NOTE 8 – CAPITAL ADEQUACY

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

Effective July 2, 2013, the Federal Reserve approved final rules known as the “Basel III Capital Rules” substantially revising the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank. The Basel III Capital Rules address the components of capital and other issues affecting the numerator in banking institutions’ regulatory capital ratios. Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to remove references to credit ratings from the federal banking agencies’ rules. Certain of the Basel III Capital Rules came into effect for the Company and the Bank on January 1, 2015; these rules are subject to a phase-in period which began on January 1, 2015.

The Basel III Capital Rules introduced a new capital measure “Common Equity Tier 1” (CET1). The rules specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements. CET1 capital consists of common stock instruments that meet the eligibility criteria in the final rules, retained earnings, accumulated other comprehensive income and common equity Tier 1 minority interest. The rules also define CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital. They also expand the scope of the adjustments as compared to existing regulations.

When fully phased-in on January 1, 2019, the Basel III Capital Rules will require banking organizations to maintain:

•

a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased-in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0% upon full implementation);

•

a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased-in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation);

•

a minimum ratio of total capital (that is, Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased-in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and

•

a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.

Bank

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), among other things, requires the federal banking agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.

Under Basel I, the “prompt corrective action” rules provide that a bank will be: (i) “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage capital ratio of 5% or greater and is not subject to certain written agreements, orders, capital directives or prompt corrective action directives by a federal bank regulatory agency to maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and generally has a leverage capital ratio of 4% or greater; (iii) “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4% or generally has a leverage capital ratio of less than 4%; (iv) “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage capital ratio of less than 3%; or (v) “critically undercapitalized” if its ratio of tangible equity to total assets is equal to or less than 2%. The federal bank regulatory agencies have authority to require additional capital.

The Basel III Capital Rules revised the “prompt corrective action” regulations pursuant to Section 38 of the FDICIA, by:

•

introducing a CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status;

•

increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 risk-based capital ratio for well-capitalized status being 8.0% (as compared to the current 6.0%); and

•

eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% leverage ratio and still be well-capitalized.

Under the applicable rules, the Bank was well capitalized as of September 30, 2015 and December 31, 2014. Depository institutions that are no longer “well capitalized” for bank regulatory purposes must receive a waiver from the Federal Deposit Insurance Corporation (FDIC) prior to accepting or renewing brokered deposits. FDICIA generally prohibits a depository institution from making any capital distribution (including paying dividends) or paying any management fee to its holding company, if the depository institution would thereafter be undercapitalized.

The Bank had a Memorandum of Understanding (MoU) with the FDIC and the Florida Office of Financial Regulation (OFR) that was entered into in 2008 (the 2008 MoU), which required the Bank to have a total risk-based capital ratio of at least 10% and a Tier 1 leverage capital ratio of at least 8%. On July 13, 2012, the 2008 MoU was replaced by a new MoU (the 2012 MoU), which, among other things, required the Bank to have a total risk-based capital ratio of at least 12% and a Tier 1 leverage capital ratio of at least 8%. The Bank received notification from the FDIC and the OFR on June 11, 2015 and June 15, 2015, respectively, stating that the Bank is now considered to be in substantial compliance with the 2012 MoU and that the FDIC and the OFR terminated their interests in the 2012 MoU as of the dates mentioned above.

Bancorp

The Federal Reserve requires bank holding companies, including Bancorp, to act as a source of financial strength for their depository institution subsidiaries.

The Federal Reserve has a minimum guideline for bank holding companies of Tier 1 capital to adjusted average quarterly assets (“leverage ratio”) equal to at least 4.00%, and total capital to risk-weighted assets of at least 8.00%, at least half of which must be Tier 1 capital. As of September 30, 2015 and December 31, 2014, the Company met these requirements.

The following table presents the capital ratios and related information for the Company and the Bank in accordance with Basel III as of September 30, 2015 and Basel I as of December 31, 2014:

(dollars in thousands)	Actual					For Capital Adequacy Purposes					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
September 30, 2015	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital to risk-weighted assets:
Consolidated	$	64,009		15.67	%	$	32,686		8.00	%		N/A		N/A
Bank		63,370		15.52			32,670		8.00		$	40,838		10.00	%
Tier 1 (Core) capital to risk-weighted assets:
Consolidated		56,442		13.81			24,515		6.00			N/A		N/A
Bank		58,173		14.24			24,503		6.00			32,670		8.00
Common equity Tier I capital (CET1):
Consolidated		56,442		13.81			18,386		4.50			N/A		N/A
Bank		58,173		14.24			18,377		4.50			26,545		6.50
Tier I (Core) capital to average assets:
Consolidated		56,442		11.35			19,896		4.00			N/A		N/A
Bank		58,173		11.71			19,871		4.00			24,839		5.00

	Actual					For Capital Adequacy Purposes					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
December 31, 2014	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital to risk-weighted assets:
Consolidated	$	57,949		15.13	%	$	30,643		8.00	%		N/A		N/	A
Bank		56,400		14.74			30,619		8.00		$	38,274		10.00	%
Tier 1 (Core) capital to risk-weighted assets:
Consolidated		49,290		12.87			15,322		4.00			N/A		N/	A
Bank		51,497		13.45			15,310		4.00			22,964		6.00
Tier 1 (Core) capital to average assets:
Consolidated		49,290		9.85			20,014		4.00			N/A		N/	A
Bank		51,497		10.31			19,980		4.00			24,975		5.00

Dividends and Distributions

Prior to October 2009, dividends received from the Bank were Bancorp’s principal source of funds to pay its expenses and interest on and principal of Bancorp’s debt. Banking regulations require the maintenance of certain capital levels and restrict the payment of dividends by the Bank to Bancorp or by Bancorp to its shareholders. Commercial banks generally may only pay dividends without prior regulatory approval out of the total of current net profits plus retained net profits of the preceding two years, and banks and bank holding companies are generally expected to pay dividends from current earnings. Banks may not pay a dividend if the dividend would result in the bank being “undercapitalized” for prompt corrective action purposes, or would violate any minimum capital requirement specified by law or the banks’ regulators. The Bank has not paid dividends since October 2009 and cannot currently pay dividends. Bancorp cannot currently pay dividends on its capital stock under applicable Federal Reserve policies. Bancorp has relied upon revolving loan agreements to pay its expenses during such time. As of September 30, 2015 and December 31, 2014, remaining funds available under the revolving loan agreements were $1.3 million and $2.2 million, respectively.