Beach First National Bancshares, Inc.
Notes to Consolidated Condensed Financial Statements (Unaudited)
1. Basis of Presentation
The accompanying consolidated condensed financial statements for Beach First National Bancshares, Inc. (“Company”) were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for fair presentation of the interim consolidated financial statements have been included. The results of operations for the three month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the entire year. These consolidated financial statements do not include all disclosures required by generally accepted accounting principles and should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the year ended December 31, 2006.
2. Principles of Consolidation
The accompanying consolidated condensed financial statements include the accounts of the Company and its subsidiaries, Beach First National Bank and BFNM Building, LLC (“LLC”) (See No. 4 “Investment in LLC” below). The Company also owns two grantor trusts, Beach First National Trust I and Beach First National Trust II. All significant inter-company items and transactions have been eliminated in consolidation. In accordance with current accounting guidance, the financial statements of the trusts have not been included in the Company’s financial statements.
3. Earnings Per Share
The Company calculates earnings per share in accordance with Statement of Financial Accounting Standard No. 128, “Earnings Per Share” (“SFAS 128”). SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities, or contingent stock agreements if those securities trade in a public market.
This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Company’s stock option plan is reflected in diluted earnings per share by application of the treasury stock method.
RECONCILIATION OF THE NUMERATORS AND DENOMINATORS OF THE BASIC AND DILUTED EPS COMPUTATIONS:
| | For the Three Months Ended | | For the Year Ended | |
| | 2007 | | 2006 | | 2006 | |
Basic earnings per share: | | | | | | | |
Net income available to common shareholders | | $ | 1,612,384 | | $ | 1,211,807 | | $ | 6,195,728 | |
| | | | | | | |
Average common shares outstanding – basic | | 4,769,102 | | 4,758,162 | | 4,764,072 | |
| | | | | | | |
Basic earnings per share | | $ | 0.34 | | $ | 0.26 | | $ | 1.30 | |
| | | | | | | |
Diluted earnings per share: | | | | | | | |
Net income available to common shareholders | | $ | 1,612,384 | | $ | 1,211,807 | | $ | 6,195,728 | |
| | | | | | | |
Average common shares outstanding – basic | | 4,769,102 | | 4,758,162 | | 4,764,072 | |
| | | | | | | |
Incremental shares from assumed conversion of stock options | | 157,701 | | 106,458 | | 110,490 | |
| | | | | | | |
Average common shares outstanding – diluted | | 4,926,803 | | 4,864,620 | | 4,874,562 | |
| | | | | | | |
Diluted earnings per share | | $ | 0.33 | | $ | 0.25 | | $ | 1.27 | |
6
4. Investment in LLC
The LLC is in partnership with our legal counsel, Nelson Mullins Riley & Scarborough LLP, for purposes of acquiring a parcel of land and constructing an office building on the property. The Company owns two-thirds of the LLC and Nelson Mullins Riley & Scarborough owns the remaining one-third. The building is a three-story, 46,066 square foot office building located on 3.5 acres at the southwest corner of Robert Grissom Parkway and 38th Avenue North in Myrtle Beach, South Carolina. The Company moved its main office to this location in December 2006. Nelson Mullins Riley & Scarborough LLP also relocated its Myrtle Beach legal office to the building in December 2006. The LLC purchased the land for approximately $1.8 million and financed the construction project through a third-party lender with each of the owners being responsible for their respective interests in the project. The total land and construction project cost approximately $7.0 million, exclusive of tenant improvements. The Company leases two-thirds of the building (approximately 30,000 square feet) from the LLC. Because the Company only occupies approximately 12,500 square feet of space, it intends to lease the other 17,500 square feet of its portion to outside tenants. Nelson Mullins Riley & Scarborough also leases one-third of the building from the LLC. As of March 31, 2007, 4,700 square feet of the 17,500 available have been leased.
Upon completion of construction, the construction financing note from the third-party lender was converted to a term loan payable by the LLC to the third-party bank and is secured by the building. The loan requires 107 installments of principal and interest based on a fifteen year amortization, with all remaining principal and interest due on June 15, 2015. The interest rate is variable based on one-month LIBOR plus 1.40%. The outstanding balance on the loan at March 31, 2007 is $7,133,561 and is shown as other borrowings in the accompanying balance sheet.
5. Interest Rate SWAP - Derivative Financial Instrument
The LLC entered into an interest rate swap agreement as a risk management tool to hedge the interest rate risk associated with the variable rate building loan discussed above. This swap instrument is a derivative financial instrument designated as a cash flow hedge and is accounted for in accordance with the provisions of Statement of Financial Accounting Standard No. 133 (“SFAS 133”). Under the swap, the LLC pays a fixed rate of 4.62% and receives interest payments that vary based on LIBOR. Through the swap, the LLC has converted the building loan to a fixed effective rate of 6.02%.
In accordance with SFAS 133, the LLC has formally documented the relationship between the building loan and the swap, as well as the risk-management objective and strategy for undertaking the hedge transaction. In connection with this process, the LLC has determined that the swap is highly effective as a cash flow hedge and the entire fair value of the swap was initially recorded in other comprehensive income. Under SFAS 133, any material ineffectiveness must be reclassified to earnings. During the formal documentation process, the LLC also determined that no hedge ineffectiveness is anticipated because the terms of the swap so closely match the terms of the building loan.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiary, Beach First National Bank, during the periods included in the accompanying financial statements. This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.
This report contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “may,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission, including, without limitation:
· significant increases in competitive pressure in the banking and financial services industries;
· changes in the interest rate environment which could reduce anticipated or actual margins;
7
· changes in political conditions or the legislative or regulatory environment;
· general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;
· changes occurring in business conditions and inflation;
· changes in management;
· changes in technology;
· changes in deposit flows;
· the level of allowance for loan loss;
· the rate of delinquencies and amounts of charge-offs;
· the rates of loan growth;
· adverse changes in asset quality and resulting credit risk-related losses and expenses;
· changes in monetary and tax policies;
· loss of consumer confidence and economic disruptions resulting from terrorist activities;
· changes in the securities markets; and
· other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our consolidated financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2006 as filed on our Form 10-K.
Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates. These differences could have a material impact on our carrying values of 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 judgment 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 subsection entitled “Allowance for Possible Loan Losses” below for a more complete discussion of our processes and methodology for determining our allowance for loan losses.
Overview
The following discussion describes our results of operations for the quarter ended March 31, 2007 as compared to the quarter ended March 31, 2006, and also analyzes our financial condition as of March 31, 2007 as compared to December 31, 2006. Like most community banks, we derive most 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. 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.
Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.
8
In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.
The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.
Results of Operations
Earnings Review
Our net income was $1,612,384, or $0.33 diluted net income per common share, for the three months ended March 31, 2007 as compared to $1,211,807, or $0.25 diluted net income per common share, for the same period in 2006, and was $6,195,728, or $1.27 diluted net income per common share, for the year ended December 31, 2006. The increase in net income reflects our continued growth, with average earning assets increasing to $506.4 million during the first three months of 2007 from $398.5 million during the same period of 2006. The return on average assets for the three month period ended March 31, 2007 was 1.21% as compared to 1.17% for the same period in 2006, and was 1.33% for the year ended December 31, 2006. The return on average equity was 14.04% for the three month period ended March 31, 2007 versus 12.02% for the same period in 2006, and was 14.53% for the year ended December 31, 2006.
Net Interest Income
Our primary source of revenue is net interest income, which represents the difference between the income on interest-earning assets and expense on interest-bearing liabilities. During the first three months of 2007, net interest income increased 26.3% to $5,481,746 from $4,340,299 for the same period of 2006 and was $20.5 million for the year ended December 31, 2006. The growth in net interest income for the first three months of 2007 resulted from an increase of $3,139,903 in interest income, partially offset by an increase in interest expense of $1,998,456. Our level of net interest income is determined by the level of our earning assets and the management of our net interest margin. The continued growth of our loan portfolio and the increases in the prime rate are the primary drivers of the increase in net interest income. Average total loans increased from $333.8 million in the first three months of 2006 to $428.5 million in the same period in 2007. Average total loans increased $56.0 million from $372.8 million for the year ended December 31, 2006 as compared to $428.5 million for the three months ended March 31, 2007. In addition, average securities increased to $72.1 million in the first three months of 2007 compared to $51.0 million for the first three months of 2006, and increased $11.9 million from $60.2 million for the year ended December 31, 2006. Net interest spread, the difference between the rate we earn on interest-earning assets and the rate we pay on interest-bearing liabilities, was 3.84% in the first three months of 2007 compared to 3.88% during the same period of 2006, and 4.06% for the year ended December 31, 2006. The net interest margin was 4.39% for the three month period ended March 31, 2007 compared to 4.42% for the same period of 2006, and 4.62% for the year ended December 31, 2006. The decline in the net interest spread and the net interest margin are due to the rising interest rate environment and the increased competition in our markets for deposits.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. The provision for loan losses was $351,200 for the first three months of 2007, $522,200 for the same period of 2006, and $2.2 million for the year ended December 31, 2006. The decrease in the provision was the result of management’s assessment of the adequacy of the reserve for possible loan losses given the size, mix, and quality of the current loan portfolio. Please see the discussion below under “Allowance for Possible Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.
Noninterest Income
Noninterest income increased to $2,334,101 for the three months ended March 31, 2007, up 649.3% from $311,520 for the same period in 2006. This increase in noninterest income is related to the income from our mortgage operations that we added in June of 2006. Noninterest income was $3,990,349 for the year ended December 31, 2006.
9
Prior to the formation of our mortgage operations, income from mortgage operations represented referral fees on mortgage loans where the bank was acting as an agent for a third party originator. With the formation of the company’s mortgage operations during the second quarter of 2006, all sources of income from this division are included in income from mortgage operations. The four key components of the revenue are loan referral fees, document preparation fees for both retail and wholesale loans which includes origination fees, servicing release premiums for both retail and wholesale loans, and the net gains on the sale of mortgage loans. The respective amounts for the three month period ended March 31, 2007 are $136,795, $552,884, $634,452, and $424,971. With these amounts included, mortgage operations income increased to $1,773,197 at March 31, 2007 as compared to $66,385 at March 31, 2006. Changes in federal law regarding the oversight of mortgage brokers and lenders could increase our costs of operations and affect our mortgage origination volume which could negatively impact our noninterest income in the future. Additional information on the expenses associated with the mortgage division can be found below in the “Noninterest Expense” section.
Noninterest Expense
Total noninterest expense increased 121.6% to $4,958,654 for the three month period ended March 31, 2007 from $2,237,793 for the same period in 2006 and was $12,575,657 for the year ended December 31, 2006. Salary and wages and employee benefits expense increased $1,475,547 to $2,733,338 during the three month period ended March 31, 2007 compared to the same period in 2006. Of the increase, $1,010,443 is directly related to salary and wages for the mortgage operations. Another $128,577 is directly related to employee benefits for the mortgage operations employees. All other increases are the result of personnel additions, normal compensation adjustments, and higher costs associated with group benefits.
We had 144 full-time equivalent employees at March 31, 2007, an increase of 76, of which 66 were for the mortgage operations, as compared to the same period in 2006. Staffing increases were primarily due to the addition of the mortgage operations and overall growth.
For the three months ended March 31, 2007, advertising and public relations costs increased $60,091 to $143,606 as compared to the same period in 2006. Advertising and public relations costs were $387,056 for the year ended December 31, 2006. These expenses continue to be a major expense item as we develop our presence in the new markets. This increase was related primarily to special promotions, such as newspaper advertisements, to attract deposits in all markets, as well as, contracting with a professional advertising agency. Professional fees increased $50,467 to $127,989 for the three month period ended March 31, 2007 compared to the same period in 2006, and were $311,627 for the year ended December 31, 2006. These fees continue to increase due to our growth, the regulatory fees associated with such growth, and the escalating cost of accounting, auditing, and legal services for a public company. We expect our expense for Sarbanes Oxley compliance to increase in 2007 as we formally prepare to meet the requirements of these comprehensive regulations.
Occupancy expenses increased $259,134 to $448,618 during the three months ended March 31, 2007 compared to the same period in 2006. This increase is related to the addition of the facilities associated with the mortgage operations, as well as, the expense related to the new corporate headquarters. This increase was also the result of increases on lease payments for most locations. As we continue to expand, we expect that occupancy costs will continue to increase. Occupancy expenses were 1,065,091 for the year ended December 31, 2006.
Data processing fees increased during the three months ended March 31, 2007 to $171,457 from $116,969 during the same period in 2006, and were $547,747 for the year ended December 31, 2006. Data processing costs are primarily related to the volume of loan and deposit accounts and associated transaction activity. Strong security of data processing and related systems is paramount to our operation. We expanded the security features of our internet banking product, in addition to upgrading all security measures for internal and external systems. We believe our data processing costs are consistent with our expansion.
Other operating expenses increased 173.3% to $966,725 during the three months ended March 31, 2007 compared to $353,671 during the same period in 2006, and $2,461,594 for the year ended December 31, 2006. These increases are primarily the result of increased operating expenses related to the growth of the company, along with other expenses associated with the expansion of loans and deposits. The increase in other operating expenses was primarily due to increase in credit and collection expenses, merchant expenses, higher travel and lodging expenses, furniture and equipment expenses, and NASDAQ fees.
Specifically, credit and collection expenses increased $400,922, merchant expenses increased $104,702, due to the expansion of merchant related activity, travel expenses increased $31,570, furniture and equipment increased $20,880,
10
NASDAQ fees increased $15,270 collectively totaling $573,343, or 90% of the total increase of $634,493. The increase in credit and collection expenses is primarily due to investor funding fees and fees paid to brokers for mortgage loans.
The following table presents a comparison of other operating expenses by category with a balance over $10,000.
Other Operating Expenses
| | For the three months ended | | For the year
ended | |
| | March 31, 2007 | | March 31, 2006 | | December, 31
2006 | |
Telephone | | 31,733 | | 17,091 | | 84,081 | |
Postage and freight | | 22,561 | | 13,025 | | 73,884 | |
Armored Car | | 19,836 | | 19,449 | | 86,482 | |
Credit and collection | | 425,863 | | 24,941 | | 446,017 | |
Dues and subscriptions | | 33,959 | | 27,816 | | 117,976 | |
Travel | | 75,952 | | 44,382 | | 189,603 | |
Entertainment | | 26,130 | | 14,124 | | 106,137 | |
FDIC insurance | | 11,682 | | 8,843 | | 41,037 | |
Other insurance | | 12,570 | | 10,736 | | 44,898 | |
Debit/ATM | | 21,931 | | 19,433 | | 77,871 | |
Merchant | | 111,829 | | 7,127 | | 167,866 | |
Software maintenance | | 15,538 | | 11,899 | | 61,610 | |
Director Supplemental Retirement Plan | | 24,640 | | 47,946 | | 137,289 | |
NASDAQ | | 21,395 | | 6,125 | | 24,500 | |
Furniture and equipment | | 65,652 | | 44,772 | | 427,015 | |
Total | | 921,271 | | 317,709 | | 2,086,266 | |
Balance Sheet Review
General
We had total assets of $552.8 million at March 31, 2007, an increase of 30.0% from $426.7 million at March 31, 2006, and an increase of 6.3% from $520.2 million at December 31, 2006. Total assets consisted primarily of $441.8 million in net loans including mortgage loans held for sale, $72.8 million in investments, $4.7 million in federal funds sold and short-term investments, and $7.7 million in cash and due from banks. Our liabilities at March 31, 2007 totaled $505.5 million, consisting primarily of $445.1 million in deposits, $37.5 million in FHLB advances, and $10.3 million of junior subordinated debentures. Our total deposits increased to $445.1 million at March 31, 2007, up 31.7% from $337.9 million at March 31, 2006, and up 6.9% from $416.4 million at December 31, 2006. Shareholder’s equity increased $7.2 million to $47.3 million at March 31, 2007 from $40.1 million, and increased $1.8 million from $45.5 million at December 31, 2006.
Investment Securities
Total investment securities averaged $72.1 million during the first three months of 2007 and totaled $72.8 million at March 31, 2007. Total investment securities averaged $51.0 million during the first three months of 2006 and totaled $55.5 million at March 31, 2006. Total investment securities averaged $60.2 million for the year ended December 31, 2006 and totaled $71.9 million at December 31, 2006. At March 31, 2007, our total investment securities portfolio had a book value of $70.1 million and a fair market value of $69.2 million for an unrealized net loss of $875,939. We primarily invest in U.S. Government Sponsored Enterprises and Federal Agency securities.
At March 31, 2007, short-term investments totaled $4.7 million, compared to $6.1 million at March 31, 2006 and $14.0 million at December 31, 2006. These funds are one source of our bank’s liquidity and are generally invested in an earning capacity on an overnight or short-term basis. This decline in short-term investments is primarily due to higher loan demand during this quarter and the competitive market for deposits.
11
Loans
Since loans typically provide higher yields than other types of earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. As of March 31, 2007, loans represented 84.6% of average earning assets as compared to 83.8% at March 31, 2006, and 84.2% at December 31, 2006. At March 31, 2007, net loans (gross loans less the allowance for loan losses and deferred loan fees) totaled $441.8 million, an increase of $97.5 million, or 28.3%, from March 31, 2006 and an increase of $36.5 million, or 9.0% from December 31, 2006. Average gross loans increased to $428.5 million with a yield of 9.20% during the first three months of 2007 from $333.8 million with a yield of 8.29% during the same period in 2006. Average gross loans were $372.8 million with a yield of 8.88% at December 31, 2006. The increase in yield on loans during these periods is due to the increasing interest rate environment in 2006 and 2007. The interest rates charged on loans vary with the degree of risk and the maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulations also influence interest rates.
The following table shows the composition of the loan portfolio by category at March 31, 2007, March 31, 2006, and December 31, 2006.
| | Composition of Loan Portfolio | |
| | March 31, 2007 | | March 31, 2006 | | December 31, 2006 | |
| | Amount | | Percent of
Total | | Amount | | Percent of
Total | | Amount | | Percent
of Total | |
Commercial | | $ | 42,476,492 | | 9.5 | % | $ | 44,178,927 | | 12.7 | % | 43,974,792 | | 10.7 | % |
Real estate — construction | | 39,645,111 | | 8.8 | % | 35,068,148 | | 10.0 | % | 44,032,693 | | 10.7 | % |
Real estate — mortgage (1) | | 357,957,716 | | 79.9 | % | 262,940,150 | | 75.2 | % | 315,689,304 | | 76.7 | % |
Consumer | | 8,234,898 | | 1.8 | % | 7,318,855 | | 2.1 | % | 7,784,157 | | 1.9 | % |
Loans, gross | | 448,314,217 | | 100.0 | % | 349,506,080 | | 100.0 | % | 411,480,946 | | 100.0 | % |
Unearned loan fees and costs, net | | (319,487 | ) | | | (317,004 | ) | | | (266,090 | ) | | |
Allowance for possible loan losses | | (6,172,091 | ) | | | (4,882,948 | ) | | | (5,888,052 | ) | | |
Loans, net | | $ | 441,822,639 | | | | $ | 344,306,128 | | | | $ | 405,326,804 | | | |
| | | | | | | | | | | | | | | | |
(1) Includes mortgage loans held for sale
The principal component of our loan portfolio at March 31, 2007, March 31, 2006, and December 31, 2006 was mortgage loans, which represented 79.9%, 75.2% and 76.7%, respectively. In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than loans for construction purposes, secured by real estate, regardless of the purpose of the loan. We follow the common practice of financial institutions in our market area of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. The collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan portfolio component. Generally, we limit the loan-to-value ratio to 80%. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentrations of collateral.
Allowance for Possible Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of income. 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. 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. The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans and may be adjusted for other risk factors. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment’s range of probable loss levels. Certain nonperforming loans are individually assessed for impairment under SFAS No. 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations.
12
The general allocation also includes a component for probable losses inherent in the portfolio, based on management’s analysis that is not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management’s evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors include the current general economic and business conditions; geographic, collateral, or other concentrations of credit; system, procedural, policy, or underwriting changes; experience of the lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations.
Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.
The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. In addition, the allowance is subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. Such regulatory agencies could require us to adjust the allowance based on information available to them at the time of their examination.
At March 31, 2007, the allowance for loan losses was $6.2 million, or 1.38% of total outstanding loans, compared to an allowance for loan losses of $4.9 million, or 1.40% of total outstanding loans, at March 31, 2007 and $5.9 million, or 1.43% of total outstanding loans, at December 31, 2006. During the first three months of 2006, we had one charge-off totaling $18,857. During the same period in 2006, we had one charge-off totaling $5,496. We had non-performing loans totaling $1.1 million, $1.9 million, and $1.6 million at March 31, 2007, March 31, 2006, and December 31, 2006, respectively. While there can be no assurances, we do not expect significant losses relating to these nonperforming loans because we believe that the collateral supporting these loans is largely sufficient to cover the outstanding loan balance. The following table sets forth certain information with respect to our allowance for loan losses and the composition of charge-offs and recoveries for the three months ended March 31, 2007, March 31, 2006, and December 31, 2006.
13
Allowance for Loan Losses
| | Three months ended March 31, | | December 31, | |
| | 2007 | | 2006 | | 2006 | |
| | | | | | | |
Average total loans outstanding | | $ | 428,506,579 | | $ | 333,815,888 | | $ | 372,791,961 | |
Total loans outstanding at period end | | 447,994,730 | | 349,189,076 | | 411,214,857 | |
Total nonperforming loans | | 1,088,422 | | 1,899,166 | | 1,625,511 | |
| | | | | | | |
Beginning balance of allowance | | $ | 5,888,052 | | $ | 4,364,287 | | $ | 4,364,287 | |
| | | | | | | |
Loans charged off | | (18,857 | ) | (5,496 | ) | (792,188 | ) |
Total recoveries | | 1,696 | | 1,957 | | 141,553 | |
Net loans charged off | | (17,161 | ) | (3,539 | ) | (650,635 | ) |
| | | | | | | |
Provision for loan losses | | 301,200 | | 522,200 | | 2,174,400 | |
Balance at period end | | $ | 6,172,091 | | $ | 4,882,948 | | $ | 5,888,052 | |
| | | | | | | |
Net charge-offs to average total loans | | 0.004 | % | 0.001 | % | 0.17 | % |
Allowance as a percent of total loans | | 1.38 | % | 1.40 | % | 1.43 | % |
Nonperforming loans as a percentage of total loans | | 0.24 | % | 0.54 | % | 0.40 | % |
Nonperforming loans as a percentage of allowance | | 17.63 | % | 38.89 | % | 27.59 | % |
The following table sets forth the breakdown of the allowance for loan losses by loan category and the percentage of loans in each category to gross loans as of March 31, 2007. We believe that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of further losses and does not restrict the use of the allowance to absorb losses in any category.
As of March 31, 2007
Commercial | | $ | 1,091,799 | | 9.47 | % |
Real estate - construction | | 556,341 | | 8.84 | |
Real estate – mortgage | | 3,859,367 | | 79.85 | |
Consumer | | 133,655 | | 1.84 | |
Unallocated. | | 530,929 | | — | |
Total allowance for loan losses | | $ | 6,172,091 | | 100.0 | % |
Nonperforming Assets
We discontinue accrual of interest on a loan when we conclude it is doubtful that we will be able to collect interest from the borrower. We reach this conclusion by taking into account factors such as the borrower’s financial condition, economic and business conditions, and the results of our previous collection efforts. Generally, we will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. When we place a loan in nonaccrual status, we reverse all interest which has been accrued on the loan but remains unpaid and we deduct this interest from earnings as a reduction of reported interest income. We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain. At March 31, 2007, there were no loans accruing interest which were 90 days or more past due and we had no restructured loans.
Deposits
Average total deposits were $424.8 million for the three months ended March 31, 2007, up 30.1% from $326.5 million during the same period in 2006 and up 15.7% from $367.1 million at December 31, 2006. Average interest-bearing deposits were $390.8 million for three months ended March 31, 2007, up 31.8% from $296.5 million during the same period of 2006 and up 17.1% from $333.6 million at December 31, 2006.
14
The following table sets forth our deposits by category as of March 31, 2007, March 31, 2006, and December 31, 2006.
Deposits
| | March 31, 2007
Percent of | | March 31, 2006
Percent of | | December 31, 2006
Percent of | |
| | Amount | | Deposits | | Amount | | Deposits | | Amount | | Deposits | |
| | | | | | | | | | | | | |
Demand deposit accounts | | $ | 35,863,807 | | 8.1 | % | $ | 28,884,753 | | 8.5 | % | $ | 37,194,469 | | 8.9 | % |
Interest bearing checking accounts | | 24,161,644 | | 5.4 | % | 23,135,091 | | 6.9 | % | 21,336,836 | | 5.1 | % |
Money market accounts | | 114,199,711 | | 25.7 | % | 69,333,354 | | 20.5 | % | 103,056,865 | | 24.8 | % |
Savings accounts | | 3,449,946 | | 0.6 | % | 3,268,256 | | 1.0 | % | 3,303,763 | | 0.8 | % |
Time deposits less than $100,000 | | 155,153,653 | | 34.8 | % | 115,576,388 | | 34.2 | % | 154,191,755 | | 37.0 | % |
Time deposits of $100,000 or over | | 113,228,262 | | 25.4 | % | 97,672,168 | | 28.9 | % | 97,273,441 | | 23.4 | % |
Total deposits | | $ | 445,057,023 | | 100.0 | % | $ | 337,870,010 | | 100.0 | % | $ | 416,357,129 | | 100.0 | % |
Deposit growth was attributable to internal growth and the generation of new deposit accounts due primarily to special promotions and increased advertising. Demand deposit accounts increased as a result of an expanded focus on demand deposit accounts. Interest bearing checking accounts increased primarily due to a change mandated by the South Carolina Bar Association requiring that all lawyer trust accounts be interest bearing. This created a shift from demand deposit accounts to interest bearing checking accounts.
Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $331.8 million at March 31, 2007 compared to $240.2 million at March 31, 2006 and $319.1 million at December 31, 2006. Our brokered deposits were $29.6 million as of March 31, 2007, $29.6 million as of March 31, 2006, and $34.6 million as of December 31, 2006. We expect a stable base of deposits to be our primary source of funding to meet both our short-term and long-term liquidity needs. Core deposits as a percentage of total deposits were 74.6% at March 31, 2007, 71.1% at March 31, 2006, and 76.6% at December 31, 2006. Our loan-to-deposit ratio was 99.3% at March 31, 2007 versus 103.4% at March 31, 2006 and 98.8% at December 31, 2006. The average loan-to-deposit ratio was 101.0% during the first three months of 2007, 100.0% during the same period of 2006 and 102.0% at December 31, 2006.
Advances from Federal Home Loan Bank
In addition to deposits, we obtained funds from the FHLB to help fund our loan growth. Average borrowings from the FHLB were $38.1 million during the first quarter of 2007 and totaled $37.5 million at March 31, 2007. The following table reflects the current borrowing terms.
FHLB Description | | Balance | | Current Rate | | Maturity Date | |
Fixed Rate Hybrid | | $ | 5,000,000 | | 4.76 | % | 10/21/2010 | |
Convertible | | 7,500,000 | | 4.51 | % | 11/29/2010 | |
Convertible | | 5,000,000 | | 3.68 | % | 07/13/2015 | |
Convertible | | 5,000,000 | | 4.06 | % | 09/29/2015 | |
Convertible | | 5,000,000 | | 4.16 | % | 03/13/2017 | |
Prime Based Advance | | 10,000,000 | | 5.41 | % | 09/19/2011 | |
| | $ | 37,500,000 | | | | | |
Junior Subordinated Debentures
On May 27, 2004 we raised $5.0 million and on March 30, 2005 we raised an additional $5.0 million through the issuance and sale of floating rate trust preferred securities through BFNB Trust I and BFNB Trust II (the “Trusts”). These trust preferred securities are reported on our consolidated balance sheet as junior subordinated debentures. The Trusts loaned these proceeds to our holding company to use for general corporate purposes. Trust preferred securities currently qualify as Tier 1 capital under Federal Reserve Board guidelines.
Debt issuance costs, net of accumulated amortiza tion, from the junior subordinated debentures totaled $39,745 at March 31, 2007, $44,534 at March 31, 2006, and $41,067 at December 31, 2006. These costs are included in other assets
15
on our consolidated balance sheet. Amortization of debt issuance costs from trust preferred debt totaled $834 for the three month period ended March 31, 2007 and $836 for the three month period ended March 31, 2006, and $4,588 for the year ended December 31, 2006. These costs are reported in other noninterest expense on the consolidated statement of income.
The trust preferred securities accrue and pay distributions annually at a rate per annum equal to the three month LIBOR plus 270 and 190 basis points, respectively, which was 8.060% and 7.255% at March 31, 2007. The distribution rate payable on these securities is cumulative and payable quarterly in arrears. We have the right, subject to events of default, to defer payments of interest on the trust preferred se curities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity dates of May 27, 2034 and March 30, 2035, respectively. We have no current intention to exercise our right to defer payments of interest on the trust preferred securities. We have the right to redeem the trust preferred securities, in whole or in part, on or after May 27, 2009 and March 30, 2010, respectively. We may also redeem the trust preferred securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium.
Capital Resources
The Federal Reserve Board and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio. At both the holding company and bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. To be considered “well-capitalized,” we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.
In October 2006, the Company announced a 3-for-2 stock split effected in the form of a 50% stock dividend to shareholders of record on December 1, 2006. The dividend was paid on December 21, 2006. All earnings per share amounts for all periods have been adjusted to reflect this 3-for-2 split.
At March 31, 2007, our total shareholders’ equity was $47.3 million ($47.8 million at the bank level). At March 31, 2007, our Tier 1 capital ratio was 13.0% (11.4% at the bank level), our total risk-based capital ratio was 14.4% (12.7% at the bank level), and our Tier 1 leverage ratio was 10.9% (9.26% at the bank level). The bank was considered “well capitalized” and the holding company met or exceeded its applicable regulatory capital requirements.
Liquidity Management
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.
Our primary sources of liquidity are deposits, scheduled repayments on our loans, and interest on and maturities of our investments. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits. All of our securities have been classified as available for sale. Occasionally, we might sell investment securities in connection with the management of our interest sensitivity gap or to manage cash availability. We may also utilize our cash and due from banks, security repurchase agreements, and federal funds sold to meet liquidity requirements as needed. In addition, we have the ability, on a short-term basis, to purchase federal funds from other financial institutions. Presently, we have made arrangements with commercial banks for short-term unsecured advances of up to $21.4 million. We maintain a secured line of credit in the amount of $10.0 million with our primary correspondent. We also have a line of credit with the FHLB to borrow up to 80% of our 1 to 4 family loans, resulting in an availability of funds of $12.4 million at March 31, 2007. The FHLB has approved borrowings up to 15% of the bank’s total assets less
16
advances outstanding. The borrowings are available by pledging additional collateral and purchasing FHLB stock. At March 31, 2007, we had borrowed $37.5 million on this line. We believe that our existing stable base of core deposits, our bond portfolio, borrowings from the FHLB, and short-term federal funds lines will enable us to successfully meet our liquidity needs for the next 12 months.
Interest Rate Sensitivity
A significant portion of our assets and liabilities are monetary in nature, and consequently they are very sensitive to changes in interest rates. This interest rate risk is our primary market risk exposure, and it can have a significant effect on our net interest income and cash flows. We review our exposure to market risk on a regular basis, and we manage the pricing and maturity of our assets and liabilities to diminish the potential adverse impact that changes in interest rates could have on our net interest income.
We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities, and it is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets. We generally would benefit from increasing market interest rates when we have an asset-sensitive, or a positive, interest rate gap and we would generally benefit from decreasing market interest rates when we have liability-sensitive, or a negative, interest rate gap. When measured on a “gap” basis, we are liability-sensitive over the cumulative one-year time frame and asset-sensitive after one year as of March 31, 2007. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but we believe those rates are significantly less interest-sensitive than market-based rates such as those paid on noncore deposits.
Net interest income is also affected by other significant factors, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities. We perform asset/liability modeling to assess the impact of varying interest rates and the impact that balance sheet mix assumptions will have on net interest income. We attempt to manage interest rate sensitivity by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities that reprice in the same time interval helps us to hedge risks and minimize the impact on net interest income of rising or falling interest rates. We evaluate interest sensitivity risk and then formulate guidelines regarding asset generation and repricing, funding sources and pricing, and off-balance sheet commitments in order to decrease interest rate sensitivity risk.
Off Balance Sheet Risk
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. 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, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.
At March 31, 2007, the bank had issued commitments to extend credit of $38.3 million through various types of lending arrangements, of which $33.0 million was at variable rates. The commitments expire over the next 18 months. Past experience indicates that many of these commitments to extend credit will expire unused. We believe that we have adequate sources of liquidity to fund commitments that are drawn upon by the borrowers.
In addition to commitments to extend credit, we also issue standby letters of credit which are assurances to a third party that they will not suffer a loss if our customer fails to meet its contractual obligation to the third party. Standby letters of credit totaled $20.2 million at March 31, 2007. Past experience indicates that many of these standby letters of credit will expire unused. However, through our various sources of liquidity, we believe that we will have the necessary resources to meet these obligations should the need arise.
17
Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments or significantly impact earnings.
Impact of Inflation
The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.
Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.
Recently Issued Accounting Standards
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by us.
In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140.” This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This Statement resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” FAS 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest only-strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after January 1, 2007. The Company does not believe that the adoption of SFAS No. 155 will have a material impact on its financial position, results of operations or cash flows.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140.” This Statement amends FASB No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits an entity to choose its subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. The required adoption date for SFAS No. 156 is January 1, 2007. The Company does not believe the adoption of SFAS No. 156 will have a material impact on its financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises’ financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in
18
interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not believe that FIN 48 will have a material impact on its financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. SFAS 157 is effective for the Company on January 1, 2008 and will not impact the Company’s accounting measurements but it is expected to result in some additional disclosures.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date — the date at which the benefit obligation and plan assets are measured — is required to be the company’s fiscal year end. SFAS 158 is effective for publicly held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan. Therefore, SFAS 158 will not impact the Company’s financial condition or results of operations.
In September, 2006, The FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF 06-4 “Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. EITF 06-4 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion—1967”. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. Entities should recognize the effects of applying this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Company is currently analyzing the effect of adoption of EITF 06-4 on its financial position, results of operations and cash flows.
In September 2006, the FASB ratified the consensus reached related to EITF 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2007. The Company is currently analyzing the effect of adoption of EITF 06-5) on its financial position, results of operations and cash flows.
In December 2006, the FASB issued a Staff Position (“FSP”) on EITF 00-19-2, “Accounting for Registration Payment Arrangements (“FSP EITF 00-19-2”). This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with SFAS No. 5, “Accounting for Contingencies.” If the transfer of consideration under a registration payment arrangement is probable and can be reasonably estimated at inception, the contingent liability under the registration payment arrangement is included in the allocation of proceeds from the related financing transaction (or recorded subsequent to the inception of a prior financing transaction) using the measurement guidance in SFAS No. 5. This FSP is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified subsequent to the issuance of the FSP. For prior arrangements, the FSP is effective for financial statements issued for fiscal years beginning after December 15, 2006 and interim periods within those years. The Company does not believe the adoption of this FSP will have a material impact on its financial position, results of operations and cash flows.
19
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.” This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS 115, available-for-sale and held-to-maturity securities at the effective date are eligible for the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS 159 is effective for the Company on January 1, 2008. The Company is currently analyzing the fair value option that is permitted, but not required, under SFAS 159.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, deposit, and borrowing activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could potentially have a material effect on our financial condition and results of operations. The information contained in Item 2 in the section captioned “Interest Rate Sensitivity” is incorporated herein by reference. Other types of market risks, such as foreign currency risk and commodity price risk, do not arise in the normal course of our business activities.
The primary objective of asset and liability management is to manage interest rate risk and achieve reasonable stability in net interest income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate-sensitive earning assets and rate-sensitive interest-bearing liabilities. The relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate-sensitive assets and liabilities are those that can be repriced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the next twelve months. At March 31, 2007, on a cumulative basis through 12 months, rate-sensitive liabilities exceeded rate-sensitive assets by $70.4 million. This liability-sensitive position is largely attributable to short-term certificates of deposit, money market accounts and interest bearing checking accounts, which totaled $402.6 million at March 31, 2007.
20
Item 4T. Controls and Procedures.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of March 31, 2007. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
There are no material legal proceedings to which the company or any of its subsidiaries is a party or of which any of their property is the subject.
Item 1A. Risk Factors.
There were no material changes from the risk factors presented in our annual report on Form 10-K for the year ended December 31, 2006.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits.
Exhibit | | 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 Certifications |
21
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| BEACH FIRST NATIONAL BANCSHARES, INC. |
| | | |
| | | |
Date: | May 11, 2007 | | By: | /s/ Walter E. Standish, III | |
| | Walter E. Standish, III | |
| | President and Chief Executive Officer | |
| | | |
| | | |
Date: | May 11, 2007 | | By: | /s/ Richard N. Burch | |
| | Richard N. Burch |
| | Chief Financial and Principal Accounting Officer | |
22
INDEX TO EXHIBITS
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 Certifications |
23
