10-K/A 1 d730971d10ka.htm 10-K/A 10-K/A
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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K/A

Amendment No. 1

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

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 or organization)

 

(I.R.S. Employer

Identification No.)

135 Boxwood Village Drive

Mocksville, North Carolina 27028

(Address of principal executive offices, including Zip Code)

(336) 751-5755

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $5.00 par value per share

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    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

The aggregate market value of the voting and non-voting common equity held by nonaffiliates (computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity), as of the last business day of the registrant’s most recently completed second fiscal quarter was $2,221,000 (based on the closing price of such stock as of June 30, 2013).

On May 15, 2014, the number of outstanding shares of Registrant’s common stock was 3,895,840.

Documents Incorporated by Reference:

None

 

 

 


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EXPLANATORY NOTE

The purpose of this Amendment No. 1 to Bank of the Carolinas Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “Form 10-K”), as filed with the Securities and Exchange Commission on March 26, 2014, is to furnish amended consolidated financial statements and its footnotes as appropriate. This Amendment No. 1 to the Form 10-K continues to speak as of the original filing date of the Form 10-K and does not reflect events that may have occurred subsequent to the original filing date.

At December 31, 2013, the Company had a total deferred tax asset of $17.7 million. There was an established valuation allowance of $14.7 million at December 31, 2013. The balance of the deferred tax asset of $3.0 million related directly to the unrealized losses in investment securities.

As a result of a recent regulatory examination, the Company conducted an evaluation as to whether the $3.0 million deferred tax asset should also be fully reserved. The Company consulted with an accounting expert, who is familiar with the Company and its deferred tax asset, and concluded that the deferred tax asset should have been fully reserved at year end 2013. The Company’s external auditor concurred after reviewing the documentation.

Consequently, the Company is restating its financial statements for December 31, 2013 to reflect a full reserve of its deferred tax asset. The net effect is the Company’s total stockholders’ equity at year end was $3.0 million less than previously reported. In addition, the Company’s income statement now reflects income tax expense of $942,000 as of December 31, 2013. The income tax expense was related to the deferred tax liability on unrealized gains in investment securities. The changes in the market value throughout 2013 reduced these unrealized gains to unrealized losses and the deferred tax liability is adjusted appropriately through income tax expense.

The amount of the deferred tax asset that is available to offset future taxes has not changed and the Company’s ability to utilize the deferred tax asset has not changed. The restatement reduces pro forma book value and book value per share. Should the Company be able to demonstrate sustained profitability in the future, we expect to be able to recognize some or all of the deferred tax asset.

The Company and Bank’s leverage ratios were not adversely impacted as the deferred tax asset was disallowed for Tier 1 capital purposes.

To reflect the changes, the Company has restated the Form 10-K for 2013 and the Bank has also restated its December 2013 Consolidated Report of Condition and Income filed with the federal banking regulators.

 

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BANK OF THE CAROLINAS CORPORATION

FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013

TABLE OF CONTENTS

 

         Page
  PART I   

Item 1.

 

Business

  
  PART II   

Item 6.

 

Selected Financial Data

  

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

  

Item 8.

 

Financial Statements and Supplementary Data

  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  

Item 9A.

 

Controls and Procedures

  

Item 9B.

 

Other Information

  
  PART IV   

Item 15.

 

Exhibits, Financial Statement Schedules

  

 

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PART I

In this Report, the terms “we,” “us,” “our” and similar terms refer to Bank of the Carolinas Corporation separately and, as the context requires, on a consolidated basis with our banking subsidiary, Bank of the Carolinas. Bank of the Carolinas is sometimes referred to separately as the “Bank.”

 

ITEM 1. BUSINESS

General

Bank of the Carolinas Corporation (the “Company”) was formed in 2006 to serve as a holding company for Bank of the Carolinas (the “Bank”). The Company is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the bank holding company laws of North Carolina. The Company’s office is located at 135 Boxwood Village Drive, Mocksville, North Carolina 27028. The Company’s primary business activity consists of directing the activities of the Bank.

The Bank is incorporated under the laws of North Carolina and began operations on December 7, 1998 as a North Carolina chartered commercial bank. The Bank operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”). As a state chartered non-Federal Reserve member bank, the Bank is subject to examination and regulation by the FDIC and the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is further subject to certain regulations of the Federal Reserve. The business and regulation of the Bank are also subject to legislative changes from time to time. See Item 1. Description of Business—Supervision and Regulation.

The Bank’s primary market area is in the Piedmont region of North Carolina where we are engaged in general commercial banking primarily in Davie, Randolph, Rowan, Cabarrus, Davidson, and Forsyth Counties. The Bank’s main office is located at 135 Boxwood Village Drive in Mocksville, North Carolina. Our main office in Mocksville and our Advance office are located in Davie County. Our other offices are located in Asheboro (Randolph County), Landis (Rowan County), Harrisburg and Concord (Cabarrus County), Lexington (Davidson County), and Winston-Salem (Forsyth County).

Services

Our operations are primarily retail oriented and directed toward individuals and small- and medium-sized businesses located in our banking market. The majority of our deposits and loans are derived from customers in our banking market, but we also make loans and have deposit relationships in areas surrounding our immediate banking market. We also occasionally solicit and accept wholesale deposits. We offer a variety of commercial and consumer banking services, but our principal activities are the taking of demand and time deposits and the making of consumer and commercial loans. To a lesser extent, we also generate income from other fee-based products and services that we provide.

The Bank’s primary source of revenue is interest and fee income from its lending activities. These lending activities consist principally of originating commercial operating and working capital loans, residential mortgage loans, home equity lines of credit, other consumer loans and loans secured by commercial real estate. Interest and dividend income from investment activities generally provide the second largest source of income to the Bank.

Deposits are the primary source of the Bank’s funds for lending and other investment purposes. The Bank attracts both short-term and long-term deposits from the general public by offering a variety of accounts and rates. The Bank offers statement savings accounts, negotiable order of withdrawal accounts, money market demand accounts, non-interest-bearing accounts and fixed interest rate certificates with varying maturities. The Bank also utilizes alternative sources of funds such as borrowings from the Federal Home Loan Bank (the “FHLB”) of Atlanta, Georgia and other commercial banks.

The Bank’s deposits are obtained primarily from its primary market area. The Bank uses traditional marketing methods to attract new customers and deposits including print media advertising and direct mailings. Deposit flows are greatly influenced by economic conditions, the general level of interest rates, competition and other factors.

 

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Organization

The Bank is the sole banking subsidiary of the Company. A trust (Bank of the Carolinas Trust I) was formed as a subsidiary of the Company to facilitate the issuance of Trust Preferred Securities as a form of non-dilutive equity to supplement our capital.

The Bank formed an LLC (East Atlantic Properties, LLC) to manage our income producing assets transferred from our Other Real Estate Owned. BOTC, LLC, is a North Carolina limited liability company which serves as the trustee for the benefit of Bank of the Carolinas in connection with real estate deeds of trust. Both LLCs are consolidated into the Bank and are disregarded entities for tax purposes.

Lending Activities

General. We make a variety of types of consumer and commercial loans to individuals and small- and medium-sized businesses for various personal, business and agricultural purposes, including term and installment loans, commercial and equity lines of credit, and overdraft checking credit. For financial reporting purposes, our loan portfolio generally is divided into real estate loans (including home equity lines of credit), commercial loans, and consumer loans. We make credit card services available to our customers through a correspondent relationship. For an analysis of the components of our loan portfolio, see Table I. Analysis of Loan Portfolio in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Real Estate Secured Loans. Our real estate loan classifications include loans secured by real estate which are made to purchase, construct or improve residential or commercial real estate, for real estate development purposes, and for various other commercial and consumer purposes (whether or not those purposes are related to our real estate collateral).

Commercial real estate and construction loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In the case of commercial real estate loans, loan repayment may be dependent on the successful operation of income producing properties, a business, or a real estate project and, thus, may, to a greater extent than in the case of other loans, be subject to the risk of adverse conditions in the economy generally or in the real estate market in particular.

Construction loans involve special risks due to the fact that loan funds are advanced upon the security of houses or other improvements that are under construction and that are of uncertain value prior to the completion of construction. For that reason, it is more difficult to evaluate accurately the total loan funds required to complete a project and the related loan-to-value ratios. To minimize these risks, generally we limit loan amounts to 80% of the projected appraised value of our collateral upon completion of construction.

Many of our real estate loans, while secured by real estate, were made for purposes unrelated to the real estate collateral. That generally is reflective of our efforts to minimize credit risk by taking real estate as primary or additional collateral, whenever possible, without regard to loan purpose. All our real estate loans are secured by first or junior liens on real property, the majority of which is located in or near our banking market. However, we have made loans, and have purchased participations in some loans from other entities, which are secured by real property located outside our banking market.

Our real estate loans may be made at fixed or variable interest rates and, generally, with the exception of our long-term residential mortgage loans discussed below, have maturities that do not exceed five years. However, we also make real estate loans that have maturities of more than five years, or which are based on amortization schedules of as much as 30 years, but that generally will include contractual provisions which allow us to call the loan in full, or provide for a “balloon” payment in full, at the end of no more than five to fifteen years.

 

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In addition to residential real estate loans made for a variety of purposes, we offer long-term, residential mortgage loans that are funded by and closed in the name of third-party lenders. This arrangement permits us to offer this product in our banking market and enhance our fee-based income, but, by closing the loans in the names of the ultimate owners of those loans, we avoid the credit and interest rate risk associated with these long-term loans. However, on a limited basis, we also make residential mortgage loans that we retain in our own loan portfolio. Those loans typically are secured by first liens on the related residential property, are made at fixed and variable interest rates, and have maturities that do not exceed 15 years, although we have a small number of residential mortgage loans in our portfolio with 30-year maturities.

Our home equity lines of credit include lines of credit that generally are used by borrowers for consumer purposes and are secured by first or junior liens on residential real property. Our commitment on each line is for a term of 15 years, and interest is charged at a variable rate. The terms of these lines of credit provide that borrowers either may pay accrued interest only, with the outstanding principal balances becoming due in full at the maturity of the lines, or they will make payments of principal and interest based on a 15-year amortization schedule.

Commercial Loans. Our commercial loan classification includes loans to individuals and small- and medium-sized businesses for working capital, equipment purchases, and various other business and agricultural purposes, but that classification excludes any such loan that is secured by real estate. These loans generally are secured by inventory, equipment or similar assets, but they also may be made on an unsecured basis. In addition to loans which are classified on our books as commercial loans, as described above, many of our loans included within the real estate loan classification were made for commercial purposes but are classified as real estate loans on our books because they are secured by first or junior liens on real estate. Commercial loans may be made at variable or fixed rates of interest. However, it is our policy that any loan which has a maturity or amortization schedule of longer than five years normally would be made at an interest rate that varies with our prime lending rate or would include contractual provisions which allow us to call the loan in full, or provide for a “balloon” payment in full, at the end of no more than five years.

Commercial loans typically are made on the basis of the borrower’s ability to make repayment from business cash flow, and those loans typically are secured by business assets, such as accounts receivable, equipment and inventory. As a result, the ability of borrowers to repay commercial loans may be substantially dependent on the success of their businesses, and the collateral for commercial loans may depreciate over time and their values may not be as determinable relative to the time the loans were originated.

Consumer Loans. Our consumer loans consist primarily of loans for various consumer purposes, as well as the outstanding balances on non-real estate secured consumer revolving credit accounts. A majority of these loans are secured by liens on various personal assets of the borrowers, but they also may be made on an unsecured basis. Additionally, our real estate loans include loans secured by first or junior liens on real estate which were made for consumer purposes unrelated to the real estate collateral. Consumer loans generally are made at fixed interest rates and with maturities or amortization schedules which generally do not exceed five years. However, consumer-purpose loans secured by real estate (and, thus, classified as real estate loans as described above) may be made for terms of up to 30 years, but under terms which allow us to call the loan in full, or provide for a “balloon” payment, at the end of no more than five to fifteen years.

Consumer loans generally are secured by personal property and other personal assets of borrowers which often depreciate rapidly or are vulnerable to damage or loss. In cases where damage or depreciation reduces the value of our collateral below the unpaid balance of a defaulted loan, repossession may not result in repayment of the entire outstanding loan balance. The resulting deficiency often does not warrant further substantial collection efforts against the borrower. In connection with consumer lending in general, the success of our loan collection efforts are highly dependent on the continuing financial stability of our borrowers. Our collection capacity on consumer loans may be more likely to be adversely affected by a borrower’s job loss, illness, personal bankruptcy or other change in personal circumstances than is the case with other types of loans.

 

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Loan Administration and Underwriting. Like most community banks, we make loans based to a great extent on our assessment of borrowers’ income, cash flow, net worth, character and ability to repay the loan. A principal risk associated with each loan category is the creditworthiness of our borrowers. Our loans may be viewed as involving a higher degree of credit risk than is typically the case with some other types of loans, such as long-term residential mortgage loans where greater emphasis is placed on assessed collateral values. To manage risk, we have adopted written loan policies and procedures. Our loan portfolio is administered under a defined process that includes guidelines for loan underwriting standards, risk assessment, procedures for loan approvals, loan risk grading, ongoing identification and management of credit deterioration, and portfolio reviews to assess loss exposure. These reviews also are used to test our compliance with our credit policies and procedures in an ongoing fashion.

The underwriting standards that we employ for loans include an evaluation of various factors, including but not limited to a loan applicant’s income, cash flow, payment history on other debts and an assessment of ability to meet existing obligations including payments on any proposed loan. Though creditworthiness of the applicant is a primary consideration within the loan approval process, we take collateral (particularly real estate) whenever it is available. This is done without regard to loan purpose. In the case of secured loans, the underwriting process includes an analysis of the value of the proposed collateral. The analysis is conducted in relation to the proposed loan amount. Consideration is given to the value of the collateral, the degree to which the value is ascertainable with any certainty, the marketability of the collateral in the event of default, and the likelihood of depreciation in the collateral value.

Our Board of Directors has approved levels of lending authority for lending personnel based on our aggregate credit exposures to borrowers, along with the secured or unsecured status and the risk grade of a proposed loan. A loan that satisfies our loan policies and is within a lending officer’s assigned authority may be approved by that officer. Anything above that amount must be approved before funding by our Credit Administration management, the Loan Committee of the Board of Directors or our Board of Directors.

At the time a loan is proposed, the account officer assigns a risk grade to the loan based on various underwriting and other criteria. The grades assigned to loans generally indicate the level of ongoing review and attention that we will give to those loans to protect our position.

After funding, all loans are reviewed by our Loan Administration personnel for adequacy of documentation and compliance with regulatory requirements. Most loans (including the largest exposure loans) are reviewed for compliance with our underwriting criteria and to reassess the grades assigned to them by the account officers.

During the life of each loan, its grade is reviewed and validated. Modifications can and are made to reflect changes in circumstances and risk. Loans generally are placed in a non-accrual status if they become 90 days past due (unless, based on relevant circumstances, we believe that collateral is sufficient to justify continued accrual and the loan is in process of collection). Non-accrual status is also applied whenever we believe that collection has become doubtful. Loans are charged off when the collection of principal and interest has become doubtful and the loans no longer can be considered a sound collectible asset (or, in the case of unsecured loans, when they become 90 days past due).

Allowance for Loan Losses. Our Board of Directors’ Loan Committee reviews all substandard loans at least monthly, and our management meets regularly to review asset quality trends and to discuss loan policy issues. Based on these reviews and our current judgments about the credit quality of our loan portfolio and other relevant internal and external factors as well as historical charge off rates, we have established an allowance for loan losses. The appropriateness of the allowance is assessed by our management, reviewed by the Loan Committee each month, and reviewed by the Board of Directors quarterly. We make provisions to the allowance based on those assessments which are charged against our earnings.

For additional information regarding loss experience, our allowance for loan losses and problem assets, see Table II. Summary of Loan Loss Experience, Table III. Allocation of Allowance for Loan Losses, and Table V. Nonperforming Assets in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

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Deposit Activities

Our deposit products include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. We monitor our competition in order to keep the rates paid on our deposits at a competitive level. However, under FDIC regulations and the terms of the regulatory consent order discussed under the heading “Supervision and Regulation” below, we may not currently solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yield on insured deposits of comparable maturity in our market area or the market area where the deposits are being solicited. The majority of our deposits are derived from within our banking market. However, we have historically solicited and accepted wholesale deposits as a way to supplement funding to support loan growth and provide added balance sheet liquidity. For additional analysis of deposit relationships, see Table VIII. Deposit Mix in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Investment Portfolio

On December 31, 2013, our investment portfolio consisted of U.S. government agency securities, state and municipal obligations, mortgage-backed securities issued by the Federal National Mortgage Association (“Fannie Mae”), the Government National Mortgage Association (“Ginnie Mae”), and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and corporate obligations. Our securities are classified as both “held to maturity” and “available for sale.” We analyze their performance monthly and carry the available for sale securities on our books at their fair market values while carrying the held to maturity securities at their amortized cost. For additional analysis of investment security balances by type and maturities and average yields by security type, see Table VI. Investment Securities and Table VII. Investment Securities in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. For additional information regarding appreciation and depreciation by security type, and information relating to Other Than Temporary Impairment, see Note 2. Investment Securities in our Notes to Consolidated Financial Statements under Item 8.

Competition

Commercial banking in North Carolina is highly competitive, due in large part to our state’s early adoption of statewide branching. Over the years, federal and state legislation (including the elimination of many of the restrictions on interstate banking) has heightened the competitive environment in which all financial institutions conduct their business, and the potential for competition among financial institutions of all types has increased significantly. As of June 30, 2013 (the most recent date for which data is available), there were 27 other FDIC-insured institutions with offices in our banking market.

Interest rates, both on loans and deposits, and prices of fee-based services are significant competitive factors among financial institutions in general. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and, in the case of larger commercial customers, relative lending limits and the ability to offer sophisticated cash management and other commercial banking services. Many of our competitors have greater resources, broader geographic markets, more extensive branch networks, and higher lending limits than we do. They also can offer more products and services and can better afford and make more effective use of media advertising, support services and electronic technology than we can. In terms of assets, we are one of the smaller commercial banks in North Carolina, and there is no assurance that we will be or continue to be an effective competitor in our banking market. However, we believe that community banks can compete successfully by providing personalized service and making timely, local decisions, and that further consolidation in the banking industry is likely to create additional opportunities for community banks to capture deposits from affected customers who may become dissatisfied as their financial institutions grow larger. Additionally, we believe that the continued growth of our banking market affords an opportunity to capture new deposits from new residents.

Substantially all of our customers are individuals and small- and medium-sized businesses. We try to differentiate ourselves from our larger competitors with our focus on relationship banking, personalized service, direct customer contact, and our ability to make credit and other business decisions locally. We also depend on our reputation as a community bank in our banking market, our involvement in the communities we serve, the experience of our senior management team, and the quality of our associates. We believe that our focus allows us to be more responsive to our customers’ needs and more flexible in approving loans based on our personal knowledge of our customers.

 

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Employees

On December 31, 2013, we had approximately 101 full-time equivalent employees (including our executive officers). We are not party to any collective bargaining agreement with our employees, and we consider our relations with our employees to be good.

Supervision and Regulation

Our business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a summary of some of the basic statutes and regulations that apply to us, but it is not a complete discussion of all the laws that affect our business. In addition to these statutes and regulations, we are subject to a consent order issued by the FDIC and the North Carolina Commissioner of Banks and a written agreement with the Federal Reserve Bank of Richmond, as summarized below.

Consent Order with FDIC and North Carolina Commissioner of Banks. The Bank entered into a Stipulation to the Issuance of a Consent Order (the “Stipulation”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Office of the Commissioner of Banks (the “Commissioner”) and the FDIC and the Commissioner issued the related Consent Order (the “Order”), effective April 27, 2011. The description of the Stipulation and the Order set forth below is qualified in its entirety by reference to the Stipulation and the Order, copies of which are included as exhibits 10.14 and 10.15 to this Form 10-K, and incorporated herein by reference.

Management. The Order requires that the Bank have and retain qualified management, including a chief executive officer, senior lending officer, and chief operating officer with qualifications and experience commensurate with their assigned duties and responsibilities within 60 days from the effective date of the Order. Within 30 days of the effective date of the Order, the board of directors was required to retain a bank consultant to develop a written analysis and assessment of the Bank’s management needs. Following receipt of the consultant’s management report, the Bank was required to formulate a written management plan that incorporated the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a time frame for completing each action.

Capital Requirements. While the Order is in effect, the Bank must maintain a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. If the Bank’s capital ratios are below these levels as of the date of any call report or regulatory examination, the Bank must, within 30 days from receipt of a written notice of capital deficiency from its regulators, present a plan to increase capital to meet the requirements of the Order.

Allowance for Loan and Lease Losses and Call Report. Upon issuance of the Order, the Bank was required to make a provision to replenish the allowance for loan and lease losses (“ALLL”). Within 30 days of the effective date of the Order, the Bank was required to review its call reports filed with its regulators on or after December 31, 2010, and amend those reports if necessary to accurately reflect the financial condition of the Bank. Within 60 days of the effective date of the Order, the Bank was required to submit a comprehensive policy for determining the adequacy of the ALLL.

Concentrations of Credit. Within 60 days of the issuance of the Order, the Bank was required to perform a risk segmentation analysis with respect to its concentrations of credit and develop a written plan for systematically reducing and monitoring the Bank’s commercial real estate and acquisition, construction, and development loans to an amount commensurate with the Bank’s business strategy, management expertise, size, and location.

 

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Charge-Offs, Credits. The Order requires that the Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified “loss” and 50% of those assets classified “doubtful.” If an asset is classified “doubtful,” the Bank may alternatively charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, “loss” or “doubtful” and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.” These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify its regulators at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from its regulators.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of its regulators. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank was required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

 

    Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management

 

    Plan to reduce assets of $500,000 or greater classified “doubtful” and “substandard”

 

    Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

 

    Effective internal loan review and grading system

 

    Policy for managing the Bank’s other real estate

 

    Business/strategic plan covering the overall operation of the Bank

 

    Plan and comprehensive budget for all categories of income and expense for the year 2011

 

    Policy and procedures for managing interest rate risk

 

    Assessment of the Bank’s information technology function

Under the Order, the Bank’s board of directors agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank was also required to establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and the Commissioner.

Written Agreement with the Federal Reserve Bank of Richmond. The Company entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of Richmond on August 26, 2011. The description of the Agreement set forth below is qualified in its entirety by reference to the Agreement, a copy of which is included as exhibit 10.16 to this Form 10-K, and is incorporated herein by reference.

Source of Strength. The Agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and to ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC and the Bank.

Dividends, Distributions, and other Payments. The Agreement prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. It also prohibits the Company from directly or indirectly taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank of Richmond.

 

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Under the terms of the Agreement, the Company and the Bank may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

Debt and Stock Redemption. The Agreement requires that the Company and any non-bank subsidiary of the Company not, directly or indirectly, incur, increase or guarantee any debt without the prior written approval of the Federal Reserve Bank. The Agreement also requires that the Company not, directly or indirectly, purchase or redeem any shares of its capital stock without the prior written approval of the Federal Reserve Bank of Richmond.

Capital Plan, Cash Flow Projections and Progress Reports. The Agreement requires that the Company file an acceptable capital plan and certain cash flow projections with the Federal Reserve Bank of Richmond. It also requires that the Company file a written progress report within 30 days after the end of each calendar quarter while the Agreement remains in effect.

The Order will remain in effect until modified or terminated by the Federal Reserve Bank of Richmond.

Regulation of Bank Holding Companies. Bank of the Carolinas Corporation is a North Carolina business corporation that operates as a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). We are subject to supervision and examination by, and the regulations and reporting requirements of, the Federal Reserve Board (the “FRB”). Under the BHCA, a bank holding company’s activities are limited to banking, managing or controlling banks, or engaging in other activities the FRB determines are closely related and a proper incident to banking or managing or controlling banks.

Bank holding companies may elect to be regulated as “financial holding companies” if all their financial institution subsidiaries are and remain well capitalized and well managed as described in the FRB’s regulations and have a satisfactory record of compliance with the Community Reinvestment Act. In addition to the activities that are permissible for bank holding companies, financial holding companies are permitted to engage in additional activities that are determined by the FRB, in consultation with the Secretary of the Treasury, to be financial in nature or incidental to a financial activity, or that are complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions, or the financial system generally, as determined by the FRB. We are not a financial holding company.

The BHCA prohibits a bank holding company or financial holding company from acquiring direct or indirect control of more than 5.0% of the outstanding voting stock, or substantially all of the assets, of any financial institution, or merging or consolidating with another bank holding company or savings bank holding company, without the prior approval of or, under specified circumstances, notice to, the FRB. Additionally, the BHCA generally prohibits banks or financial holding companies from acquiring ownership or control of more than 5.0% of the outstanding voting stock of any company that engages in an activity other than one that is permissible for the holding company. In approving an application to engage in a nonbanking activity, the FRB must consider whether that activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

The law imposes a number of obligations and restrictions on a bank holding company and its insured bank subsidiaries designed to minimize potential losses to depositors and the FDIC insurance fund. For example, if a bank holding company’s insured bank subsidiary becomes “undercapitalized,” the bank holding company is required to guarantee the bank’s compliance (subject to certain limits) with the terms of any capital restoration plan filed with its federal banking agency. A bank holding company is required to serve as a source of financial strength to its bank subsidiaries and to commit resources to support those banks in circumstances in which, absent that policy, it might not do so. Under the BHCA, the FRB may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary if the FRB determines that the activity or control constitutes a serious risk to the financial soundness and stability of a bank subsidiary of a bank holding company. As described above, Bank of the Carolinas Corporation is currently party to a written agreement with the Federal Reserve Bank of Richmond.

 

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Regulation of the Bank. The Bank is an FDIC-insured, North Carolina-chartered bank. Its deposits are insured under the FDIC’s Deposit Insurance Fund (“DIF”), and it is subject to supervision and examination by, and the regulations and reporting requirements of, the FDIC and the Commissioner. The FDIC and the Commissioner are its primary federal and state banking regulators. The Bank is not a member bank of the Federal Reserve System.

As a state insured bank, the Bank is prohibited from engaging as principal in any activity that is not permitted for national banks unless (1) the FDIC determines that the activity or investment would not pose a significant risk to the DIF, and (2) the Bank is, and continues to be, in compliance with the capital standards that apply to it. The Bank also is prohibited from directly acquiring or retaining any equity investment of a type or in an amount that is not permitted for national banks.

The FDIC and the Commissioner regulate all areas of the Bank’s business, including its reserves, mergers, payment of dividends and other aspects of its operations. They conduct regular examinations of the Bank, and the Bank must furnish periodic reports to the FDIC and the Commissioner containing detailed financial and other information about its affairs. The FDIC and the Commissioner have broad powers to enforce laws and regulations that apply to the Bank and to require the Bank to correct conditions that affect its safety and soundness. Among others, these powers include issuing cease and desist orders, imposing civil penalties, and removing officers and directors, and their ability otherwise to intervene in the Bank’s operation if their examinations of the Bank, or the reports it files, reflect a need for them to do so. As described above, the Bank is currently subject to a Consent Order issued by the FDIC and the Commissioner.

The Bank’s business also is influenced by prevailing economic conditions and governmental policies, both foreign and domestic, and, though it is not a member bank of the Federal Reserve System, by the monetary and fiscal policies of the FRB. The FRB’s actions and policy directives determine to a significant degree the cost and availability of funds the Bank obtains from money market sources for lending and investing, and they also influence, directly and indirectly, the rates of interest the Bank pays on time and savings deposits and the rates it charges on commercial bank loans.

Powers of the FDIC in Connection with the Insolvency of an Insured Depository Institution. Under the Federal Deposit Insurance Act (the “FDIA”), if any insured depository institution becomes insolvent and the FDIC is appointed as its conservator or receiver, the FDIC may disaffirm or repudiate any contract or lease to which the institution is a party which it determines to be burdensome, and the disaffirmance or repudiation of which is determined to promote the orderly administration of the institution’s affairs. The disaffirmance or repudiation of any of our obligations would result in a claim of the holder of that obligation against the conservatorship or receivership. The amount paid on that claim would depend upon, among other factors, the amount of conservatorship or receivership assets available for the payment of unsecured claims and the priority of the claim relative to the priority of other unsecured creditors and depositors.

In its resolution of the problems of an insured depository institution in default or in danger of default, the FDIC generally is required to satisfy its obligations to insured depositors at the least possible cost to the DIF. In addition, the FDIC may not take any action that would have the effect of increasing the losses to the DIF by protecting depositors for more than the insured portion of deposits or creditors other than depositors. The FDIA authorizes the FDIC to settle all uninsured and unsecured claims in the insolvency of an insured bank by making a final settlement payment after the declaration of insolvency as full payment and disposition of the FDIC’s obligations to claimants. The rate of the final settlement payments will be a percentage rate determined by the FDIC reflecting an average of the FDIC’s receivership recovery experience.

North Carolina Banking Law Modernization Act. On October 1, 2012, as a result of the recommendations of the Joint Legislative Study Commission on the Modernization of North Carolina Banking Laws, legislation went into effect that comprehensively modernizes North Carolina’s banking laws for the first time since the Great Depression. As a result of the legislation, Articles 1 through 10, 12, and 13 of Chapter 53 of the North Carolina General Statutes were repealed, and new Chapter 53C, entitled “Regulation of Banks,” became law. Major changes enacted by the law include: a comprehensive list of definitions enhancing the clarity and meaning of the various sections of North Carolina’s banking law, a broader reliance on the North Carolina Business Corporations Act, and incorporation of modern concepts of capital adequacy and regulatory supervision. On April 16, 2013, a bill was signed into law making certain technical corrections and clarifications to Chapter 53C.

 

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Dodd–Frank Wall Street Reform and Consumer Protection Act. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. This law has significantly changed the current bank regulatory structure and is affecting the lending, deposit, investment, trading, and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies have significant discretion in drafting rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many years. The Dodd-Frank Act included, among other things:

 

    the creation of a Financial Stability Oversight Council to identify emerging systemic risks posed by financial firms, activities and practices, and to improve cooperation between federal agencies;

 

    the creation of the Consumer Financial Protection Bureau, which is authorized to promulgate and enforce consumer protection regulations relating to financial products, affecting both banks and non-bank financial companies;

 

    the establishment of strengthened capital and prudential standards for banks and bank holding companies;

 

    enhanced regulation of financial markets, including derivatives and securitization markets;

 

    the elimination of certain trading activities by banks;

 

    a permanent increase of FDIC deposit insurance to $250,000 per deposit category and an increase in the minimum DIF reserve requirement from 1.15% to 1.35%, with assessments to be based on assets as opposed to deposits;

 

    amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations; and

 

    new disclosure and other requirements relating to executive compensation and corporate governance.

As required by the Dodd-Frank Act, federal regulators have adopted regulations to (1) increase capital requirements on banks and bank holding companies pursuant to Basel III, and (2) implement the so-called “Volcker Rule” of the Dodd-Frank Act, which significantly restricts certain activities by covered bank holding companies, including restrictions on proprietary trading and private equity investing. Additional information on these regulations can be found below under the headings Volcker Rule and Implementation of Basel III Capital Rules.

Many of the regulations to implement the Dodd-Frank Act have not yet been published for comment or adopted in final form and/or will take effect over several years, making it difficult to anticipate the overall financial impact on the Company and the Bank, our customers, or the financial industry more generally. Individually and collectively, these proposed regulations resulting from the Dodd-Frank Act may materially and adversely affect the Company’s and the Bank’s business, financial condition, and results of operations. Provisions in the legislation that require revisions to the capital requirements of the Company and the Bank could require the Company and the Bank to seek additional sources of capital in the future.

Volcker Rule. The final rules adopted on December 10, 2013, to implement a part of the Dodd-Frank Act commonly referred to as the “Volcker Rule,” prohibit insured depository institutions and companies affiliated with insured depository institutions from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account. The final rules also impose limits on banking entities’ investments in, and other relationships with, hedge funds or private equity funds. These rules will become effective on April 1, 2014. Certain collateralized debt obligations (“CDOs”), securities backed by trust preferred securities which were initially defined as covered funds subject to the investment prohibitions, have been exempted to address the concern that many community banks holding such CDOs may have been required to recognize significant losses on those securities.

Like the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organizing hedge funds or private equity funds. The final rules also clarify that certain activities are not prohibited, including acting as agent, broker, or custodian.

The compliance requirements under the final rules vary based on the size of the banking entity and the scope of activities conducted. Banking entities with significant trading operations will be required to establish a detailed compliance program and their management officials will be required to attest that the program is reasonably designed to achieve compliance with the final rule. Independent testing and analysis of an institution’s compliance program will also be required. The final rules reduce the burden on smaller, less-complex institutions by limiting their compliance and reporting requirements. Additionally, a banking entity that does not engage in covered trading activities will not need to establish a compliance program. Therefore, while these new rules may require us to conduct certain internal analysis and reporting, we do not believe that they will require any material changes in our operations or business.

 

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Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act, enacted in 1999 (the “GLB Act”), dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act permitted bank holding companies to become “financial holding companies” and, in general (1) expanded opportunities to affiliate with securities firms and insurance companies; (2) overrode certain state laws that would prohibit certain banking and insurance affiliations; (3) expanded the activities in which banks and bank holding companies may participate; (4) required that banks and bank holding companies engage in some activities only through affiliates owned or managed in accordance with certain requirements; and (5) reorganized responsibility among various federal regulators for oversight of certain securities activities conducted by banks and bank holding companies. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, while this expanded authority permits financial institutions to engage in additional activities, it also presents smaller institutions with challenges as larger competitors continue to expand their services and products into areas that are not feasible for smaller, community-oriented financial institutions. We are not a financial holding company.

Payment of Dividends. Under North Carolina law, we are authorized to pay dividends as declared by our Board of Directors, provided that no such distribution results in our insolvency on a going concern or balance sheet basis. However, although we are a legal entity separate and distinct from the Bank, our principal source of funds with which we can pay dividends to our shareholders and pay our own obligations is dividends we receive from the Bank. For that reason, our ability to pay dividends effectively is subject to the same limitations that apply to the Bank. There are statutory and regulatory limitations on the Bank’s payment of dividends to us.

As described above, the terms of the consent order issued by the Bank’s regulators prohibit the Bank from declaring or paying dividends without the prior written approval of its regulators. The Company is also prohibited from declaring or paying dividends without prior regulatory approval under the terms of its written agreement with the Federal Reserve.

Our sale of Series A Preferred Stock to the U.S. Treasury during April 2009 under the TARP Capital Purchase Program resulted in additional restrictions on our ability to pay dividends on our common stock and to repurchase shares of our common stock. Unless all accrued dividends on the Series A Preferred Stock have been paid in full, (1) no dividends may be declared or paid on our common stock, and (2) we may not repurchase any of our outstanding common stock. We began deferring dividend payments on our Series A Preferred Stock in February 2011.

Under North Carolina banking law, the Bank’s Board of Directors may declare dividends so long as they do not reduce the Bank’s capital below its applicable required capital. As described above, the Bank is currently restricted from paying dividends under the terms of the Consent Order with the FDIC and the Commissioner.

In addition to the restrictions described above, other state and federal statutory and regulatory restrictions apply to the Bank’s payment of cash dividends. As an insured depository institution, federal law prohibits the Bank from making any capital distributions, including the payment of a cash dividend if it is “undercapitalized” (as that term is defined in the FDIA) or after making the distribution, would become undercapitalized. The Bank was considered “significantly undercapitalized” at December 31, 2013. If the FDIC believes that we are engaged in, or about to engage in, an unsafe or unsound practice, the FDIC may require, after notice and hearing, that we cease and desist from that practice. The FDIC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. The FDIC has issued policy statements that provide that insured banks generally should pay dividends only from their current operating earnings, and, under the FDIA, no dividend may be paid by an insured bank while it is in default on any assessment due the FDIC. The Bank’s payment of dividends also could be affected or limited by other factors, such as events or circumstances which lead the FDIC to require (as further described below) that it maintain capital in excess of regulatory guidelines.

In the future, our ability to declare and pay cash dividends will be subject to our Board of Directors’ evaluation of our operating results, capital levels, financial and regulatory condition, future growth plans, general business and economic conditions, and tax and other relevant considerations.

Federal Capital Adequacy Regulations. We and the Bank are required to comply with the FRB’s and FDIC’s capital adequacy standards for bank holding companies and insured banks. The FRB and FDIC have issued risk-based capital and leverage capital guidelines for measuring capital adequacy, and all applicable capital standards must be satisfied for us or the Bank to be considered in compliance with regulatory capital requirements.

 

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Under the FDIC’s risk-based capital measure, the minimum ratio (“Total Capital Ratio”) of the Bank’s total capital (“Total Capital”) to its risk-weighted assets (including various off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of Total Capital must be composed of “Tier 1 Capital.” Tier 1 Capital includes common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and various other intangible assets. The remainder of Total Capital may consist of “Tier 2 Capital” which includes certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of loan loss reserves. A bank or bank holding company that does not satisfy minimum capital requirements may be required to adopt and implement a plan acceptable to its federal banking regulator to achieve an adequate level of capital.

Under the leverage capital measure, the minimum ratio (“Leverage Capital Ratio”) of Tier 1 Capital to average assets, less goodwill and various other intangible assets, generally is 3.0% for entities that meet specified criteria, including having the highest regulatory rating. All other entities generally are required to maintain an additional cushion of 100 to 200 basis points above the stated minimum. The FDIC’s guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets, and a bank’s “Tangible Leverage Ratio” (determined by deducting all intangible assets) and other indicators of a bank’s capital strength also are taken into consideration by banking regulators in evaluating proposals for expansion or new activities.

As described above, the Bank is subject to a consent order issued by the FDIC and the North Carolina Commissioner of Banks. The consent order requires that the Bank maintain capital levels in excess of normal statutory minimums, including a Leverage Capital Ratio of at least 8% and a Total Capital Ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%.

The FRB and FDIC also consider interest rate risk (arising when the interest rate sensitivity of the Bank’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of the Bank’s capital adequacy. Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk. The regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s trading activities.

Our capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of our overall financial condition or prospects for other purposes. A failure to meet the capital guidelines could subject us to a variety of enforcement actions under those rules, including the issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and other restrictions on our business. As described below, the FDIC also can impose other substantial restrictions on banks that fail to meet applicable capital requirements.

Implementation of Basel III Capital Rules. In July 2013, the federal banking regulators published the Basel III capital rules establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the December 2010 framework of the Basel Committee on Banking Supervision (the “Basel Committee”), known as “Basel III,” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III capital rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the current U.S. risk-based capital rules.

The Basel III capital rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. These rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach, which was derived from the Basel I capital accords of the Basel Committee, with a more risk-sensitive approach based, in part, on the standardized approach in the Basel Committee’s 2004 Basel II capital accords. The Basel III capital rules also implement the requirements of the Dodd-Frank Act to remove references to credit ratings from the federal banking rules. The Basel III capital rules will be effective for the Company and the Bank on January 1, 2015, subject to a phase-in period.

The Basel III capital rules, among other things: (1) revise minimum capital requirements and adjust prompt corrective action thresholds; (2) revise the components of regulatory capital and create a new capital measure called “Tier 1 Common Equity” (“T1CE”), which must constitute at least 4.5% of risk-weighted assets; (3) specify that Tier 1 capital consists only of T1CE and certain “Additional Tier 1 Capital” instruments meeting specified requirements; (4) increase the

 

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minimum Tier 1 capital ratio requirement from 4% to 6%; (5) retain the existing risk-based capital treatment for 1–4 family residential mortgage exposures; (6) permit most banking organizations, including the Company and the Bank, to retain, through a one-time permanent election, the existing capital treatment for accumulated other comprehensive income; (7) implement a new capital conservation buffer of T1CE equal to 2.5% of risk-weighted assets, which will be in addition to the 4.5% T1CE ratio and will be phased in over a three-year period beginning January 1, 2016, which buffer is generally required in order for an institution to make capital distributions and pay executive bonuses; (8) increase capital requirements for past-due loans, high volatility commercial real estate exposures and certain short-term loan commitments; (9) require the deduction of mortgage servicing assets and deferred tax assets that exceed 10% of T1CE in each category and 15% of T1CE in the aggregate; and (10) remove references to credit ratings consistent with the Dodd-Frank Act and establish due diligence requirements for securitization exposures.

Compliance with the Basel III capital rules is required for most banking organizations beginning January 1, 2015, including the Company and the Bank, subject to a transition period for several aspects of the final rules, including the new minimum capital ratio requirements, the capital conservation buffer and the regulatory capital adjustments and deductions. We are still in the process of assessing the impact that these complex new rules will have on the Company and the Bank.

Regulatory Guidance on “CRE” Lending Concentrations. During 2006, the FDIC and other federal banking regulators issued guidance for sound risk management for financial institutions whose loan portfolios are deemed to have significant concentrations in commercial real estate (“CRE”). In 2008, the FDIC and other federal banking regulators issued further guidance on applying these principles in the current real estate lending environment, and they noted particular concern about construction and development loans. The banking regulators have indicated that this guidance does not set strict limitations on the amount or percentage of CRE within any given loan portfolio, and that they also will examine risk indicators in banks which have amounts or percentages of CRE below the thresholds. However, if a bank’s CRE exceeds these thresholds or if other risk indicators are present, the FDIC and other federal banking regulators may require additional reporting and analysis to document management’s evaluation of the potential additional risks of such concentration and the impact of any mitigating factors. The 2008 supplementary guidance stated that banks with significant CRE concentrations should maintain or implement processes to: (1) increase and maintain strong capital levels; (2) ensure that their loan loss allowances are appropriately strong; (3) closely manage their CRE and construction and development loan portfolios; (4) maintain updated financial and analytical information about borrowers and guarantors; and (5) bolster their workout infrastructure for problem loans. It is possible that regulatory constraints associated with this guidance could increase the costs of monitoring and managing this component of our loan portfolio.

Prompt Corrective Action. Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) and is required to take various mandatory supervisory actions, and is authorized to take other discretionary actions, with respect to banks in the three undercapitalized categories. The severity of any such actions taken will depend upon the capital category in which a bank is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for a bank that is critically undercapitalized.

Under the FDIC’s prompt corrective action rules, a bank that (1) has a Total Capital Ratio of 10.0% or greater, a Tier 1 Capital Ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater, and (2) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is considered to be “well capitalized.” A bank with a Total Capital Ratio of 8.0% or greater, a Tier 1 Capital Ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater, is considered to be “adequately capitalized.” A bank that has a Total Capital Ratio of less than 8.0%, a Tier 1 Capital Ratio of less than 4.0%, or a Leverage Ratio of less than 4.0%, is considered to be “undercapitalized.” A bank that has a Total Capital Ratio of less than 6.0%, a Tier 1 Capital Ratio of less than 3.0%, or a Leverage Ratio of less than 3.0%, is considered to be “significantly undercapitalized,” and a bank that has a tangible equity capital to assets ratio equal to or less than 2.0% is deemed to be “critically undercapitalized.” For purposes of these rules, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards, plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets (with various exceptions). A bank may be considered to be in a capitalization category lower than indicated by its actual capital position if it receives an unsatisfactory examination rating.

A bank that becomes “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing new branches, or engaging in any new line of business, except in

 

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accordance with an accepted capital restoration plan or with the approval of the FDIC. Also, the FDIC may treat an “undercapitalized” bank as being “significantly undercapitalized” if it determines that those actions are necessary to carry out the purpose of the law.

The following table lists our and the Bank’s capital ratios at December 31, 2013. As described above, the Bank is subject to a consent order issued by the FDIC and the North Carolina Commissioner of Banks. The consent order requires that the Bank maintain capital levels in excess of normal statutory minimums, including a Leverage Capital Ratio of at least 8% and a Total Capital Ratio of at least 10%.

 

           Required ratios              
     Minimum     to be considered     The Company’s     The Bank’s  
     required ratios     “Well capitalized”     capital ratios     capital ratios  

Risk-based capital ratios:

        

Leverage Capital Ratio (Tier 1 Capital to fourth quarter average assets)

     4.0     5.0     1.79     3.55

Tier 1 Capital Ratio (Tier 1 Capital to risk-weighted assets)

     4.0     6.0     2.46     4.87

Total Capital Ratio (Total Capital to risk-weighted assets)

     8.0     10.0     4.93     6.13

North Carolina Capital Requirements and Regulatory Action. Under North Carolina banking law, a bank’s “required capital” is equal to at least the amount required for the bank to be considered “adequately capitalized” under the federal regulatory capital standards described above. “Inadequate capital” is defined as an amount of capital equal to at least 75% but less than 100% of required capital. “Insufficient capital” is defined as an amount of capital less than 75% of required capital.

The Commissioner is empowered to take regulatory action if a bank’s capital falls below the required capital level. If the Commissioner determines that a bank has “inadequate capital” or “insufficient capital,” the Commissioner may order the bank to take corrective action. If the Commissioner determines that that a bank has insufficient capital and is conducting business in an unsafe or unsound manner or in a fashion that threatens the financial integrity of the bank, the Commissioner may serve a notice of charges and show-cause order on the bank and, if after a hearing, he determines that supervisory control of the bank is necessary to protect the bank’s customers, creditors, or the general public, the Commissioner may take supervisory control of the bank. The Commissioner may also take custody of the books and records of a bank and appoint a receiver if the bank’s capital is impaired such that the likely realizable value of the bank’s assets is insufficient to pay and satisfy the claims of its depositors and creditors.

U.S. Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program. On April 17, 2009, we issued Series A Preferred Stock in the amount of $13.179 million and a warrant to purchase 475,204 shares of our common stock to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The Series A Preferred Stock qualifies as Tier 1 capital for purposes of regulatory capital requirements and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Unless all accrued dividends on the Series A Preferred Stock have been paid in full, (1) no dividends may be declared or paid on our common stock, and (2) we may not repurchase any of our outstanding common stock. We began deferring dividend payments on our Series A Preferred Stock in February 2011. In addition, until the U.S. Treasury ceases to own our securities sold under the TARP Capital Purchase Program, the compensation arrangements for our senior executive officers must comply in all respects with the U.S. Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009, and the rules and regulations thereunder.

Reserve Requirements. Under the FRB’s regulations, all FDIC-insured depository institutions must maintain average daily reserves against their transaction accounts. No reserves are required to be maintained on the first $11.5 million of transaction accounts, but reserves equal to 3.0% must be maintained on the aggregate balances of those accounts between $11.5 million and $59.5 million, and reserves equal to 10.0% must be maintained on aggregate balances in excess of $59.5 million. The FRB may adjust these percentages from time to time. Because the Bank’s reserves are required to be maintained in the form of vault cash or in an account at a Federal Reserve Bank or with a qualified correspondent bank, one effect of the reserve requirement is to reduce the amount of our assets that are available for lending and other investment activities.

 

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Deposit Insurance. The Bank’s deposits are insured up to limits set by the DIF. The DIF was formed on March 31, 2006, upon the merger of the Bank Insurance Fund and the Savings Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). The Reform Act established a range of 1.15% to 1.50% within which the FDIC may set the Designated Reserve Ratio (the “reserve ratio”). The Dodd-Frank Act gave the FDIC greater discretion to manage the DIF, raised the minimum DIF reserve ratio to 1.35%, and removed the upper limit of 1.50%. In 2010, the FDIC adopted a restoration plan to ensure that the DIF reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. The FDIC also proposed a comprehensive, long-range plan for management of the DIF. As part of this comprehensive plan, the FDIC has adopted a final rule to set the reserve ratio at 2.0%.

In 2010, the Dodd-Frank Act permanently increased FDIC insurance coverage to $250,000 per deposit category.

The FDIC imposes a risk-based deposit insurance premium assessment on member institutions in order to maintain the DIF. This assessment system was amended by the Reform Act and further amended by the Dodd-Frank Act. Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. The Dodd-Frank Act changed the methodology for calculating deposit insurance assessments from the amount of an insured institution’s domestic deposits to its total assets minus tangible capital. In 2011, the FDIC issued a new regulation implementing these revisions to the assessment system.

In 2008, the FDIC announced the Temporary Liquidity Guarantee Program (the “TLGP”) to strengthen confidence and encourage liquidity in the banking system. The TLGP consists of two components: a temporary guarantee of newly-issued senior unsecured debt named the Debt Guarantee Program, and a temporary unlimited guarantee of funds in noninterest-bearing transaction accounts at FDIC insured institutions named the Transaction Account Guarantee Program (“TAG”). All newly-issued senior unsecured debt will be charged an annual assessment of up to 100 basis points (depending on term) multiplied by the amount of debt issued and calculated through the date of that debt or June 30, 2012, whichever is earlier. The Bank elected to opt out of the Debt Guarantee Program and elected to participate in the TAG Program. In 2009, the FDIC adopted a final rule extending the TAG portion of the TLGP for six months through June 30, 2010 and it was extended again through December 31, 2010. The Bank elected to continue to participate in the TAG Program through December 31, 2010. In 2010, the Dodd-Frank Act extended unlimited FDIC insurance coverage to noninterest-bearing transaction deposit accounts through December 31, 2012. As of January 1, 2013, funds in noninterest-bearing accounts (including Interest on Lawyers’ Trust Accounts, or IOLTA, accounts) were no longer eligible for unlimited deposit insurance coverage. Deposits held in these accounts are now aggregated with any interest-bearing deposits the owner may hold in the same ownership category, and the combined total is insured up to $250,000.

During 2009, the FDIC took several measures aimed at replenishing the DIF. On May 22, 2009, the FDIC imposed a 5 basis point special assessment on each insured institution’s assets minus Tier 1 capital as of June 30, 2009. On November 17, 2009, the FDIC voted to require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, as well as all of 2010, 2011, and 2012. For purposes of determining the prepayment, the FDIC used an institution’s assessment rate in effect on September 30, 2009.

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Insurance of deposits may be terminated by the FDIC upon a finding that an insured institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Community Reinvestment. Under the Community Reinvestment Act (the “CRA”), an insured institution has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or

 

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programs for banks, nor does it limit a bank’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of various applications by those banks. All banks are required to publicly disclose their CRA performance ratings. The Bank received a “Satisfactory” rating in its last CRA examination during August 2012.

Interstate Banking and Branching. The BHCA, as amended by the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Law”), permits adequately capitalized and managed bank holding companies to acquire control of the assets of banks in any state. Acquisitions are subject to antitrust provisions that cap at 10.0% the portion of the total deposits of insured depository institutions in the United States that a single bank holding company may control, and generally cap at 30.0% the portion of the total deposits of insured depository institutions in a state that a single bank holding company may control. Under certain circumstances, states have the authority to increase or decrease the 30.0% cap, and states may set minimum age requirements of up to five years on target banks within their borders.

The Dodd-Frank Act allows national and state banks to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.

Restrictions on Transactions with Affiliates. The Bank is subject to the provisions of Sections 23A and 23B of the Federal Reserve Act which restrict a bank’s ability to enter into certain types of transactions with its “affiliates,” including its parent holding company or any subsidiaries of its parent company. Section 23A places limits on the amount of:

 

    a bank’s loans or extensions of credit to, or investment in, its affiliates;

 

    assets a bank may purchase from affiliates, except for real and personal property exempted by the FRB;

 

    the amount of loans or extensions of credit by a bank to third parties which are collateralized by the securities or obligations of the bank’s affiliates; and

 

    a bank’s guarantee, acceptance or letter of credit issued on behalf of one of its affiliates.

Transactions of the type described above are limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank also must comply with other provisions designed to avoid the taking of low-quality assets from an affiliate.

Among other things, Section 23B prohibits a bank or its subsidiaries generally from engaging in transactions with its affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Federal law also places restrictions on our ability to extend credit to our executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

USA Patriot Act of 2001. The USA Patriot Act of 2001 is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification when accounts are opened, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

 

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Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 is sweeping federal legislation that addressed accounting, corporate governance and disclosure issues. The Act applies to all public companies and imposed significant new requirements for public company governance and disclosure requirements.

In general, the Sarbanes-Oxley Act mandated important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a new regulatory body to oversee auditors of public companies. It backed these requirements with new SEC enforcement tools, increased criminal penalties for federal mail, wire and securities fraud, and created new criminal penalties for document and record destruction in connection with federal investigations. It also increased the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.

The economic and operational effects of the Sarbanes-Oxley Act on public companies, including us, have been and will continue to be significant in terms of the time, resources and costs associated with compliance. Because the Act, for the most part, applies equally to larger and smaller public companies, we have been and will continue to be presented with additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in our market.

Federal Banking Agency Guidance on Executive Compensation. In 2010, the federal banking agencies issued guidance which applies to all banking organizations supervised by the agencies. Pursuant to the guidance, to be consistent with safety and soundness principles, a banking organization’s incentive compensation arrangements should: (1) provide employees with incentives that appropriately balance risk and reward; (2) be compatible with effective controls and risk management; and (3) be supported by strong corporate governance including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation.

Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the Consumer Financial Protection Bureau (“CFPB”) issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z under the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a qualified mortgage is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount.

Consumer Laws and Regulations. The Bank is also subject to other federal and state consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Check Clearing for the 21st Century Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair and Accurate Transactions Act, the Mortgage Disclosure Improvement Act and the Real Estate Settlement Procedures Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.

Statistical Data

Certain statistical data regarding our loans, deposits, investment securities and business is included in the information provided in Part II of this Report under the caption Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

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PART II

Item 6. Selected Financial Data.

Smaller reporting companies such as the Company are not required to provide the information required by this item.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Restatement

The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to certain adjustments made to the previously reported consolidated financial statements for the years ended December 31, 2013, 2012 and 2011 (including interim periods therein) in connection with the restatement of our previously filed consolidated financial statements and data (and related disclosures) for the fiscal years ended December 31, 2013, 2012 and 2011. For this reason the data set forth in this section may not be comparable to discussions and data in our previously filed Annual and Quarterly Reports.

The purpose of the restatement is to record an increase in our deferred tax asset valuation allowance and the related income tax impact. See “Explanatory Note” immediately preceding Item 1 of this Form 10-K/A and Note 19, “Explanatory Note—Restatement of Prior Financial Statements” of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K/A for a detailed discussion of the review and effect of the restatement.

The following presents management’s discussion and analysis of our financial condition and results of operations. The discussion is intended to assist in understanding our consolidated financial condition and results of operations, and it should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of various factors. All share and per share data have been adjusted to give retroactive effect to stock splits and stock dividends.

Bank of the Carolinas Corporation (the “Company”) is a North Carolina-chartered bank holding company that was incorporated on May 30, 2006, for the sole purpose of serving as the parent bank holding company for Bank of the Carolinas (the “Bank”). The Bank is an FDIC-insured, North Carolina-chartered bank that began operations on December 7, 1998.

Because the Company has no operations and conducts no business on its own other than owning the Bank, the discussion contained herein concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and its subsidiary are collectively referred to herein as the “Company” unless otherwise noted.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The notes to our audited financial statements for the years ended December 31, 2013, 2012, and 2011 contain a summary of our significant accounting policies. We believe our policies with respect to methodology for the determination of our allowance for loan losses, and our asset impairment judgments, such as the recoverability of other real estate values, involve a higher degree of complexity and require us to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Accordingly, we consider the policies related to those areas critical.

The allowance for loan losses represents our best estimate of probable losses that are inherent in the loan portfolio at the balance sheet date. The allowance is based on generally accepted accounting principles, which require that losses be accrued when they are probable of occurring and estimable and require that losses be accrued based on the differences between the value of collateral, the present value of future cash flows or values that are observable in the secondary market, and the loan balance.

 

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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 those loans, in our opinion, become uncollectible. Recoveries during the period are credited to the allowance. The factors that influence our judgment in determining the amount charged against operating income include analyzing historical loan and lease losses, current trends in delinquencies and charge-offs, current assessment of problem loan administration, the results of regulatory examinations, and changes in the size, composition and risk assessment of the loan and lease portfolio. Also included in our estimates for loan losses are considerations with respect to the impact of current economic events, the outcomes of which are uncertain. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which we conduct business.

The factors that are enumerated above form the basis for a model which we utilize in calculating the appropriate level of our allowance for loan losses at the balance sheet date. This model has three main components. First, losses are estimated on loans we have individually identified and determined to be “impaired”. A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The loss allowance applicable to impaired loans is the difference, if any, between the loan balances outstanding and the value of the impaired loans as determined by either 1) an estimate of the cash flows that we expect to receive from those borrowers discounted at the loan’s effective rate, or 2) in the case of collateral-dependent loans, the fair value of the collateral securing those loans less estimated costs to sell.

Second, for all other loans, we divide the loan portfolio into groups or pools based on similarity of risk characteristics. Historical loss rates, which are an average of the most recent 12 quarters, are then applied to determine an appropriate allowance for each pool or group.

Finally, an adjustment is applied, if appropriate, to give effect to qualitative or environmental factors that could cause estimated credit losses within the existing loan portfolio to differ from the historical loss experience.

We review our allowance on a quarterly basis and believe that it is adequate to cover inherent loan losses on the loans outstanding as of each reporting date. However, the appropriateness of the allowance using our procedures and methods is dependent upon the accuracy of various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not, in any particular period, sustain loan losses that are significantly different from the amounts reserved for those loans, or that subsequent evaluations of the loan portfolio and our allowance, in light of conditions and factors then prevailing, will not require material 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 our allowance. Those agencies may require that we make additions to the allowance based on their judgments about information available to them at the time of their examinations.

Accounting for intangible assets is as prescribed by generally accepted accounting principles. We account for recognized intangible assets based on their estimated useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with an indefinite useful life are not amortized. Goodwill is not amortized, but is subject to fair value impairment tests on at least an annual basis. If we determine that impairment has occurred based on our evaluation, the impairment charge is recognized at that time.

Accrued taxes represent the estimated amount payable to or receivable from taxing jurisdictions, either currently or in the future, and are reported, on a net basis, as a component of either “other assets” or “other liabilities” in the consolidated balance sheets. The calculation of the Company’s income tax expense is complex and requires the use of many estimates and judgments in its determination.

Management’s determination of the realization of the net deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income and the implementation of various tax plans to maximize realization of the deferred tax asset. As of December 31, 2013, an $17.7 million valuation allowance has been established primarily due to the possibility that all of the deferred tax asset associated with the allowance for loan losses may not be realized. See Note 10 Income Taxes in the notes to the audited consolidated financial statements for further disclosure on this matter.

From time to time, management bases the estimates of related tax liabilities on its belief that future events will validate management’s current assumptions regarding the ultimate outcome of tax-related exposures. While the Company has obtained the opinion of advisors that the anticipated tax treatment of these transactions should prevail and has assessed the relative merits and risks of the appropriate tax treatment, examination of the Company’s income tax returns, changes in tax law and regulatory guidance may impact the treatment of these transactions and resulting provisions for income taxes.

 

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Overview

Our net loss available to common shareholders was $2.3 million for 2013, $5.5 million for 2012, and $29.2 million for 2011. The loss in 2011 was driven by substantial increases in loan loss provisions due to deterioration in our loan portfolio, significant losses and net operating expenses associated with foreclosed real estate, as well as lost interest revenue caused by elevated levels of nonperforming assets. The loss in 2012 decreased compared to 2011, but higher provisions continued as loan demand declined. Costs related to foreclosed real estate continued into 2012 as well. In 2013, significant improvements were made in levels of nonperforming assets compared to 2012 and 2011. The Company still has excessive cost related to its term repurchase agreements and FDIC insurance premiums.

In 2012, a reduced loan demand led to a decline of $37.5 million in our loan portfolio. An increased loan demand in 2013 led to an increase of $8.1 million in our loan portfolio. Given the prominence of real estate loans in our lending activities, it has been and continues to be a challenge to generate quality credit in sufficient volume to outpace payments.

We strive to serve the financial needs of small to medium-sized businesses and individuals in our market area, offering an array of financial products emphasizing superior customer service.

Real estate secured loans, including construction loans and loans secured by existing commercial and residential properties, made up almost 89% of our loan portfolio at December 31, 2013, with the remainder of our loans consisting of commercial and industrial loans and loans to individuals. We also offer certain loan products through associations with various mortgage lending companies. Through these associations, we originate 1-4 family residential mortgages, at both fixed and variable rates. We earn fees for originating these loans and transferring the loan package to the mortgage lending companies.

The deposit services we offer include small business and personal checking accounts, savings accounts, money market checking accounts and certificates of deposit. The Company concentrates on providing customer service to build its customer deposit base.

Additional funding includes advances from the Federal Home Loan Bank, term repurchase agreements from two money center financial institutions and federal funds lines of credit from correspondent banks.

Over 90% of our revenue (net interest income plus noninterest income) consisted of net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. Therefore, the levels of interest rates and our ability to effectively manage the effect that changes in interest rates have on net interest income can have a significant impact on revenue and results of operations. Results of operations may also be materially affected by our provision for loan losses, which was much higher during 2012 and 2011 than our long-term trend. In 2013, our provision for loan losses reflected a recovery. Service charges and fee income generated from customer services represented less than 10% of revenue in each of the past two years and represents an area of potential revenue growth. Noninterest expense is the third major driver of operating results along with net interest income and the provision for loan losses. Total noninterest expenses absorbed over 120% of our revenue in 2013 and 114% in 2012. Noninterest expenses include compensation and employee benefits, occupancy and equipment expenses, FDIC insurance premiums, expenses related to foreclosed real estate, professional services, expenditures for data processing services and various other costs of doing business.

In addition, due to the establishment of the valuation allowance against the deferred tax asset in 2011, there was a tax expense of $942,000 in 2013, but no income tax expense or benefit in 2012. Results for 2011 were significantly impacted by a provision for income taxes of $4.5 million that was made to establish a deferred income tax valuation allowance to reduce the carrying value of the Company’s net deferred tax asset to zero, thereby increasing a loss before income taxes of $23.7 million to a net loss of $28.3 million.

 

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Regulatory Action

Consent Order with FDIC and North Carolina Commissioner of Banks. The Bank entered into a Stipulation to the Issuance of a Consent Order (the “Stipulation”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Office of the Commissioner of Banks (the “Commissioner”) and the FDIC and the Commissioner issued the related Consent Order (the “Order”), effective April 27, 2011. The description of the Stipulation and the Order set forth below is qualified in its entirety by reference to the Stipulation and the Order, copies of which are included as exhibits 10.14 and 10.15 to this Form 10-K, and incorporated herein by reference.

Management. The Order requires that the Bank have and retain qualified management, including a chief executive officer, senior lending officer, and chief operating officer with qualifications and experience commensurate with their assigned duties and responsibilities within 60 days from the effective date of the Order. Within 30 days of the effective date of the Order, the board of directors was required to retain a bank consultant to develop a written analysis and assessment of the Bank’s management needs. Following receipt of the consultant’s management report, the Bank was required to formulate a written management plan that incorporated the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a time frame for completing each action.

Capital Requirements. While the Order is in effect, the Bank must maintain a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. If the Bank’s capital ratios are below these levels as of the date of any call report or regulatory examination, the Bank must, within 30 days from receipt of a written notice of capital deficiency from its regulators, present a plan to increase capital to meet the requirements of the Order.

Allowance for Loan and Lease Losses and Call Report. Upon issuance of the Order, the Bank was required to make a provision to replenish the allowance for loan and lease losses (“ALLL”). Within 30 days of the effective date of the Order, the Bank was required to review its call reports filed with its regulators on or after December 31, 2010, and amend those reports if necessary to accurately reflect the financial condition of the Bank. Within 60 days of the effective date of the Order, the Bank was required to submit a comprehensive policy for determining the adequacy of the ALLL.

Concentrations of Credit. Within 60 days of the issuance of the Order, the Bank was required to perform a risk segmentation analysis with respect to its concentrations of credit and develop a written plan for systematically reducing and monitoring the Bank’s commercial real estate and acquisition, construction, and development loans to an amount commensurate with the Bank’s business strategy, management expertise, size, and location.

Charge-Offs, Credits. The Order requires that the Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified “loss” and 50% of those assets classified “doubtful.” If an asset is classified “doubtful,” the Bank may alternatively charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, “loss” or “doubtful” and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.” These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify its regulators at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from its regulators.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of its regulators. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized

 

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institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank was required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

 

    Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management

 

    Plan to reduce assets of $500,000 or greater classified “doubtful” and “substandard”

 

    Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

 

    Effective internal loan review and grading system

 

    Policy for managing the Bank’s other real estate

 

    Business/strategic plan covering the overall operation of the Bank

 

    Plan and comprehensive budget for all categories of income and expense for the year 2011

 

    Policy and procedures for managing interest rate risk

 

    Assessment of the Bank’s information technology function

Under the Order, the Bank’s board of directors agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank was also required to establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and the Commissioner.

Written Agreement with the Federal Reserve Bank of Richmond. The Company entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of Richmond on August 26, 2011. The description of the Agreement set forth below is qualified in its entirety by reference to the Agreement, a copy of which is included as exhibit 10.16 to this Form 10-K, and is incorporated herein by reference.

Source of Strength. The Agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and to ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC and the Bank.

Dividends, Distributions, and other Payments. The Agreement prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. It also prohibits the Company from directly or indirectly taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank of Richmond.

Under the terms of the Agreement, the Company and the Bank may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

Debt and Stock Redemption. The Agreement requires that the Company and any non-bank subsidiary of the Company not, directly or indirectly, incur, increase or guarantee any debt without the prior written approval of the Federal Reserve Bank. The Agreement also requires that the Company not, directly or indirectly, purchase or redeem any shares of its capital stock without the prior written approval of the Federal Reserve Bank of Richmond.

Capital Plan, Cash Flow Projections and Progress Reports. The Agreement requires that the Company file an acceptable capital plan and certain cash flow projections with the Federal Reserve Bank of Richmond. It also requires that the Company file a written progress report within 30 days after the end of each calendar quarter while the Agreement remains in effect.

The Order will remain in effect until modified or terminated by the Federal Reserve Bank of Richmond.

 

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Financial Condition at December 31, 2013 and December 31, 2012

Total assets at December 31, 2013, decreased by $13.7 million or 3.1% to $423.7 million compared to $437.4 million at December 31, 2012. We had earning assets of $385.6 million at December 31, 2013 consisting of $273.7 million in accruing loans, $90.3 million in investment securities and $21.6 million in temporary investments. Stockholders’ equity was $1.7 million at December 31, 2013 compared to $9.1 million at December 31, 2012.

Loans. Total loans increased by $8.1 million or 3.0% during the twelve months of 2013, from $270.4 million on December 31, 2012 to $278.5 million at December 31, 2013. On December 31, 2013, real estate loans made up 92.5% of total loans while commercial non-real estate loans comprised another 6.3% of the portfolio. Total loans represented 65.3% and 61.8% of our total assets on December 31, 2013 and 2012, respectively.

Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulation also influence interest rates. On average, our loan portfolio yielded 4.76% for the year ending December 31, 2013 as compared to an average yield of 4.97% during 2012.

The following table contains selected data relating to the composition of our loan portfolio by type of loan on the dates indicated.

Table I. Analysis of Loan Portfolio (dollars in thousands)

 

     At December 31,  
     2013     2012     2011     2010     2009  
     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  

Real estate loans:

                    

Residential 1-4 family

   $ 84,855        30.47   $ 72,595        26.85   $ 78,631        25.54   $ 78,750        21.51   $ 76,767        19.62

Commercial real estate

     117,463        42.18        110,527        40.88        126,849        41.20        161,839        44.20        161,904        41.38   

Construction and development

     27,049        9.71        28,976        10.72        33,081        10.74        35,310        9.64        41,580        10.63   

Home equity

     28,217        10.12        29,462        10.89        29,727        9.65        31,465        8.59        30,775        7.87   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     257,584        92.48        241,560        89.34        268,288        87.13        307,364        83.94        311,026        79.50   

Commercial business loans

     17,428        6.26        22,992        8.50        34,271        11.13        51,581        14.09        75,762        19.36   

Consumer loans:

                    

Installment

     2,554        0.92        3,158        1.17        3,490        1.13        4,300        1.17        3,303        0.84   

Other

     944        0.34        2,664        0.99        1,858        0.61        2,908        0.80        1,174        0.30   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

     278,510        100.00     270,374        100.00     307,907        100.00     366,153        100.00     391,265        100.00
    

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Allowance for loan losses

     (6,015       (6,890       (8,101       (6,863       (8,167  
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans, net

   $ 272,495        $ 263,484        $ 299,806        $ 359,290        $ 383,098     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

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The following table reflects the scheduled maturities of commercial real estate loans, construction and development loans, and commercial business loans (dollars in thousands):

 

     December 31, 2013  
     1 year
or less
     After 1 year
but within
5 years
     After
5 years
     Total  

Commercial real estate loans

   $ 26,246       $ 57,584       $ 33,633       $ 117,463   

Constructions and development loans

     9,913         11,989         5,147         27,049   

Commercial business loans

     10,947         6,480         1         17,428   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 47,106       $ 76,053       $ 38,781       $ 161,940   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table reflects the scheduled maturities of all fixed and variable interest rate loans (dollars in thousands):

 

     December 31, 2013  
     1 year
or less
     After 1 year
but within
5 years
     After
5 years
     Total  

Loans with fixed interest rates

   $ 31,472       $ 98,256       $ 92,192       $ 221,920   

Loans with variable interest rates

     16,382         12,603         27,605         56,590   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 47,854       $ 110,859       $ 119,797       $ 278,510   
  

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for Loan Losses. On December 31, 2013, our allowance totaled approximately $6.0 million and amounted to 2.16% of total loans and 125.6% of our nonperforming loans. This compares to an allowance of $6.9 million, or 2.55% of loans and 89.1% of nonperforming loans at December 31, 2012 and $8.1 million, or 2.63% of loans and 42.5% of nonperforming loans as of December 31, 2011.

 

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Table of Contents

The following table contains an analysis of our allowance for loan losses for the time periods indicated.

Table II. Summary of Loan Loss Experience (dollars in thousands)

 

     Year ended December 31,  
     2013     2012     2011     2010     2009  

Balance at beginning of year

   $ 6,890      $ 8,101      $ 6,863      $ 8,167      $ 6,308   

Provision for loan losses

     (2,039     2,359        17,565        6,441        5,547   

Charge-offs:

          

Residential mortgage

     (897     (1,233     (3,125     (1,041     (256

Commercial real estate

     (544     (1,804     (7,339     (1,090     (141

Construction and development

     (248     (1,118     (1,256     (1,006     (1,381

Commercial business

     (115     (453     (5,310     (4,561     (1,912

Installment

     (51     (76     (150     (233     (218
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (1,855     (4,684     (17,180     (7,931     (3,908
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Residential mortgage

     689        126        118        3        4   

Commercial real estate

     573        116        101        28        50   

Construction and development

     22        169        145        94        9   

Commercial business

     1,698        671        470        23        128   

Installment

     37        32        19        38        29   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     3,019        1,114        853        186        220   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     1,164        (3,570     (16,327     (7,745     (3,688
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

   $ 6,015      $ 6,890      $ 8,101      $ 6,863      $ 8,167   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs (recoveries) during period to average loans outstanding

     -0.42     1.24     4.78     2.08     0.92

Ratio of allowance for loan losses to non-performing loans

     125.6     89.1     42.5     27.8     88.5

Ratio of allowances for loan losses to total loans

     2.16     2.55     2.63     1.87     2.09

During 2013, we incurred net loan recoveries of $1.2 million, compared to net loan charge-offs of $3.6 million in 2012 and $16.3 million in 2011. These levels of net recoveries and charge-offs produced a net recovery ratio of 0.42% for 2013 and net loss ratios of 1.24% for 2012 and 4.78% for 2011. The loss ratios for 2012 and 2011 were substantially higher than our longer-term trend which contributed to increased loan loss provisions in their respective years. The deterioration in our loan portfolio, as evidenced by rising loss ratios and nonperforming loans, resulted in the increases in our allowance for loan losses for 2011. By late 2012, our nonperforming loans had decreased significantly compared to the two prior years and we had our first quarter of net loan recoveries in five years. In 2013, continued efforts reduced nonperforming loans to loss ratios that compared to peers and a full year of net recoveries.

 

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Table of Contents

An analysis of the allowance for loan losses for the years ended December 31, 2013, 2012, 2011, 2010, and 2009 is contained in the following table:

Table III. Allocation of Allowance for Loan Losses (1) (dollars in thousands)

 

     At December 31,  
     2013     2012     2011     2010     2009  
     Amount      Percent     Amount      Percent     Amount      Percent     Amount      Percent     Amount      Percent  

Real estate loans:

                         

Residential, 1-4 family

   $ 1,218         20.25   $ 1,267         18.39   $ 1,168         14.42   $ 1,078         15.71   $ 721         8.83

Commercial real estate

     2,105         35.00        2,210         32.08        2,421         29.89        1,154         16.81        4,072         49.86   

Construction and development

     635         10.56        806         11.70        719         8.88        667         9.72        1,007         12.33   

Home equity

     332         5.51        314         4.55        279         3.44        459         6.69        93         1.14   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

     4,290         71.32        4,597         66.72        4,587         56.63        3,358         48.93        5,893         72.16   

Commercial business loans

     176         2.93        1,209         17.55        2,247         27.74        2,252         32.81        2,165         26.51   

Consumer loans:

                         

Installment

     44         0.73        98         1.42        143         1.77        161         2.35        104         1.27   

Other

     —           —          —           —          —           —          —           —          5         0.06   

Unallocated

     1,505         25.02        986         14.31        1,124         13.86        1,092         15.91        —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Loans

   $ 6,015         100.00   $ 6,890         100.00   $ 8,101         100.00   $ 6,863         100.00   $ 8,167         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) The allowance has been allocated on an approximate basis. The entire amount of the allowance is available to absorb losses occurring in any category. The allocation is not necessarily indicative of future losses.

Asset Quality. Credit risks are inherent in making loans. We assess these risks and attempt to manage them effectively 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 non-accrual status when, in our judgment, the collection of interest appears doubtful. Nonperforming assets are defined as nonaccrual loans, loans contractually past due for more than 90 days but still accruing interest, and foreclosed or idled properties. At December 31, 2013, the Company’s non-performing assets totaled $6.0 million, or 2.15% of loan-related assets, compared to $12.7 million, or 4.62% of loan-related assets at December 31, 2012.

On December 31, 2013, we had no loans that were delinquent over 90 days and still accruing interest, and $4.8 million that were in non-accrual status. Interest accrued, but not recognized as income on non-accrual loans, was approximately $170,000 during 2013. Compared to December 31, 2012, we had no loans that were delinquent over 90 days and still accruing interest, and $7.7 million that were in non-accrual status. Interest accrued, but not recognized as income on non-accrual loans, was approximately $159,000 during 2012.

“Other real estate owned,” also referred to as “OREO,” generally consists of all real estate, other than bank premises, that is owned or controlled by a financial institution, including real estate acquired through foreclosure. Financial institutions such as the Company typically acquire OREO through foreclosure or a deed in lieu of foreclosure after a borrower defaults on a loan.

Other real estate owned at December 31, 2013 amounted to $1.2 million compared to $5.0 million as of December 31, 2012. Other real estate is carried at the lower of cost or estimated net realizable value. During the year ended December 31, 2013 and 2012, $953,000 and $5.8 million of real property, respectively, was foreclosed on and transferred to OREO. Properties transferred to OREO are initially recorded at the lower of the loan balance or the fair value of the property, less estimated costs to sell the property at the date of the foreclosure. The $953,000 and $5.8 million transferred to OREO in 2013 and 2012 represents the fair value of the properties at the date of transfer. As a result of obtaining the fair values of these properties prior to transferring them to OREO, the Company charged $539,000 to the allowance for loan losses in 2013 and $2.2 million to the allowance for loan losses in 2012. As noted above, the Company also considers the estimated costs to sell a property when transferring a property to OREO. The Company takes the following factors into consideration when estimating the costs to sell a property:

 

    potential discount for liquidation,

 

    prior liens on the property,

 

    taxes,

 

    sales commissions, and

 

    closing expenses.

The estimated cost to sell a property is subtracted from the fair value of the property prior to transferring the property to OREO.

 

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The following table provides a roll-forward of OREO for the periods ended December 31, 2013, 2012, and 2011:

Table IV. OREO Rollforward (dollars in thousands)

 

     Year Ended December 31,  
     2013     2012     2011  

Beginning Balance

   $ 4,976      $ 8,524      $ 8,314   

Additions from Transfers In

     953        5,823        10,520   

Valuation Adjustments

     (539     (2,040     (3,449

Gross Sales

     (4,080     (7,523     (6,113

Gross Gains (Losses)

     (77     192        (748
  

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 1,233      $ 4,976      $ 8,524   
  

 

 

   

 

 

   

 

 

 

In April 2011, the Company established a special assets department to provide expertise in the areas of problem loans and OREO. This new department revised the Company’s procedures with respect to foreclosed properties. Previously, when a property was in foreclosure, the balance of the loan was transferred to OREO. Losses on the OREO property were taken upon the sale of the property. As a result, the charge-off did not become part of the loss history of the loan. The special assets department implemented changes such that management now obtains updated fair values for properties and prepares an impairment analysis when there is an indication that the loan is problematic. Any resulting impairment is charged to the allowance for loan losses and becomes part of the loan’s loss history. The Company conducts an annual review of problem loans to ensure that proper fair value is recognized.

The following table summarizes information regarding our nonperforming assets on December 31, 2013, 2012, 2011, 2010, and 2009.

Table V. Nonperforming Assets (dollars in thousands)

 

     At December 31,  
     2013     2012     2011     2010     2009  

Loans accounted for on a nonaccrual basis:

          

Real estate loans:

          

Mortgage

   $ 1,276      $ 2,491      $ 6,875      $ 4,071      $ 2,971   

Commercial

     2,192        4,153        9,167        15,176        1,606   

Construction and development

     851        880        1,764        2,274        1,488   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     4,319        7,524        17,806        21,521        6,065   

Commercial business customers

     463        202        1,246        3,068        3,151   

Installment

     6        7        10        101        8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     4,788        7,733        19,062        24,690        9,224   

Accruing loans which are contractually past due 90 days or more

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     4,788        7,733        19,062        24,690        9,224   

Other real estate owned

     1,233        4,976        8,524        8,314        8,233   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 6,021      $ 12,709      $ 27,586      $ 33,004      $ 17,457   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans as a percentage of loans

     1.72     2.86     6.19     6.74     2.36

Total nonperforming assets as a percentage of loans and other real estate owned

     2.15     4.62     8.72     8.81     4.37

Total nonperforming assets as a percentage of total assets

     1.42     2.91     5.68     6.17     2.86

Investment Securities. Our investment securities totaled $90.3 million at December 31, 2013 and $106.9 million at December 31, 2012. Our investment portfolio includes U.S. Government Agency bonds, mortgage backed securities, state and municipal bonds and corporate subordinated debt of other financial institutions, all of which are classified as held to maturity or available for sale. Held to maturity securities are carried at amortized cost value and available for sale securities are carried at fair value.

 

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Table of Contents

We use our investment portfolio to employ liquid funds and as a tool in the management of interest rate risk, while at the same time providing interest income. Practically all of our securities are classified as available for sale and, as such, may be sold from time to time to increase liquidity or re-balance the interest rate sensitivity profile of our balance sheet. However, we do have the available liquidity to hold our securities to maturity should we have the need to. In fact, we have classified some of our more illiquid securities as held to maturity because we fully intend to hold them until their maturity date. All securities classified as held to maturity were purchased in 2008 and consist of subordinated debt and trust preferred securities issued or guaranteed by other financial institutions. In December 2011, we recorded an additional impairment charge of $397,000 for a total impairment of $1.0 million on a $1.0 million investment in a trust preferred security as a result of the guarantor bank holding company exercising its right to defer interest payments to the issuing trust in December 2009. In 2012, the guarantor bank holding company’s sole subsidiary bank was closed by regulatory authorities. As a result, we removed the investment from our portfolio.

The following table summarizes the carrying value of our investment securities on the dates indicated.

Table VI. Investment Securities (dollars in thousands)

 

     December 31,  
     2013      2012      2011  

U.S. Government agency securities

   $ 40,930       $ 48,118       $ 44,259   

State and municipal seurities

     10,181         10,326         3,590   

Mortgage-backed securities

     38,204         46,492         61,571   

Corporate securities

     1,000         1,995         2,984   
  

 

 

    

 

 

    

 

 

 

Total

   $ 90,315       $ 106,931       $ 112,404   
  

 

 

    

 

 

    

 

 

 

The following tables summarize information regarding the scheduled maturities, amortized cost, and weighted average yields on a tax equivalent basis for our investment securities portfolio on December 31, 2013 and 2012.

Table VII. Investment Securities (dollars in thousands)

 

At December 31, 2013:                 Over 1 to 5     Over 5 to 10     Over 10     Total  
     1 year or less     years     years     years     Securities  
     Amortized      Average     Amortized      Average     Amortized      Average     Amortized      Average     Amortized      Average  
     Cost      Yield     Cost      Yield     Cost      Yield     Cost      Yield     Cost      Yield  

U.S. Government agency securities

   $ 19,000         1.38   $ 1,681         3.78   $ 13,810         2.20   $ 9,586         2.58   $ 44,077         1.99

State and municipal securities

     —           —          508         2.50        10,079         2.69        572         2.38        11,159         2.67   

Mortgage-backed securities

     —           —          —           —          200         6.03        39,258         2.43        39,458         2.44   

Corporate securities

     —           —          1,000         3.75        —           —          —           —          1,000         3.75   
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total investment securities

   $ 19,000         1.38   $ 3,189         3.57   $ 24,089         2.44   $ 49,416         2.46   $ 95,694         2.28
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    
At December 31, 2012:                 Over 1 to 5     Over 5 to 10     Over 10     Total  
     1 year or less     years     years     years     Securities  
     Amortized      Average     Amortized      Average     Amortized      Average     Amortized      Average     Amortized      Average  
     Cost      Yield     Cost      Yield     Cost      Yield     Cost      Yield     Cost      Yield  

U.S. Government agency securities

   $ 6,000         1.62   $ 5,006         2.78   $ 27,204         2.18   $ 9,582         2.58   $ 47,792         2.26

State and municipal securities

     —           —          508         2.50        8,066         2.59        1,790         2.64        10,364         2.60   

Mortgage-backed securities

     —           —          —           —          —           —          45,861         2.34        45,861         2.34   

Corporate securities

     995         7.79        —           —          1,000         3.86        —           —          1,995         5.82   
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total investment securities

   $ 6,995         2.50   $ 5,514         2.75   $ 36,270         2.32   $ 57,233         2.39   $ 106,012         2.39
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Deposits. Our deposit service offerings include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. On December 31, 2013, total deposits were $366.2 million compared with $373.0 million on December 31, 2012. During the year, there were increases in interest-checking and savings deposits, with decreases in noninterest-checking, money markets, and time deposits.

Under FDIC regulations and the terms of the regulatory consent order discussed under the heading “Regulatory Action” above, we may not currently solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yield on insured deposits of comparable maturity in our market area or the market area where the deposits are being solicited.

 

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Brokered deposits have decreased from $15.1 million at December 31, 2012 to none at December 31, 2013. On December 31, 2013, there were no brokered deposits as a percentage of total deposits as compared to 4.0% at December 31, 2012 and 10.3% as of December 31, 2011. Under FDIC regulations and the terms of the regulatory consent order discussed under the heading “Regulatory Action” above, we may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions, such as the Bank, from accepting, renewing, or rolling over any brokered deposits. On December 31, 2013, total time deposits issued in denominations of $100,000 or more made up approximately 31.7% of our total deposits as compared to 31.1% as of December 31, 2012 and 36.6% at December 31, 2011.

Retail deposits gathered through our branch network continue to be our principal source of funding. It is our intent to focus our efforts and marketing resources on the growth of our deposit base as we believe this to be the most effective long term strategy for profitable growth.

The following table summarizes our average deposits for the years ended December 31, 2013, 2012, and 2011.

Table VIII. Deposit Mix (dollars in thousands)

 

     For the Years ended December 31,  
     2013     2012     2011  
     Average      Average     Average      Average     Average      Average  
     Balance      Cost     Balance      Cost     Balance      Cost  

Interest-bearing deposits:

               

Interest-checking deposits

   $ 39,910         0.34   $ 37,421         0.38   $ 36,829         0.55

Money market and savings deposits

     110,542         0.49        105,141         0.55        107,696         0.59   

Time deposits

     178,882         0.91        218,492         1.15        241,763         1.47   
  

 

 

      

 

 

      

 

 

    

Total interest-bearing deposits

     329,334         0.70        361,054         0.89        386,288         1.14   

Noninterest-bearing demand deposits

     35,365           37,555           36,984      
  

 

 

      

 

 

      

 

 

    

Total deposits

   $ 364,699         0.63   $ 398,609         0.81   $ 423,272         1.04
  

 

 

      

 

 

      

 

 

    

The following table contains an analysis of our time deposits of $100,000 or more at December 31, 2013, 2012, and 2011.

 

     December 31,  
     2013      2012      2011  
     (dollars in thousands)  

Remaining maturity of three months or less

   $ 29,553       $ 29,580       $ 15,564   

Remaining maturity of over three to twelve months

     49,084         53,527         86,341   

Remaining maturity of over twelve months

     37,289         33,021         50,600   
  

 

 

    

 

 

    

 

 

 

Total time deposits of $100,000 or more

   $ 115,926       $ 116,128       $ 152,505   
  

 

 

    

 

 

    

 

 

 

 

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Borrowed Funds. The following table summarizes our borrowings at December 31, 2013, 2012, and 2011.

Table IX. Borrowed Funds (dollars in thousands)

 

     At December 31,  
     2013     2012     2011  
     Outstanding      Average     Outstanding      Average     Outstanding      Average  
     Balance      Rate     Balance      Rate     Balance      Rate  

Federal funds purchased and securities sold under overnight repurchase agreements

   $ 388         0.14   $ 362         0.10   $ 381         0.10

Securities sold under term repurchase agreements

     45,000         4.38        45,000         4.38        45,000         4.38   

Federal Home Loan Bank advances

     —           —          —           —          —           —     

Trust preferred securities

     5,155         3.19        5,155         3.25        5,155         3.49   

Subordinated debt

     2,700         4.00        2,700         4.00        2,700         4.00   
  

 

 

      

 

 

      

 

 

    

Total borrowed funds

   $ 53,243         4.21   $ 53,217         4.22   $ 53,236         4.24
  

 

 

      

 

 

      

 

 

    

The following table presents our average balances as well as the average cost associated with those balances for the specified periods.

 

     For the years ended December 31,  
     2013     2012     2011  
     Average      Average     Average      Average     Average      Average  
     Balance      Cost     Balance      Cost     Balance      Cost  

Federal funds purchased and securities sold under overnight repurchase agreements

   $ 805         0.12   $ 346         0.29   $ 478         0.21

Securities sold under term repurchase agreements

     45,000         4.38        45,000         4.39        45,000         4.38   

Federal Home Loan Bank advances

     —           —          —           —          14,038         2.89   

Trust preferred securities

     5,155         3.51        5,155         3.59        5,155         3.30   

Subordinated debt

     2,700         4.00        2,700         4.00        2,700         4.00   
  

 

 

      

 

 

      

 

 

    

Total borrowed funds

   $ 53,660         4.21   $ 53,201         4.26   $ 67,371         3.94
  

 

 

      

 

 

      

 

 

    

During 2008, we entered into term repurchase agreements with two money center financial institutions. These two borrowing arrangements total $45.0 million in the aggregate and currently bear interest at an effective annual blended rate of 4.38%. These borrowings were secured by marketable securities totaling approximately $55.5 million at December 31, 2013. The agreements have final maturity dates in July 2018 and August 2015 but may be terminated by the lenders beginning July 2013 and August 2011, respectively.

On December 31, 2013, we had no advances from the Federal Home Loan Bank (“FHLB”). We have immediate availability of $7.8 million as we have pledged our eligible one-to-four family mortgages, commercial real estate loans and home equity loans with aggregate outstanding principal balances of approximately $11.5 million.

During 2008, the Company issued $5.2 million of junior subordinated debentures to Bank of the Carolinas Trust I (the “Trust”), which, in turn, issued $5.0 million in trust preferred securities having a like liquidation amount and $155,000 in common securities (all of which are owned by the Company). The Company has fully and unconditionally guaranteed the Trust’s obligations related to the trust preferred securities. The Trust has the right to redeem the trust preferred securities in whole or in part, on or after March 26, 2013 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest. In addition, the Trust 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 debenture). The trust preferred securities bear interest at the annual rate of 90-day LIBOR plus 300 basis points adjusted quarterly. In February 2011, the Company announced its election to defer its regularly scheduled March 2011 interest payment on the junior subordinated debentures related to the trust preferred securities and continued to defer interest payments throughout 2011, 2012, and 2013.

 

 

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The Company also has issued $2.7 million of subordinated debt in a private transaction with another banking institution. This subordinated note has a floating interest rate equal to 75 basis points over the Prime Rate published by the Wall Street Journal and a maturity date of August 13, 2018. This debt can be repaid in full at any time with no penalty.

Capital Resources. Total stockholders’ equity decreased by $7.3 million to $1.7 million on December 31, 2013, compared to $9.1 million on December 31, 2012. The decrease was substantially the net result of the current year’s net loss and net unrealized losses on securities available for sale, along with an increase in the deferred tax valuation allowance.

On April 17, 2009, the Company became a participant in the U.S. Department of the Treasury Capital Purchase Program by selling shares of Series A preferred stock to the Treasury having a liquidation value of $13.2 million. The preferred shares have a cumulative dividend rate of 5% per annum for the first five years and 9% per annum thereafter. As a part of the transaction, the Company also issued the Treasury warrants to purchase 475,204 shares of the Company’s common stock at $4.16 per share for a term of ten years.

Off-Balance Sheet Transactions. Certain financial transactions are entered into by the Company in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. The off-balance sheet transactions as of December 31, 2013 and 2012 were commitments to extend credit and financial letters of credit. Except as disclosed in this report, the Company does not have any ownership interest in any off-balance sheet subsidiaries or special purpose entities.

 

     December 31,  
     2013      2012  
     (In thousands)  

Loan commitments

   $ 29,553       $ 27,807   

Financial standby letters of credit

     181         512   
  

 

 

    

 

 

 

Total unused commitments

   $ 29,734       $ 28,319   
  

 

 

    

 

 

 

Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates. Since many of these commitments expire without being funded, the commitment amounts do not necessarily represent liquidity requirements.

Contractual Obligations. The following disclosure shows the contractual obligations that the Company had outstanding at December 31, 2013.

 

     Total payments due by period  
            Less than                    More than  
     Total      1 Year      1-3 Years      3-5 Years      5 Years  
     (in thousands)  

Time deposits

   $ 180,549       $ 114,091       $ 62,827       $ 3,631       $ —     

Securities sold under term repurchase agreements(1)

     45,000         —           20,000         25,000         —     

Trust preferred securities

     5,155         —           —           —           5,155   

Subordinated debt

     2,700         —           —           —           2,700   

Leases

     833         260         573         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 234,237       $ 114,351       $ 83,400       $ 28,631       $ 7,855   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Obligations in this category are classified as to maturity dates. One repurchase agreement, with a principal balance of $20 million, may be called by the holder on a quarterly basis beginning August 20, 2011. The other repurchase agreement included above, which has a principal balance of $25 million, may be called by the holder on a quarterly basis beginning July 8, 2013.

Comparison of Results of Operations for the Years Ended December 31, 2013, 2012, and 2011

Net Income (Loss). We had a net loss available to common shareholders of $2.3 million or $0.60 per diluted common share for the year ended December 31, 2013, compared to net loss of $5.5 million or $1.42 per diluted common share for the year ended December 31, 2012 and net loss for the year ended December 31, 2011 of $29.2 million, or $7.49 per diluted common share. As noted earlier, the principal reason for the losses incurred in 2012 and 2011 was related to deterioration in our loan portfolio which resulted in materially higher loan loss provisions and increased expenses related to the ownership and disposal of foreclosed real estate. In 2013, the provision for loan loss reported a recovery and the Company experienced increased performance in the loan portfolio.

 

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In addition, due to the establishment of the valuation allowance against the deferred tax asset in 2011, there was a tax expense of $942,000 in 2013 and no tax expense or benefit in 2012. Results for 2011 were significantly impacted by a provision for income taxes of $4.5 million that was made to establish a deferred income tax valuation allowance to reduce the carrying value of the Company’s net deferred tax asset to zero, thereby increasing a loss before income taxes of $23.7 million to a net loss of $28.3 million.

Net Interest Income. Our primary source of revenue is net interest income, which is the difference between interest income generated by our interest-earning assets (primarily loans and investment securities) and interest expense on interest-bearing liabilities (primarily deposits and borrowed funds). Net interest income decreased $908,000 to $10.6 million in 2013 from 2012 after decreasing $2.0 million from 2011. Our net interest margin stayed consistent in 2013 at 2.72% compared to 2012 and decreased compared a margin in 2011 of 2.86%. Our net interest spread increased to 2.70% in 2013 from 2.68% in 2012 and declined from 2.79% in 2011. The volatility in our net interest margin and net interest spread and resulting net interest income over the past three years has been primarily due to the declines in short-term rates brought about by very aggressive Federal Reserve policies, declining total balances of loans and investments, and increased levels of nonperforming assets.

Table X summarizes the average balances of our various categories of assets and liabilities and their associated yields or costs for the years ended December 31, 2013, 2012, and 2011.

Table X. Summary of Net Interest Income and Average Balances (dollars in thousands)

 

     December 31, 2013     December 31, 2012     December 31, 2011  
            Interest                   Interest                   Interest         
     Average      Income/      Yield/     Average      Income/      Yield/     Average      Income/      Yield/  
     Balance      Expense      Cost     Balance      Expense      Cost     Balance      Expense      Cost  

Interest-earning assets:

                        

Loans

   $ 272,614       $ 12,978         4.76   $ 287,764       $ 14,303         4.97   $ 341,459       $ 17,398         5.10

Investment securities

     95,569         2,156         2.26        108,990         2,669         2.45        114,523         3,175         2.77   

Other interest-earning assets

     22,671         74         0.33        28,631         77         0.27        19,315         59         0.31   
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-earning assets

     390,854         15,208         3.89     425,385         17,049         4.01     475,297         20,632         4.34
     

 

 

         

 

 

         

 

 

    

Other assets, net

     36,935              39,156            `        48,899         
  

 

 

         

 

 

         

 

 

       

Total assets

   $ 427,789            $ 464,541            $ 524,196         
  

 

 

         

 

 

         

 

 

       

Interest bearing liabilities:

                        

Interest-checking deposits

   $ 39,910         137         0.34   $ 37,421         142         0.38   $ 36,829         201         0.55

Money Market and Savings deposits

     110,542         543         0.49        105,141         575         0.55        107,696         634         0.59   

Time deposits

     178,882         1,621         0.91        218,492         2,508         1.15        241,763         3,552         1.47   
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing deposits

     329,334         2,301         0.70        361,054         3,225         0.89        386,288         4,387         1.14   

Borrowed funds

     53,660         2,259         4.21        53,201         2,268         4.26        67,371         2,653         3.94   
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

Total Interest-bearing liabilities

     382,994         4,560         1.19        414,255         5,493         1.33        453,659         7,040         1.55   
     

 

 

         

 

 

         

 

 

    

Noninterest-bearing demand deposits

     35,365              37,555              36,984         

Other liabilities

     2,068              2,243              1,695         

Stockholders’ Equity

     7,362              10,488              31,858         
  

 

 

         

 

 

         

 

 

       

Total liabilities and stockholders’ equity

   $ 427,789            $ 464,541            $ 524,196         
  

 

 

         

 

 

         

 

 

       

Net interest income & interest rate spread

      $ 10,648         2.70      $ 11,556         2.68      $ 13,592         2.79
     

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

 

Net yield on average interest-earning assets

           2.72           2.72           2.86
        

 

 

         

 

 

         

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

           102.05           102.69           104.77
        

 

 

         

 

 

         

 

 

 

Non-accrual loans are included in the table for the years ended December 31, 2013, 2012, and 2011.

Loan fees and late charges of $150,000, $146,000, and $143,000 for 2013, 2012, and 2011, respectively, are included in interest income.

 

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Table XI summarizes the dollar amount of changes in interest income and interest expense for the major components of our interest-earning assets and interest-bearing liabilities during the twelve months ended December 31, 2013, 2012, and 2011. The table shows changes in interest income and expense attributable to volume changes and interest rate changes. The changes attributable to both rate and volume changes have been allocated between the two components on a relative basis. As the table indicates, the decrease in net interest income realized in 2013 in comparison to 2012 was the result of the decrease in volume and rates resulting in a negative effect on the current year results. The table also indicates that rates reduced the cost of interest-bearing liabilities, but not to the extent to which it could offset the reduced income from interest-earning assets.

Table XI. Volume / Rate Variance Analysis (dollars in thousands)

 

    Year Ended December 31, 2013 vs. 2012     Year Ended December 31, 2012 vs. 2011     Year Ended December 31, 2011 vs. 2010  
    Increase (Decrease) Due to     Increase (Decrease) Due to     Increase (Decrease) Due to  
    Volume     Rate     Total     Volume     Rate     Total     Volume     Rate     Total  

Interest-earning assets:

                 

Loans

  $ (755   $ (570   $ (1,325   $ (2,746   $ (349   $ (3,095   $ (1,773   $ (1,552   $ (3,325

Investment securities

    (332     (181     (513     (154     (352     (506     (120     (23     (143

Other interest-earning assets

    (15     12        (3     27        (9     18        24        (18     6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

    (1,102     (739     (1,841     (2,874     (709     (3,583     (1,869     (1,593     (3,462
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

                 

Deposits

    (289     (635     (924     (291     (871     (1,162     (98     (551     (649

Borrowed funds

    20        (29     (9     (548     163        (385     (295     324        29   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

    (269     (664     (933     (839     (708     (1,547     (393     (227     (620
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

  $ (833   $ (75   $ (908   $ (2,035   $ (1   $ (2,036   $ (1,476   $ (1,366   $ (2,842
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for Loan Losses. Provisions for loan losses are charged to income in order to maintain the allowance for loan losses at a level we deem appropriate under circumstances known to exist at the balance sheet date. In evaluating the allowance for loan losses, we consider factors that include portfolio size, composition and industry diversification of the portfolio, historical loan loss experience, current levels of impaired and delinquent loans, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. The allowance for loan losses expressed as a percentage of total loans was 2.16%, 2.55%, and 2.63% at December 31, 2013, 2012, and 2011, respectively. The allowance included $563,000 at December 31, 2013, $755,000 at December 31, 2012, and $770,000 at December 31, 2011 allocated to specific loans with principal balances totaling approximately $24.0 million, $26.6 million, and $23.8 million, respectively. See “Critical Accounting Policies”.

The provision for loan losses decreased 186.4% to a recovery of $2.0 million in 2013 from an expense of $2.4 million in 2012 and decreased from an expense of $17.6 million in 2011. The sizable provisions recorded in 2012 and 2011 were the result of net charge-offs and nonperforming asset levels that were significantly above long-term historic trends on a relative basis.

Losses on loans are charged against the allowance for loan losses. These charge-offs are made in the period in which we determine that the loans in question have become uncollectible. For additional details regarding our methodology for the determination of our allowance for loan losses, see “Critical Accounting Policies” above.

 

 

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Net loan recoveries for 2013 totaled $1.2 million which equates to 0.42% of average loans for the year and a 132.6% decrease from 2012 net charge-offs of $3.6 million, which represented 1.24% of average loans outstanding for that year, and a 107.1% decrease from 2011 net charge-offs of $16.3 million, which represented 4.78% of average loans outstanding for that year. For the five years prior to the current credit cycle (2007 – 2011), our net charge-offs averaged 1.82% of average loans on an annual basis. The following table shows the Company’s net loan charge-offs by loan category for each quarter in 2013, 2012, and 2011:

Table XII. Net Charge-offs by Quarter

(dollars in thousands)

 

    December 31, 2013     December 31, 2012     December 31, 2011  
    1Q     2Q     3Q     4Q     Total     1Q     2Q     3Q     4Q     Total     1Q     2Q     3Q     4Q     Total  

Commercial - Non Real Estate

  $ (1,281   $ 24      $ (241   $ (85   $ (1,583   $ 180      $ 81      $ (185   $ (294   $ (218   $ (13   $ 1,911      $ 1,760      $ 1,182      $ 4,840   

Commercial Real Estate

                             

Owner occupied

    204        74        (537     229        (30     442        (12     53        82        565        317        4,232        1,161        127        5,837   

Income producing

    1        —          —          —          1        —          (47     1,170        —          1,123        —          54        47        1,182        1,283   

Multifamily

    —          —          —          —          —          —          —          —          —          —          —          —          —          118        118   

Construction & Development

                             

1-4 Family

    5        —          —          —          5        (1     —          99        —          98        168        (4     44        (28     180   

Other

    (2     (5     (2     209        200        646        (50     257        (2     851        (2     267        128        538        931   

Farmland

    8        13        —          —          21        —          —          —          —          —          —          —          —          —          —     

Residential

                             

Equity Lines

    188        (11     (3     9        183        14        (1     5        97        115        251        419        20        74        764   

1-4 Family

    123        (7     36        (127     25        54        768        137        33        992        154        1,266        459        364        2,243   

Consumer - Non Real Estate

    —          —          10        4        14        10        1        26        7        44        19        56        25        31        131   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals by Quarter

  $ (754   $ 88      $ (737   $ 239      $ (1,164   $ 1,345      $ 740      $ 1,562      $ (77   $ 3,570      $ 894      $ 8,201      $ 3,644      $ 3,588      $ 16,327   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loan charge-offs decreased from 2011 to 2012. Net loan charge-offs during 2011 were also affected by certain changes in the Company’s policies and procedures with respect to problem loans implemented by the Company’s special assets department. For a description of these policy changes, please refer to the discussion of other real estate owned under the heading “Asset Quality” above. Of the $16.3 million in net charge-offs in 2011, $12.4 million was related to eighteen large commercial relationships. The real property that served as collateral for these commercial relationships was ultimately sold during the foreclosure process or transferred to other real estate owned. Of the $3.6 million in net charge-offs in 2012, $1.2 million was related to a restructured loan and $2.3 million was related to ten relationships that were ultimately sold during the foreclosure process or transferred to other real estate owned. Net loan charge-offs of $3.6 million in 2012 were significantly less than the $16.3 million in net loan charge-offs in 2011. In 2011, our special assets department was aggressive in addressing our substandard loans. As a result, in 2012 we saw a decrease in our net loan-chargeoffs. In 2013, the loan loss provision reflects a specific recovery of a $1.25 million loan that was previously charged off in 2011.

Total nonperforming assets amounted to $6.0 million at December 31, 2013, a decrease of 52.6% from the year-end 2012 total of $12.7 million. Total nonperforming assets as a percent of loan-related assets (loans plus foreclosed real estate) amounted to 2.15% at December 31, 2013 compared to 4.62% as of year-end 2012. For the five year-ends preceding the current credit cycle, nonperforming assets averaged 5.47% of loan-related assets. Nonperforming assets as a percent of total assets was 1.42% of total assets at the end of 2013 compared to 2.91% at December 31, 2012 and 5.68% at December 31, 2011. On a historic basis, nonperforming assets as a percent of total assets averaged 3.77% for the 2007 – 2011 year-ends.

Noninterest Income. In addition to net interest income, we derive revenues from providing a variety of financial services to our customers. Fees from providing these services totaled $1.1 million in 2013, $1.2 million in 2012, and $1.3 million in 2011. The largest component of customer service fees is revenues from deposit services which totaled $610,000 in 2013, $620,000 in 2012, and $698,000 in 2011. While this is a mature and very competitive part of our business, we believe this is an area of opportunity. The fastest growing area of fee revenue is from debit card services. Our revenues in this area increased to over $400,000 for the past three years. Fees from loan services, which primarily includes fees related to real estate loan production, has been insignificant for the last three years as real estate lending slowed.

Other significant components of noninterest income are gains and losses on investment securities and increase in the cash value of life insurance policies we hold on our officer level employees. In 2013, we did not realize any gains or losses on investment securities as compared to $2.2 million in net gains on investment securities in 2012 and a net loss of $391,000 in 2011. This includes an other than temporary impairment charge of $397,000 for 2011 on a $1.0 million investment in the trust preferred securities of another financial institution as a result of the guarantor exercising its right to defer interest payments to the issuing trust. The increase in the cash value of life insurance policies was $352,000 in 2013 compared to $359,000 for 2012 and $361,000 for 2011. The Bank also received net proceeds from a bank owned life insurance policy of $415,000 due to the death of a former officer in 2012.

 

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The following is a tabular presentation of our non-interest income for the years ended December 31, 2013, 2012, and 2011.

Table XIII. Noninterest Income (dollars in thousands)

 

     2013      2012      2011  

Deposit services fees

   $ 610       $ 620       $ 698   

Card services fees

     408         418         402   

Loan services fees

     23         20         25   

Other customer services fees

     108         118         125   
  

 

 

    

 

 

    

 

 

 

Total customer services fees

     1,149         1,176         1,250   

Net gain (loss) on investment securities

     —           2,190         (391

Increase in cash value of bank owned life insurance

     352         359         361   

Net proceeds from bank owned life insurance

     —           415         —     

All other income

     28         28         19   
  

 

 

    

 

 

    

 

 

 

Total noninterest income

   $ 1,529       $ 4,168       $ 1,239   
  

 

 

    

 

 

    

 

 

 

Non-interest Expense. Non-interest expense totaled $14.6 million for the year ended December 31, 2013, a decrease of $3.3 million, or 18.5% from the $17.9 million reported for the year ended December 31, 2012, which was a $3.0 million decrease, or 14.4%, below the 2011 amount. The major factors contributing to the decrease in noninterest expenses in 2013 compared to 2012 were (1) a decrease of $1.6 million, or 66.5%, in valuation allowances and net operating cost associated with foreclosed real estate, (2) a decrease of $494,000, or 34.7%, in professional services due to a reduction in attorney fees, (3) a decrease of $440,000, or 6.4%, in salaries and benefits, (4) a decrease of $141,000, or 8.8%, in FDIC insurance premiums, and (5) a decrease of $116,000, or 1.6%, in occupancy and equipment expenses. There was also a recovery of $197,000 of specific loan-related expenses.

The major factors contributing to the decrease in noninterest expenses in 2012 compared to 2011 were (1) a decrease of $2.8 million, or 53.7%, in valuation allowances and net operating cost associated with foreclosed real estate, (2) a decrease of $171,000, or 8.2%, in occupancy and equipment expenses, (3) a decrease of $131,000, or 58.7%, in advertising costs, and (4) a decrease of $92,000, or 6.1%, in professional services due to a reduction in consulting fees.

One of the largest components of the Company’s noninterest expense for the year ended December 31, 2011, were valuation allowances and net operating costs associated with foreclosed real estate. During 2011, properties were transferred to OREO at an average of 51% of their book value. Upon sale of these properties, the Company was able to recover 89% of the balance transferred to OREO. Although the Company was able to recover a high percentage of the transferred balances upon sale, there were $5.2 million in valuation allowances and net operating costs associated with foreclosed real estate for the year ended December 31, 2011. Of the $5.2 million in valuation allowances and net operating costs, there were valuation allowances of approximately $3.1 million that were related to properties added to OREO in 2010 and 2009, for which the Company received a current appraisal in 2011. A new fair value calculation was performed, which resulted in valuation allowances. The Company managed approximately 152 OREO properties in 2011, including a golf course, restaurants, and 1–4 family residential housing. The remainder of the $5.2 million in valuation allowances and other operating costs consists of operating costs related to paying delinquent taxes, obtaining current appraisals, managing, and repairing these OREO properties.

During 2013 and 2012, foreclosed property was sold at 99% and 103% of book value, respectively, which were 58% and 44% of original loan book value. At December 31, 2013, we owned 11 OREO properties compared to 34 properties at December 31, 2012.

 

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The following table summarizes the major components of our non-interest expense for the years ended December 31, 2013, 2012, and 2011.

Table XIV. Noninterest Expenses (dollars in thousands)

 

     2013      2012      2011  

Salaries and employee benefits

   $ 6,437       $ 6,877       $ 6,684   

Net occupancy expense

     1,787         1,903         2,074   

FDIC insurance assessments

     1,459         1,600         1,516   

Data processing

     1,054         989         885   

Professional services

     931         1,425         1,517   

Telephone and data communications

     361         383         393   

Advertising and promotional

     158         92         223   

Postage and courier

     155         221         218   

Printing and supplies

     139         154         167   

Valuation allowances and net operating costs associated with foreclosed real estate

     810         2,417         5,222   

All other expenses

     1,338         1,883         2,075   
  

 

 

    

 

 

    

 

 

 

Total noninterest expenses

   $ 14,629       $ 17,944       $ 20,974   
  

 

 

    

 

 

    

 

 

 

Income Taxes. There was an income tax provision in 2013 of $942,000 and none in 2012. We recorded income tax expense of $4.5 million in 2011. As of year-end 2011, the Company updated its evaluation of the likelihood of realization of a net deferred tax asset that had arisen principally as a result of operating losses incurred during the previous four years. Based upon that evaluation the Company determined that it is unlikely that any significant realization of any portion of the net deferred tax asset is likely to occur within a timeframe that would support a decision to continue to include a net deferred tax asset in the Company’s consolidated balance sheet. Accordingly, the Company recorded a provision for income taxes of $4.5 million for 2011 to reduce the carrying value of the Company’s net deferred tax asset to zero. Due to the change in unrealized gains to unrealized losses on our investment securities, an additional provision for income taxes of $942,000 was recorded. Also, a valuation allowance of $3.0 million was established against the deferred tax asset for the increased unrealized losses on investment securities. As of December 31, 2013 the net deferred tax asset had a zero value as a result of a deferred tax asset of $17.7 million and an allowance of $17.7 million.

Capital Adequacy

The Bank is required to comply with the capital adequacy standards established by the Federal Deposit Insurance Corporation (FDIC). The FDIC has issued 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 the Bank to be considered in compliance with the FDIC’s requirements. On December 31, 2013, the Bank’s Total Capital Ratio and Tier 1 Risk-Based Capital Ratio were 6.13% and 4.87%, respectively, both below the minimum levels required by the FDIC’s “well-capitalized” guidelines. On December 31, 2013 our Tier 1 Leverage Capital Ratio was 3.55%, which was also well below the minimum level required by the FDIC’s “well-capitalized” guidelines. As described above, the Bank is subject to a consent order issued by the FDIC and the North Carolina Commissioner of Banks. The consent order requires that the Bank maintain capital levels in excess of normal statutory minimums, including a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. As of December 31, 2013, the Bank had not achieved these minimum levels.

Liquidity and Interest Rate Sensitivity

Liquidity. Liquidity management is the process of managing assets and liabilities as well as their maturities to ensure adequate funding for loan and deposit activity. Sources of liquidity come from both balance sheet and off-balance sheet sources. We define balance sheet liquidity as the relationship that net liquid assets have to unsecured liabilities. Net liquid assets is the sum of cash and cash items, less required reserves on demand and NOW deposits, plus demand deposits due from banks, plus

 

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temporary investments, including federal funds sold, plus the fair value of investment securities, less collateral requirements related to public funds on deposit and repurchase agreements. Unsecured liabilities is equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest-checking deposits and less the outstanding balances of all secured liabilities, whether secured by liquid assets or not. We consider off-balance sheet liquidity to include unsecured federal funds lines from other banks and loan collateral which may be used for additional advances from the Federal Home Loan Bank. As of December 31, 2013 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 17.04% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 18.78%.

In addition, we have the ability to borrow $10.0 million from the Discount Window of the Federal Reserve subject to our pledge of marketable securities, which could be used for temporary funding needs. We also have the ability to borrow from the Federal Home Loan Bank on similar terms. While we consider these arrangements sources of back-up funding, we do not consider them as liquidity sources because they require our pledge of liquid assets as collateral. We regularly borrow from the Federal Home Loan Bank as a normal part of our business. These advances are secured by various types of real estate-secured loans. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at December 31, 2013 is adequate to meet its operating needs.

Interest Rate Sensitivity. Our goal is to maintain a neutral interest rate sensitivity position whereby little or no change in interest income would occur as interest rates change. On December 31, 2013, we were cumulatively liability sensitive for the next twelve months, which means that our interest-bearing liabilities would reprice more quickly than our interest bearing assets. Theoretically, our net interest margin will decrease if market interest rates rise or increase if market interest rates fall. However, the repricing characteristics of assets are different from the repricing characteristics of funding sources. Therefore, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

The following table shows the interest rate sensitivity of our balance sheet on December 31, 2013, but is not necessarily indicative of our position on other dates. Each category of assets and liabilities is shown with projected repricing and maturity dates. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. NOW accounts, savings accounts, and money market accounts are assumed to be subject to immediate repricing and depositor availability. Prepayment assumptions on mortgage loans and decay rates on deposit accounts have not been included in this analysis. Also, the table does not reflect scheduled principal repayments that will be received on loans. The interest rate sensitivity of our assets and liabilities may vary substantially if different assumptions are used or if our actual experience differs from that indicated by the assumptions.

 

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Table XV. Interest Sensitivity (dollars in thousands)

 

     December 31, 2013  
     1-3     Over 3 to     Over 12 to     Over        
     months     12 months     60 months     60 months     Total  

Interest-earning assets:

          

Loans

   $ 60,488      $ 20,005      $ 99,252      $ 93,976      $ 273,721   

Investment securities

     2,727        —          1,389        86,199        90,315   

Other interest-earning assets

     19,905        1,739        —          —          21,644   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ 83,120      $ 21,744      $ 100,641      $ 180,175      $ 385,680   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

          

Interest-checking deposits

   $ 40,939      $ —        $ —        $ —        $ 40,939   

Money market and savings deposits

     109,419        —          —          —          109,419   

Time deposits

     39,835        74,256        66,458        —          180,549   

Borrowed funds

     8,243        —          45,000        —          53,243   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ 198,436      $ 74,256      $ 111,458      $ —        $ 384,150   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-sensitivity gap

   $ (115,316   $ (52,512   $ (10,817   $ 180,175      $ 1,530   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative sensitivity gap

   $ (115,316   $ (167,828   $ (178,645   $ 1,530      $ 1,530   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative gap as a % of total interest-earning assets

     (29.90 )%      (43.51 )%      (46.32 )%      0.40     0.40
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative ratio of sensitive assets to sensitive liabilities

     41.89     29.28     90.29     —       100.40
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Quarterly financial data for 2013 and 2012 is summarized in the table below.

Table XVI. Quarterly Financial Data (dollars in thousands except per share amounts)

 

     2013     2012  
     4th Qtr     3rd Qtr.     2nd Qtr.     1st Qtr.     4th Qtr     3rd Qtr.     2nd Qtr.     1st Qtr.  

Interest income

   $ 3,842      $ 3,801      $ 3,746      $ 3,819      $ 4,042      $ 4,307      $ 4,160      $ 4,540   

Interest expense

     1,110        1,130        1,142        1,178        1,265        1,349        1,416        1,463   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     2,732        2,671        2,604        2,641        2,777        2,958        2,744        3,077   

Provision for loan losses

     39        (920     (12     (1,146     (637     1,471        233        1,292   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for loan losses

     2,693        3,591        2,616        3,787        3,414        1,487        2,511        1,785   

Noninterest income

     400        380        383        366        449        391        2,201        1,127   

Noninterest expense

     3,610        3,579        3,721        3,719        3,479        5,225        4,220        5,020   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (517     392        (722     434        384        (3,347     492        (2,108

Income taxes (benefit)

     152        152        341        297        (409     (383     424        368   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     (669     240        (1,063     137        793        (2,964     68        (2,476

Dividends and accretion on preferred stock

     (247     (245     (243     (243     (242     (239     (238     (237
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ (916   $ (5   $ (1,306   $ (106   $ 551      $ (3,203   $ (170   $ (2,713
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per common share:

                

Basic

   $ (0.24   $ —        $ (0.33   $ (0.03   $ 0.14      $ (0.82   $ (0.04   $ (0.70

Diluted

   $ (0.24   $ —        $ (0.33   $ (0.03   $ 0.14      $ (0.82   $ (0.04   $ (0.70

Effects of Inflation and Changing Prices

A commercial bank has an asset and liability structure that is distinctly different from that of a company with substantial investments in plant and inventory because the major portion of its assets is monetary in nature. As a result, a bank’s performance may be significantly influenced by changes in interest rates. Although the banking industry is more affected by changes in interest

rates than by inflation in the price of goods and services, inflation also is a factor that may influence interest rates. Yet, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect our operating expense in that personnel expense and the cost of supplies and outside services tend to increase more during periods of high inflation.

 

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DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

This Report and its exhibits may 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, risk factors discussed in the Company’s Annual Report on Form 10-K and in other documents 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 at www.sec.gov. Other factors that could influence the accuracy of 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) 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; (c) the financial success or changing strategies of the Company’s customers; (d) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect the Company’s business; (e) 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; (f) 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); (g) governmental action as of a result of our inability to comply with regulatory orders and agreements; and (h) other unexpected developments or changes in the Company’s business. 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 does not intend, to update these forward-looking statements.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Smaller reporting companies such as the Company are not required to provide the information required by this item.

 

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Item 8. Financial Statements and Supplementary Data.

Bank of the Carolinas Corporation and Subsidiary

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

    of Bank of the Carolinas Corporation

We have audited the accompanying consolidated balance sheets of Bank of the Carolinas Corporation and Subsidiary (hereinafter referred to as the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive loss, changes in stockholders’ equity, and cash flows for the years ended December 31, 2013, 2012, and 2011. Bank of the Carolinas Corporation and Subsidiary’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bank of the Carolinas Corporation and Subsidiary as of December 31, 2013 and 2012, and the results of its operations and cash flows for years ended December 31, 2013, 2012, and 2011 in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 18 to the financial statements, the Company has suffered recurring credit losses that have eroded certain regulatory capital ratios. As of December 31, 2013, the Company is considered undercapitalized based on their regulatory capital level. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 18. The financial statements do not include any adjustments that would be necessary should the Company be unable to continue as a going concern.

/s/ Turlington and Company, LLP

Lexington, North Carolina

March 26, 2014

except for Note 19, as to which the date is May 15, 2014

 

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Bank of the Carolinas Corporation and Subsidiary

Consolidated Balance Sheets

December 31, 2013 and 2012

(In thousands except share data)

 

     2013     2012  
     (Restated)        

Assets:

    

Cash and due from banks, noninterest-bearing

   $ 12,778      $ 5,942   

Interest-bearing deposits in banks

     2,064        1,844   
  

 

 

   

 

 

 

Cash and cash equivalents

     14,842        7,786   

Federal funds sold

     19,580        27,370   

Investment securities

     90,315        106,931   

Loans receivable

     278,510        270,374   

Less: Allowance for loan losses

     (6,015     (6,890
  

 

 

   

 

 

 

Total loans, net

     272,495        263,484   

Premises and equipment, net

     11,274        11,843   

Other real estate owned

     1,233        4,976   

Bank owned life insurance

     10,888        10,536   

Deferred tax assets

     —          607   

Prepaid FDIC insurance assessment

     —          630   

Accrued interest receivable

     1,156        1,315   

Other assets

     1,867        1,914   
  

 

 

   

 

 

 

Total Assets

   $ 423,650      $ 437,392   
  

 

 

   

 

 

 

Liabilities:

    

Deposits:

    

Noninterest-bearing demand deposits

   $ 35,243      $ 36,622   

Interest-checking deposits

     40,939        37,768   

Money market and savings deposits

     109,419        111,459   

Time deposits

     180,549        187,123   
  

 

 

   

 

 

 

Total deposits

     366,150        372,972   

Securities sold under repurchase agreements

     45,388        45,362   

Subordinated debt

     7,855        7,855   

Other liabilities

     2,509        2,138   
  

 

 

   

 

 

 

Total Liabilities

     421,902        428,327   
  

 

 

   

 

 

 

Commitments and contingencies (Notes 5, 13, and 14)

     —          —     

Stockholders’ Equity:

    

Preferred stock, no par value

     13,179        13,179   

Discount on preferred stock

     (100     (419

Common stock, $5 par value per share

     19,479        19,479   

Additional paid-in capital

     12,991        12,991   

Retained deficit

     (38,422     (36,748

Accumulated other comprehensive income (loss)

     (5,379     583   
  

 

 

   

 

 

 

Total Stockholders’ Equity

     1,748        9,065   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 423,650      $ 437,392   
  

 

 

   

 

 

 

Preferred shares authorized

     3,000,000        3,000,000   

Preferred shares issued and outstanding

     13,179        13,179   

Unaccrued preferred stock dividend

   $ 1,894      $ 1,235   

Common shares authorized

     15,000,000        15,000,000   

Common shares issued and outstanding

     3,895,840        3,895,840   

The accompanying notes are an integral part of these consolidated financial statements.

 

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Bank of the Carolinas Corporation and Subsidiary

Consolidated Statements of Operations

For the Years Ended December 31, 2013, 2012, and 2011

(In thousands except per share data)

 

     2013     2012     2011  
     (Restated)              

Interest and dividend income:

      

Loans, including fees

   $ 12,978      $ 14,303      $ 17,398   

Investment securities

     2,156        2,669        3,175   

Other

     74        77        59   
  

 

 

   

 

 

   

 

 

 

Total interest income

     15,208        17,049        20,632   
  

 

 

   

 

 

   

 

 

 

Interest expense:

      

Deposits

     2,301        3,225        4,387   

Other borrowings

     2,259        2,268        2,653   
  

 

 

   

 

 

   

 

 

 

Total interest expense

     4,560        5,493        7,040   
  

 

 

   

 

 

   

 

 

 

Net interest income

     10,648        11,556        13,592   

Provision for loan losses

     (2,039     2,359        17,565   
  

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for loan losses

     12,687        9,197        (3,973
  

 

 

   

 

 

   

 

 

 

Non-interest income:

      

Customer service fees

     1,149        1,176        1,250   

Increase in bank owned life insurance

     352        359        361   

Net proceeds from bank owned life insurance

     —          415        —     

Gain (loss) on sale of securities (net)

     —          2,190        (391

Other

     28        28        19   
  

 

 

   

 

 

   

 

 

 

Total non-interest income

     1,529        4,168        1,239   
  

 

 

   

 

 

   

 

 

 

Non-interest expense:

      

Salaries and employee benefits

     6,437        6,877        6,684   

Net occupancy expense

     1,787        1,903        2,074   

FDIC insurance assessments

     1,459        1,600        1,516   

Data processing

     1,054        989        885   

Professional services

     931        1,425        1,517   

Advertising

     158        92        223   

Valuation allowances and net operating costs associated with foreclosed real estate

     810        2,417        5,222   

Other

     1,993        2,641        2,853   
  

 

 

   

 

 

   

 

 

 

Total non-interest expense

     14,629        17,944        20,974   
  

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (413     (4,579     (23,708

Income tax expense

     942        —          4,543   
  

 

 

   

 

 

   

 

 

 

Net loss

     (1,355     (4,579     (28,251

Preferred stock dividends and accretion

     (978     (956     (934
  

 

 

   

 

 

   

 

 

 

Net loss available to common stockholders

   $ (2,333   $ (5,535   $ (29,185
  

 

 

   

 

 

   

 

 

 

Net loss per common share

      

Basic

   $ (0.60   $ (1.42   $ (7.49
  

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.60   $ (1.42   $ (7.49
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Consolidated Statements of Comprehensive Loss

For the Years Ended December 31, 2013, 2012, and 2011

(In thousands)

 

     2013     2012     2011  
     (Restated)              

Net loss

   $ (1,355   $ (4,579   $ (28,251

Other comprehensive income (loss):

      

Unrealized holding gains (losses) on securities available-for-sale

     (6,298     (1,576     2,019   

Reclassification adjustment for (gains) losses realized in net loss

     —          (2,190     391   

Income tax effect

     336        2,796        (1,167
  

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss), net of income tax effect

     (5,962     (970     1,243   
  

 

 

   

 

 

   

 

 

 

Total comprehensive loss

   $ (7,317   $ (5,549   $ (27,008
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

For the Years Ended December 31, 2013, 2012, and 2011

(In thousands except share data)

 

                                                 Accumulated        
                   Discount                 Additional           Other     Total  
     Preferred Stock      on Preferred     Common Stock     Paid-In     Retained     Comprehensive     Stockholders’  
     Shares      Amount      Stock     Shares     Amount     Capital     Deficit     Income (Loss)     Equity  

Balance, December 31, 2010

     13,179       $ 13,179       $ (991     3,897,174      $ 19,486      $ 12,988      $ (3,268   $ 310      $ 41,704   

Restricted stock expense

     —           —           —          —          —          4        —          —          4   

Stock based compensation benefit

     —           —           —          —          —          (8     —          —          (8

Cash dividends on common

     —           —           —          —          —          —          —          —          —     

Cash dividends on preferred

     —           —           —          —          —          —          (77     —          (77

Accretion of discount on preferred

     —           —           275        —          —          —          (275     —          —     

Forfeiture of common stock

     —           —           —          (1,334     (7     7        —          —          —     

Net loss

     —           —           —          —          —          —          (28,251     —          (28,251

Other comprehensive income

     —           —           —          —          —          —          —          1,243        1,243   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2011

     13,179         13,179         (716     3,895,840        19,479        12,991        (31,871     1,553        14,615   

Restricted stock benefit

     —           —           —          —          —          (1     —          —          (1

Stock based compensation expense

     —           —           —          —          —          1        —          —          1   

Cash dividends on common

     —           —           —          —          —          —          —          —          —     

Cash dividends on preferred

     —           —           —          —          —          —          (1     —          (1

Accretion of discount on preferred

     —           —           297        —          —          —          (297     —          —     

Net loss

     —           —           —          —          —          —          (4,579     —          (4,579

Other comprehensive loss

     —           —           —          —          —          —          —          (970     (970
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2012

     13,179         13,179         (419     3,895,840        19,479        12,991        (36,748     583        9,065   

Cash dividends on common

     —           —           —          —          —          —          —          —          —     

Cash dividends on preferred

     —           —           —          —          —          —          —          —          —     

Accretion of discount on preferred

     —           —           319        —          —          —          (319     —          —     

Net loss

     —           —           —          —          —          —          (1,355     —          (1,355

Other comprehensive loss

     —           —           —          —          —          —          —          (5,962     (5,962
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2013

     13,179       $ 13,179       $ (100     3,895,840      $ 19,479      $ 12,991      $ (38,422   $ (5,379   $ 1,748   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

47


Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2013, 2012, and 2011

(In thousands)

 

     2013     2012     2011  
     (Restated)              

Cash flows from operating activities:

      

Net loss

   $ (1,355   $ (4,579   $ (28,251

Adjustments to reconcile net loss to net cash provided by operating activities:

      

Depreciation and amortization

     678        807        988   

Deferred tax expense

     942        —          4,543   

Provision for loan losses

     (2,039     2,359        17,565   

Amortization of premiums on securities, net

     521        925        819   

Stock based compensation expense (benefit)

     —          1        (8

Restricted stock expense (benefit)

     —          (1     4   

Decrease (increase) in bank owned life insurance

     (352     196        (361

(Gain) loss on sale of other real estate owned

     77        (192     748   

Impairment valuation of other real estate owned

     539        2,040        3,449   

(Gain) loss on sale of premises and equipment

     (5     —          5   

Gain on sale of securities

     —          (2,190     (6

Impairment valuation of securities

     —          —          397   

Net changes in:

      

Accrued interest receivable

     159        188        311   

Prepaid FDIC insurance assessment

     630        1,570        1,470   

Other assets

     (158     45        (474

Accrued expenses and other liabilities

     372        235        187   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     9        1,404        1,386   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Net change in federal funds sold

     7,790        795        (18,835

Activity in available for sale securities:

      

Purchases

     (16,893     (120,851     (40,956

Proceeds from sale

     —          71,767        2,006   

Maturities and calls of securities

     26,690        54,246        37,729   

Net loan originations and principal payments

     (7,925     28,140        31,399   

Redemption of FHLB stock

     205        842        488   

Purchase of premises and equipment

     (125     (421     (117

Proceeds from sale of premises and equipment

     21        —          1   

Proceeds from sale of other real estate owned

     4,080        7,523        6,113   
  

 

 

   

 

 

   

 

 

 

Net cash provided by investing activities

     13,843        42,041        17,828   
  

 

 

   

 

 

   

 

 

 

(continued)

 

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Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Consolidated Statements of Cash Flows, Continued

 

For the Years Ended December 31, 2013, 2012, and 2011

(In thousands)

 

     2013     2012     2011  

Cash flows from financing activities:

      

Net increase (decrease) in deposits

   $ (6,822   $ (43,241   $ 44   

Net repayments of FHLB advances

     —          —          (22,000

Net change in retail repurchase agreements

     26        (19     (222

Cash dividends paid on preferred stock

     —          —          —     

Cash dividends paid on common stock

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Net cash used by financing activities

     (6,796     (43,260     (22,178
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     7,056        185        (2,964

Cash and cash equivalents at beginning of year

     7,786        7,601        10,565   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 14,842      $ 7,786      $ 7,601   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

      

Cash paid during the year for:

      

Interest

   $ 4,327      $ 5,225      $ 6,817   
  

 

 

   

 

 

   

 

 

 

Income taxes paid

   $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

 

Non-cash investing and financing activities:

      

Unrealized gains (losses) on securities available for sale, net of income tax effect

   $ (5,962   $ (970   $ 1,243   

Transfer of other real estate owned from loans receivable

     953        5,823        10,520   

Dividends declared, not paid

     —          —          165   

The accompanying notes are an integral part of these consolidated financial statements.

 

49


Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements

December 31, 2013, 2012, and 2011

 

1. Summary of Significant Accounting Policies

Organization—Bank of the Carolinas Corporation (“the Company”) is a North Carolina-chartered bank holding company that was incorporated on May 30, 2006, for the sole purpose of serving as the parent bank holding company for Bank of the Carolinas (“the Bank”). The Bank is a FDIC-insured, North Carolina-chartered bank that began operations on December 7, 1998.

Because the Company has no significant operations and conducts no business on its own other than owning the Bank, the discussion contained in these footnotes concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and its subsidiary are collectively referred to herein as the “Company” unless otherwise noted.

The accounting and reporting policies of the Company follow accounting principles generally accepted in the United States of America and general practices within the banking industry. The following is a summary of the more significant accounting policies.

Business—The Company provides a variety of financial services to individuals and small businesses through its retail offices. Its primary deposit products are demand deposits and time certificate accounts and its primary lending products are consumer, commercial, and mortgage loans. The Company does not have significant concentrations to any one industry or customer.

Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses.

Cash and Cash Equivalents—The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents are defined as those amounts included in the balance sheet captions “cash and due from banks, noninterest-bearing,” and “interest-bearing deposits in banks.” At times, the Company places deposits with high credit quality financial institutions in amounts which may be in excess of federally insured limits.

Investment Securities—Securities available for sale are carried at fair value and held to maturity securities are carried at amortized cost. The unrealized holding gains or losses on securities available for sale are reported, net of related income tax effects, as accumulated other comprehensive income unless a valuation reserve has been established. Changes in unrealized holding gains or losses are included as a component of other comprehensive income until realized. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in income as realized losses. Gains or losses on sales of securities available for sale are based on the specific identification method.

 

50


Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

Loans Receivable - The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is invested within the central North Carolina region. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, loans in process, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan using the interest method.

The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. All interest accrued, but not collected, for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Premises and Equipment - Land is carried at cost. Buildings, leasehold improvements and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the lesser of estimated useful lives of the assets or lease terms ranging from 3 to 40 years. The cost of maintenance and repairs are charged to expense as incurred while expenditures that materially increase the useful lives of property are capitalized.

 

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Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

Federal Home Loan Bank Stock - Investment in stock of the Federal Home Loan Bank is required by law of every member. The investment is carried at cost since redemptions of this stock have historically been at par. No ready market exists for the stock, and it has no quoted market value. The stock is presented in other assets. Due to the redemption provisions of the FHLB, the Bank estimates carrying value equals fair value and that it was not impaired at December 31, 2013. The stock had a carrying value of $524,000 and $728,700 at December 31, 2013 and 2012, respectively.

Other Real Estate Owned - Assets acquired through, or in lieu of, loan foreclosure are held for sale and initially recorded at the lower of the loan balance or the fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of carrying amount or fair value. Expenses associated with maintaining these properties are included in other non-interest expense. The provision for real estate losses is included in other non-interest expense. Realized gains and losses on disposal of real estate are included in other non-interest expense. Foreclosed assets are presented in other real estate owned. As of December 31, 2013, the Company held a variety of properties in other real estate owned, including 1-4 family residential real estate and commercial real estate. These properties are generally held within the Company’s market area.

Income Taxes - The Company utilizes the liability method of computing income taxes. Under the liability method, deferred tax liabilities and assets are established for future tax return effects of the temporary differences between the stated value of assets and liabilities for financial reporting purposes and their tax bases. The focus is on accruing the appropriate balance sheet deferred tax amount, with the statement of income effect being the result of the changes in the balance sheet amounts from period to period. The current portion of income tax expense is provided based upon the actual tax liability incurred for tax return purposes.

An evaluation of the probability of being able to realize the future benefits of deferred tax assets is made. A valuation allowance is provided for the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

The Company’s policy is to report interest and penalties, if any, in tax expense in the Consolidated Statements of Operations. The Company and its subsidiary each reflect the tax expense or benefit associated with the results of their individual operating results. During 2010, the Internal Revenue Service performed an audit of the Company’s federal tax returns for the years ended 2008 and 2009. Their audit was triggered by the amount of refund received when the Company filed NOL carrybacks to tax years 2006 and 2007 of the tax losses incurred for the years ended December 31, 2008 and 2009. These carrybacks resulted in federal refunds of $1.3 million and $728,000, respectively. The IRS concluded their audit as of February 23, 2011 with the Company paying income tax of $210,000 for the tax year 2006 and $52,000 in alternative minimum tax for tax year 2007. Due to the audits of 2008 and 2009, only the Company’s 2010 through 2013 federal and state income tax returns are open and subject to examination.

Earnings Per Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and warrants, and are determined using the treasury stock method.

 

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Table of Contents

Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

Losses per share have been computed based on the following:

 

     Years Ended December 31,  
     2013     2012     2011  
     (in thousands except for share data)  

Net loss applicable to common stock

   $ (2,333   $ (5,535   $ (29,185
  

 

 

   

 

 

   

 

 

 

Average number of common shares outstanding used to calculate basic earnings per share

     3,895,840        3,895,840        3,896,428   

Additional potential common shares due to stock options and warrants

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Average number of common shares outstanding used to calculate diluted earnings per share

     3,895,840        3,895,840        3,896,428   
  

 

 

   

 

 

   

 

 

 

The Company had 497,205; 497,205; and 497,605 stock options and warrants that were considered anti-dilutive because the Company incurred net losses for the years ended December 31, 2013, 2012, and 2011, respectively.

Stock Compensation Plans - The Company under generally accepted accounting principles accounts for stock option expense using the modified prospective method. The Company records expense throughout the options’ vesting period.

Advertising Expense – The Company’s policy is to expense advertising cost as incurred.

Comprehensive Income (Loss) - Accounting principles generally require that recognized revenues, expenses, gains and losses be included in net income (loss). Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section in the balance sheet, such items, along with net income (loss), are components of comprehensive income (loss).

ReclassificationsIn certain instances, amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the current presentation. Such reclassifications had no effect on previously reported cash flows, stockholders’ equity or net loss.

New Accounting Pronouncements – In January 2011, the FASB issued Accounting Standards Update 2011-01, Receivables: Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The amendments in this Update temporarily defer the effective date for interim and annual periods ending after June 15, 2011, enabling public-entity creditors to provide those disclosures after the Board clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. The deferral in this amendment is effective upon issuance and has not had a significant impact on the Company.

In April 2011, the FASB issued Accounting Standards Update 2011-02, Receivables: A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance and amendments to Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: the restructuring constitutes a concession, and the debtor is experiencing financial difficulties. The amendments clarify the guidance on a creditor’s evaluation of whether it has granted a concession, and on a creditor’s evaluation of whether a debtor is experiencing financial difficulties.

 

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Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies—Loss Contingencies. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, for interim and annual periods beginning on or after June 15, 2011. The amendments have not had a significant impact on the Company.

In April 2011, the FASB issued Accounting Standards Update 2011-03, Transfers and Servicing: Reconsideration of Effective Control for Repurchase Agreements. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity when all of the listed conditions have been met. The amendments in this Update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments have not had a significant impact on the Company.

In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820.

Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this Update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments have not had a significant impact on the Company.

In June 2011, the FASB issued Accounting Standards Update 2011-05, Comprehensive Income: Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this Update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income.

Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.

 

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Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

The amendments in this Update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. The amendments in this Update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments have not had a significant impact on the Company.

In December 2011, the FASB issued Accounting Standards Update 2011-12, Comprehensive Income:Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. Under the amendments in Update 2011-05, entities are required to present reclassification adjustments and the effect of those reclassification adjustments on the face of the financial statements where net income is presented, by component of net income, and on the face of the financial statements where other comprehensive income is presented, by component of other comprehensive income. In addition, the amendments in Update 2011-05 require that reclassification adjustments be presented in interim financial periods.

The amendments in this Update supersede changes to those paragraphs in Update 2011-05 that pertain to how, when, and where reclassification adjustments are presented.

The objective of Update 2011-05 was to help financial statement users better understand the causes of an entity’s change in financial position and results of operations. However, it is important that the benefits of improving the usefulness of financial statement information to users of financial statements be justified by the related costs. The Board received more information about the systems challenges for preparers to comply with the presentation requirements for reclassifications out of accumulated other comprehensive income by the effective date since the issuance of Update 2011-05. The information received caused the Board to reassess the costs and benefits of those provisions in Update 2011-05 related to reclassifications out of accumulated other comprehensive income. Due to the time required to properly make such a reassessment and to evaluate alternative presentation formats, the Board decided that it is necessary to reinstate the requirements for the presentation of reclassifications out of accumulated other comprehensive income that were in place before the issuance of Update 2011-05. The amendments in this Update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments have not had a significant impact on the Company.

In July 2012, the FASB issued Accounting Standards Update 2012-02, Intangibles – Goodwill and Other (Topic 350). The amendments in this Update are intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment, which is equivalent to the impairment testing requirements for other long-lived assets. The amendments have not had a significant impact on the Company.

In October 2012, the FASB issued Accounting Standards Update 2012-06, Business Combinations (Topic 805). When a reporting entity recognizes an indemnification asset (in accordance with Subtopic 805-20) as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs (as a result of a change in cash flows expected to be collected on the assets subject to indemnification), the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement (that is, the lesser of the term of the indemnification

 

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Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

agreement and the remaining life of the indemnified assets). For public and nonpublic entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. Early adoption is permitted. The amendments should be applied prospectively to any new indemnification assets acquired after the date of adoption and to indemnification assets existing as of the date of adoption arising from a government-assisted acquisition of a financial institution. The amendments have not had a significant impact on the Company.

In January 2013, the FASB issued Accounting Standards Update 2013-01, Balance Sheet (Topic 210). The amendments in this Update affect entities that have derivatives accounted for in accordance with Topic 815, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement also are affected because these amendments make them no longer subject to the disclosure requirements in Update 2011-11. The amendments clarify the intended scope of the disclosures required by Section 210-20-50. The FASB concluded that the clarified scope will reduce significantly the operability concerns expressed by preparers while still providing decision-useful information about certain transactions involving master netting arrangements. The amendments provide a user of financial statements with comparable information as it relates to certain reconciling differences between financial statements prepared in accordance with U.S. GAAP and those financial statements prepared in accordance with International Financial Reporting Standards (IFRS). An entity is required to apply the amendments for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of Update 2011-11. The amendments have not had a significant impact on the Company.

In February 2013, the FASB issued Accounting Standards Update 2013-02, Comprehensive Income (Topic 220). The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. Substantially all of the information that this Update requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. However, the new requirement about presenting information about amounts reclassified out of accumulated other comprehensive income and their corresponding effect on net income will present, in one place, information about significant amounts reclassified and, in some cases, cross-references to related footnote disclosures. Currently, this information is presented in different places throughout the financial statements. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. For nonpublic entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. The amendments have not had a significant impact on the Company.

In February 2013, the FASB issued Accounting Standards Update 2013-03, Financial Instruments (Topic 825). The amendments clarify that the requirement to disclose “the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (Level 1, 2, or 3)” does not apply to nonpublic entities for items that are not measured at fair value in the statement of financial position but for which fair value is disclosed. The amendments will be effective upon issuance. The amendments have not had a significant impact on the Company.

In April 2013, the FASB issued Accounting Standards Update 2013-07, Presentation of Financial Statements (Topic 205). The amendments require an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. Liquidation is imminent when the likelihood is remote that the entity will return from liquidation and either (a) a plan for liquidation is approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or (b) a plan for liquidation is being imposed by other forces (for example, involuntary bankruptcy). If a plan for liquidation was specified in the entity’s governing documents from the entity’s inception (for example, limited-life entities), the entity should apply the liquidation basis of accounting only if the approved plan for liquidation differs from the plan for liquidation that was specified at the entity’s inception.

 

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Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

The amendments require financial statements prepared using the liquidation basis of accounting to present relevant information about an entity’s expected resources in liquidation by measuring and presenting assets at the amount of the expected cash proceeds from liquidation. The entity should include in its presentation of assets any items it had not previously recognized under U.S. GAAP but that it expects to either sell in liquidation or use in settling liabilities (for example, trademarks).

An entity should recognize and measure its liabilities in accordance with U.S. GAAP that otherwise applies to those liabilities. The entity should not anticipate that it will be legally released from being the primary obligor under those liabilities, either judicially or by creditor(s). The entity also is required to accrue and separately present the costs that it expects to incur and the income that it expects to earn during the expected duration of the liquidation, including any costs associated with sale or settlement of those assets and liabilities.

Additionally, the amendments require disclosures about an entity’s plan for liquidation, the methods and significant assumptions used to measure assets and liabilities, the type and amount of costs and income accrued, and the expected duration of the liquidation process. The amendments are effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The amendments are not expected to have a significant impact on the Company.

In July 2013, the FASB issued Accounting Standards Update 2013-11, Income Taxes (Topic 740). An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows.

To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled.

The amendments in this Update do not require new recurring disclosures. The amendments are not expected to have a significant impact on the Company.

From time to time the FASB issues Proposed Accounting Standards Updates. Such proposed updates are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as Accounting Standards Updates. Management considers the effect of the proposed updates on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of proposed updates.

 

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Bank of the Carolinas Corporation and Subsidiary

Notes to Consolidated Financial Statements, Continued

 

2. Investment Securities

The amortized cost, estimated fair values and carrying values of the investment securities portfolio is summarized as follows (dollars in thousands):

 

     December 31, 2013  
            Gross      Gross      Estimated         
     Amortized      Unrealized      Unrealized      Fair      Carrying  
     Cost      Gains      Losses      Value      Value  

Investment securities available for sale:

              

U.S. Government agency securities

   $ 44,077       $ 87       $ 3,234       $ 40,930       $ 40,930   

State and municipal securities

     11,159         —           978         10,181         10,181   

Corporate securities

     —           —           —           —           —     

Mortgage-backed securities

     39,458         34         1,288         38,204         38,204   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

     94,694         121         5,500         89,315         89,315   

Investment securities held to maturity:

              

Corporate securities

     1,000         —           180         820         1,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Investment Securities

   $ 95,694       $ 121       $ 5,680       $ 90,135       $ 90,315   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2012  
            Gross      Gross      Estimated         
     Amortized      Unrealized      Unrealized      Fair      Carrying  
     Cost      Gains      Losses      Value      Value  

Investment securities available for sale:

              

U.S. Government agency securities

   $ 47,792       $ 406       $ 80       $ 48,118       $ 48,118   

State and municipal securities

     10,364         44         82         10,326         10,326   

Corporate securities

     —           —           —           —           —     

Mortgage-backed securities

     45,861         648         17         46,492         46,492   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

     104,017         1,098         179         104,936         104,936   

Investment securities held to maturity:

              

Corporate securities

     1,995         12         190         1,817         1,995   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Investment Securities

   $ 106,012       $ 1,110       $ 369       $ 106,753       $ 106,931   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Notes to Consolidated Financial Statements, Continued

 

The amortized cost and fair value of debt securities by contractual maturity at December 31, 2013 is as follows (dollars in thousands):

 

     Amortized      Estimated  
     Cost      Fair Value  

Within 1 year

   $ 19,000       $ 17,826   

Over 1 year through 5 years

     3,189         3,224   

Over 5 years through 10 years

     23,889         21,955   

Over 10 years

     10,158         8,926   
  

 

 

    

 

 

 
     56,236         51,931   

Mortgage backed securities

     39,458         38,204   
  

 

 

    

 

 

 
   $ 95,694       $ 90,135   
  

 

 

    

 

 

 

The fair values of securities with unrealized losses at December 31, 2013 and 2012 are as follows (dollars in thousands):

 

December 31, 2013:                                          
     Less than 12 Months      12 Months or More      Total  
     Estimated      Unrealized      Estimated      Unrealized      Estimated      Unrealized  
Temporarily impaired securities:    Fair Value      Losses      Fair Value      Losses      Fair Value      Losses  

U.S. Government agency securities

   $ 35,679       $ 2,731       $ 3,482       $ 503       $ 39,161       $ 3,234   

State and municipal securities

     7,835         723         2,346         255         10,181         978   

Mortgage-backed securities

     34,564         1,287         528         1         35,092         1,288   

Corporate securities

     —           —           820         180         820         180   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 78,078       $ 4,741       $ 7,176       $ 939       $ 85,254       $ 5,680   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
December 31, 2012:                                          
     Less than 12 Months      12 Months or More      Total  
     Estimated      Unrealized      Estimated      Unrealized      Estimated      Unrealized  
Temporarily impaired securities:    Fair Value      Losses      Fair Value      Losses      Fair Value      Losses  

U.S. Government agency securities

   $ 9,881       $ 80       $ —         $ —         $ 9,881       $ 80   

State and municipal securities

     7,340         82         —           —           7,340         82   

Mortgage-backed securities

     4,490         17         —           —           4,490         17   

Corporate securities

     —           —           810         190         810         190   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 21,711       $ 179       $ 810       $ 190       $ 22,521       $ 369   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Management of the Bank believes all unrealized losses on available for sale securities as of December 31, 2013 represent temporary impairments related to market fluctuations. The unrealized losses on our securities are a nominal portion of the total value of the portfolio. The Bank has no intention of selling these securities before their maturity and has the appropriate sources of liquidity to hold these securities until maturity so that no recognized losses will occur. The Bank believes that the unrealized losses are primarily the result of the interest rate environment and general illiquidity currently in the marketplace for these types of securities. The Bank had one held to maturity corporate security at December 31, 2013 that had an unrealized loss position of longer than 12 months in duration. The Bank has no intention of selling this security before its maturity and has the appropriate sources of liquidity to hold the security until maturity so that no recognized loss will occur. Investment securities with market values of $67.7 million and $69.4 million at December 31, 2013 and 2012, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. Gross realized gains and losses for the years ended December 31, 2013, 2012, and 2011 are as follows (dollars in thousands):

 

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Notes to Consolidated Financial Statements, Continued

 

     December 31,  
     2013      2012      2011  
     (dollars in thousands)  

Realized gains

   $ —         $ 2,190       $ 6   

Realized losses

     —           —           (397
  

 

 

    

 

 

    

 

 

 
   $ —         $ 2,190       $ (391
  

 

 

    

 

 

    

 

 

 

 

3. Loans Receivable

Loans receivable are summarized as follows (dollars in thousands):

 

     December 31,  
     2013     2012  

Real estate loans:

    

Residential, 1-4 family

   $ 84,855      $ 72,595   

Commercial real estate

     117,463        110,527   

Construction

     27,049        28,976   

Home equity

     28,217        29,462   
  

 

 

   

 

 

 

Total real estate loans

     257,584        241,560   
  

 

 

   

 

 

 

Commercial business loans

     17,428        22,992   

Consumer loans:

    

Installment

     2,554