and $6.2 million, respectively, at September 30, 2014. Comparatively, our net loans, investment securities available for sale, other real estate owned, federal funds sold and cash and due from banks totaled $62.4 million, $20.1 million, $2.5 million, $7.9 million and $6.5 million, respectively, at December 31, 2013.
Our liabilities and shareholders’ equity at September 30, 2014, totaled $91.3 million and $11.0 million, respectively, compared to liabilities of $90.0 million and shareholders’ equity of $14.3 million at December 31, 2013. The principal component of our liabilities is deposits, which were $84.1 million and $89.2 million at September 30, 2014 and December 31, 2013, respectively.
Our net loss was $997,966 for the three months ended September 30, 2014, or $0.05 per share, as slight decrease of $20,134, or 1.9%, compared to a net loss of $1.0 million, or $0.05 per share, for the three months ended September 30, 2013. This decrease in net loss was primarily driven by increases in net interest income and non-interest income, including service fees on deposit accounts and residential loan origination fees, and decreases in real estate owned activity, insurance, data processing, and other expenses and professional fees, as well as a decrease in provisions for loan losses partially offset by increases in compensation and benefits, occupancy, and product research and development expenses.
Our net loss was $4.5 million for the nine months ended September 30, 2014, or $0.22 per share, an increase of $849,708, or 23.2%, compared to net loss of $3.7 million, or $0.18 per share, for the nine months ended September 30, 2013. This increase in net loss was primarily driven by an increase in product research and development expense, and compensation and benefits expense, partially offset by decreases in real estate owned activity and professional fees, as well as a decrease in the reversal of provisions for loan losses.
The Bank
Like most community banks, we derive the majority of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
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At September 30, 2014, we had total assets at the Bank of $99.9 million compared to $99.3 million at December 31, 2013. The largest components of total assets at the Bank are net loans, investment securities available for sale, other real estate owned, federal funds sold and cash and due from banks, which were $65.8 million, $19.8 million, $1.4 million, $4.1 million and $5.7 million, respectively, at September 30, 2014. Comparatively, our net loans, investment securities available for sale, other real estate owned, federal funds sold and cash and due from banks totaled $61.6 million, $20.1 million, $1.4 million, $7.9 million and $5.0 million, respectively, at December 31, 2013. At September 30, 2014, we had total liabilities at the Bank of approximately $89.7 million compared to approximately $89.5 million at December 31, 2013. The largest components of total liabilities at the Bank are deposits and FHLB advances, which were $84.5 million and $5.0 million, respectively.
The Company
The Company’s cash balances, independent of the Bank, were approximately $782,000 and its real estate held for sale was approximately $1.4 million at September 30, 2014 compared to cash balances of approximately $2.3 million and real estate held for sale of $1.1 million at December 31, 2013. In addition, at December 31, 2013, the Company had loans held for investment of approximately $811,000 and loans held for sale of $900,000. The loan held for investment was transferred to other real estate and the held for sale loans were sold prior to June 30, 2014. The decrease in liquid assets of approximately $3.5 million is due primarily to expenses incurred related to the transaction services segment. In addition, the Company has payables due to unsecured vendors of $1.3 million and a note payable to a related party of $600,000 which was advanced in September 2014. See “Note 8 – Business Segments” and “Note 9 – Note Payable”, for additional information related to the transaction services segment and the related advance.
Under Regulation W, the Bank may not be a source of cash or capital for the Company. Due to the uncertainty of timing and amount of cash that might be received from the conversion of the held for sale assets, the current commitments outstanding, the current run rate on fixed expenses, the current payables, and the prohibition within Regulation W, we believe that the Company does not have sufficient working capital to continue to fund its current level of activities without raising additional funding. Our ability to raise additional capital will depend on a number of factors, including conditions in the capital markets, which are outside of our control. There is a risk we will not be able to raise the capital we need at all or upon favorable terms. If we cannot raise this additional capital, we will not be able to implement our growth objective for our business, and we may be subject to increased regulatory supervision and restriction. These restrictions would most likely have a material adverse effect on our ability to grow and expand which would negatively impact our financial condition and results of operations.
Recent Regulatory Developments
On June 5, 2014, the Board of Directors of the Bank received an Order Terminating the Consent Order indicating that the Bank’s Consent Order with the OCC, which, among other things, required the Bank to maintain minimum capital levels in excess of the minimum regulatory capital ratios for “well-capitalized” banks, had been terminated effective June 4, 2014. The Bank was considered “well-capitalized” as of September 30, 2014.
Transaction Services
As part of our development plan to build a digital payment technology platform and explore transaction services business opportunities, the Company filed three patent applications with the U.S. Patent and Trademark Office covering concepts associated with mobile wallet messages among different software platforms; entered into multiple contracts with third party technology developers and vendors to support its business operations; and has received approval from the Federal Reserve for an additional ABA number to support its operations, including its transaction services. We may also enter into agreements with vendors, payment networks and payment gateways as well as marketing and distribution partners and work with other banks and financial institutions in offering transaction and payment services or other forms of digital banking services, in each case subject to the discretion of the board of directors and management and the receipt of any necessary regulatory approvals or non-objections.
We have made and plan to continue to make substantial investments in research and development, and we expect to focus our future research and development efforts on enhancing existing products and services and on developing new products and services. We expect to continue to develop technologies and operating functionalities to improve the efficiencies of and reduce the cost of transaction services, mobile and digital payments, data management and compliance services. These services may include expanding or introducing prepaid debit programs, decoupled debit and real time
30
processing capabilities as well as expanding our traditional debit card issuance programs to generate additional interchange income. We may also seek to develop types of accounts and channels that reduce fraud, credit and settlement risks including near real time settlement accounts as well as those that reduce the types and amount of potential charge-backs. Product offerings may include cloud-based platform services, customized mobile wallets and payment Apps, financial planning and savings Apps, device finance and credit products and interconnectivity and integration web services. They could also include integration, development and engineering services, as well as providing operational, compliance and technology support. These products and services would be designed as separate product offerings, as well as integration services with existing core processing and data management systems, so that the companies may not be required to make wholesale conversions from their existing core processing systems.
We also anticipate expanding marketing and sales capabilities, treasury, funding, risk management and customer support programs which may involve expansion of activities and offices in Greenville, New York City, and other geographic locations as well as forming associations with other banks and financial institutions to establish policies and procedures and infrastructure services for more efficient payment networks and operations. We expect to continue to focus significant research and development efforts on ongoing projects to update the technology platforms for several of our offerings.
Under Regulation W, the Bank may not be a source of cash or capital for the Company. Due to the uncertainty of timing and amount of cash that might be received from the conversion of the held for sale assets, the current commitments outstanding, the current run rate on fixed expenses, the current payables, and the prohibition within Regulation W, we believe that the Company does not have sufficient working capital to continue to fund its current level of activities without raising additional funding. Our ability to raise additional capital will depend on a number of factors, including conditions in the capital markets, which are outside of our control. There is a risk we will not be able to raise the capital we need at all or upon favorable terms. If we cannot raise this additional capital, we will not be able to implement our growth objective for our business, and we may be subject to increased regulatory supervision and restriction. These restrictions would most likely have a material adverse effect on our ability to grow and expand which would negatively impact our financial condition and results of operations.
Our digital strategy remains subject to our having adequate capital to invest in its development and the support of our banking regulators. See our Risk Factors in our 2013 Form 10-K and in our Current Report on Form 8-K filed with the SEC on July 18, 2014.
Results of Operations
Three months ended September 30, 2014 and 2013
We recorded a net loss of $997,966, or $0.05 per diluted share, for the quarter ended September 30, 2014, compared to a net loss of $1.0 million, or $0.05 per diluted share, for the quarter ended September 30, 2013. The slight change in net loss between comparable periods was primarily driven by increases net interest income and non-interest income, including service fees on deposit accounts and residential loan origination fees, and decreases in real estate owned activity, insurance, data processing and other expenses and professional fees, as well as a decrease in provisions for loan losses, partially offset by increases in compensation and benefits, occupancy, and product research and development expenses. Each of these components is discussed in greater detail below.
During the quarter ended June 30, 2013,the Company purchased several pieces of real estate owned totaling $3.3 million and three loans totaling $2.2 million, from the Bank (under terms that meet the Market Terms Requirement as described in Regulation W covering transactions between affiliates) in order to support a reduction in the Bank’s adversely classified assets ratio. Through June 30, 2014, the Company sold eight pieces of the real estate owned purchased from the Bank for proceeds of approximately $2.1 million, which resulted in an aggregate loss of $1,509,442 to the Company. During the quarter ended September 30, 2014, the Company sold two additional pieces of real estate owned purchased from the Bank for proceeds of $39,707, which resulted in a gain of $12,617 (and an aggregate loss to the Company through September 30, 2014 of $1,496,825). The remaining pieces of real estate owned and loan purchased from the Bank are being actively marketed for sale.
The following table sets forth information related to our average balances, average yields on assets, and average costs of liabilities for the three months ended September 30, 2014 and 2013. We derived these yields by dividing annualized income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees are amortized into interest income on loans.
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| | | | | | | | | | | | | |
| | | For the Three Months Ended September 30, |
| | | 2014 | | 2013 |
| | | | | | | | | | | | | |
| | | | Average
Balance | | | | Income/
Expense | | | | Yield/
Rate | | | | Average
Balance | | | | Income/
Expense | | | | Yield/
Rate | |
| Federal funds sold and other | | $ | 3,356,987 | | | $ | 7,406 | | | | 0.88 | % | | $ | 14,337,507 | | | $ | 15,116 | | | | 0.42 | % |
| Investment securities | | | 19,966,011 | | | | 126,260 | | | | 2.54 | | | | 20,988,844 | | | | 115,586 | | | | 2.21 | |
| Loans (1) | | | 67,088,432 | | | | 880,640 | | | | 5.27 | | | | 63,771,145 | | | | 877,959 | | | | 5.52 | |
| Total interest-earning assets | | $ | 90,411,430 | | | $ | 1,014,306 | | | | 4.50 | % | | $ | 99,097,536 | | | $ | 1,008,661 | | | | 4.08 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | $ | 7,536,256 | | | $ | 2,202 | | | | 0.12 | % | | $ | 7,302,108 | | | $ | 4,417 | | | | 0.24 | % |
| Savings & money market | | | 38,001,476 | | | | 22,138 | | | | 0.23 | | | | 41,430,317 | | | | 24,468 | | | | 0.24 | |
Time deposits (excluding brokered
time deposits) | | | 28,654,954 | | | | 47,801 | | | | 0.67 | | | | 35,884,146 | | | | 67,009 | | | | 0.75 | |
| Brokered time deposits | | | — | | | | — | | | | — | | | | 1,594,095 | | | | 6,226 | | | | 1.57 | |
| Total interest-bearing deposits | | | 74,192,686 | | | | 72,141 | | | | 0.39 | | | | 86,210,666 | | | | 102,120 | | | | 0.48 | |
| Borrowings and note payable | | | 4,394,042 | | | | 5,922 | | | | 0.54 | | | | 115,025 | | | | 41 | | | | 0.14 | |
| Total interest-bearing liabilities | | $ | 78,586,728 | | | $ | 78,063 | | | | 0.40 | % | | $ | 86,325,691 | | | $ | 102,161 | | | | 0.47 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest spread | | | | | | | | | | | 4.10 | % | | | | | | | | | | | 3.61 | % |
| Net interest income/ margin | | | | | | $ | 936,243 | | | | 4.15 | % | | | | | | $ | 906,500 | | | | 3.67 | % |
(1)
Nonaccrual loans are included in average balances for yield computations.
For the three months ended September 30, 2014, we recognized $1,014,306 in interest income and $78,063 in interest expense, resulting in net interest income of $936,243, an increase of $29,743, or 3.3%, over the same period in 2013. Average earning assets decreased to $90.4 million for the three months ended September 30, 2014 from $99.1 million for the three months ended September 30, 2013, a decrease of $8.7 million, or 8.8%. This decrease in earning assets was primarily due to a $11.0 million decrease in average federal funds sold and a $1.0 million decrease in average investment securities, partially offset by a $3.3 million increase in average loans between periods. Average interest bearing liabilities decreased to $78.6 million for the three months ended September 30, 2014 from $86.3 million for the three months ended September 30, 2013, a decrease of $7.7 million, or 9.0%. Net interest margin, calculated as annualized net interest income divided by average earning assets, increased from 3.67% for the quarter ended September 30, 2013 to 4.15% for the quarter ended September 30, 2014, primarily due to an increase in yield on earning assets from 4.08% to 4.50% between periods and a decrease in cost of funds from 0.47% to 0.40% between periods due to the mix of liabilities and the timing of their repricing.
We recorded no provision for loan losses for the quarter ended September 30, 2014 compared to the provision for loan losses of $5,795 for the quarter ended September 30, 2013. The allowance as a percentage of gross loans decreased to 1.74% as of September 30, 2014 compared to 2.04% at December 31, 2013. Specific reserves were approximately $258,000 on impaired loans of $2.5 million as of September 30, 2014 compared to specific reserves of approximately $192,000 on impaired loans of $1.5 million as of December 31, 2013. As of September 30, 2014, the general reserve allocation was 1.36% of gross loans not impaired compared to 1.78% as of December 31, 2013. The provision for loan losses is discussed further below under “Provision and Allowance for Loan Losses.”
For the three months ended September 30, 2014, noninterest income was $86,003 compared to $44,238 for the three months ended September 30, 2013, an increase of $41,765, or 94.4%. Noninterest income for the three months ended September 30, 2014 and 2013 was derived from service charges on deposits, customer service fees, and mortgage origination income. The primary contributor for this quarter’s increase was an increase in mortgage origination income of $23,190.
During the quarter ended September 30, 2014, we incurred noninterest expenses of $2.0 million, compared to noninterest expenses of $2.0 million for the quarter ended September 30, 2013, an increase of $57,169, or 2.9%. This increase in noninterest expenses for the three month period ended September 30, 2014 primarily resulted from increases in product research and development expenses of $247,990 and compensation and benefits expenses of $24,713, partially offset by a decrease of $159,061 in real estate owned activity which includes expenses to carry other real estate, gains and losses on sales of other real estate, and write-downs on real estate owned, a decrease in data processing fees of $15,646, a
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decrease in insurance expenses of $14,939, and a decrease in other noninterest expenses of $29,363. Compensation and benefits expenses increased due to changes in staffing levels year over year for the quarter ended September 30, 2014.
We did not recognize any income tax benefit or expense for the three months ended September 30, 2014 and 2013. Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighing all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. During our September 30, 2010 quarterly analysis of the valuation allowance recorded against our deferred tax assets, we determined that it was not more likely than not that our deferred tax assets will be recognized in future years due to the continued decline in credit quality and the resulting impact on net interest margin, increased net losses, and negative impact on capital as a result of provision for loan losses and write-downs on other real estate owned, and booked a 100% valuation allowance against the deferred tax asset. We will continue to analyze our deferred tax assets and related valuation allowance each quarter taking into account performance compared to forecast and current economic or internal information that would impact forecasted earnings. No benefit was recognized on net loss for the quarter ended September 30, 2014 due to the Company’s large cumulative net operating loss carry-forward position as well as the 100% valuation allowance on our deferred tax assets.
Nine months ended September 30, 2014 and 2013
We recorded a net loss of $4.5 million or $0.22 per diluted share, for the nine months ended September 30, 2014, an increase of $849,708 compared to a net loss of $3.7 million, or $0.18 per diluted share, for the nine months ended September 30, 2013. This increase in net loss between comparable periods was primarily driven by increases in several noninterest expense areas, including product research and development expense and compensation and benefits expense, which were partially offset by decreases in real estate owned activity expenses and professional fees, and a decrease in the reversal of provision for loan losses. Each of these components is discussed in greater detail below.
The following table sets forth information related to our average balances, average yields on assets, and average costs of liabilities for the nine months ended September 30, 2014 and 2013. We derived these yields by dividing annualized income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees are amortized into interest income on loans.
| | | | | | | | | | | | | |
| | | 2014 | | 2013 |
| | | | | | | | | | | | | |
| | | | Average
Balance | | | | Income/
Expense | | | | Yield/
Rate | | | | Average
Balance | | | | Income/
Expense | | | | Yield/
Rate | |
| Federal funds sold and other | | $ | 4,678,396 | | | $ | 23,784 | | | | 0.68 | % | | $ | 12,526,743 | | | $ | 41,063 | | | | 0.44 | % |
| Investment securities | | | 20,070,705 | | | | 393,178 | | | | 2.64 | | | | 23,013,336 | | | | 352,768 | | | | 2.05 | |
| Loans (1) | | | 66,137,954 | | | | 2,548,961 | | | | 5.19 | | | | 66,248,028 | | | | 2,633,290 | | | | 5.31 | |
| Total interest-earning assets | | $ | 90,887,055 | | | $ | 2,965,923 | | | | 4.39 | % | | $ | 101,788,107 | | | $ | 3,027,121 | | | | 3.97 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | $ | 7,110,899 | | | $ | 7,596 | | | | 0.14 | % | | $ | 7,054,864 | | | $ | 13,820 | | | | 0.26 | % |
| Savings & money market | | | 39,376,986 | | | | 70,362 | | | | 0.24 | | | | 43,015,255 | | | | 107,379 | | | | 0.33 | |
Time deposits (excluding brokered
time deposits) | | | 27,988,773 | | | | 134,239 | | | | 0.65 | | | | 36,706,168 | | | | 220,237 | | | | 0.80 | |
| Brokered time deposits | | | 519,675 | | | | 6,034 | | | | 1.56 | | | | 1,594,076 | | | | 18,474 | | | | 1.55 | |
| Total interest-bearing deposits | | | 74,996,333 | | | | 218,231 | | | | 0.39 | | | | 88,374,363 | | | | 359,910 | | | | 0.54 | |
| Borrowings and note payable | | | 1,552,275 | | | | 5,996 | | | | 0.52 | | | | 3,639,374 | | | | 43,907 | | | | 1.61 | |
| Total interest-bearing liabilities | | $ | 76,548,608 | | | $ | 224,227 | | | | 0.39 | % | | $ | 92,013,737 | | | $ | 403,817 | | | | 0.59 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest spread | | | | | | | | | | | 4.00 | % | | | | | | | | | | | 3.39 | % |
| Net interest income/ margin | | | | | | $ | 2,741,696 | | | | 4.06 | % | | | | | | $ | 2,623,304 | | | | 3.44 | % |
(1)
Nonaccrual loans are included in average balances for yield computations.
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For the nine months ended September 30, 2014, we recognized $3.0 million in interest income and $224,227 in interest expense, resulting in net interest income of $2.7 million, an increase of $118,392, or 4.5%, over the same period in 2013. Average earning assets decreased to $90.9 million for the nine months ended September 30, 2014 from $101.8 million for the nine months ended September 30, 2013 a decrease of $10.9 million, or 10.7%. This decrease in earning assets was due to a $7.8 million decrease in average federal funds sold, a $2.9 million decrease in average investment securities and a $110,074 decrease in average loans between periods. Average interest bearing liabilities decreased to $76.5 million for the nine months ended September 30, 2014 from $92.0 million for the nine months ended September 30, 2013 a decrease of $15.5 million, or 16.9%. Net interest margin, calculated as annualized net interest income divided by average earning assets, increased from 3.44% for the nine months ended September 30, 2013 to 4.06% for the nine months ended September 30, 2014, primarily due to an increase in yield on earning assets from 3.97% to 4.39% and a decrease in cost of funds from 0.59% to 0.39% for the same periods, respectively.
A reversal of provision for loan losses of $30,000 was recognized for the nine months ended September 30, 2014 representing a decrease of $247,576, or 89.2%, compared to the reversal of provision of $277,576 for the nine months ended September 30, 2013. The decrease in the reversal of provision for loan losses for the current nine months is due to a decrease in specific reserves as well as the general reserve level. Over the last year, we have seen a decrease in the amount of charge-offs and specific reserves needed due to the apparent stabilization of nonperforming loans. The provision for loan losses is discussed further below under “Provision and Allowance for Loan Losses.”
For the nine months ended September 30, 2014, noninterest income was $338,407 compared to $145,810 for the nine months ended September 30, 2013, an increase of $192,597, or 132.1%, between comparable periods. Noninterest income for the nine months ended September 30, 2014 and 2013 was derived from service charges on deposits, customer service fees, rental income, mortgage origination income and gains on the sale of loans held for sale. The largest contributor for the increase was the gain resulting from the sale of loans held for sale in the amount of $118,452 during the nine months ended September 30, 2014.
During the nine months ended September 30, 2014, we incurred noninterest expenses of $7.6 million, compared to noninterest expenses of $6.7 million for the nine months ended September 30, 2013, an increase of $913,121, or 13.6%. This increase in noninterest expenses resulted primarily from an increase in product research and development expenses of $1.5 million, due to expenses incurred to prepare for the implementation of our new strategic plan. An increase in compensation and benefits of $292,064 also contributed to the increase in noninterest expenses. Compensation and benefits increased due to the filling of vacancies at the Bank and hiring new employees at the Company. Real estate owned activity, which includes expenses to carry other real estate, gains and losses on sales of other real estate, and write-downs on real estate owned, decreased $640,791.
We did not recognize any income tax benefit for the nine months ended September 30, 2014 or 2013.
Assets and Liabilities
General
Total assets as of September 30, 2014 and December 31, 2013 were $102.3 million and $104.3 million, respectively, a decrease of $2.0 million. Net loans increased $3.4 million, which was the result of approximately $4.5 million of net loan originations, partially offset by $1.1 million in loans transferred to other real estate owned. Other real estate owned increased $235,387 due to the repossession of three properties of approximately $1.1 million, which was offset by the sale of two properties for proceeds of approximately $505,000 and net write-downs of approximately $416,000 taken during the nine months ended September 30, 2014. Investment securities decreased $353,958 due to $1.1 million in paydowns, $185,983 in amortization and $915,250 in change in unrealized losses. Cash and due from banks decreased $389,673 and federal funds sold decreased $3.8 million. At September 30, 2014, our total assets consisted principally of $6.2 million in cash and due from banks, $19.8 million in investment securities, $65.8 million in net loans, $4.1 million in fed funds sold, $2.4 million in property and equipment and $2.7 million in other real estate owned and repossessed assets. Our management closely monitors and seeks to maintain appropriate levels of interest-earning assets and interest-bearing liabilities so that maturities of assets are such that adequate funds are provided to meet customer withdrawals and demand.
Liabilities at September 30, 2014 totaled $91.3 million, representing an increase of $1.3 million compared to December 31, 2013, and consisted principally of $84.1 million in deposits, $5.0 million in FHLB borrowings, a $600,000 note payable and $1.5 million in accounts payable and accrued expenses. Our accrued expenses consisted primarily of accrued legal and accounts payable, accounting and tax fees, and FDIC assessments. At September 30, 2014, shareholders’ equity was $11.0 million compared to $14.3 million at December 31, 2013. The decrease in shareholders’ equity was due to a net loss of $4.5
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million and stock option expense of $328,687 for the nine months ended September 30, 2014 partially offset by a reduction of $915,250 in unrealized losses on investment securities available for sale.
Loans
Since loans typically provide higher interest yields than other types of interest-earning assets, we invest a substantial percentage of our earning assets in our loan portfolio. At September 30, 2014, our gross loan portfolio consisted primarily of $33.0 million of commercial real estate loans, $14.5 million of commercial business loans, and $19.6 million of consumer and home equity loans. Our current loan portfolio composition is not materially different than the loan portfolio composition disclosed in the footnotes to the consolidated financial statements included in our 2013 Form 10-K. We experienced net originations of approximately $4.5 million during the nine months ended September 30, 2014, due to higher market demand, while continuing to carefully consider liquidity needs and conservative credit risk management.
The composition of net loans by major category is as follows:
| | | | | | | | | |
| | | September 30, 2014 | | % of Total | | December 31, 2013 | | % of Total |
| Real estate: | | | | | | | | | | | | | | | | |
| Commercial | | $ | 24,741,347 | | | | 36.9 | % | | $ | 21,795,047 | | | | 34.2 | % |
| Construction and development | | | 8,237,563 | | | | 12.3 | | | | 10,053,100 | | | | 15.8 | |
| Single and multifamily residential | | | 18,201,506 | | | | 27.2 | | | | 18,757,484 | | | | 29.5 | |
| Total real estate loans | | | 51,180,416 | | | | 76.4 | | | | 50,605,631 | | | | 79.5 | |
| Commercial business | | | 14,548,154 | | | | 21.7 | | | | 12,170,698 | | | | 19.1 | |
| Consumer | | | 1,354,233 | | | | 2.0 | | | | 999,941 | | | | 1.6 | |
| Deferred origination fees, net | | | (132,314 | ) | | | (0.1 | ) | | | (106,134 | ) | | | (0.2 | ) |
| Gross loans, net of deferred fees | | | 66,950,489 | | | | 100.0 | % | | | 63,670,136 | | | | 100.0 | % |
| Less allowance for loan losses | | | (1,167,703 | ) | | | | | | | (1,301,886 | ) | | | | |
| Loans, net | | $ | 65,782,786 | | | | | | | $ | 62,368,250 | | | | | |
The largest component of our loan portfolio at September 30, 2014 was $24.7 million of commercial real-estate loans, which represented 36.9% of the portfolio. The remainder of our loan portfolio consisted primarily of $18.2 million of single and multifamily residential loans, $8.2 million of construction and development loans, and $14.5 million of commercial business loans.
Loan Performance and Asset Quality
The downturn in general economic conditions over the past several years has resulted in increased loan delinquencies, defaults and foreclosures within our loan portfolio although the last 18 months have seen a stabilization in delinquencies, defaults and foreclosures and an increase in recoveries. The declining real estate market has had a significant impact on the performance of our loans secured by real estate. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure. Although the real estate collateral provides an alternate source of repayment in the event of default by the borrower, in our current market the value of the collateral has deteriorated during the time the credit is extended. There is a risk that this trend will continue, which could result in additional loss of earnings, increases in our provision for loan losses and loan charge-offs.
Past due payments are often one of the first indicators of a problem loan. We perform a continuous review of our past due report in order to identify trends that can be resolved quickly before a loan becomes significantly past due. We determine past due and delinquency status based on the contractual terms of the note. When a borrower fails to make a scheduled loan payment, we attempt to cure the default through several methods including, but not limited to, collection contact and assessment of late fees. Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest (unless the loan is well-collateralized and in the process of collection), or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal.
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Refer to Note 5, Loans, for a table summarizing delinquencies and nonaccruals, by portfolio class, as of September 30, 2014 and December 31, 2013. Total delinquent and nonaccrual loans decreased from $2.0 million at December 31, 2013 to $1.5 million at September 30, 2014, a decrease of $504,715, or 25.6%. This decrease was a result of movement in several categories. Nonaccrual loans decreased during the nine months due to our repossession of single and multifamily residential real estate and construction and development properties in satisfaction of loans as well as due to one loan being brought back to accrual status. At September 30, 2014, nonaccrual loans represented 0.9% of gross loans compared to 2.2% of gross loans as of December 31, 2013. Loans past due 30-89 days are considered potential problem loans and amounted to $658,284 and $566,972 at September 30, 2014 and December 31, 2013, respectively, due to four loans moving from current status to past due, partially offset by two loans moving to nonaccrual status.
Another method used to monitor the loan portfolio is credit grading. As part of the loan review process, loans are given individual credit grades, representing the risk we believe is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. Refer to Note 5, Loans, for a table summarizing management’s internal credit risk grades, by portfolio class, as of September 30, 2014 and December 31, 2013.
Loans graded one through four are considered “pass” credits. Approximately 92% of the loan portfolio had a credit grade of “pass” at September 30, 2014 and December 31, 2013. For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade.
Loans with a credit grade of five are not considered classified; however they are categorized as a special mention or watch list credit, and are considered potential problem loans. This classification is utilized by us when we have an initial concern about the financial health of a borrower. These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information. There are times when we may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard.As of September 30, 2014, we had loans totaling $1.7 million on the watch list compared to $1.5 million as of December 31, 2013, an increase of approximately $237,633 or 15.9%. This increase in watch list loans was due to one loan being deemed classified partially offset by two loans being deemed impaired during the nine months ended September 30, 2014.
Loans graded six or greater are considered classified credits. At September 30, 2014 and December 31, 2013, classified loans totaled $3.3 million and $3.4 million, respectively. The decrease in this category of $40,337, or 1.2%, during the nine months ended September 30, 2014 is primarily due to the repossession of four properties totaling $1.1 million as well as one loan for $85,000 being removed from the classified status due to performance, partially offset by five new loans added to the classified list for $1.8 million and paydowns of approximately $334,000. Classified credits are evaluated for impairment on a quarterly basis.
A loan is considered impaired when, based on current information and events, we conclude it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan-by-loan basis by calculating either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The resultant shortfall is charged to provision for loan losses and is classified as a specific reserve. When an impaired loan is ultimately charged-off, the charge-off is taken against the specific reserve.
At September 30, 2014, impaired loans totaled $2.5 million, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral. Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower. As of September 30, 2014, we had loans totaling $774,800 that were classified in accordance with our loan rating policies but
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were not considered impaired. Refer to Note 5, Loans, for a table summarizing information relative to impaired loans, by portfolio class at September 30, 2014 and December 31, 2013.
TDRs are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.
At September 30, 2014 and December 31, 2013, the principal balance of TDRs was approximately $344,000 and $0, respectively. As of September 30, 2014, the carrying balance of TDRs consisted of one performing loan for approximately $344,000, which was restructured and granted a period of interest only payments during January 2014. At December 31, 2013, the principal balance of TDRs was $0 as these loans had been reclassified as loans held for sale at that date. During the nine months ended September 30, 2014, the two loans classified as held for sale and previously classified as TDRs were sold for total proceeds of $1,033,000. A success fee of approximately $41,000 and a gain of approximately $118,000 was recognized as a result of this sale.
There were no loans modified as troubled debt restructurings within the previous 12-month period for which there was a payment default during the nine months ended September 30, 2014.
Provision and Allowance for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. At September 30, 2014, the allowance for loan losses was $1.2 million, or 1.74% of gross loans, compared to $1.3 million at December 31, 2013, or 2.04% of gross loans.
The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. We strive to follow a comprehensive, well-documented, and consistently applied analysis of our loan portfolio in determining an appropriate level for the allowance for loan losses. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based onwhat we believe are all significant factors that impact the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and Board of Director oversight, concentrations of credit, and peer group comparisons.
Our allowance for loan losses consists of both specific and general reserve components. The specific reserve component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. Loans determined to be impaired are excluded from the general reserve calculation described below and evaluated individually for impairment. Impaired loans totaled $2.5 million at September 30, 2014, with an associated specific reserve of $258,189. See Note 5, Loans, as well as the above discussion under “Loan Performance and Credit Quality” for additional information related to impaired loans.
The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.
Refer to Note 5, Loans, for a table summarizing activity related to our allowance for loan losses for the quarter ended September 30, 2014 and 2013, by portfolio segment. As of September 30, 2014, the allowance for loan losses was $1.2 million, or 1.74% of gross loans, compared to $1.3 million, or 2.04% of gross loans, as of December 31, 2013 and $1.4 million, or 2.19% of gross loans, as of September 30, 2013. We recognized a reversal of provision for loan losses of $30,000 for the nine months ended September 30, 2014 and a reversal of provision for loan losses of $277,576 for the nine months ended September 30, 2013. Net charge-offs for the nine months ended September 30, 2014 were $104,183 compared to $173,203 for the nine months ended September 30, 2013. The charge-offs during the nine months ended September 30, 2014 related to three commercial loans and write-downs of collateral to fair value against specific reserves.
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Partial charge-offs were based on recent appraisals and evaluations on one residential loan and one construction and development loan in the process of foreclosure. Loans with partial charge-offs are typically considered impaired loans and may remain on nonaccrual status.
Other Real Estate Owned and Repossessed Assets
At September 30, 2014 and December 31, 2013, we had approximately $2.7 and $2.5 million in other real estate owned, respectively. During the nine months ended September 30, 2014, we completed the sale of five pieces of real estate. The sale of those pieces of real estate resulted in a gain of approximately $14,274 and is included in the gain (loss) below. The following table summarizes changes in other real estate owned and repossessed assets for the nine months ended September 30, 2014 and 2013:
| | | | | | |
| | | 2014 | | 2013 |
| Balance at beginning of period | | $ | 2,508,170 | | | $ | 4,468,294 | |
| Repossessed property acquired in settlement of loans | | | 1,143,000 | | | | 1,351,257 | |
| Proceeds from sales of repossessed property | | | (505,263 | ) | | | (1,353,282 | ) |
| Gain (loss) on sale and write-downs of repossessed property, net | | | (402,350 | ) | | | (1,109,112 | ) |
| Balance at end of period | | $ | 2,743,557 | | | $ | 3,357,157 | |
As of September 30, 2014, other real estate owned consisted of residential land lots valued at $743,200, 1-4 family residential dwellings valued at $57,357, commercial land valued at $710,000 and commercial office space valued at $1.2 million. During the quarter ended June 30, 2013, the Bank completed an asset sale to the Company (under terms that meet the Market Terms Requirement as described in Regulation W covering transactions between affiliates) for a purchase price of $5.5 million. Real estate owned of $3.3 million was transferred to the Company as a result of the sale. No gains or losses were recognized as a result of the asset sale as the assets were sold at fair value. Through June 30, 2014, the Company sold eight pieces of the real estate owned purchased from the Bank for proceeds of approximately $2.1 million, which resulted in an aggregate loss of $1,509,442 to the Company. During the quarter ended September 30, 2014, the Company sold two additional pieces of real estate owned purchased from the Bank for proceeds of $39,707, which resulted in a gain of $12,617 (and an aggregate loss to the Company through September 30, 2014 of $1,496,825). These assets are being actively marketed with the primary objective of liquidating the collateral at a level which most accurately approximates fair value and allows recovery of as much of the unpaid principal loan balance as possible upon the sale of the asset within a reasonable period of time. Based on currently available valuation information, the carrying value of these assets is believed to be representative of their fair value less estimated costs to sell, although there can be no assurance that the ultimate proceeds from the sale of these assets will be equal to or greater than their carrying values, particularly in the current real estate environment.
Deposits
Our primary source of funds for loans and investments is our deposits. At September 30, 2014, we had $84.1 million in deposits, representing a decrease of $5.0 million compared to December 31, 2013. Deposits at September 30, 2014 consisted primarily of $17.4 million in demand deposit accounts, $36.7 million in money market accounts and $30.0 million in time deposits. Due to previous regulatory constraints beginning in 2010, we were no longer able to accept brokered time deposits without prior approval from the FDIC. Accordingly, beginning in 2010 we began reducing our reliance on brokered time deposits. At December 31, 2013, we had $1.6 million in brokered time deposits. We had no brokered time deposits as of September 30, 2014 as the remaining $1.6 million time deposit matured and was not renewed. We plan to continue to not utilize brokered time deposits and reduce our reliance on other noncore funding sources, while focusing our efforts to gather core deposits in our local market. Our loan-to-deposit ratio was 79.6% and 71.4% at September 30, 2014 and December 31, 2013, respectively.
Borrowings
We use borrowings to fund growth of earning assets in excess of deposit growth. At September 30, 2014 and December 31, 2013, there were $37,415 and $96,879, respectively, in borrowings representing customer repurchase agreements. FHLB advances accounted for $5.0 million of total borrowings as of September 30, 2014. There were no
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FHLB advances at December 31, 2013. In September 2014, the Company received a loan for $600,000 from a board member of the Bank to assist in covering outstanding commitments related to the transaction services segment. The loan is secured by two pieces of real estate owned by the Company with a combined book value of $1.4 million. The terms of this note require monthly interest payments over the next twelve months at a rate of 7% for the first six months and then at a rate of 8% until maturity. The balance of the note, along with any unpaid accrued interest, is due at maturity in September 2015.
Liquidity
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
The Company
The Company’s cash balances, independent of the Bank, were approximately $782,000 and its real estate held for sale (which serve as collateral for the Company’s note payable) was $1.4 million at September 30, 2014 compared to cash balances of approximately $2.3 million and real estate held for sale of $1.1 million at December 31, 2013. In addition, at December 31, 2013, the Company had loans held for investment of approximately $811,000 and loans held for sale of approximately $900,000. The loan held for investment was transferred to other real estate and the held for sale loans were sold prior to June 30, 2014.The decrease in liquid assets of approximately $3.5 million is due primarily to expenses incurred related to the transaction services segment. In addition, the Company has payables due of $1.3 million and a note payable by a related party of $600,000 which was advanced in September 2014. See “Note 8 – Business Segments”, for additional information related to the transaction services segment.
Under Regulation W, the Bank may not be a source of cash or capital for the Company. Due to the uncertainty of timing and amount of cash that might be received from the conversion of the held for sale assets, the current commitments outstanding, the current run rate on fixed expenses, the current payables, and the prohibition within Regulation W, we believe that the Company does not have sufficient working capital to continue to fund its current level of activities without raising additional funding. Our ability to raise additional capital will depend on a number of factors, including conditions in the capital markets, which are outside of our control. There is a risk we will not be able to raise the capital we need at all or upon favorable terms. If we cannot raise this additional capital, we will not be able to implement our growth objective for our business, and we may be subject to increased regulatory supervision and restriction. These restrictions would most likely have a material adverse effect on our ability to grow and expand which would negatively impact our financial condition and results of operations.
The Bank
Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity at the Bank. We plan to meet our future cash needs at the Bank through the liquidation of temporary investments and the generation of deposits within our market. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. Our investment securities available for sale at September 30, 2014 amounted to $19.8 million, or 19.8% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. At September 30, 2014, $2.8 million of our investment portfolio was pledged against outstanding debt. Therefore, the related debt would need to be repaid prior to the securities being sold and converted to cash.
The Bank is a member of the FHLB, from which applications for borrowings can be made for leverage purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. At September 30, 2014, we had collateral that would support approximately $40.4 million in additional borrowings. We are subject to the FHLB’s credit risk rating policy which assigns member institutions a rating which is reviewed quarterly. The rating system utilizes key factors such as loan quality, capital, liquidity, profitability, etc. Our ability to access our available borrowing capacity from the FHLB in the future is subject to our rating and any subsequent changes based on our financial performance as compared to factors considered by the FHLB in their assignment of our credit risk rating each quarter.
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The Bank also pledges collateral to the Federal Reserve Bank’s Borrower-in-Custody of Collateral program, and our available credit under this program was $13.8 million as of September 30, 2014.
The Bank has a $2.0 million federal funds purchased line of credit through a correspondent bank that is unsecured, but has not been utilized.
We believe our liquidity sources are adequate to meet our operating needs at the Bank. However, we continue to carefully focus on liquidity management during 2014. Comprehensive weekly and monthly liquidity analyses serve management as vital decision-making tools by providing summaries of anticipated changes in loans, investments, core deposits, and wholesale funds. These internal funding reports provide management with the details critical to anticipate immediate and long-term cash requirements, such as expected deposit runoff, loan pay downs and amount and cost of available borrowing sources, including secured overnight federal funds lines with our various correspondent banks.
The Consolidated Company
The Company’s level of liquidity is measured by the cash, cash equivalents, and investment securities available for sale to total assets ratio and was 29.3% at September 30, 2014 compared to 33.1% as of December 31, 2013. The decrease in liquid assets is due primarily to the decrease in cash and due from bank and fed funds sold, primarily due to losses recognized related to the transaction services segment. See Note 8 – Business Segments, for additional information related to the transaction services segment.
Impact of Off-Balance Sheet Instruments
Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At September 30, 2014, we had issued commitments to extend credit of $11.2 million through various types of lending arrangements. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.
Commitments and Contingencies
As of September 30, 2014, there were $893,000 in commitments, primarily for systems and development software, most of which will be expensed in 2014. One commitment for $170,000 was due in October 2014, but has not yet been paid.
Capital Resources
Total shareholders' equity decreased from $14.3 million for December 31, 2013 to $11.0 million for September 30, 2014 due to a net loss of $4,510,871, partially offset by compensation expense related to stock options of $328,687 granted, and by a $915,250 change in unrealized loss on investment securities available for sale. We believe that our capital is sufficient to fund the activities of our Bank’s operations; however, due to the uncertainty of timing and amount of cash that might be received from the conversion of the held for sale assets, the current commitments outstanding, the current run rate on fixed expenses, the current payables, and the prohibition within Regulation W, we believe that the Company does not have sufficient working capital to continue to fund its current level of activities without raising additional funding.
Our Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies. However, the Federal Reserve guidelines contain an exemption from the capital requirements for “small bank holding companies,” which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC. Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively traded, the Federal Reserve Board will interpret its guidelines to mean that we qualify as a small bank holding company. Nevertheless, our Bank remains subject to these capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as
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calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%. Tier 1 capital of the Bank consists of common shareholders' equity, excluding the unrealized gain or loss on securities available for sale, less certain intangible assets. The Bank's Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 capital and 8% for total risk-based capital.
The Bank is also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%. All others are subject to maintaining ratios 1% to 2% above the minimum.
See also additional discussion above under “Recent Regulatory Developments” for more information regarding our required capital ratios.
The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at September 30, 2014 and December 31, 2013.
| | | | | | | | | | | | | | | | | |
| | | | | Target Capitalized Requirement | | Adequately Capitalized Requirement | | Well Capitalized Requirement |
| | | Actual | | Minimum | | Minimum | | Minimum |
| | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| | | | | | | | | | | | | | | |
| As of September 30, 2014 | | | | | | | | | | | | |
| Total Capital (to risk weighted assets) | | $ | 11,455,000 | | | | 15.4 | % | | $ | 8,942,000 | | | | 12.0 | % | | $ | 5,961,000 | | | | 8.0 | % | | $ | 7,451,000 | | | 10.0 | % |
| Tier 1 Capital (to risk weighted assets) | | | 10,521,000 | | | | 14.1 | | | | 7,451,000 | | | | 10.0 | | | | 2,981,000 | | | | 4.0 | | | | 4,471,000 | | | 6.0 | |
| Tier 1 Capital (to average assets) | | | 10,521,000 | | | | 10.7 | | | | 8,837,000 | | | | 9.0 | | | | 3,927,000 | | | | 4.0 | | | | 4,909,000 | | | 5.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2013 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Capital (to risk weighted assets) | | $ | 11,201,000 | | | | 15.7 | % | | $ | 8,546,000 | | | | 12.0 | % | | $ | 5,698,000 | | | | 8.0 | % | | $ | 7,122,000 | | | 10.0 | % |
| Tier 1 Capital (to risk weighted assets) | | | 10,307,000 | | | | 14.5 | | | | 7,122,000 | | | | 10.0 | | | | 2,849,000 | | | | 4.0 | | | | 4,273,000 | | | 6.0 | |
| Tier 1 Capital (to average assets) | | | 10,307,000 | | | | 10.2 | | | | 9,082,000 | | | | 9.0 | | | | 4,036,000 | | | | 4.0 | | | | 5,045,000 | | | 5.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2014, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II - Other Information
Item 1. Legal Proceedings
We are a party to claims and lawsuits arising in the ordinary course of business. Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, would have a material adverse impact on the Company’s financial position, results of operations or cash flows.
Item 1A. Risk Factors
Not applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable
Item 3. Default Upon Senior Securities
Not applicable
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
Not applicable
42
Item 6. Exhibits
The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated by reference.
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | |
| Date: November 14, 2014 | By: /s/Gordon A. Baird |
| | Gordon A. Baird |
| | Chief Executive Officer |
| | (Principal Executive Officer) |
| | |
| | |
| | |
| | By: /s/Martha L. Long |
| | Martha L. Long |
| | Chief Financial Officer |
| | (Principal Financial Officer and Accounting Officer) |
44
EXHIBIT INDEX
Exhibit
Number
Description
31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
32
Section 1350 Certification.
101
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in eXtensible Business Reporting Language (XBRL); (i) Consolidated Balance Sheets at September 30, 2014 and December 31, 2013, (ii) Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013, (iii) Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2014 and 2013, (iv) Consolidated Statements of Cash Flows for nine months ended September 30, 2014 and 2013, and (v) Notes to Consolidated Financial Statements
