10-K 1 d897534d10k.htm 10-K 10-K
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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2014

 

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, no 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 $1,831,000 (based on the closing price of such stock as of June 30, 2014).

 

On March 31, 2015, the number of outstanding shares of Registrant’s common stock was 462,028,831.

 

Documents Incorporated by Reference:

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BANK OF THE CAROLINAS CORPORATION

 

FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2014

 

TABLE OF CONTENTS

 

PART I

  
          Page  

Item 1.

   Business      3   

Item 1A.

   Risk Factors      20   

Item 1B.

   Unresolved Staff Comments      20   

Item 2.

   Properties      20   

Item 3.

   Legal Proceedings      20   

Item 4.

   Mine Safety Disclosures      20   
PART II   

Item 5.

  

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     21   

Item 6.

   Selected Financial Data      23   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      24   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      45   

Item 8.

   Financial Statements and Supplementary Data      46   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      84   

Item 9A.

   Controls and Procedures      84   

Item 9B.

   Other Information      85   
PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance      86   

Item 11.

   Executive Compensation      91   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     97   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      99   

Item 14.

   Principal Accounting Fees and Services      101   
PART IV   

Item 15.

   Exhibits, Financial Statement Schedules      102   

 

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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 (“NOW”) 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. Although the trust is still in existence, we repurchase all of our outstanding trust preferred securities in 2014.

 

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.

 

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,

 

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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.

 

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.

 

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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.

 

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.

 

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Investment Portfolio

 

On December 31, 2014, our investment portfolio consisted of U.S. government agency securities, state and municipal obligations, and 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”). Our securities are classified as either “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, 2014 (the most recent date for which data is available), there were 26 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.

 

Employees

 

On December 31, 2014, we had approximately 89 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.

 

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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 10.13 and 10.14 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. At December 31, 2014, the Bank was in compliance with the capital requirements contained in 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

 

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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 10.15 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 of Richmond. 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.

 

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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.

 

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-chartered, FDIC-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.

 

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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.    The Bank is incorporated under and subject to the provisions of Chapter 53C of the General Statutes of North Carolina, which provides for the supervision and regulation of the Bank by the State of North Carolina through the State Banking Commission, the Commissioner of Banks, and the Office of the Commissioner of Banks. It contains provisions regarding the following topics:

 

   

formation and organization of banks,

 

   

corporate governance of banks,

 

   

activities and powers of banks,

 

   

bank operations,

 

   

mergers and other change-in-control or business combination transactions,

 

   

charter conversions, and

 

   

bank holding companies.

 

The statute also grants the Commissioner the authority to issue administrative rules with respect to the establishment, operation, conduct, and termination of any and all activities and businesses that are subject to regulation by the Commissioner. Rules issued by the Commissioner are subject to review and approval of the State Banking Commission. The Bank is subject to these rules, which are set forth in Chapter 3 of Title 4 of the North Carolina Administrative Code.

 

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The Office of the Commissioner of Banks conducts regular supervisory examinations of the Bank in coordination with the FDIC. The FDIC serves as the Bank’s primary federal regulator.

 

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 significantly changed the structure of bank regulation, affecting the lending, deposit, investment, trading, and operating activities of financial institutions and their holding companies. The Dodd-Frank Act required 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 were granted broad discretion in drafting rules and regulations. 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.

 

Some 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 Dodd-Frank Act prohibits insured depository institutions and their holding companies from engaging in proprietary trading except in limited circumstances, and prohibits them from owning equity interests in excess of three percent (3%) of Tier 1 capital in private equity and hedge funds (known as the “Volcker Rule”). On December 10, 2013, five U.S. financial regulators adopted final rules (the “Final Rules”) implementing the Volcker Rule. The Final Rules prohibit banking entities from (1) engaging in short-term proprietary trading for their own accounts, and (2) having certain ownership interests in and relationships with hedge funds or private equity funds, which are referred to as “covered funds.” The Final Rules are intended to provide greater clarity with respect to both the extent of those primary prohibitions and of the related exemptions and exclusions. The Final Rules also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule. Although the Final Rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company and the Bank. The Final Rules were effective on April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2015. In addition, the FRB recently granted an extension until July 21, 2016 of the

 

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conformance period for banking entities to conform investments in and relationships with covered funds that were in place prior to December 31, 2013, and announced its intention to further extend this aspect of the conformance period until July 21, 2017. The Volcker Rule is not expected to have a material impact on the Bank or the Company.

 

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.

 

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. 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.

 

Capital Requirements.    The Company and the Bank are subject to various regulatory capital requirements administered by federal and state regulators. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the financial condition of the Company and the Bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (described below), the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. Capital amounts and classifications are also subject to judgments by the regulators regarding qualitative components, risk weightings, and other factors.

 

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On July 2, 2013, the FRB approved a final rule that establishes an integrated regulatory capital framework that addresses shortcomings in certain capital requirements. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act. The major provisions of the new rule applicable to us are:

 

   

The new rule implements higher minimum capital requirements, includes a new common equity Tier1 capital requirement, and establishes criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. These enhancements will improve the quality and increase the quantity of capital required to be held by banking organizations, better equipping the U.S. banking system to deal with adverse economic conditions. The new minimum capital to risk-weighted assets (RWA) requirements are a common equity Tier 1 capital ratio of 4.5% and a Tier 1 capital ratio of 6.0%, which is an increase from 4%, and a total capital ratio that remains at 8.0%. The minimum leverage ratio (Tier 1 capital to total assets) is 4.0%. The new rule maintains the general structure of the current prompt corrective action (PCA) framework while incorporating these increased minimum requirements.

 

   

The new rule improves the quality of capital by implementing changes to the definition of capital. Among the most important changes are stricter eligibility criteria for regulatory capital instruments that would disallow the inclusion of instruments such as trust preferred securities in Tier 1 capital going forward, and new constraints on the inclusion of minority interests, mortgage-servicing assets (MSAs), deferred tax assets (DTAs), and certain investments in the capital of unconsolidated financial institutions. In addition, the new rule requires that most regulatory capital deductions be made from common equity Tier 1 capital.

 

   

Under the new rule, to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements. This buffer will help to ensure that banking organizations conserve capital when it is most needed, allowing them to better weather periods of economic stress. The buffer is measured relative to RWA. Phase-in of the capital conservation buffer requirements will begin on January 1, 2016. A banking organization with a buffer greater than 2.5% would not be subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The new rule also prohibits a banking organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. When the new rule is fully phased in, the minimum capital requirements plus the capital conservation buffer will exceed the PCA well-capitalized thresholds.

 

   

The new rule also increases the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

 

On July 9, 2013, the FDIC confirmed that it would join in the Basel III standards and, on September 10, 2013, issued an “interim final rule” applicable to the Bank that is identical in substance to the final rules issued by the FRB described above. The Bank is required to comply with the interim final rule beginning on January 1, 2015.

 

Also, 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 risk-based capital ratio of at least 10%.

 

Prompt Corrective Regulatory Action.    Under the Federal Deposit Insurance Corporation Improvement Act of 1991, the federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy the minimum capital requirements discussed above, including a leverage limit, a risk-based capital requirement, a common equity Tier 1 capital requirement (applicable beginning January 1, 2015), and any other measure deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements. An institution that fails to meet the minimum level for any relevant capital measure (an “undercapitalized institution”) may be: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of businesses. The capital restoration plan must include a

 

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guarantee by the institution’s holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable up to the lesser of 5% of the institution’s total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan. A “significantly undercapitalized” institution, as well as any undercapitalized institution that does not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution. Any company controlling the institution may also be required to divest the institution or the institution could be required to divest subsidiaries. The senior executive officers of a significantly undercapitalized institution may not receive bonuses or increases in compensation without prior approval and the institution is prohibited from making payments of principal or interest on its subordinated debt. In their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective action provisions. If an institution’s ratio of tangible capital to total assets falls below the “critical capital level” established by the appropriate federal banking regulator, the institution will be subject to conservatorship or receivership within specified time periods.

 

Under the implementing regulations, the federal banking regulators, including the FDIC, generally measure an institution’s capital adequacy on the basis of its total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). The following table shows the Bank’s actual capital ratios and the required capital ratios for the various prompt corrective action categories as of December 31, 2014. Please note that, in order to be considered “well capitalized,” a bank must not only satisfy the capital ratio requirements set forth in the table below, but must not be subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC to meet and maintain a specific capital level for any capital measure. 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%. As long as the Consent Order is in place, the Bank will not be considered “well capitalized” under FDIC regulations, even if its capital ratios satisfy the requirements for that designation.

 

Capital Requirements as of December 31, 2014 (pre-Basel III implementation)

 

     Actual    Adequately
Well Capitalized
   Capitalized    Significantly
Undercapitalized
   Undercapitalized

Total risk-based capital ratio

   16.16%    10.0% or more    8.0% or more    Less than 8.0%    Less than 6.0%

Tier 1 risk-based capital ratio

   14.90%    6.0% or more    4.0% or more    Less than 4.0%    Less than 3.0%

Leverage ratio

   11.46%    5.0% or more    4.0% or more*    Less than 4.0%*    Less than 3.0%

 

*   3.0% if institution has the highest regulatory rating and meets certain other criteria.

 

The table above presents the required capital ratios as they were on December 31, 2014. On January 1, 2015, the Basel III regulatory capital requirements went into effect. As shown in the table below, the Basel III requirements include a new common equity Tier 1 capital requirement. In addition, the new rules require a minimum Tier 1 risk-based capital ratio of 6.0% (formerly 4.0%). In order to be considered “well capitalized,” the Basel III regulations require a Tier 1 risk-based capital ratio of 8.0% (formerly 6.0%).

 

Capital Requirements as of January 1, 2015 (reflecting Basel III standards)

 

     Well Capitalized      Adequately
Capitalized
     Undercapitalized      Significantly
Undercapitalized
 

Total risk-based capital ratio

     10.0% or more         8.0% or more         Less than 8.0%         Less than 6.0%   

Tier 1 risk-based capital ratio

     8.0% or more         6.0% or more         Less than 6.0%         Less than 4.0%   

Leverage ratio

     5.0% or more         4.0% or more         Less than 4.0%         Less than 3.0%   

Common equity Tier 1 risk-based capital ratio

     6.5% or more         4.5% or more         Less than 4.5%         Less than 4.0%   

 

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A “critically undercapitalized” institution is defined as one that has a ratio of “tangible equity” to total assets of less than 2.0%. Tangible equity is defined as Tier 1 capital plus non-Tier 1 perpetual preferred stock. The FDIC may reclassify a well-capitalized institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically undercapitalized) if the FDIC determines, after notice and an opportunity for a hearing, that the institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any regulatory rating category.

 

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.

 

As described above, the Bank is subject to a Consent Order issued by the FDIC and the North Carolina Commissioner of Banks.

 

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.

 

Reserve Requirements.    Under the FRB’s regulations, all FDIC-insured depository institutions must maintain average daily reserves against their transaction accounts. Under regulations in effect at December 31, 2014, no reserves were required to be maintained on the first $13.3 million of transaction accounts, but reserves equal to 3.0% were required to be maintained on the aggregate balances of those accounts between $13.3 million and $89.0 million, and reserves equal to 10.0% were required to be maintained on aggregate balances in excess of $89.0 million. The FRB may adjust these percentages from time to time. Effective January 22, 2015, no reserves are required to be maintained on the first $14.5 million of transaction accounts, but reserves equal to 3% must be maintained on the aggregate balances of those accounts between $14.5 million and $103.6 million, and reserves equal to 10% must be maintained on aggregate balances in excess of $103.6 million. 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.

 

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 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.

 

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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.

 

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 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

 

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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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Item 1A. Risk Factors.

 

 

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

 

Item 1B. Unresolved Staff Comments.

 

 

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

 

Item 2. Properties.

 

 

As of December 31, 2014, we owned the facilities housing six of our banking offices, and we leased the facilities housing our remaining two offices. In addition, we own an operations center which houses the finance, deposit operations, information technology, and loan administration departments of the Bank. Each of our banking offices is in good condition and fully equipped for our purposes. On December 31, 2014, our investment in premises and equipment (cost less accumulated depreciation) was approximately $10.8 million.

 

Item 3. Legal Proceedings.

 

 

There are no material pending legal proceedings to which the Company or the Bank is a party, or of which any of their property is the subject other than routine litigation that is incidental to their business.

 

Item 4. Mine Safety Disclosures.

 

 

Not applicable

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

 

 

Market for Registrant’s Common Stock; Dividends.    During the year ended December 31, 2014, our common stock has been quoted under the symbol “BCAR” on the OTCQB marketplace operated by OTC Markets Group, Inc. The following table shows the reported high and low bid prices for shares of our common stock on the OTCQB marketplace and cash dividends declared on our common stock for each calendar quarter during 2014 and 2013:

 

     Bid price range      Cash
Dividends

Declared
 

Quarter

   High      Low     

2014 Fourth

   $ 0.75       $ 0.12       $   

Third

     1.35         0.45           

Second

     0.56         0.42           

First

     0.84         0.45           
     Bid price range      Cash
Dividends

Declared
 

Quarter

       High              Low         

2013 Fourth

   $ 0.90       $ 0.54       $   

Third

     1.55         0.41           

Second

     0.64         0.34           

First

     0.61         0.17           

 

On December 31, 2014, there were approximately 1,850 total shareholders of our common stock, including 980 shareholders of record and approximately 870 holders whose shares were in street name.

 

Under North Carolina law, subject to certain restrictions, we are authorized to pay dividends as declared by our Board of Directors. 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. Information regarding restrictions on our and the Bank’s ability to pay dividends is contained in Item 1 of this Report under the caption “Payment of Dividends.”

 

In the future, any declaration and payment of cash dividends will be subject to the Board of Directors’ evaluation of our operating results, financial condition, future growth plans, general business and economic conditions, and tax and other relevant considerations. Also, the payment of cash dividends in the future will be subject to ongoing review by our banking regulators and to certain other legal and regulatory limitations including the requirement that our capital be maintained at certain minimum levels.

 

There is no assurance that, in the future, we will have funds available to pay cash dividends, or, even if funds are available, that we will pay or the Bank will be permitted to pay dividends in any particular amount or at any particular times, or that we will pay dividends at all.

 

Securities Authorized for Issuance under Equity Compensation Plans.    This information is included under Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

Recent Sales of Unregistered Securities.    On July 15, 2014, the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with certain institutional and other accredited investors, including entities controlled or advised by, or affiliated with the following: Wellington Management Company LLP; FJ Capital Management, LLC; EJF Capital Management; The Family Office; RMB Capital Management LLC; JCSD Partners; Siena Capital Partners; PRB Investors; Sandler O’Neill Asset Management, LLC (now Maltese Capital Management, LLC); Tricadia Capital Management; and Allstate Investments (the “Investors”). The Purchase Agreement was entered into by the Company in connection with a private placement of its common stock in which the Company issued and sold to the Investors, as well as other investors who were not a party to the Purchase Agreement, a total of 458,132,991 shares (the “Shares”) of the Company’s common stock, no par value per share, at a sales price of $0.10 per share, for an aggregate purchase price of $45,813,299.10.

 

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The private placement closed on July 16, 2014. The issuance and sale of the Shares was exempt from registration under the Securities Act, pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D as promulgated thereunder, as a transaction by an issuer not involving a public offering.

 

FIG Partners, LLC, Atlanta, Georgia, served as placement agent in the private placement, and The Hutchison Company, Durham, North Carolina, served as the Company’s financial advisor in connection with the transaction. The Company paid FIG Partners a placement agent fee of $1,723,431.96 and paid The Hutchison Company a financial advisory fee of $390,107.99.

 

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Item 6. Selected Financial Data.

 

 

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

 

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

 

 

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, 2014, 2013, and 2012 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.

 

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.

 

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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.

 

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, 2014, a $17.5 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 11 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.

 

Overview

 

The Company completed a private placement of common stock resulting in gross proceeds of approximately $45.8 million on July 16, 2014. In connection with the private placement, the Company repurchased all 13,179 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued under the Capital Purchase Program from the U.S. Treasury for a cash payment of $3.3 million. The Treasury also agreed to waive any unpaid dividends on the Series A Preferred Stock, and to cancel the warrant to purchase 475,204 shares of the Company’s common stock held by the Treasury. The Company also repurchased all of its floating rate trust preferred securities issued through its subsidiary, Bank of the Carolinas Trust I, from the holders of those securities for an aggregate cash payment of $1.75 million. The holders of the trust preferred securities agreed to forgive any unpaid interest on the securities. The Company also agreed to repurchase a subordinated note from the holder of the note for a cash payment of $1.35 million. The noteholder agreed to forgive any unpaid interest on the note. As of December 31, 2014, the Company and its subsidiaries have no debt obligations. The Company injected $34.8 million from the private placement into the Company’s banking subsidiary.

 

Our net income available to common shareholders was $10.4 million for 2014 compared to net loss available to common shareholders of $2.3 million for 2013 and $5.5 million for 2012. The loss in 2012 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. In 2013 and 2014, significant improvements were made in levels of nonperforming assets compared to 2012. The increase in net income in 2014 was primarily due to the gain on redemption of preferred stock. Also, after completion of the private placement in 2014, FDIC insurance premiums have been significantly reduced which we believe will decrease our non-interest expense.

 

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An increased loan demand in 2013 led to an increase of $8.1 million in our loan portfolio over the prior year. In 2014, our loan portfolio remained relatively constant throughout the year. 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 90% of our loan portfolio at December 31, 2014, 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 and federal funds lines of credit from correspondent banks.

 

Over 90% of our net revenue (net interest income plus noninterest income) in 2014 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 than our long-term trend. In 2013 and 2014, 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 103% of our revenue in 2014 and 120% in 2013. 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. In 2014, an income tax expense of $200,000 was incurred at the holding company state income tax level due to the gain on extinguishment of debt.

 

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 10.13 and 10.14 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.

 

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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. At December 31, 2014, the Bank was in compliance with the capital requirements contained in 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 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

 

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  -   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 10.15 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 of Richmond. 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.

 

Financial Condition at December 31, 2014 and December 31, 2013

 

Total assets at December 31, 2014, decreased by $38.2 million or 9.0% to $385.5 million compared to $423.7 million at December 31, 2013. We had earning assets of $352.8 million at December 31, 2014 consisting of $275.5 million in accruing loans, $40.3 million in investment securities and $37.0 million in interest-bearing deposits in banks. Stockholders’ equity was $47.1 million at December 31, 2014 compared to $1.7 million at December 31, 2013, which was primarily due to the sale of common stock.

 

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Loans.    Total loans increased by $100,000 or 0.04% during the twelve months of 2014, from $278.5 million on December 31, 2013 to $278.6 million at December 31, 2014. On December 31, 2014, real estate loans made up 90.3% of total loans while commercial non-real estate loans comprised another 8.3% of the portfolio, compared to 92.5% and 6.3% in the prior year. Total loans represented 72.3% and 65.3% of our total assets on December 31, 2014 and 2013, 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 4.63% for the year ending December 31, 2014 as compared to an average yield of 4.76% during 2013.

 

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,  
    2014     2013     2012     2011     2010  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  

Real estate loans:

                   

Residential 1-4 family

  $ 88,990        31.94   $ 84,855        30.47   $ 72,595        26.85   $ 78,631        25.54   $ 78,750        21.51

Commercial real estate

    111,195        39.91        117,463        42.18        110,527        40.88        126,849        41.20        161,839        44.20   

Construction and development

    23,081        8.29        27,049        9.71        28,976        10.72        33,081        10.74        35,310        9.64   

Home equity

    28,207        10.12        28,217        10.12        29,462        10.89        29,727        9.65        31,465        8.59   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

    251,473        90.26        257,584        92.48        241,560        89.34        268,288        87.13        307,364        83.94   

Commercial business loans

    23,105        8.29        17,428        6.26        22,992        8.50        34,271        11.13        51,581        14.09   

Consumer loans:

                   

Installment

    3,065        1.10        2,554        0.92        3,158        1.17        3,490        1.13        4,300        1.17   

Other

    967        0.35        944        0.34        2,664        0.99        1,858        0.61        2,908        0.80   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    278,610        100.00     278,510        100.00     270,374        100.00     307,907        100.00     366,153        100.00
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Allowance for loan losses

    (5,126       (6,015       (6,890       (8,101       (6,863  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans, net

  $ 273,484        $ 272,495        $ 263,484        $ 299,806        $ 359,290     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

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, 2014  
     1 year
or less
     After 1 year
but within
5 years
     After 5
years
     Total  

Commercial real estate loans

   $ 20,253       $ 55,996       $ 34,946       $ 111,195   

Constructions and development loans

     4,827         9,317         8,937         23,081   

Commercial business loans

     6,218         13,095         3,792         23,105   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 31,298       $ 78,408       $ 47,675       $ 157,381   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

 

     December 31, 2014  
     1 year
or less
     After 1 year
but within
5 years
     After
5 years
     Total  

Loans with fixed interest rates

   $ 28,119       $ 98,335       $ 102,758       $ 229,212   

Loans with variable interest rates

     12,363         10,979         26,056         49,398   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 40,482       $ 109,314       $ 128,814       $ 278,610   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Allowance for Loan Losses.    On December 31, 2014, our allowance for loan losses totaled approximately $5.1 million and amounted to 1.84% of total loans and 162.9% of our nonperforming loans. This compares to an allowance for loan losses of $6.0 million, or 2.16% of total loans and 125.6% of nonperforming loans at December 31, 2013 and $6.9 million, or 2.55% of total loans and 89.1% of nonperforming loans as of December 31, 2012.

 

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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,  
     2014     2013     2012     2011     2010  

Balance at beginning of year

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

Provision for loan losses

     (967     (2,039     2,359        17,565        6,441   

Charge-offs:

          

Residential mortgage

     (189     (897     (1,233     (3,125     (1,041

Commercial real estate

     (104     (544     (1,804     (7,339     (1,090

Construction and development

     (719     (248     (1,118     (1,256     (1,006

Commercial business

     (57     (115     (453     (5,310     (4,561

Installment

     (34     (51     (76     (150     (233
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (1,103     (1,855     (4,684     (17,180     (7,931
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Residential mortgage

     148        689        126        118        3   

Commercial real estate

     112        573        116        101        28   

Construction and development

     59        22        169        145        94   

Commercial business

     836        1,698        671        470        23   

Installment

     26        37        32        19        38   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     1,181        3,019        1,114        853        186   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     78        1,164        (3,570     (16,327     (7,745
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

   $ 5,126      $ 6,015      $ 6,890      $ 8,101      $ 6,863   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     -0.03     -0.42     1.24     4.78     2.08

Ratio of allowance for loan losses to non-performing loans

     162.9     125.6     89.1     42.5     27.8

Ratio of allowances for loan losses to total loans

     1.84     2.16     2.55     2.63     1.87

 

During 2014, we experienced net loan recoveries of $78,000, compared to net loan recoveries of $1.2 million in 2013 and net loan charge-offs of $3.6 million in 2012. These levels of net recoveries and charge-offs produced net recovery ratio of 0.03% for 2014 and 0.42% for 2013 and a net loss ratio of 1.24% for 2012. The net loss ratio for 2012 was substantially higher than our longer-term trend which contributed to increased loan loss provisions. 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 and 2014, continued efforts reduced nonperforming loans to loss ratios that were comparable to our peers and full years of net recoveries.

 

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An analysis of the allowance for loan losses for the years ended December 31, 2014, 2013, 2012, 2011, and 2010 is contained in the following table:

 

Table III.

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

 

    At December 31,  
    2014     2013     2012     2011     2010  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  

Real estate loans:

                   

Residential, 1-4 family

  $ 1,235        24.09   $ 1,218        20.25   $ 1,267        18.39   $ 1,168        16.95   $ 1,078        15.71

Commercial real estate

    2,147        41.89        2,105        35.00        2,210        32.08        2,421        35.14        1,154        16.81   

Construction and development

    603        11.76        635        10.56        806        11.70        719        8.88        667        9.72   

Home equity

    609        11.88        332        5.51        314        4.55        279        4.05        459        6.69   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

    4,594        89.62        4,290        71.32        4,597        66.71        4,587        65.02        3,358        48.93   

Commercial business loans

    324        6.32        176        2.93        1,209        17.55        2,247        32.61        2,252        32.81   

Consumer loans

    44        0.86        44        0.73        98        1.42        143        2.08        161        2.35   

Other

    5        0.10                                                           

Unallocated

    159        3.10        1,505        25.02        986        14.31        1,124        13.86        1,092        15.91   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan losses

  $ 5,126        100.00   $ 6,015        100.00   $ 6,890        100.00   $ 8,101        100.00   $ 6,863        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, 2014, the Company’s non-performing assets totaled $4.3 million, or 1.52% of loan-related assets, compared to $6.0 million, or 2.15% of loan-related assets at December 31, 2013.

 

On December 31, 2014, we had no loans that were delinquent over 90 days and still accruing interest, and $3.1 million that were in non-accrual status. Interest accrued, but not recognized as income on non-accrual loans, was approximately $37,000 during 2014. 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.

 

“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, 2014 amounted to $1.1 million compared to $1.2 million as of December 31, 2013. Other real estate is carried at the lower of cost or estimated net realizable value. During the years ended December 31, 2014 and 2013, $1.2 million and $953,000 of real property, respectively, was foreclosed on and transferred to OREO. Properties transferred to OREO are initially recorded at the fair value of the property, less estimated costs to sell the property at the date of the foreclosure. The $1.2 million and $953,000 transferred to OREO in 2014 and 2013 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 $7,000 to the allowance for loan losses in 2014 and $539,000 to the allowance for loan losses in 2013. 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,

 

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  -   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.

 

The following table provides a roll-forward of OREO for the periods ended December 31, 2014, 2013, and 2012:

 

Table IV.

OREO Rollforward (dollars in thousands)

 

     Year Ended December 31,  
     2014     2013     2012  

Beginning Balance

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

Additions from Transfers In

     1,188        953        5,823   

Valuation Adjustments

     (103     (539     (2,040

Sales Proceeds

     (1,290     (4,080     (7,523

Net Gains (Losses)

     80        (77     192   
  

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 1,108      $ 1,233      $ 4,976   
  

 

 

   

 

 

   

 

 

 

 

In April 2011, the Company established a special assets department to provide expertise in the areas of problem loans and OREO. This 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, 2014, 2013, 2012, 2011, and 2010.

 

Table V.

Nonperforming Assets (dollars in thousands)

 

     At December 31,  
     2014     2013     2012     2011     2010  

Loans accounted for on a nonaccrual basis:

          

Real estate loans:

          

Mortgage

   $ 738      $ 1,276      $ 2,491      $ 6,875      $ 4,071   

Commercial

     682        2,192        4,153        9,167        15,176   

Construction and development

     1,550        851        880        1,764        2,274   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

     2,970        4,319        7,524        17,806        21,521   

Commercial business customers

     171        463        202        1,246        3,068   

Installment

     5        6        7        10        101   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     3,146        4,788        7,733        19,062        24,690   

Accruing loans which are contractually past due 90 days or more

                                   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     3,146        4,788        7,733        19,062        24,690   

Other real estate owned

     1,108        1,233        4,976        8,524        8,314   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 4,254      $ 6,021      $ 12,709      $ 27,586      $ 33,004   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans as a percentage of loans

     1.13     1.72     2.86     6.19     6.74

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

     1.52     2.15     4.62     8.72     8.81

Total nonperforming assets as a percentage of total assets

     1.10     1.42     2.91     5.68     6.17

 

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Investment Securities.    Our investment securities totaled $40.3 million at December 31, 2014 and $90.3 million at December 31, 2013. Our investment portfolio includes U.S. Government Agency bonds, mortgage backed securities, and state and municipal bonds, all of which are classified as available for sale. Available for sale securities are carried at fair value.

 

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.

 

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

 

Table VI.

Investment Securities (dollars in thousands)

 

     December 31,  
     2014      2013      2012  

U.S. Government agency securities

   $ 4,985       $ 40,930       $ 48,118   

State and municipal securities

     6,155         10,181         10,326   

Mortgage-backed securities

     29,208         38,204         46,492   

Corporate securities

             1,000         1,995   
  

 

 

    

 

 

    

 

 

 

Total

   $ 40,348       $ 90,315       $ 106,931   
  

 

 

    

 

 

    

 

 

 

 

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, 2014 and 2013.

 

Table VII.

Investment Securities (dollars in thousands)

 

At December 31, 2014:

 

    1 year or less     Over 1 to 5
years
    Over 5 to 10
years
    Over 10
years
    Total
Securities
 
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
 

U.S. Government agency securities

  $ 89        4.29   $ 1,101        3.79   $ 3,705        2.41   $          $ 4,895        2.76

State and municipal securities

                  505        2.30        5,664        2.85                      6,169        2.81   

Mortgage-backed securities

                                156        5.61        28,965        2.36        29,121        2.38   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total investment securities

  $ 89        4.29   $ 1,606        3.32   $ 9,525        2.73   $ 28,965        2.36   $ 40,185        2.49
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

At December 31, 2013:

 

    1 year or less     Over 1 to 5
years
    Over 5 to 10
years
    Over 10
years
    Total
Securities
 
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
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
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

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, 2014, total deposits were $336.6 million compared with $366.2 million on December 31, 2013. During the year, there were increases in noninterest-checking, money market, and savings deposits, with decreases in interest-checking and time deposits.

 

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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.

 

On December 31, 2014 and 2013, there were no brokered deposits. 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 from accepting, renewing, or rolling over any brokered deposits. On December 31, 2014, total time deposits issued in denominations of $100,000 or more made up approximately 27.0% of our total deposits as compared to 31.7% as of December 31, 2013 and 31.1% at December 31, 2012.

 

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, 2014 and 2013.

 

Table VIII.

Deposit Mix (dollars in thousands)

 

     For the Years ended December 31,  
     2014     2013  
     Average
Balance
     Average
Cost
    Average
Balance
     Average
Cost
 

Interest-bearing deposits:

          

Interest-checking deposits

   $ 41,723         0.22   $ 39,910         0.34

Money market and savings deposits

     112,179         0.44        110,542         0.49   

Time deposits

     171,725         0.81        178,882         0.91   
  

 

 

      

 

 

    

Total interest-bearing deposits

     325,627         0.61        329,334         0.70   

Noninterest-bearing demand deposits

     35,479           35,365      
  

 

 

      

 

 

    

Total deposits

   $ 361,106         0.55   $ 364,699         0.63
  

 

 

      

 

 

    

 

The following table contains an analysis of our time deposits of $100,000 or more at December 31, 2014 and 2013.

 

     December 31,  
     2014      2013  
     (dollars in thousands)  

Remaining maturity of three months or less

   $ 27,814       $ 29,553   

Remaining maturity of over three to twelve months

     33,419         49,084   

Remaining maturity of over twelve months

     29,657         37,289   
  

 

 

    

 

 

 

Total time deposits of $100,000 or more

   $ 90,890       $ 115,926   
  

 

 

    

 

 

 

 

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Borrowed Funds.    The following table summarizes our borrowings at December 31, 2014 and 2013.

 

Table IX.

Borrowed Funds (dollars in thousands)

 

     At December 31,  
     2014     2013  
     Outstanding
Balance
     Average
Rate
    Outstanding
Balance
     Average
Rate
 

Federal funds purchased and securities sold under overnight repurchase agreements

   $ 491         0.14   $ 388         0.10

Securities sold under term repurchase agreements

                    45,000         4.38   

Trust preferred securities

                    5,155         3.19   

Subordinated debt

                    2,700         4.00   
  

 

 

      

 

 

    

Total borrowed funds

   $ 491         0.14   $ 53,243         4.21
  

 

 

      

 

 

    

 

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,  
     2014     2013  
     Average
Balance
     Average
Cost
    Average
Balance
     Average
Cost
 

Federal funds purchased and securities sold under overnight repurchase agreements

   $ 491         0.20   $ 805         0.12

Securities sold under term repurchase agreements

     24,356         4.38        45,000         4.38   

Trust preferred securities

     2,768         3.54        5,155         3.51   

Subordinated debt

     1,450         4.00        2,700         4.00   
  

 

 

      

 

 

    

Total borrowed funds

   $ 29,065         4.21   $ 53,660         4.21
  

 

 

      

 

 

    

 

During 2008, we entered into term repurchase agreements with two money center financial institutions. These two borrowing arrangements totaled $45.0 million in the aggregate and had interest at an effective annual blended rate of 4.38%. These borrowings were secured by marketable investment securities equal to approximately 109.5% of the principal balances outstanding plus accrued interest and the value of an imbedded interest rate cap. The borrowings were repaid as of July 18, 2014. There was prepayment expense of $4.4 million. The security interests in the pledged investment securities were released in connection with the Company’s repayment of these borrowings.

 

On December 31, 2014, we had no advances from the Federal Home Loan Bank (“FHLB”). At December 31, 2014, we had immediate availability of $6.9 million as we pledged our eligible one-to-four family mortgages, commercial real estate loans and home equity loans with aggregate outstanding principal balances of approximately $9.1 million at that date.

 

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 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, 2013, and 2014.

 

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On July 16, 2014, the Company repurchased all of its floating rate trust preferred securities issued through the Trust from the holders of those securities for an aggregate cash payment of $1.75 million. The holders of the trust preferred securities agreed to forgive any unpaid interest on the securities.

 

The Company had also issued $2.7 million of subordinated debt in a private transaction with another banking institution. This subordinated note had 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.

 

On July 16, 2014, the Company repurchased the subordinated note representing this debt from the holder of the note for a cash payment of $1.35 million. The noteholder also agreed to forgive any unpaid interest on the note.

 

Capital Resources.    Total stockholders’ equity increased by $45.3 million to $47.1 million on December 31, 2014, compared to $1.7 million on December 31, 2013. The Company completed a private placement of common stock resulting in gross proceeds of approximately $45.8 million on July 16, 2014.

 

In connection with the private placement, the Company repurchased all 13,179 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued under the Capital Purchase Program from the U.S. Treasury for a cash payment of $3.3 million. The Treasury also agreed to waive any unpaid dividends on the Series A Preferred Stock, and to cancel the warrant to purchase 475,204 shares of the Company’s common stock held by the Treasury. As noted above, the Company also repurchased all of its trust preferred securities and a subordinated note held by another financial institution in connection with the closing of the private placement. The Company invested $34.8 million into its banking subsidiary.

 

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, 2014 and 2013 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,  
     2014      2013  
     (In thousands)  

Unfunded loan commitments

   $ 29,549       $ 29,553   

Financial standby letters of credit

     209         181   
  

 

 

    

 

 

 

Total unused commitments

   $ 29,758       $ 29,734   
  

 

 

    

 

 

 

 

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, 2014.

 

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

Time deposits

   $ 147,045       $ 97,337       $ 45,788       $ 3,920       $   

Leases

     330         214         116                   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 147,375       $ 97,551       $ 45,904       $ 3,920       $   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Comparison of Results of Operations for the Years Ended December 31, 2014, 2013, and 2012

 

Net Income (Loss).    Net income available to common shareholders was $10.4 million or $0.05 per diluted common share for the year ended December 31, 2014, compared to a net loss of $2.3 million or $0.60 per diluted common share for the year ended December 31, 2013 and net loss for the year ended December 31, 2012 of $5.5 million, or $1.42 per diluted common share. The increase in net income in 2014 was primarily due to the gain on redemption of preferred stock. As noted earlier, the principal reason for the losses incurred in 2012 was related to deterioration in our loan

 

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portfolio which resulted in materially higher loan loss provisions and increased expenses related to the ownership and disposal of foreclosed real estate. In 2013 and 2014, the provision for loan loss reported a recovery and the Company experienced increased performance in the loan portfolio.

 

Income tax expense was $200,000, $942,000 and $0 during the years ended December 31, 2014, 2013, and 2012. Pretax income and changes in the valuation allowance on net deferred tax assets were the primary reasons for changes in income tax expense each year.

 

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 increased $811,000 to $11.5 million in 2014 from 2013 after decreasing $908,000 from 2012. Our net interest margin increased in 2014 to 3.01% compared to a constant 2.72% during 2013 and 2012. Our net interest spread increased to 2.94% in 2014 from 2.70% in 2013 and from 2.68% in 2012. 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.

 

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, 2014, 2013, and 2012.

 

Table X.

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

 

    December 31, 2014     December 31, 2013     December 31, 2012  
    Average
Balance
    Interest
Income/
Expense
    Yield/
Cost
    Average
Balance
    Interest
Income/
Expense
    Yield/
Cost
    Average
Balance
    Interest
Income/
Expense
    Yield/
Cost
 

Interest-earning assets:

                 

Loans

  $ 278,839      $ 12,924        4.63   $ 272,614      $ 12,978        4.76   $ 287,764      $ 14,303        4.97

Investment securities

    68,972        1,644        2.38        95,569        2,156        2.26        108,990        2,669        2.45   

Other interest-earning assets

    33,276        90        0.27        22,671        74        0.33        28,631        77        0.27   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-earning assets

    381,087        14,658        3.85     390,854        15,208        3.89     425,385        17,049        4.01
   

 

 

       

 

 

       

 

 

   

Other assets, net

    34,482            36,935            39,156       
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 415,569          $ 427,789          $ 464,541       
 

 

 

       

 

 

       

 

 

     

Interest bearing liabilities:

                 

Interest-checking deposits

  $ 41,723        91        0.22   $ 39,910        137        0.34   $ 37,421        142        0.38

Money Market and Savings deposits

    112,179        492        0.44        110,542        543        0.49        105,141        575        0.55   

Time deposits

    171,725        1,393        0.81        178,882        1,621        0.91        218,492        2,508        1.15   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-bearing deposits

    325,627        1,976        0.61        329,334        2,301        0.70        361,054        3,225        0.89   

Borrowed funds

    29,065        1,223        4.21        53,660        2,259        4.21        53,201        2,268        4.26   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total Interest-bearing liabilities

    354,692        3,199        0.90        382,994        4,560        1.19        414,255        5,493        1.33   
   

 

 

       

 

 

       

 

 

   

Noninterest-bearing demand deposits

    35,479            35,365            37,555       

Other liabilities

    2,044            2,068            2,243       

Stockholders’ Equity

    23,354            7,362            10,488       
 

 

 

       

 

 

       

 

 

     

Total liabilities and stockholders’ equity

  $ 415,569          $ 427,789          $ 464,541       
 

 

 

       

 

 

       

 

 

     

Net interest income & interest rate spread

    $ 11,459        2.94     $ 10,648        2.70     $ 11,556        2.68
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Net yield on average interest-earning assets

        3.01         2.72         2.72
     

 

 

       

 

 

       

 

 

 

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

        107.44         102.05         102.69
     

 

 

       

 

 

       

 

 

 

 

Non-accrual loans are included in the table for the years ended December 31, 2014, 2013, and 2012.

 

Loan fees and late charges of $210,000, $150,000, and $146,000 for 2014, 2013, and 2012, 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, 2014, 2013, and 2012. 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 increase in net interest income realized in 2014 in comparison to 2013 was the result of the decrease in volume and rates of deposits and borrowings resulting in a positive effect on the current year results.

 

Table XI.

Volume / Rate Variance Analysis (dollars in thousands)

 

    Year Ended December 31, 2014 vs. 2013
Increase (Decrease) Due to
    Year Ended December 31, 2013 vs. 2012
Increase (Decrease) Due to
    Year Ended December 31, 2012 vs. 2011
Increase (Decrease) Due to
 
        Volume             Rate             Total             Volume             Rate             Total             Volume             Rate             Total      

Interest-earning assets:

                 

Loans

  $ 296      $ (350   $ (54   $ (755   $ (570   $ (1,325   $ (2,746   $ (349   $ (3,095

Investment securities

    (591     79        (512     (332     (181     (513     (154     (352     (506

Other interest-earning assets

    32        (16     16        (15     12        (3     27        (9     18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

    (263     (287     (550     (1,102     (739     (1,841     (2,874     (709     (3,583
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

                 

Deposits

    (26     (299     (325     (289     (635     (924     (291     (871     (1,162

Borrowed funds

    (1,036     (0     (1,036     20        (29     (9     (548     163        (385
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

    (1,062     (299     (1,361     (269     (664     (933     (839     (708     (1,547
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

  $ 799      $ 12      $ 811      $ (833   $ (75   $ (908   $ (2,035   $ (1   $ (2,036
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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 1.84%, 2.16%, and 2.55% at December 31, 2014, 2013, and 2012, respectively. The allowance included $1.7 million at December 31, 2014, $563,000 at December 31, 2013, and $755,000 at December 31, 2012 allocated to specific loans with principal balances totaling approximately $21.6 million, $24.0 million, and $26.6 million, respectively. See “Critical Accounting Policies”.

 

The recovery of loan losses decreased 52.6% to a recovery of $967,000 in 2014 from a recovery of $2.0 million in 2013 and decreased from an expense of $2.4 million in 2012. The sizable provision recorded in 2012 was 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 2014 totaled $78,000 which equates to 0.03% of average loans for the year and a 93.3% decrease from 2013 net recoveries of $1.2 million, which represented 0.42% of average loans outstanding for that year, and a 102.2% decrease from 2012 net charge-offs of $3.6 million, which represented 1.24% of average loans outstanding for that year. For the five years prior to the current credit cycle (2008—2012), our net charge-offs averaged 2.01% 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 2014, 2013, and 2012:

 

Table XII.

Net Charge-offs by Quarter (dollars in thousands)

 

    December 31, 2014     December 31, 2013     December 31, 2012  
    1Q     2Q     3Q     4Q     Total     1Q     2Q     3Q     4Q     Total     1Q     2Q     3Q     4Q     Total  

Commercial—Non Real Estate

  $ (32   $ (16   $ (700   $ (31   $ (779   $ (1,281   $ 24      $ (241   $ (85   $ (1,583   $ 180      $ 81      $ (185   $ (294   $ (218

Commercial Real Estate

                             

Owner occupied

    (4     (3     (4     (3     (14     204        74        (537     229        (30     442        (12     53        82        565   

Income producing

                  104        (98     6        1                             1               (47     1,170               1,123   

Multifamily

                                                                                                        

Construction & Development

                             

1—4 Family

                                       5                             5        (1            99               98   

Other

    (2     670        (4     (4     660        (2     (5     (2     209        200        646        (50     257        (2     851   

Farmland

                                       8        13                      21                                      

Residential

                             

Equity Lines

    57        20        40        (52     65        188        (11     (3     9        183        14        (1     5        97        115   

1—4 Family

    (54     (3     (6     39        (24     123        (7     36        (127     25        54        768        137        33        992   

Consumer—Non Real Estate

    1        3        5        (1     8                      10        4        14        10        1        26        7        44   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals by Quarter

  $ (34   $ 671      $ (565   $ (150   $ (78   $ (754   $ 88      $ (737   $ 239      $ (1,164   $ 1,345      $ 740      $ 1,562      $ (77   $ 3,570   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Net loan charge-offs decreased from 2012 to 2013 and decreased again 2013 to 2014. Net loan charge-offs during 2012 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 $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 for which the underlying collateral was ultimately sold during the foreclosure process or transferred to other real estate owned. As a result of aggressively addressing our substandard loans, in 2012 we saw a decrease in our net loan-chargeoffs. In 2013, the loan loss provision reflected a specific recovery of a $1.25 million loan that was previously charged off in 2011. In 2014, $719,000 was related to a restructured loan relationship and $700,000 was recovered in a settlement from a loan previously charged off in 2011.

 

Total nonperforming assets amounted to $4.3 million at December 31, 2014, a decrease of 29.3% from the year-end 2013 total of $6.0 million. Total nonperforming assets as a percent of loan-related assets (loans plus foreclosed real estate) amounted to 1.52% at December 31, 2014 compared to 2.15% as of year-end 2013. For the five year-ends preceding the current credit cycle, nonperforming assets averaged 5.90% of loan-related assets. Nonperforming assets as a percent of total assets was 1.10% of total assets at the end of 2014 compared to 1.42% at December 31, 2013 and 2.91% at December 31, 2012.

 

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 $1.2 million in 2014, $1.1 million in 2013, and $1.2 million in 2012. The largest component of customer service fees is revenues from deposit services which totaled $606,000 in 2014, $610,000 in 2013, and $620,000 in 2012. 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 2014, we realized net losses on investment securities of $1.3 million as compared to no gains or losses on investment securities in 2013 and net gains of $2.2 million in 2012. The increase in the cash value of life insurance policies was $346,000 in 2014 compared to $352,000 for 2013 and $359,000 for 2012. 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. In 2014, the private placement transaction included discounts and interest forgiveness on the Company’s trust preferred securities and subordinated debt in the amount of $5.4 million.

 

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The following is a tabular presentation of our non-interest income for the years ended December 31, 2014, 2013, and 2012.

 

Table XIII.

Noninterest Income (dollars in thousands)

 

     2014     2013      2012  

Deposit services fees

   $ 606      $ 610       $ 620   

Card services fees

     433        408         418   

Loan services fees

     27        23         20   

Other customer services fees

     105        108         118   
  

 

 

   

 

 

    

 

 

 

Total customer services fees

     1,171        1,149         1,176   

Net gain (loss) on investment securities

     (1,275             2,190   

Increase in cash value of bank owned life insurance

     346        352         359   

Net proceeds from bank owned life insurance

                    415   

Extinguishment of debt

     5,443                  

All other income

     22        28         28   
  

 

 

   

 

 

    

 

 

 

Total noninterest income

   $ 5,707      $ 1,529       $ 4,168   
  

 

 

   

 

 

    

 

 

 

 

Non-interest Expense.    Non-interest expense totaled $17.8 million for the year ended December 31, 2014, an increase of $3.2 million, or 21.7% from the $14.6 million reported for the year ended December 31, 2013, which was a $3.3 million decrease, or 18.5%, below the 2012 amount. The Company prepaid two term repurchase agreements at a prepayment expense of $4.4 million. There were other major factors which contributed to the decrease in certain noninterest expenses in 2014 compared to 2013, including (1) a decrease of $698,000, or 86.2%, in valuation allowances and net operating cost associated with foreclosed real estate, (2) a decrease of $366,000, or 5.7%, in salaries and benefits, and (3) a decrease of $296,000, or 20.3%, in FDIC insurance premiums.

 

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.

 

During 2014 and 2013, foreclosed property was sold at 105% and 99% of book value, respectively, which were 75% and 58% of original loan book value. At December 31, 2014, we owned 7 OREO properties compared to 11 properties at December 31, 2013.

 

The following table summarizes the major components of our non-interest expense for the years ended December 31, 2014, 2013, and 2012.

 

Table XIV.

Noninterest Expenses (dollars in thousands)

 

    2014     2013      2012  

Salaries and employee benefits

  $ 6,071      $ 6,437       $ 6,877   

Net occupancy expense

    1,858        1,787         1,903   

FDIC insurance assessments

    1,163        1,459         1,600   

Data processing

    1,026        1,054         989   

Professional services

    1,054        931         1,425   

Telephone and data communications

    328        361         383   

Advertising and promotional

    122        158         92   

Postage and courier

    131        155         221   

Printing and supplies

    115        139         154   

Valuation allowances and net operating costs associated with foreclosed real estate

    112        810         2,417   

Debt prepayment penalty

    4,353                  

All other expenses

    1,463        1,338         1,883   
 

 

 

   

 

 

    

 

 

 

Total noninterest expenses

  $ 17,796      $ 14,629       $ 17,944   
 

 

 

   

 

 

    

 

 

 

 

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Income Taxes.    There was an income tax provision in 2014 of $200,000 and $942,000 in 2013. The Company continuously updates 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 five 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. As of December 31, 2014 the net deferred tax asset had a zero value as a result of a deferred tax asset of $17.5 million and an allowance of $17.5 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, 2014, the Bank’s Total Capital Ratio and Tier 1 Risk-Based Capital Ratio were 16.16% and 14.90%, respectively, both above the minimum levels required by the FDIC’s “well-capitalized” guidelines. On December 31, 2014 our Tier 1 Leverage Capital Ratio was 11.46%, which was also well above 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, 2014, the Bank had achieved these minimum levels. As long as the consent order is in place, the Bank will not be considered well-capitalized under FDIC regulations, even if its capital ratios satisfy the requirements for that designation.

 

Revised Capital Requirements.    On July 2, 2013, the Federal Reserve and the Office of the Comptroller of the Currency adopted a final rule that revised the current risk-based and leverage capital requirements for banking organizations. The final rule is a continuation of joint notices of proposed rulemaking originally published in the Federal Register during August 2012.

 

The final rule implements a revised definition of regulatory capital, a new common equity Tier 1 minimum capital requirement, and a higher overall minimum Tier 1 capital requirement, incorporating these new requirements into the existing prompt corrective action (PCA) framework. It also establishes limits on a banking organization’s capital distributions and certain discretionary bonus payments if the organization does not hold a specified amount of common equity Tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. This additional capital is referred to as the “capital conservation buffer.” The “countercyclical capital buffer” provisions from the proposed rule have also been adopted, however, they apply only to large financial institutions (banks and bank holding companies with total consolidated assets of $250 billion or more) implementing the “advanced approaches” framework and are not applicable to the Bank.

 

The final rule permanently grandfathers the Tier 1 capital treatment for certain non-qualifying capital instruments, including trust preferred securities, outstanding as of May 19, 2010.

 

Under the proposed rules released in August 2012, banking organizations would have been required to recognize in regulatory capital all components of accumulated other comprehensive income (excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet). The final rule carries this requirement forward, with an exception for smaller banking organizations, such as the Bank, which are not subject to the “advanced approaches” rule. Such organizations may make a one-time election not to include most elements of accumulated other comprehensive income (including unrealized gains and losses on securities designated as available-for-sale) in regulatory capital under the final rule. Organizations making this election will be permitted to use the currently existing treatment under the general risk-based capital rules that exclude most accumulated other comprehensive income elements from regulatory capital. The election must be made with the first call report or FR Y-9 report filed after the banking organization becomes subject to the final rule (January 2015 in the Bank’s case).

 

The new rule also amends the existing methodologies for determining risk-weighted assets for all banking organizations. Specifically, the final rule assigns a 50% or 100% risk weight to mortgage loans secured by one-to-four family residential properties. Generally, residential mortgage loans secured by a first lien on a one- to-four family

 

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residential property that are prudently underwritten and that are performing according to their original terms receive a 50% risk weight. All other one-to-four family residential mortgage loans, including loans secured by a junior lien on residential property, are assigned a 100% risk weight.

 

The mandatory compliance date for the Bank was January 1, 2015, with a transition period for the capital conservation buffer until January 1, 2016, and additional transition periods for certain other measures under the new rule.

 

Management considered these new capital rules during its capital planning in 2014 and will continue to evaluate the effects of the new final rule and the Company’s compliance over the coming quarters.

 

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 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, 2014 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 23.25% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 24.67%.

 

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, 2014 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, 2014, 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.

 

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The following table shows the interest rate sensitivity of our balance sheet on December 31, 2014, 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.

 

     December 31, 2014  
     1-3
months
    Over 3 to
12 months
    Over 12 to
60 months
    Over
60 months
    Total  

Interest-earning assets:

          

Loans

   $ 54,355      $ 16,212      $ 98,278      $ 106,619      $ 275,464   

Investment securities

     1,381               1,459        37,508        40,348   

Other interest-earning assets

     34,561               2,480               37,041   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ 90,297      $ 16,212      $ 102,217      $ 144,127      $ 352,853   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

          

Interest-checking deposits

   $ 39,557      $      $      $      $ 39,557   

Money market and savings deposits

     112,487                             112,487   

Time deposits

     37,209        60,128        49,708               147,045   

Borrowed funds

     491                             491   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ 189,744      $ 60,128      $ 49,708      $      $ 299,580   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-sensitivity gap

   $ (99,447   $ (43,916   $ 52,509      $ 144,127      $ 53,273   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative sensitivity gap

   $ (99,447   $ (143,363   $ (90,854   $ 53,273      $ 53,273   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative gap as a % of total interest-earning assets

     (28.18 )%      (40.63 )%      (25.75 )%      15.10     15.10
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative ratio of sensitive assets to sensitive liabilities

     47.59     26.96     205.63         117.78
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Quarterly financial data for 2014 and 2013 is summarized in the table below.

 

Table XVI.

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

 

    2014     2013  
    4th Qtr     3rd Qtr.     2nd Qtr.     1st Qtr.     4th Qtr     3rd Qtr.     2nd Qtr.     1st Qtr.  

Interest income

  $ 3,514      $ 3,608      $ 3,787      $ 3,749      $ 3,842      $ 3,801      $ 3,746      $ 3,819   

Interest expense

    415        611        1,089        1,084        1,110        1,130        1,142        1,178   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    3,099        2,997        2,698        2,665        2,732        2,671        2,604        2,641   

Provision for loan losses

    (207     (535     (1,287     1,062        39        (920     (12     (1,146
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for loan losses

    3,306        3,532        3,985        1,603        2,693        3,591        2,616        3,787   

Noninterest income

    380        4,553        384        390        400        380        383        366   

Noninterest expense

    3,084        7,715        3,482        3,515        3,610        3,579        3,721        3,719   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    602        370        887        (1,522     (517     392        (722     434   

Income taxes (benefit)

    200                             152        152        341        297   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    402        370        887        (1,522     (669     240        (1,063     137   

Dividends and accretion on preferred stock

           165        (288     (249     (247     (245     (243     (243

Gain on redemption of preferred stock

           10,203                                             
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common shareholders

  $ 402      $ 10,738      $ 599      $ (1,771   $ (916   $ (5   $ (1,306   $ (106
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per common share:

               

Basic

  $ 0.001      $ 0.028      $ 0.15      $ (0.45   $ (0.24   $      $ (0.33   $ (0.03

Diluted

  $ 0.001      $ 0.028      $ 0.15      $ (0.45   $ (0.24   $      $ (0.33   $ (0.03

 

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.

 

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, including but 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

 

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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

 

LOGO

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

Bank of the Carolinas Corporation and Subsidiaries

Mocksville, North Carolina

 

We have audited the accompanying balance sheet of Bank of the Carolinas Corporation and Subsidiaries (the “Company”) as of December 31, 2014, and the related consolidated statement of operations, comprehensive income, stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides 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 Subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

 

LOGO

 

Raleigh, North Carolina

March 31, 2015

 

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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 sheet of Bank of the Carolinas Corporation and Subsidiary (hereinafter referred to as the “Company”) as of December 31, 2013, and the related consolidated statements of operations, comprehensive loss, changes in stockholders’ equity, and cash flows for the years ended December 31, 2013 and 2012. 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 report dated March 26, 2014, we expressed an opinion that the 2013 financial statements present fairly the financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. Our report raised substantial doubt about the Company’s ability to continue as a going concern. There is no longer substantial doubt about the Company’s ability to continue as a going concern as it relates to 2013. Accordingly, our present opinion on the 2013 financial statements, as presented herein, is different from that expressed in our previous report.

 

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 the results of its operations and cash flows for the years ended December 31, 2013 and 2012 in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 19 to the 2013 financial statements, the 2013 consolidated financial statements have been restated to correct a misstatement.

 

/s/ Turlington and Company, L.L.P.

Lexington, North Carolina

March 26, 2014, except for the restatement noted above, as to which the date is October 10, 2014

 

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Bank of the Carolinas Corporation and Subsidiary

 

Consolidated Balance Sheets

December 31, 2014 and 2013

(In thousands except share data)

 

     2014     2013  

Assets:

    

Cash and due from banks, noninterest-bearing

   $ 9,571      $ 12,778   

Interest-bearing deposits in banks

     37,041        2,064   
  

 

 

   

 

 

 

Cash and cash equivalents

     46,612        14,842   

Federal funds sold

            19,580   

Investment securities

     40,348        90,315   

Loans receivable

     278,610        278,510   

Less: Allowance for loan losses

     (5,126     (6,015
  

 

 

   

 

 

 

Total loans, net

     273,484        272,495   

Premises and equipment, net

     10,811        11,274   

Other real estate owned

     1,108        1,233   

Bank owned life insurance

     11,234        10,888   

Accrued interest receivable

     852        1,156   

Other assets

     1,010        1,867   
  

 

 

   

 

 

 

Total Assets

   $ 385,459      $ 423,650   
  

 

 

   

 

 

 

Liabilities:

    

Deposits:

    

Noninterest-bearing demand deposits

   $ 37,533      $ 35,243   

Interest-checking deposits

     39,557        40,939   

Money market and savings deposits

     112,487        109,419   

Time deposits

     147,045        180,549   
  

 

 

   

 

 

 

Total deposits

     336,622        366,150   

Securities sold under repurchase agreements

     491        45,388   

Subordinated debt

            7,855   

Other liabilities

     1,290        2,509   
  

 

 

   

 

 

 

Total Liabilities

     338,403        421,902   
  

 

 

   

 

 

 

Stockholders’ Equity:

    

Preferred stock, no par value

            13,179   

Discount on preferred stock

            (100

Common stock, no par value per share at December 31, 2014, $5 par value per share at December 31, 2013

            19,479   

Additional paid-in capital

     73,815        12,991   

Accumulated deficit

     (26,922     (38,422

Accumulated other comprehensive income (loss)

     163        (5,379
  

 

 

   

 

 

 

Total Stockholders’ Equity

     47,056        1,748   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 385,459      $ 423,650   
  

 

 

   

 

 

 

Preferred shares authorized

     3,000,000        3,000,000   

Preferred shares issued and outstanding

     0        13,179   

Unaccrued preferred stock dividend

   $      $ 1,894   

Common shares authorized

     580,000,000        15,000,000   

Common shares issued and outstanding

     462,028,831        3,895,840   

 

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

 

48


Table of Contents

Bank of the Carolinas Corporation and Subsidiary

 

Consolidated Statements of Operations

For the Years Ended December 31, 2014, 2013, and 2012

(In thousands except per share data)

 

     2014     2013     2012  

Interest and dividend income:

      

Loans, including fees

   $ 12,924      $ 12,978      $ 14,303   

Investment securities

     1,644        2,156        2,669   

Other

     90        74        77   
  

 

 

   

 

 

   

 

 

 

Total interest income

     14,658        15,208        17,049