10-Q 1 fofn930201410q.htm 10-Q FOFN 9.30.2014 10Q



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C.  20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2014

Commission File Number      000-22787      

FOUR OAKS FINCORP, INC.
(Exact name of registrant as specified in its charter)
 
NORTH CAROLINA
 
56-2028446
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification Number)
 
6114 U.S. 301 SOUTH, FOUR OAKS, NC  27524
(Address of principal executive office, including zip code)
 
(919) 963-2177
(Registrant's telephone number, including area code)

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. xYES   oNO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) xYES   oNO

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  o
Accelerated filer o
Non-accelerated filer    o (Do not check if a smaller reporting company)  
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):
oYES   xNO

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock,
32,023,556
par value $1.00 per share  
(Number of shares outstanding
(Title of Class)
November 14, 2014

-1-


TABLE OF CONTENTS
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014 (Unaudited) and December 31, 2013
 
 
 
 
 
 
Three and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
 
 
Three and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
Nine Months Ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2 -
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 

-2-




Part I. FINANCIAL INFORMATION

Item 1 – FINANCIAL STATEMENTS

FOUR OAKS FINCORP, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
 
 
September 30, 2014
 
December 31, 2013
 
(Unaudited)
 
(*)
ASSETS
 
 
 
Cash and due from banks
$
12,535

 
$
11,890

Interest-earning deposits
198,795

 
116,739

Cash and cash equivalents
211,330

 
128,629

CDs held for investment
29,645

 
31,850

Investment securities available-for-sale, at fair value
17,827

 
32,566

Investment securities held-to-maturity, at amortized cost
85,773

 
98,013

Total investment securities
103,600

 
130,579

Loans
446,347

 
492,712

Allowance for loan losses
(9,347
)
 
(11,590
)
Net loans
437,000

 
481,122

Loans held for sale
12,237



Accrued interest receivable
1,486

 
1,576

Bank premises and equipment, net
12,057

 
12,571

FHLB stock
5,553

 
6,076

Bank owned life insurance
14,537

 
14,380

Foreclosed assets
4,724

 
8,502

Other assets
5,750

 
6,261

Total assets
$
837,919

 
$
821,546

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 

 
 

Deposits:
 

 
 

Noninterest-bearing demand
$
252,967

 
$
228,203

Money market, NOW accounts and savings accounts
168,205

 
166,102

Time deposits, $100,000 and over
147,476

 
162,403

Other time deposits
93,164

 
100,912

Total deposits
661,812

 
657,620

Borrowings
107,000

 
112,000

Subordinated debentures
12,372

 
12,372

Subordinated promissory notes
12,000

 
12,000

Accrued interest payable
1,747

 
1,642

Other liabilities
2,916

 
4,289

Total liabilities
797,847

 
799,923

Commitments (Note F)


 


Shareholders’ equity:
 

 
 

Common stock, $1.00 par value, 80,000,000 shares authorized; 32,023,556 and 7,977,657 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively.
32,024

 
7,978

Additional paid-in capital
32,503

 
34,269

Accumulated deficit
(25,212
)
 
(20,390
)
Accumulated other comprehensive income (loss)
757

 
(234
)
Total shareholders' equity
40,072

 
21,623

Total liabilities and shareholders' equity
$
837,919

 
$
821,546


 (*)  Derived from audited consolidated financial statements.
 The accompanying notes are an integral part of the consolidated financial statements.

-3-




FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands, except share data)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Interest and dividend income:
 
 
 
 
 
 
 
Loans, including fees
$
6,590

 
$
6,827

 
$
19,686

 
$
20,608

Taxable investments
516

 
443

 
1,799

 
918

Dividends
76

 
78

 
239


263

Interest-earning deposits
173

 
164

 
515

 
498

Total interest and dividend income
7,355

 
7,512

 
22,239

 
22,287

Interest expense:
 

 
 

 
 
 
 
Deposits
716

 
846

 
2,173

 
2,693

Borrowings
1,025

 
1,025

 
3,041

 
3,041

Subordinated debentures
50

 
51

 
149

 
153

Subordinated promissory notes
257

 
257

 
763

 
763

Total interest expense
2,048

 
2,179

 
6,126

 
6,650

Net interest income
5,307

 
5,333

 
16,113

 
15,637

Provision for loan losses
7,954

 

 
7,954

 
35

Net interest income after provision for loan losses
(2,647
)
 
5,333

 
8,159

 
15,602

Non-interest income:
 

 
 

 
 
 
 
Service charges on deposit accounts
446

 
458

 
1,259

 
1,333

Other service charges, commissions and fees
732

 
947

 
2,639

 
2,649

Gains on sale of investment securities available-for-sale, net
51

 
92

 
265

 
462

Recovery of impairment loss on redemption of equity securities
175

 

 
264

 

Income from investment in life insurance
50

 
49

 
157

 
186

Indemnification from third party payment processor clients
772

 

 
3,049

 

Other
44

 
80

 
137

 
786

Total non-interest income
2,270

 
1,626

 
7,770

 
5,416

Non-interest expenses:
 

 
 

 
 
 
 
Salaries
2,470

 
2,435

 
7,321

 
7,749

Employee benefits
402

 
384

 
1,364

 
1,384

Occupancy expenses
328

 
250

 
921

 
903

Equipment expenses
287

 
354

 
918

 
1,059

Professional and consulting fees
976

 
903

 
2,406

 
2,309

FDIC assessments
460

 
371

 
1,368

 
1,290

Foreclosed asset-related costs, net
1,359

 
697

 
1,806

 
1,637

Collection expenses
143

 
234

 
497

 
925

Other
1,796

 
1,252

 
4,150

 
3,710

Total non-interest expenses
8,221

 
6,880

 
20,751

 
20,966

Income (loss) before income taxes
(8,598
)
 
79

 
(4,822
)
 
52

Income tax

 

 

 

Net income (loss)
$
(8,598
)
 
$
79

 
$
(4,822
)
 
$
52

 
 
 
 
 
 
 
 
Basic net income (loss) per common share
$
(0.42
)
 
$
0.01

 
$
(0.38
)
 
$
0.01

Diluted net income (loss) per common share
$
(0.42
)
 
$
0.01

 
$
(0.38
)
 
$
0.01

Weighted Average Shares Outstanding, Basic
20,696,393

 
7,944,600

 
12,584,239

 
7,897,348

Weighted Average Shares Outstanding, Diluted
20,696,393

 
7,944,600

 
12,584,239

 
7,897,348

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

-4-




FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) UNAUDITED)
(Amounts in thousands)
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss)
$
(8,598
)
 
$
79

 
$
(4,822
)
 
$
52

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 

 
 

 
 

 
 

Securities available-for-sale:
 

 
 

 
 

 
 

Unrealized gains (losses) on securities available-for-sale
(47
)
 
(154
)
 
1,329

 
(728
)
Tax effect

 
59

 

 
281

Reclassification of gains recognized in net income
(51
)
 
(92
)
 
(265
)
 
(462
)
Tax effect

 
35

 

 
178

Amortization of unrealized (losses) gains on investment securities transferred from available-for-sale to held-to-maturity
(21
)
 
50

 
(73
)
 
60

Tax effect

 
(19
)
 

 
(23
)
Total other comprehensive income (loss)
(119
)
 
(121
)
 
991

 
(694
)
 
 
 
 
 
 
 
 
Comprehensive (loss)
$
(8,717
)
 
$
(42
)
 
$
(3,831
)
 
$
(642
)
 
The accompanying notes are an integral part of the consolidated financial statements.



-5-




 FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
(Amounts in thousands, except share data)
 

 
Common stock
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Accumulated other comprehensive
income
 
Total
shareholders'
equity
 
Shares
 
Amount
 
 
 
 
BALANCE, DECEMBER 31, 2012
7,815,385

 
$
7,815

 
$
34,192

 
$
(20,040
)
 
$
709

 
$
22,676

Net income

 

 

 
52

 

 
52

Other comprehensive loss

 

 

 

 
(694
)
 
(694
)
Issuance of common stock
144,129

 
145

 
50

 

 

 
195

Stock based compensation

 

 
20

 

 

 
20

BALANCE, SEPTEMBER 30, 2013
7,959,514

 
$
7,960

 
$
34,262

 
$
(19,988
)
 
$
15

 
$
22,249



 
Common stock
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Accumulated other comprehensive
income
 
Total
shareholders'
equity
 
Shares
 
Amount
 
 
 
 
BALANCE, DECEMBER 31, 2013
7,977,657

 
$
7,978

 
$
34,269

 
$
(20,390
)
 
$
(234
)
 
$
21,623

Net loss

 

 

 
(4,822
)
 

 
(4,822
)
Other comprehensive income

 

 

 

 
991

 
991

Issuance of common stock
24,045,899

 
24,046

 
(1,817
)
 

 

 
22,229

Stock based compensation

 

 
51

 

 

 
51

BALANCE, SEPTEMBER 30, 2014
32,023,556

 
$
32,024

 
$
32,503

 
$
(25,212
)
 
$
757

 
$
40,072

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

-6-




FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Amounts in thousands)
 
 
 
Nine Months Ended
 
September 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(4,822
)
 
$
52

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Provision for loan losses
7,954

 
35

Depreciation and amortization
649

 
735

Net amortization of bond premiums and discounts
915

 
1,368

Stock based compensation
51

 
20

Gain on sale of investment securities
(265
)
 
(462
)
Gain on sale of branches

 
(586
)
Gain on disposition of bank premises and equipment
(4
)
 

(Gain) loss on sale of foreclosed assets, net
(224
)
 
1

Valuation adjustment on foreclosed assets
1,680

 
1,207

Earnings on bank-owned life insurance
(157
)
 
(186
)
Gain on sale of mortgage loans held for sale
(402
)
 
(473
)
Originations of mortgage loans held for sale
(17,227
)
 
(21,136
)
Proceeds from sale of mortgage loans held for sale
16,581

 
21,993

Recovery of impairment loss on redemption of securities
(264
)
 

Changes in assets and liabilities:
 
 
 
Other assets
345

 
2,174

Accrued interest receivable
90

 
299

Other liabilities
(1,373
)
 
96

Accrued interest payable
105

 
(127
)
Net cash provided by operating activities
3,632

 
5,010

 
 
 
 
Cash flows from investing activities:
 

 
 

Proceeds from sales and calls of investment securities available-for-sale
22,661

 
20,874

Proceeds from paydowns of investment securities available-for-sale
888

 
5,610

Proceeds from paydowns of investment securities held-to-maturity
11,381

 
8,604

Purchases of investment securities available-for-sale
(7,180
)
 
(29,253
)
Purchases of investment securities held-to-maturity

 
(24,660
)
Net cash from sale of branches

 
(39,622
)
Redemption (purchase) of CDs held for investment
2,205

 
(8,575
)
Redemption of FHLB stock
523

 
339

Net decrease (increase) in loans outstanding
23,424

 
(666
)
Purchases of bank premises and equipment, net of disposals
(131
)
 
(161
)
Proceeds from sales of foreclosed assets
3,877

 
5,429

Net recoveries on foreclosed assets

 
13

Net cash provided by (used in) investing activities
57,648

 
(62,068
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Net repayments from borrowings
(5,000
)
 

Net increase in deposit accounts
4,192

 
3,885

Proceeds from issuance of common stock
22,229

 
195

Net cash provided by financing activities
21,421

 
4,080

 
 
 
 
Change in cash and cash equivalents
82,701

 
(52,978
)
Cash and cash equivalents at beginning of period
128,629

 
183,150

Cash and cash equivalents at end of period
$
211,330

 
$
130,172


-7-




FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Amounts in thousands)
 
 
Nine Months Ended
 
September 30,
 
2014
 
2013
Supplemental disclosures of cash flow information:
 
 
 
Interest paid on deposits and borrowings
$
(6,021
)
 
$
(6,777
)
Income taxes paid
(110
)
 

 
 
 
 
Supplemental disclosure for sale of branches:
 
 
 
Proceeds from sale of fixed assets
$

 
$
1,867

Proceeds from sale of loans

 
15,061

Assumption of customer deposits

 
(57,361
)
Gain on sale of branches

 
586

Proceeds from sale of other assets

 
225

Total proceeds paid to First Bank
$

 
$
(39,622
)
 
 
 
 
Supplemental disclosures of noncash investing and financing activities:
 

 
 

Unrealized gains (losses) on investment securities available-for-sale, net of taxes
$
1,231

 
$
(694
)
Amortization of net loss on investment securities transferred to held-to-maturity
(73
)


Transfers of loans to foreclosed assets
1,555

 
1,957

Transfer of available-for-sale securities to held-to-maturity securities

 
76,487

Transfers of loans to loans held for sale
11,189

 
3,639


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


-8-


FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 

NOTE A - BASIS OF PRESENTATION

In management’s opinion, the financial information contained in the accompanying unaudited consolidated financial statements reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the nine months ended September 30, 2014 and 2013, in conformity with accounting principles generally accepted in the United States of America.  The consolidated financial statements include the accounts and transactions of Four Oaks Fincorp, Inc., a bank holding company incorporated under the laws of the State of North Carolina (the “Company”), and its wholly-owned subsidiary, Four Oaks Bank & Trust Company (the “Bank”). Operating results for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. This Quarterly Report should be read in conjunction with such Annual Report.

Certain amounts previously presented in our Consolidated Financial Statements for the prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods' Statements of Operations, Comprehensive Income (Loss), or Shareholders' Equity as previously reported.

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This update requires management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date the financial statements are issued. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. If the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables financial statement users to understand the principal conditions or events that raised substantial doubt, management’s evaluation of the conditions and management’s plans to alleviate the substantial doubt. If substantial doubt exists about an entity’s ability to continue as a going concern, and the substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a going concern. The amendments in this update become effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company does not believe the adoption of this update will have a material impact of the Company’s consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-14, Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40), Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.  This update addresses classification of government-guaranteed mortgage loans, including those where guarantees are offered by the Federal Housing Administration (“FHA”), the U.S. Department of Housing and Urban Development (“HUD”), and the U.S. Department of Veterans Affairs (“VA”).  Although current accounting guidance stipulates proper measurement and classification in situations where a creditor obtains from a debtor, assets in satisfaction of a receivable (such as through foreclosure), current guidance does not specify how to measure and classify foreclosed mortgage loans that are government-guaranteed.  Under the provisions of this update, a creditor would derecognize a mortgage loan that has been foreclosed upon, and recognize a separate receivable if the following conditions are met: (1) The loan has a government guarantee that is not separable from the loan before foreclosure, (2) At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed.  The amendments within this update are effective for annual and interim periods beginning after December 15, 2014.  The Company does not believe the adoption of this update will have a material impact of the Company’s consolidated financial statements.


-9-


In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) which supersedes the revenue recognition requirements of Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition, and most industry-specific guidance on revenue recognition throughout the ASC. The new standard is principles based and provides a five step model to determine when and how revenue is recognized. The core principle of the new standard is that revenue should be recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also requires disclosure of qualitative and quantitative information surrounding the amount, nature, timing and uncertainty of revenues and cash flows arising from contracts with customers. The new standard is effective for the Company in the first quarter of the year ended December 31, 2017 and can be applied either retrospectively to all periods presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is not permitted. The Company is currently evaluating the impact of adoption of the new standard on its consolidated financial statements.
In January 2014, the FASB issued ASU No. 2014-04, Receivables–Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This update clarifies that an in-substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This amendment is effective for annual and interim periods beginning after December 15, 2014. The Company does not expect the adoption of this guidance to have a material impact on the Company's financial statements.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This update seeks to eliminate the diversity in practice in the presentation of unrecognized tax benefits by providing explicit guidance on the financial statement presentation of an unrecognized tax benefit with a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This amendment is effective for annual and interim periods beginning after December 15, 2013. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

Other accounting standards that have been issued by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.



-10-


NOTE B - NET INCOME (LOSS) PER SHARE
 
Basic net income (loss) per share represents earnings credited to common shareholders divided by the weighted average number of common shares outstanding during the period.  Diluted income (loss) per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.  Potential common shares that may be issued by the Company relate solely to outstanding stock options.

Basic and diluted net income (loss) per common share have been computed based upon net income (loss) as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below (amounts in thousands, except share data)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss) available to common shareholders
$
(8,598
)
 
$
79

 
$
(4,822
)
 
$
52

 
 
 
 
 
 
 
 
Weighted average number of common shares - basic
20,696,393

 
7,944,600

 
12,584,239

 
7,897,348

Effect of dilutive stock options

 

 

 

Weighted average number of common shares - dilutive
20,696,393

 
7,944,600

 
12,584,239

 
7,897,348

 
 
 
 
 
 
 
 
Basic earnings per common share
$
(0.42
)
 
$
0.01

 
$
(0.38
)
 
$
0.01

Diluted earnings per common share
$
(0.42
)
 
$
0.01

 
$
(0.38
)
 
$
0.01

Anti-dilutive awards
280,982

 
303,980

 
280,982

 
303,980

 
For the three and nine month period ended September 30, 2014, there were 280,982 outstanding stock options that were anti-dilutive due to the losses incurred compared to 303,980 for the three and nine month period ended September 30, 2013.

During the third quarter of 2014, the Company raised approximately $22.2 million, net of fees and costs, through the Rights Offering and the Standby Offering. As a result of the offerings, approximately 24.0 million shares of common stock were issued. Consequently, the average weighted shares of common stock increased 12.8 million for the quarter ended September 30, 2014 compared to 7.9 million at September 30, 2013.

-11-


NOTE C – INVESTMENT SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale and securities held-to-maturity as of September 30, 2014 and December 31, 2013 are as follows (amounts in thousands):

 
September 30, 2014
Securities Available-for-Sale:
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Taxable municipal securities
$
10,844

 
$
495

 
$
32

 
$
11,307

Mortgage-backed securities
 
 
 
 
 
 
 
GNMA
6,355

 
78

 

 
6,433

Equity securities
53

 
34

 

 
87

Total
$
17,252

 
$
607

 
$
32

 
$
17,827


 
September 30, 2014
Securities Held-to-Maturity:
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Taxable municipal securities
$
3,597

 
$

 
$
43

 
$
3,554

Mortgage-backed securities
 
 
 
 
 
 
 
GNMA
78,429

 
565

 
508

 
78,486

FNMA
3,747

 
31

 

 
3,778

Total
$
85,773

 
$
596

 
$
551

 
$
85,818


 
December 31, 2013
Securities Available-for-Sale:
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Taxable municipal securities
$
6,176

 
$

 
$
243

 
$
5,933

Mortgage-backed securities
 
 
 
 
 
 
 
GNMA
25,773

 

 
296

 
25,477

Trust preferred securities
1,175

 

 
150

 
1,025

Equity securities
98

 
33

 

 
131

Total
$
33,222

 
$
33

 
$
689

 
$
32,566


 
December 31, 2013
Securities Held-to-Maturity:
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Taxable Municipals
$
3,635


$
3


$
157


$
3,481

Mortgage-backed securities











  GNMA
89,892


162


2,171


87,883

  FNMA
4,486




19


4,467

Total
$
98,013


$
165


$
2,347


$
95,831


-12-


During the second quarter of 2013, the Company transferred $76.5 million available-for-sale state and municipal debt and mortgage-backed securities to the held-to-maturity category, reflecting the Company's intent to hold those securities to maturity. Transfers of investment securities into the held-to-maturity category from the available-for-sale category are made at fair value at the date of the transfer. The related $346,000 of holding gains for these held-to-maturity securities remained in accumulated other comprehensive income and is being amortized as an adjustment to interest income over the remaining life of the securities. This will offset the amortization of the net premium created in the transfer. There were no gains or losses recognized as a result of this transfer.

The following tables show gross unrealized losses and fair values of investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at September 30, 2014 and December 31, 2013 (amounts in thousands).
 
September 30, 2014
 
Less Than 12 Months
 
12 Months or More
 
Total
 
# Securities
 
Fair
value
 
Unrealized
losses
 
# Securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
Securities Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable municipal securities
3

 
$
3,175

 
$
32

 

 
$

 
$

 
$
3,175

 
$
32

Total temporarily impaired securities
3

 
$
3,175

 
$
32

 

 
$

 
$

 
$
3,175

 
$
32


 
September 30, 2014
 
Less Than 12 Months
 
12 Months or More
 
Total
Securities Held-to-Maturity:
# Securities
 
Fair
value
 
Unrealized
losses
 
# Securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
Taxable municipal securities

 
$

 
$

 
7

 
$
3,102

 
$
43

 
$
3,102

 
$
43

Mortgage-backed securities

 
 
 
 
 

 
 
 
 
 
 
 
 
GNMA
5

 
8,106

 
57

 
16

 
32,488

 
451

 
40,594

 
508

Total temporarily impaired securities
5

 
$
8,106

 
$
57

 
23

 
$
35,590

 
$
494

 
$
43,696

 
$
551


 
December 31, 2013
 
Less Than 12 Months
 
12 Months or More
 
Total
Securities Available-for-Sale:
# Securities
 
Fair
value
 
Unrealized
losses
 
# Securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
Taxable municipal securities
6

 
$
5,933

 
$
243

 

 
$

 
$

 
$
5,933

 
$
243

Mortgage-backed securities

 

 

 

 

 

 


 


GNMA
8

 
25,477

 
296

 

 

 

 
25,477

 
296

Trust preferred securities

 

 

 
2

 
1,025

 
150

 
1,025

 
150

Total temporarily impaired securities
14

 
$
31,410

 
$
539

 
2

 
$
1,025

 
$
150

 
$
32,435

 
$
689


 
December 31, 2013
 
Less Than 12 Months
 
12 Months or More
 
Total
Securities Held-to-Maturity:
# Securities
 
Fair
value
 
Unrealized
losses
 
# Securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
Taxable municipal securities
8

 
$
2,776

 
$
157

 

 
$

 
$

 
$
2,776

 
$
157

Mortgage-backed securities

 
 
 
 
 

 
 
 
 
 
 
 
 
GNMA
39

 
74,830

 
2,073

 
1

 
2,223

 
98

 
77,053

 
2,171

FNMA
3

 
4,467

 
19

 

 

 

 
4,467

 
19

Total temporarily impaired securities
50

 
$
82,073

 
$
2,249

 
1

 
$
2,223

 
$
98

 
$
84,296

 
$
2,347


-13-


Management evaluates each quarter whether unrealized losses on securities represent impairment that is other than temporary. For debt securities, the Company considers its intent to sell the securities or if it is more likely than not that the Company will be required to sell the securities.  If such impairment is identified, based upon the intent to sell or the more likely than not threshold, the carrying amount of the security is reduced to fair value with a charge to earnings. Upon the result of the aforementioned review, management then reviews for potential other than temporary impairment based upon other qualitative factors.  In making this evaluation, management considers changes in market rates relative to those available when the security was acquired, changes in market expectations about the timing of cash flows from securities that can be prepaid, performance of the debt security, and changes in the market's perception of the issuer's financial health and the security's credit quality.  If determined that a debt security has incurred other than temporary impairment, then the amount of the credit related impairment is determined.  If a credit loss is evident, the amount of the credit loss is charged to earnings and the non-credit related impairment is recognized through other comprehensive income.

The unrealized gains and losses on securities at September 30, 2014 resulted from changing market interest rates compared to the yields available at the time the underlying securities were purchased. As of September 30, 2014 there were 21 of 52 Government National Mortgage Association ("GNMA") mortgage backed securities ("MBS"), 0 of 3 Federal National Mortgage Association ("FNMA") MBS securities, 10 of 22 taxable municipal securities, and 0 of 7 equity securities that contained net unrealized losses. Management identified no impairment related to credit quality.  For debt securities in an unrealized loss position, the Company does not intend to sell and it is not likely that the Company will be required to sell these securities before the anticipated recovery of the amortized cost basis. As a result, no other than temporary impairment losses were recognized during the three and nine months ended September 30, 2014.

The amortized cost and fair value of available-for-sale and held-to-maturity securities at September 30, 2014 by contractual maturities are shown on the following table (amounts in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
September 30, 2014
Securities Available-for-Sale:
Amortized Cost
 
Fair Value
Taxable municipal securities:
 
 
 
Due after ten years
$
10,844

 
$
11,307

Total taxable municipal securities
10,844

 
11,307

 
 
 
 
Mortgage-backed securities - GNMA/FNMA:
 
 
 
Due after five years through ten years
6,355

 
6,433

Total mortgage-backed securities - GNMA/FNMA
6,355

 
6,433

 
 
 
 
Other securities:
 
 
 
Equity securities
53

 
87

Total other securities
53

 
87

 
 
 
 
Total available-for-sale securities
$
17,252

 
$
17,827

 
 
 
 
Securities Held-to-Maturity:
 
 
 
Taxable municipal securities:
 
 
 
Due after one year through five years
$
982

 
$
976

Due after five years through ten years
2,615

 
2,578

Total taxable municipal securities
3,597

 
3,554

 
 
 
 
Mortgage-backed securities - GNMA/FNMA:
 
 
 
Due after one year through five years
50,365

 
50,628

Due after five years through ten years
24,088

 
23,987

Due after ten years
7,723

 
7,649

Total mortgage-backed securities - GNMA/FNMA
82,176

 
82,264

 
 
 
 
Total held-to-maturity securities
$
85,773

 
$
85,818



-14-


Sales and calls of securities available-for-sale for the nine months ended September 30, 2014 and 2013 of $22.7 million and $20.9 million generated net realized gains of $265,000 and $462,000, respectively, and no net realized losses for either period. Sales and calls of securities available-for-sale for the three months ended September 30, 2014 and 2013 of $2.7 million and $8.0 million generated net realized gains of $51,000 and $92,000, respectively, and no net realized losses for either period.


-15-


NOTE D – LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures, which are reviewed on a regular basis. Each class of loans is subject to risks that could have an adverse impact on the credit quality of the loan portfolio. Loans are primarily made in the Company's market area in North Carolina, principally Johnston County, and parts of Wake, Harnett, Duplin, Sampson, and Moore counties. There have been no significant changes to loan class definitions outlined in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.
During the third quarter of 2014, the Company identified problem assets and began the disposition process under the asset resolution plan (the "Asset Resolution Plan"), required by that certain Securities Purchase Agreement with Kenneth R. Lehman dated March 24, 2014 and approved by Company management. Execution of these actions resulted in net charge-offs for the quarter of $9.6 million and a provision expense of $8.0 million. Additionally, the Company transferred $11.2 million of loans held for investment to loans held for sale in anticipation of near term loan sales as a result of the Asset Resolution Plan. These loans are not included in the tables within Note D however, additional details about these loans have been added to provide information on the credit quality of these assets.

The classification of loans as of September 30, 2014 and December 31, 2013 are summarized as follows (amounts in thousands):
 
September 30, 2014
 
December 31, 2013
Commercial and industrial
$
24,343

 
$
25,858

Commercial construction and land development
53,009

 
66,253

Commercial real estate
192,202

 
214,159

Residential construction
31,161

 
28,697

Residential mortgage
135,120

 
147,300

Consumer
7,040

 
6,750

Consumer credit cards
2,257

 
2,339

Business credit cards
1,241

 
1,124

Other
522

 
738

Gross loans
446,895

 
493,218

Less:
 

 
 

Net deferred loan fees
(548
)
 
(506
)
Net loans before allowance
446,347

 
492,712

Allowance for loan losses
(9,347
)
 
(11,590
)
Total net loans 
$
437,000

 
$
481,122




-16-


Allowance for Loan Losses and Recorded Investment in Loans
 
The allowance for loan losses represents management’s estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business.  Management evaluates the adequacy of this allowance at least quarterly during which time those loans that are identified as impaired are evaluated individually.

The following tables are an analysis of the allowance for loan losses by loan class, as of and for the three and nine months ended September 30, 2014 and 2013 and as of and for the twelve months ended December 31, 2013 (amounts in thousands). These tables do not include loans classified as held for sale.


Three Months Ended

September 30, 2014
 
 
 
Real Estate
 
 
 
 
 
 
Allowances for loan losses:
Commercial
and
Industrial
 
Commercial
Construction
and Land
Development
 
Commercial
Real
Estate
 
Residential
Construction
 
Residential
Mortgage
 
Consumer
 
Other
 
Totals
Balance June 30, 2014
$
389


$
5,567


$
2,241


$
620


$
1,945


$
169


$
15


$
10,946

























Provision for loan losses
135


2,282


2,139


23


3,407


(32
)



7,954

























Loans charged-off
(436
)

(2,779
)

(2,529
)



(4,177
)

(25
)



(9,946
)
Recoveries
49


113


43




123


64


1


393

Net recoveries (charge-offs)
(387
)

(2,666
)

(2,486
)



(4,054
)

39


1


(9,553
)
























Balance September 30, 2014
$
137


$
5,183


$
1,894


$
643


$
1,298


$
176


$
16


$
9,347



Nine Months Ended

September 30, 2014
 
 
 
Real Estate
 
 
 
 
 
 
Allowances for loan losses:
Commercial
and
Industrial
 
Commercial
Construction
and Land
Development
 
Commercial
Real
Estate
 
Residential
Construction
 
Residential
Mortgage
 
Consumer
 
Other
 
Totals
Balance December 31, 2013
$
487

 
$
5,037

 
$
2,981

 
$
713

 
$
2,146

 
$
188

 
$
38

 
$
11,590




 


 


 


 


 


 


 


Provision for loan losses
(53
)
 
2,945

 
1,727

 
101

 
3,257

 
21

 
(44
)
 
7,954




 


 


 


 


 


 


 


Loans charged-off
(460
)
 
(3,096
)
 
(3,019
)
 
(171
)
 
(4,417
)
 
(114
)
 

 
(11,277
)
Recoveries
163

 
297

 
205

 

 
312

 
81

 
22

 
1,080

Net recoveries (charge-offs)
(297
)
 
(2,799
)
 
(2,814
)
 
(171
)
 
(4,105
)
 
(33
)
 
22

 
(10,197
)
 


 


 


 


 


 


 


 


Balance September 30, 2014
$
137

 
$
5,183

 
$
1,894

 
$
643

 
$
1,298

 
$
176

 
$
16

 
$
9,347

Ending balance: individually evaluated for impairment
$

 
$
528

 
$
6

 
$

 
$

 
$

 
$

 
$
534

Ending balance: collectively evaluated for impairment (1)
$
137

 
$
4,655

 
$
1,888

 
$
643

 
$
1,298

 
$
176

 
$
16

 
$
8,813



 

 

 

 

 

 

 

Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance September 30, 2014
$
25,584

 
$
53,009

 
$
192,202

 
$
31,161

 
$
135,120

 
$
9,297

 
$
522

 
$
446,895

Less ending balance: individually evaluated for impairment
$

 
$
5,504

 
$
4,946

 
$

 
$
2,844

 
$
8

 
$

 
$
13,302

Ending balance: collectively
evaluated for impairment
(1)
$
25,584

 
$
47,505

 
$
187,256

 
$
31,161

 
$
132,276

 
$
9,289

 
$
522

 
$
433,593


(1) There were no small dollar homogeneous loans collectively evaluated for impairment for the nine months ended September 30, 2014.

-17-


 
Three Months Ended
 
September 30, 2013
 
 
 
Real Estate
 
 
 
 
 
 
Allowances for loan losses:
Commercial
and
Industrial
 
Commercial
Construction
and Land
Development
 
Commercial
Real
Estate
 
Residential
Construction
 
Residential
Mortgage
 
Consumer
 
Other
 
Totals
Balance June 30, 2013
$
969

 
$
6,574

 
$
2,763

 
$
449

 
$
3,013

 
$
178

 
$
92

 
$
14,038

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
(263
)
 
125

 
817

 
79

 
(718
)
 
(11
)
 
(29
)
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans charged-off
(207
)
 
(1,485
)
 
(503
)
 

 
(259
)
 
(52
)
 

 
(2,506
)
Recoveries
175

 
318

 
11

 

 
211

 
49

 

 
764

Net recoveries (charge-offs)
(32
)
 
(1,167
)
 
(492
)
 

 
(48
)
 
(3
)
 

 
(1,742
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance September 30, 2013
$
674

 
$
5,532

 
$
3,088

 
$
528

 
$
2,247

 
$
164

 
$
63

 
$
12,296


 
Nine Months Ended
 
September 30, 2013
 
 
 
Real Estate
 
 
 
 
 
 
Allowances for loan losses:
Commercial
and
Industrial
 
Commercial
Construction
and Land
Development
 
Commercial
Real
Estate
 
Residential
Construction
 
Residential
Mortgage
 
Consumer
 
Other
 
Totals
Balance December 31, 2012
$
1,185

 
$
7,251

 
$
2,961

 
$
423

 
$
4,471

 
$
188

 
$
70

 
$
16,549

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
(670
)
 
1,128

 
836

 
243

 
(1,553
)
 
58

 
(7
)
 
35

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans charged-off
(267
)
 
(3,343
)
 
(1,728
)
 
(138
)
 
(1,164
)
 
(216
)
 

 
(6,856
)
Recoveries
426

 
496

 
1,019

 

 
493