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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2008
Commission File No.: 000-52195
BANK OF THE CAROLINAS CORPORATION
(Exact name of registrant as specified in its charter)
NORTH CAROLINA | 20-4989192 | |
(State or other jurisdiction of incorporation) | (IRS Employer Identification No.) |
135 Boxwood Village Drive Mocksville, North Carolina | 27028 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (336) 751-5755
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ | |
Non-accelerated filer ¨ | 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). Yes ¨ No x
On November 12, 2008 there were 3,891,174 outstanding shares of the registrant’s common stock.
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BANK OF THE CAROLINAS CORPORATION
FORM 10-Q
September 30, 2008
INDEX
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Item 1. | Financial Statements |
Bank of the Carolinas Corporation
Consolidated Balance Sheets
(In thousands, except share and per share data)
September 30 2008 | December 31 2007* | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Cash and due from banks | $ | 12,734 | $ | 8,192 | ||||
Interest-bearing deposits in banks | 10,407 | 12,756 | ||||||
Securities held to maturity | 4,500 | — | ||||||
Securities available for sale | 102,087 | 60,717 | ||||||
Loans | 406,886 | 395,052 | ||||||
Less, Allowance for loan losses | (4,218 | ) | (4,245 | ) | ||||
Total Loans, net | 402,668 | 390,807 | ||||||
Premises and equipment | 15,245 | 13,888 | ||||||
Accrued interest receivable | 3,057 | 3,239 | ||||||
Other real estate owned | 5,155 | 2,528 | ||||||
Deferred tax assets | 722 | 578 | ||||||
Goodwill | — | 591 | ||||||
Bank owned life insurance | 9,556 | 9,283 | ||||||
Other assets | 4,739 | 3,419 | ||||||
Total assets | $ | 570,870 | $ | 505,998 | ||||
Liabilities and Shareholders’ Equity | ||||||||
Deposits: | ||||||||
Non-interest bearing demand deposits | $ | 33,303 | $ | 29,835 | ||||
Interest bearing demand deposits | 198,203 | 62,883 | ||||||
Savings deposits | 22,259 | 19,655 | ||||||
Large denomination time deposits | 98,764 | 174,181 | ||||||
Other time deposits | 100,067 | 135,374 | ||||||
Total deposits | 452,596 | 421,928 | ||||||
Borrowings | 25,000 | 34,000 | ||||||
Subordinated debt | 7,855 | — | ||||||
Federal funds purchased and repurchase agreements | 47,369 | 7,657 | ||||||
Other liabilities | 1,750 | 2,173 | ||||||
Total liabilities | 534,570 | 465,758 | ||||||
Commitments and contingencies (Note 3) | ||||||||
Shareholders’ Equity: | ||||||||
Preferred stock, No par value: authorized 3,000,000 shares: none issued | $ | — | $ | — | ||||
Common stock, par value $5 per share: 15,000,000 shares authorized; Issued and outstanding 3,891,174 shares in 2008 and 3,920,752 in 2007 | 19,456 | 19,604 | ||||||
Additional paid-in capital | 11,593 | 11,716 | ||||||
Retained earnings | 4,902 | 8,476 | ||||||
Accumulated other comprehensive income | 349 | 444 | ||||||
Total shareholders’ equity | 36,300 | 40,240 | ||||||
Total liabilities and shareholders’ equity | $ | 570,870 | $ | 505,998 | ||||
* | Derived from audited consolidated financial statements. |
See accompanying notes.
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Bank of the Carolinas Corporation
Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)
Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||
Interest Income | ||||||||||||||
Interest and fees on loans | $ | 6,268 | $ | 7,659 | $ | 19,962 | $ | 22,253 | ||||||
Interest on securities | 1,202 | 757 | 2,638 | 2,070 | ||||||||||
Interest on federal funds sold | 59 | 22 | 173 | 383 | ||||||||||
Interest on deposits in banks | 2 | 4 | 8 | 9 | ||||||||||
Total interest income | 7,531 | 8,442 | 22,781 | 24,715 | ||||||||||
Interest Expense | ||||||||||||||
Interest on deposits | 3,764 | 4,296 | 11,958 | 12,857 | ||||||||||
Interest on borrowed funds | 757 | 333 | 1,418 | 921 | ||||||||||
Total interest expense | 4,521 | 4,629 | 13,376 | 13,778 | ||||||||||
Net Interest Income | 3,010 | 3,813 | 9,405 | 10,937 | ||||||||||
Provision for loan losses | 3,150 | 546 | 4,245 | 1,020 | ||||||||||
Net interest income (loss) after provision for loan losses | (140 | ) | 3,267 | 5,160 | 9,917 | |||||||||
Non-interest income | ||||||||||||||
Customer service fees | 337 | 259 | 976 | 761 | ||||||||||
Mortgage loan broker fees | 44 | 78 | 111 | 140 | ||||||||||
Investment services | 3 | 99 | 18 | 198 | ||||||||||
Income from bank owned life insurance | 93 | 89 | 273 | 257 | ||||||||||
Other income | (7 | ) | 29 | 62 | 99 | |||||||||
Total non-interest income | 470 | 554 | 1,440 | 1,455 | ||||||||||
Noninterest Expense | ||||||||||||||
Salaries and benefits | 1,764 | 1,543 | 5,460 | 4,478 | ||||||||||
Occupancy and equipment | 502 | 447 | 1,482 | 1,286 | ||||||||||
Goodwill impairment | 591 | — | 591 | — | ||||||||||
Data processing expense | 216 | 185 | 638 | 561 | ||||||||||
Other | 1,067 | 794 | 2,641 | 2,210 | ||||||||||
Total non-interest expense | 4,140 | 2,969 | 10,812 | 8,535 | ||||||||||
Income (Loss) before income taxes | (3,810 | ) | 852 | (4,212 | ) | 2,837 | ||||||||
Income taxes | (1,090 | ) | 247 | (1,228 | ) | 860 | ||||||||
Net Income (Loss) | $ | (2,720 | ) | $ | 605 | $ | (2,984 | ) | $ | 1,977 | ||||
Earnings (Loss) Per Share | ||||||||||||||
Basic | $ | (0.69 | ) | $ | 0.16 | $ | (0.76 | ) | $ | 0.52 | ||||
Diluted | $ | (0.69 | ) | $ | 0.15 | $ | (0.76 | ) | $ | 0.50 | ||||
Dividends Declared | $ | 0.05 | $ | 0.05 | $ | 0.15 | $ | 0.15 | ||||||
See accompanying notes.
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Bank of the Carolinas Corporation
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Nine Months Ended September 30, 2008 | Nine Months Ended September 30, 2007 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net income (loss) | $ | (2,984 | ) | $ | 1,977 | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
Provision for loan losses | 4,245 | 1,020 | ||||||
Stock based compensation expense | 17 | 16 | ||||||
Depreciation and amortization | 675 | 538 | ||||||
Loss on sale of other real estate owned | 151 | 7 | ||||||
Loss on disposal of premises and equipment | 33 | 3 | ||||||
Income from bank owned life insurance | (273 | ) | (257 | ) | ||||
Net amortization/accretion of premiums and discounts on investments | 23 | 50 | ||||||
Net change in other assets | (1,570 | ) | (1,301 | ) | ||||
Net change in other liabilities | (421 | ) | (12 | ) | ||||
Net cash provided (used) by operating activities | (104 | ) | 2,041 | |||||
Cash Flows from Investing Activities: | ||||||||
Decrease in federal funds sold | — | 2,229 | ||||||
Purchases of premises and equipment | (1,396 | ) | (2,683 | ) | ||||
Purchases of securities | (64,980 | ) | (22,057 | ) | ||||
Proceeds from sales, calls, maturities and principal repayments of securities available for sale | 18,939 | 14,070 | ||||||
Sale of FHLB stock | 313 | 142 | ||||||
Improvement of other real estate owned | (12 | ) | (10 | ) | ||||
Proceeds from the sale of other real estate owned | 1,542 | 602 | ||||||
Proceeds from sale of premises and equipment | 8 | — | ||||||
Net Increase in loans | (20,474 | ) | (24,299 | ) | ||||
Net cash used in investing activities | (66,060 | ) | (32,006 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Net increase in deposits | 30,668 | 27,718 | ||||||
Net originations (repayments) of other borrowings | (16,358 | ) | (4,000 | ) | ||||
Issuance of subordinated debt | 7,700 | — | ||||||
Increase in repurchase agreements | 47,225 | — | ||||||
Proceeds from exercise of stock options | 424 | 269 | ||||||
Tax effect of stock options exercised | 10 | 44 | ||||||
Common stock acquired | (722 | ) | — | |||||
Cash dividends paid | (590 | ) | (576 | ) | ||||
Net cash provided by financing activities | 68,357 | 23,455 | ||||||
Net increase (decrease) in cash and cash equivalents | 2,193 | (6,510 | ) | |||||
Cash and cash equivalents at beginning of period | 20,948 | 13,403 | ||||||
Cash and cash equivalents at end of period | $ | 23,141 | $ | 6,893 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the period for interest | $ | 14,124 | $ | 13,834 | ||||
Cash paid during the period for income taxes | $ | — | $ | 794 | ||||
Noncash investing and financing activities: | ||||||||
Decrease in fair value of securities available for sale, net of tax | $ | 95 | $ | 204 | ||||
Dividends declared | 199 | 193 | ||||||
Transfer from loans to other real estate owned | 4,985 | 1,509 | ||||||
Transfer from OREO to premises and equipment | 677 | — | ||||||
See accompanying notes.
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Bank of the Carolinas Corporation
Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited) (In thousands, except share and per share data)
Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Shareholders’ Equity | |||||||||||||||||||
Shares | Amount | ||||||||||||||||||||||
Balance, December 31, 2006 | 3,826,792 | $ | 19,134 | $ | 11,444 | $ | 7,293 | $ | (157 | ) | $ | 37,714 | |||||||||||
Stock options exercised | 42,270 | 211 | 58 | 269 | |||||||||||||||||||
Current Income tax benefit on options exercised | 44 | 44 | |||||||||||||||||||||
Stock based compensation expense | 16 | 16 | |||||||||||||||||||||
Cash dividends declared ($.15 per share) | (578 | ) | (578 | ) | |||||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||
Net income | 1,977 | 1,977 | |||||||||||||||||||||
Other comprehensive loss | 204 | 204 | |||||||||||||||||||||
Total comprehensive income | 2,181 | ||||||||||||||||||||||
Balance, September 30, 2007 | 3,869,062 | $ | 19,345 | $ | 11,562 | $ | 8,692 | $ | 47 | $ | 39,646 | ||||||||||||
Balance, December 31, 2007 | 3,920,752 | $ | 19,604 | $ | 11,716 | $ | 8,476 | $ | 444 | $ | 40,240 | ||||||||||||
Stock options exercised | 66,622 | 333 | 91 | 424 | |||||||||||||||||||
Repurchased shares | (96,200 | ) | (481 | ) | (241 | ) | (722 | ) | |||||||||||||||
Current Income tax benefit on options exercised | 10 | 10 | |||||||||||||||||||||
Stock based compensation expense | 17 | 17 | |||||||||||||||||||||
Cash dividends declared ($.15 per share) | (590 | ) | (590 | ) | |||||||||||||||||||
Comprehensive loss: | |||||||||||||||||||||||
Net loss | (2,984 | ) | (2,984 | ) | |||||||||||||||||||
Other comprehensive loss | (95 | ) | (95 | ) | |||||||||||||||||||
Total comprehensive loss | (3,079 | ) | |||||||||||||||||||||
Balance, September 30, 2008 | 3,891,174 | $ | 19,456 | $ | 11,593 | $ | 4,902 | $ | 349 | $ | 36,300 | ||||||||||||
See accompanying notes
Notes to Consolidated Financial Statements
September 30, 2008 and 2007
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
In the opinion of management, the financial information included in these unaudited financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and nine month periods ended September 30, 2008 and 2007, in conformity with accounting principles generally accepted in the United States of America.
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The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three and nine month periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2008.
The results presented here are for Bank of the Carolinas Corporation (“BankCorp”), the parent company of Bank of the Carolinas (“the Bank”). The organization and business of BankCorp, accounting policies followed by BankCorp and other relevant information are contained in the notes to the financial statements filed as part of BankCorp’s annual report on Form 10-K for the year ended December 31, 2007. This quarterly report should be read in conjunction with the annual report. Because BankCorp has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, BankCorp and the Bank are collectively referred to as the “Company” unless otherwise noted.
NOTE 2. EARNINGS PER SHARE
Basic earnings (loss) per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. When applicable, the weighted average shares outstanding for the diluted earnings per share computations are adjusted to reflect the assumed conversion of shares available under stock options using the treasury stock method.
Earnings per share have been computed based on the following:
Nine months ended September 30, | ||||
2008 | 2007 | |||
Weighted average number of common shares oustanding used to calculate basic earnings per share | 3,941,582 | 3,841,070 | ||
Additional potential common shares due to stock options | — | 104,172 | ||
Weighted average number of common shares outstanding used to calculate diluted earnings per share | 3,941,582 | 3,945,242 | ||
Three months ended September 30, | ||||
2008 | 2007 | |||
Weighted average number of common shares oustanding used to calculate basic earnings per share | 3,936,649 | 3,856,660 | ||
Additional potential common shares due to stock options | — | 83,445 | ||
Weighted average number of common shares outstanding used to calculate diluted earnings per share | 3,936,649 | 3,940,105 | ||
There were 30,063 shares for the three month and 40,455 shares for the nine month period ended September 30, 2008 that are anti-dilutive due to the net loss for the three and nine month periods then ended.
NOTE 3. COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.
The Company’s risk of loss with the unfunded loans and lines of credit or standby letters of credit is represented by the
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contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At September 30, 2008, outstanding financial instruments whose contract amounts represent credit risk were approximately:
(in thousands) | |||
Loan commitments | $ | 60,624 | |
Letters of credit | $ | 2,585 |
NOTE 4. COMPREHENSIVE INCOME (LOSS)
Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the balance sheet. Such items, along with net income, are considered components of comprehensive income (loss). Accounting principles do not require per share amounts of comprehensive income (loss) to be disclosed. The information that follows reconciles net income (loss) to comprehensive income (loss).
Three-months ended September 30, | Nine-months ended September 30, | |||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||
(In thousands) | ||||||||||||||
Net Income (loss) | $ | (2,720 | ) | $ | 605 | $ | (2,984 | ) | $ | 1,977 | ||||
Net unrealized gain (loss) on AFS securities, net of taxes | 166 | 405 | (95 | ) | 204 | |||||||||
Comprehensive income (loss) | $ | (2,554 | ) | $ | 1,010 | $ | (3,079 | ) | $ | 2,181 | ||||
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued FASB Statement No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities.” FASB 159 allows companies to measure financial instruments at fair value. The statement will be effective as of the beginning of each fiscal year that begins after November 15, 2007. The adoption had no effect on the Company’s financial statements as management has not elected the fair value option on any assets or liabilities.
In December 2007, the FASB issue SFAS NO. 141R “Business Combinations,” which replaces SFAS 141. SFAS 141R establishes principals and requirements for recognition and measurement of assets, liabilities, and any noncontrolling interest acquired due to a business combination. SFAS 141R requires that the acquirer record 100 percent of all assets and liabilities of the acquired business generally at fair value, including goodwill. The acquirer will not be able to recognize the allowance for loan losses of the acquiree. Under SFAS 141R, acquisition related and restructuring costs will be expensed as incurred rather than treated as part of the cost of the acquisition and included in the amount recorded for assets acquired. SFAS 141R is effective for fiscal years beginning after December 15, 2008. Accordingly, for acquisitions completed after December 31, 2008, the Company will apply the provisions of SFAS 141R.
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In March 2008, the FASB issue SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” SFAS 161 applies to all derivatives and hedge agreements covered under FASB 133. SFAS 161 requires greater transparency regarding how and why they are using derivative instruments, how they are accounting for those instruments as well as how they affect a company’s financial position, results of operation and cash flow. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS 161 to have a material effect on its financial condition or results of operations.
NOTE 6. FAIR VALUE
Effective January 1, 2008, the Company adopted SFAS 157 which requires that certain assets and liabilities be measured at fair value and to record any adjustments to the fair value of those assets. Securities are recorded at fair value on a recurring basis while other assets are recorded at fair value on a non-recurring basis such as impaired loans.
The Company uses three levels of measurement to group those assets measured at fair value. These groupings are made based on the markets the assets are traded in and the reliability of the assumptions used to determine fair value. The groupings include:
• | Level 1 pricing for an asset or liability is derived from the most likely actively traded markets and considered very reliable. Quoted prices on actively traded equities, for example, fall into this category. |
• | Level 2 pricing is derived from observable data including market spreads, current and projected rates, prepayment data and credit quality. Our bond price adjustments fall into this category as well as impaired loans that use appraisals or brokered price opinions to determine fair value. |
• | Level 3 pricing is used without the use of observable data. In such cases, market-to- market strategies are typically employed. Often, these types of instruments have no active market, possess unique characteristics and are thinly traded. Our impaired and other real estate loan balances fall into this category. We currently have no assets or liabilities that fall into this category. |
The Company’s securities are measured on a recurring basis through a model used by our bond agent. All of our bond price adjustments meet level 2 criteria. Prices are derived from a model which uses actively quoted rates, prepayment models and other underlying credit and collateral data.
Our impaired loans fall into the level 2 criteria. These assets are marked to market value, if lower than the current loan balance, from either their most recent appraisals or a broker’s price opinion, whichever is most recent.
Total at 9/30/2008 | Level 1 | Level 2 | Level 3 | |||||||||
(In thousands) | ||||||||||||
Assets valued on a recurring basis | ||||||||||||
AFS securities | $ | 102,087 | $ | — | $ | 102,087 | — | |||||
Assets valued on a non-recurring basis | ||||||||||||
Impaired loans | 3,086 | — | 3,086 | — | ||||||||
Total | $ | 105,173 | $ | — | 105,173 | $ | — | |||||
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Note 7. SUBORDINATED DEBT
The Company has issued $5.2 million of junior subordinated debentures to its wholly owned capital trust, Bank of the Carolinas Trust I, to fully and unconditionally guarantee the preferred securities issued by the trust. This long term obligation constitutes a full and unconditional guarantee by the Company of the trust’s obligations.
A description of the junior subordinated debenture outstanding is as follows:
Issuing Entity | Date of Issuance | Interest Rate | Maturity Date | Principal Amount | ||||||
Bank of the Carolinas Trust I | 3/26/2008 | Libor + 3.00 | % | 3/26/2038 | $ | 5,155,000 |
The Company has the right to redeem the trust preferred securities in whole or in part, on or after March 26, 2013. If the trust preferred securities are redeemed on or after March 26, 2013, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, the Company may redeem the trust preferred securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event or a capital treatment event at a special redemption price (as defined in the indenture).
The Company also has $2.7 dollars of private placement subordinated debt at a rate of Prime plus 75 basis points. The Company has the right to repay the debt at any time with no prepayment penalty. The debt was issued on August 13, 2008 and matures on August 13, 2018. The Company makes monthly interest payments on the outstanding debt to the holder of the note.
Note 8. IMPAIRED LOANS
We had impaired loans of $9.6 million at September 30, 2008. Of those loans $245 thousand had specific reserves of $103 thousand at September 30, 2008. Loans classified as impaired with no specific reserve totaled $9.3 million for the same period. Included in the $9.3 million impaired balance is $4.1 million in two impaired loans that are backed by a USDA guarantee. These loans have been charged down to the guaranteed amount and the Company expects no further losses on these loans. Without these two loans, our impaired loan balance would have been $5.2 million at September 30, 2008. The average recorded balance of impaired loans was $3.8 million for the period ending September 30, 2008. The interest accrued but not recognized on non-accrual loans was $809,000 for the nine months ended September 30, 2008.
Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
GENERAL
Introduction
Bank of the Carolinas Corporation (“BankCorp”) is the parent holding company of Bank of the Carolinas (“the Bank”). Because BankCorp has no separate operations and conducts no business on its own other than owning the Bank, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, BankCorp and the Bank are collectively referred to herein as the “Company” unless otherwise noted.
The Bank began in December 1998 as a state chartered bank and currently has ten offices in the Piedmont region of North Carolina. The Bank competes for loans and deposits throughout the markets it serves. The Bank, like other financial institutions, derives most of its revenue from net interest income which is the difference between the income it earns from loans and securities minus the interest expense it incurs on deposits and borrowings.
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Recent Developments
On September 24, 2008, the Company declared a cash dividend of $ .05 per share on its common stock, payable October 23, 2008 to shareholders of record on October 09, 2008.
In an effort to stabilize the credit system the government has implemented a capital infusion program in which the nation’s nine largest financial institutions are required to participate. The Treasury has earmarked $250 billion of the $700 billion Economic Stabilization Act as a capital infusion for banks. Of that $250 billion, the largest banks will receive $125 billion with the rest being spread amongst the remainder of the nation’s institutions. This infusion is intended to stimulate the credit markets and restore confidence in the financial system. In order to preserve our options, the Corporation has applied for the Treasury’s TARP Capital Purchase program which would allow the Corporation to receive a capital infusion of between 1 and 3 percent of its risk weighted assets while we will continue to evaluate whether we can appropriately utilize these funds.
CHANGES IN FINANCIAL CONDITION
Total Assets
At September 30, 2008, total assets were $570.8 million compared to $506.0 million at December 31, 2007, and $480.2 million at September 30, 2007 representing a 18.9% percent year over year increase.
Investment Securities
Investment securities totaled $106.6 million at September 30, 2008, compared to $60.7 million at December 31, 2007 and $64.0 million at September 30, 2007. Total investments increased $45.9 million or 75.6 percent from December 31, 2007 and $42.6 million or 66.6 percent from September 30, 2007. The Company held $4.5 million of securities that were classified as held to maturity at September 30, 2008.
The investment portfolio includes U.S. Government Agency bonds, mortgage-backed securities, corporate bonds, municipal bonds, and treasuries and debt securities.
Loans and Allowance for Loan Losses
At September 30, 2008, the loan portfolio totaled $406.9 million and represented 71.3 percent of total assets compared to $395.0 million or 78.1 percent of total assets at December 31, 2007 and $376.6 million or 78.4 percent of total assets at September 30, 2007. Total loans increased $11.9 million or 3.0 percent from December 31, 2007 and $30.3 million or 8.0 percent from September 30, 2007. Real estate loans (including commercial real estate) constituted approximately 75.8 percent of the loan portfolio, and commercial loans comprised approximately 21.5 percent of the total loan portfolio at September 30, 2008.
The allowance for loan losses is created by direct charges to income. Losses on loans are charged against the allowance in the period in which such loans, in management’s opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence management’s judgment in determining the amount charged to operating expense include past loan experience, composition of the loan portfolio, current economic conditions and probable losses.
The appropriateness of the allowance for loan losses is measured on a quarterly basis using an allocation model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses. It must be emphasized, however, that the determination of the reserve using the Company’s procedures and methods rests upon various judgments and assumptions about current economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to their amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, various regulatory agencies, as an integral part of their routine examination process, periodically review the Company’s allowance. Those agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance is appropriate based on management’s current analysis.
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The provision for loan losses has increased substantially from September 30, 2007 primarily due to specific charge-offs related to several commercial credits. The majority of the impaired loan balance without a specific associated reserve is tied to two large credits of which the remaining balance is backed by a USDA guarantee. The Company has not made nor does it hold any subprime loans. However, we have been affected by the economic downturn in several of our markets. The significant write-offs in the third quarter are a reflection of this downturn and our intention to write troubled credits down to their current realizable value. We continue to work with our customers with troubled credit relationships to the extent that it is reasonably possible. The Company has historically been aggressive in identifying and recording losses as we believe they are necessary and these charges reflect that continued philosophy. Our allowance for loan loss as a percentage of loans is essentially unchanged from last year as a result of these aggressive charge offs rather than making specific reserves for problem loans.
The following table describes the activity in our allowance for loan losses for the nine-month periods ended September 30, 2008 and 2007.
Nine-months ended September 30, | ||||||||
2008 | 2007 | |||||||
(dollars in thousands) | ||||||||
Balance at beginning of period | $ | 4,245 | $ | 3,732 | ||||
Provision for loan losses | 4,245 | 1,020 | ||||||
Charge-offs | (4,450 | ) | (1,006 | ) | ||||
Recoveries of loans previously charged-off | 178 | 32 | ||||||
Balance at end of period | $ | 4,218 | $ | 3,778 | ||||
Ratio of allowance for loan losses to total loans at end of period | 1.04 | % | 1.00 | % |
Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Company also attempts to reduce repayment risks by adhering to internal credit underwriting policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies. A loan is placed in nonaccrual status when, in management’s judgment, the collection of interest appears doubtful.
The following table summarizes information regarding our nonaccrual loans, other real estate owned, and certain other repossessed assets and loans, as of September 30, 2008 and December 31, 2007. On those dates, we had no loans categorized as troubled debt restructuring within the meaning of SFAS 15.
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September 30, 2008 | December 31, 2007 | |||||||
(dollars in thousands) | ||||||||
Loans accounted for on a nonaccrual basis: | ||||||||
Real estate loans: | ||||||||
Mortgage | $ | — | $ | — | ||||
Commercial | 1,528 | 300 | ||||||
Construction | 285 | — | ||||||
Home Equity | — | — | ||||||
Commercial business and consumers | 5,357 | 248 | ||||||
Total nonaccrual loans | 7,170 | 548 | ||||||
Accruing loans, which are contractually past due 90 days or more | 2,746 | 6,661 | ||||||
Total non-performing loans | 9,916 | 7,209 | ||||||
Other real estate owned, net | 5,155 | 2,528 | ||||||
Total non-performing assets | $ | 15,071 | $ | 9,737 | ||||
Non-performing loans as a percentage of net loans | 2.28 | % | 1.82 | % | ||||
Total non-performing assets as a percentage of total assets | 2.64 | % | 1.92 | % |
The Company’s non-performing assets were $15.1 million at September 30, 2008, or 2.46% of net loans. As has been previously discussed, while the reported amount is at a historically high level it includes one credit relationship of approximately $4.1 million for which any remaining loss incurred by the Company is guaranteed by the US Department of Agriculture. It also includes a $2.2 million loan related to an A&D property in Chimney Rock, NC. The Company believes it can sell the property at the current book value but it may take some time to find a qualified interested buyer. The Company also has several rental property loans outstanding to one borrower, all of the properties are occupied and are not sub-prime loans, but due to borrower’s current delinquent status the Company has found it necessary to begin foreclosure proceedings. These loans total $794,000.
Deposits
The Company’s deposit services include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. At September 30, 2008, total deposits were $452.6 million compared to $421.9 million at December 31, 2007 and $410.4 million at September 30, 2007. These figures represent an increase of 7.2 percent over December 31, 2007 and an increase of 10.3 percent over September 30, 2007. While the Company’s overall deposits have increased over the period, the mix of deposits has also changed substantially. Our Company has increased its focus on developing long term relationships with our clients and as a result our core deposits have increased significantly over the period. At September 30, 2008, time deposits of $100,000 and over made up approximately 22.1 percent of total deposits versus 43.5 percent at December 31, 2007 and 39.1 percent at September 30, 2007. Our deposits are generated primarily within our banking market. However, the Company had $39.6 million in brokered deposits at September 30, 2008 compared to $97.1 million at December 31, 2007 and $89.2 million at September 30, 2007. The Company has chosen to intentionally roll off significant amounts of brokered deposits during the period in an effort to reduce our reliance on this funding source.
The Company has focused on developing long term relationships with its customers through establishing core deposit relationships, particularly through increased money market and savings accounts. This focus is evidenced through the substantial year over year increase in these deposits. The Company believes that this strategy will result in an increase in our net interest margin through the addition of long term profitable relationships with our expanded customer base.
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Liquidity
Liquidity management is the process of managing assets and liabilities as well as their maturities to insure adequate funding for loan and deposit activity as well as continued growth of the Company. Sources of funding come from both the asset and liability side of the balance sheet. Asset side sources include cash and cash equivalents, federal funds sold and unpledged available for sale securities. These totaled $60.2 million at September 30, 2008 and $67.0 million at December 31, 2007. Liquidity sources from liabilities include deposits and lines of credit with other institutions. These sources are largely affected by our ability to attract and maintain deposits. Our deposits, together with equity capital, funded 85.6% percent of total assets at September 30, 2008. The Company has $20.5 million in borrowing lines available from various correspondent banks and $57.5 million at the Federal Home Loan Bank of Atlanta (FHLB) for short-term or long-term funding. At September 30, 2008, the Company had total borrowings of $25 million from the FHLB, with maturity dates on these borrowings extending through 2013. A blanket lien on loans secured by residential 1-4 family dwellings, qualifying non-residential loans and home equity lines of credit is in place with the FHLB to secure these advances. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at September 30, 2008 is adequate to meet its operating needs.
Interest Rate Sensitivity
Fluctuating interest rates, increased competition and changes in the regulatory environment continue to significantly affect the importance of interest-rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest-rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company’s net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. The Company is liability sensitive over the next twelve months, which means that interest-earning liabilities could re-price more quickly than interest bearing assets. Theoretically, the Company’s net interest margin will decline if market interest rates rise or improve if market interest rates fall.
During the quarter the Company entered into two separate term repurchase agreements, totaling $45 million. The agreements were offset by purchases of mortgage backed securities which were pledged against these agreements. The Company primarily entered into these agreements in an effort to protect itself against customers’ possible inability to maintain their current loan structure in an increasing rate environment.
Capital Adequacy
Regulatory guidelines require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for measuring the adequacy of a bank’s capital, and all applicable capital standards must be satisfied for us to be considered in compliance with regulatory requirements. On September 30, 2008, the Bank’s Total Capital Ratio and Tier 1 Capital Ratio were 10.44 percent and 9.44 percent, respectively, which were well above the minimum levels required by regulatory guidelines. At September 30, 2008, the Bank’s Leverage Capital Ratio was 8.04 percent, which was also well above the minimum level required by the regulatory guidelines. Banks are placed into one of four capital categories based on the above three separate capital ratios. The four categories are “well-capitalized,” “adequately capitalized,” “under-capitalized,” and “critically under-capitalized.” The Company is considered “well-capitalized” as of September 30, 2008.
RESULTS OF OPERATIONS
Three-Month Period Ended September 30, 2008 and September 30, 2007
The Company had a net loss of $2.7 million or $(.69) per diluted share for the three-month period ended September 30, 2008 while reporting income of $605,000 or $0.15 per diluted share for the three-month period ended September 30, 2007.
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Net interest income, or the difference between income generated by earning assets (primarily loans, investment securities, and interest-bearing balances) and the expense incurred on interest bearing liabilities (primarily deposits and borrowed funds used to fund earning assets), is the Company’s primary source of earnings. The Company’s net interest income for the three-month period ended September 30, 2008 and 2007 was $3.0 million and $3.8 million, respectively. The decrease was primarily attributable to a decrease in interest income on loans, which was in large part due to several loans that were placed in non-accrual status during the quarter as well as the continued effects of the Federal Reserve’s rate cuts of 325 basis points since September 2007.
The loan loss provision increased $2.6 million in the third quarter of 2008 and was mainly due to specific charge-offs related to several troubled commercial credits. As previously discussed, the Company has no subprime loans and has taken aggressive measures to write down troubled credits to their net realizable values.
Interest expense for the three-month period ending September 30, 2008 was $4.5 million compared to $4.6 million during the same period in 2007. This decrease of $109,000 or 2.3% was primarily attributable to an increase in more cost effective savings deposits during the period as well as some benefit from the Fed’s rate reductions over the time period.
Non-interest income was $470,000 for the three-months compared to $554,000 for the three-month period ended September 30, 2007. The non-interest income total includes service charges on deposit accounts, bank owned life insurance, and mortgage broker fees. The $84,000 period over period decrease was largely the result of a $34,000 decrease in income from mortgage loan broker fees as well as a $96,000 decrease in revenue from our investment services division. The Company experienced a decline in non-interest income of 15.2% for the three month periods ended September 30, 2008 versus 2007.
Non-interest expense was $4.1 million for the three-months ended September 30, 2008, compared to $3.0 million for the same period in 2007, an increase of $1.2 million or 39.4 percent. Salaries and benefits increased $221,000, occupancy expense increased $55,000 and other non-interest expense increased $304,000 for the current year period. The increased salary and benefit and occupancy expense levels are comprised of normal salary adjustments plus increased staffing and occupancy costs associated with two banking offices opened in mid-2007.
The Company also took a $591,000 charge related to the impairment of our goodwill; reducing our intangible assets to zero. The write-down of goodwill is a non-cash charge that did not affect the Company’s liquidity or operations. Goodwill is deducted from regulatory capital therefore the charge had no effect on the regulatory capital ratios of the Company.
The Company accrued a tax benefit of $1.1 million for the three months ended September 30, 2008 based on the loss in the quarter. This compares to tax expense of $247,000 in the second quarter of 2007. The effective tax benefit for the period ending September 30, 2008 was 29.2% and the effective tax rate at September 30, 2007 was 30.3%. These changes are due to the Company’s loss during the quarter.
Nine-Month Period Ended September 30, 2008 and September 30, 2007
The Company had net loss of $3.0 million or ($.76) per diluted share for the nine-month period ended September 30, 2008 and net income of $2.0 million or $.50 per diluted share for the nine-month period ended September 30, 2007.
Net interest income, or the difference between income generated by earning assets (primarily loans, investment securities, and interest-bearing balances) and the expense incurred on interest bearing liabilities (primarily deposits and borrowed funds used to fund earning assets), is the Company’s primary source of earnings. The Company’s net interest income for the nine-month period ended September 30, 2008 and 2007 was $9.4 million and $10.9 million, respectively.
Interest expense for the nine-month period ending September 30, 2008 was $13.4 million compared to $13.8 million during the same period in 2007. The $402,000 decrease resulted from lower market interest rates offset by increased deposits and borrowings.
Principal factors leading to the decrease in net income for the nine-month period ended in 2008, relative to 2007, was a decline in the Company’s net interest income, an increase in the provision for loan losses and increased non-interest expense. For the nine-month period ended in 2008, the net interest margin declined to 2.62% from 3.40% in 2007. For the nine-month period ended September 30, 2008, approximately $809,000 or 28.2% of the decline in our net interest margin was attributable to the loss of income associated with non-accrual loans. The provision for loan losses increased $3.2 million from the previous year primarily due to charge offs and the identification of impaired loans by Bank’s management.
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Non-interest income was $1,440,000 for the nine-months compared to $1,455,000 for the nine-month period ended September 30, 2007. The non-interest income total includes service charges on deposit accounts, bank owned life insurance, and mortgage broker fees. The $15,000 year over year difference was virtually unchanged from the same period in 2007. During the period there was a $215,000 increase in customer service fees while income from our investment services division decreased by $180,000.
Non-interest expense was $10.8 million for the nine-months ended September 30, 2008, compared to $8.5 million for the same period in 2007 an increase of $2.3 million or 26.7 percent. While non-interest expense has increased on an annualized basis it has decreased from 2.63% to 2.35% of assets during 2008; a result of the Company’s continuing focus on expense control. Salaries and benefits increased $982,000, occupancy expense increased $196,000 and other non-interest expense increased $508,000 for the current year period. The increased salary and benefit and occupancy expense levels are comprised of normal salary adjustments plus increased staffing and occupancy costs associated with two banking offices opened in mid-2007. As was previously stated in the three month discussion the Company charged off $591,000 related to goodwill impairment during the third quarter of 2008. The write-down was a non-cash charge and did not affect the Company’s liquidity or operations. It also had no effect on the Company’s regulatory ratios.
The Company accrued a tax benefit of $1,228,000 for the nine months ending September 30, 2008 compared to tax expense of $860,000 for the same time period in 2007. The effective tax benefit for the nine months ended September 30, 2008 was 29.9% as compared to a tax rate of 30.3% for the nine months ended September 30, 2007. The tax benefit was a result of the Company’s loss for the nine-month period.
DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS
This Report and its exhibits contain statements relating to our financial condition, results of operations, plans, strategies, trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts. Those statements may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of the Company’s management about future events. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in reports the Company files with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the Commission’s website atwww.sec.gov.Other factors that could influence the accuracy of such forward-looking statements include, but are not limited to, (a) pressures on the earnings, capital and liquidity of financial institutions resulting from current and future adverse conditions in the credit and equity markets and the banking industry in general, (b) our ability to manage and collect our non-performing loans and dispose of other real estate owned, (c) changes in competitive pressures among depository and other financial institutions or in the Company’s ability to compete successfully against the larger financial institutions in its banking markets; (d) the financial success or changing strategies of the Company’s customers; (e) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect the Company’s business; (f) changes in the interest rate environment and the level of market interest rates that reduce the Company’s net interest margins and/or the volumes and values of loans it makes and securities it holds; (g) changes in general economic or business conditions and real estate values in the Company’s banking markets (particularly changes that affect the Company’s loan portfolio, the abilities of its borrowers to repay their loans, and the values of loan collateral); and (h) other developments or changes in our business that the Company does not expect. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to the Company are expressly qualified in their entirety by the cautionary statements in this paragraph. The Company has no obligation, and do not intend, to update these forward-looking statements.
Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable
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Item 4. | CONTROLS AND PROCEDURES |
The Company’s management, under the supervision and with the participation of its Chief Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, the Chief 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 effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it filed under the Exchange Act.
In connection with the above evaluation of the effectiveness of the Company’s disclosure controls and procedures, no change in the Company’s internal control over financial reporting was identified that occurred during the most recent quarterly period and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Item 1. | Legal Proceedings |
None
Item 1A. | Risk Factors |
Not applicable
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
ISSUER REPURCHASES OF EQUITY SECURITIES
Period | (a) Total Number of Shares Purchased | (b) Average Price Paid Per Share (1) | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | (d) Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs (2) | |||||
Month #1 7/01/08 through 07/31/08 | 12,900 | $ | 7.78 | 12,900 | 385,837 | ||||
Month #2 08/01/08 through 08/31/08 | 65,800 | $ | 7.48 | 65,800 | 320,037 | ||||
Month #3 09/01/08 through 09/30/08 | 17,500 | $ | 7.10 | 17,500 | 302,537 | ||||
Total | 96,200 | $ | 7.45 | 96,200 | 302,537 |
(1) | Reflects weighted average price paid per share. |
(2) | On June 27, 2008, the Company announced that its Board of Directors had authorized the repurchase of up to 398,737 shares of the Company’s outstanding common stock during the following year in the open market, in block purchases, or in solicited or unsolicited privately negotiated transactions, in accordance with the SEC’s rules and subject to factors such as market price, the Company’s operating results and available cash, general economic and market conditions, and other conditions. In conjunction with the Board’s authorization, the Company entered into a stock trading plan in accordance with guidelines specified under Rule 10b5-1 of the Securities and Exchange Act of 1934. The Board’s actions approving share repurchases did not obligate the Company to acquire any particular amount of shares, and purchases could be suspended or discontinued at any time at the Company’s discretion. Although the Board’s action authorizing the Company to repurchase shares remains in effect, during September 2008, the Company suspended the stock purchase plan. |
Item 3. | Defaults Upon Senior Securities. |
None
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Item 4. | Submission of Matters to a Vote of Security Holders |
None
Item 5. | Other Information |
None
Item 6. | Exhibits |
The following exhibits are being furnished or filed with this report.
10.01 | Employment Agreement between Bank of the Carolinas and Michael D. Larrowe (filed herewith) | |
31.01 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
31.02 | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
32.01 | Certification of our Chief Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith) |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
BANK OF THE CAROLINAS CORPORATION
Date: November 14, 2008 | By: | /s/ Robert E. Marziano | ||
Robert E. Marziano | ||||
President and Chief Executive Officer | ||||
Date: November 14, 2008 | By: | /s/ Michelle L. Clodfelter | ||
Michelle L. Clodfelter | ||||
Vice President and Principal Financial Officer |
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Exhibit | Description | |
10.01 | Employment Agreement between Bank of the Carolinas and Michael D. Larrowe (filed herewith) | |
31.01 | Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
31.02 | Certification of our Principal Financial Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
32.01 | Certifications of our Chief Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith) |
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