10-K 1 e00158_tdbk-10k.htm
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

 

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

For the fiscal year ended December 31, 2015

 

or

 

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

For the transition period from ______ to _____

 

Commission file number 001-33065

 

TIDELANDS BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

South Carolina   02-0570232
(State or other jurisdiction or incorporation of organization)   (I.R.S. Employer Identification No.)
     
875 Lowcountry Blvd., Mount Pleasant, South Carolina   29464
(Address of principal executive offices)   (Zip Code)

Telephone number: (843) 388-8433

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

Securities registered under Section 12(g) of the Act: Common Stock, $0.01 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 o            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 Act.

Yes o            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 o

 

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).

Yes x            No o

 

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.

o

 

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. (Check one):

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).

Yes o            No x

 

As of the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $1,131,825 based upon the closing sales price of $0.29 per share as quoted on the OTC Pink Marketplace.

 

The number of shares outstanding of the issuer’s common stock, as of March 21, 2016 was 4,277,176.

 

DOCUMENTS INCORPORATED BY REFERENCE

 None.

 
 

Index  
     
Page No.
PART I - OTHER INFORMATION  
     
Item 1. Business 3-20
     
Item 1A. Risk Factors 21-32
     
Item 1B. Unresolved Staff Comments 32
     
Item 2. Properties 33
     
Item 3. Legal Proceedings 34
     
Item 4. Mine Safety Disclosures 34
     
PART II - FINANCIAL INFORMATION  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 35
     
Item 6. Selected Financial Data 35
     
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 36-59
     
Item 7A. Quantitative and Qualitative Disclosure About Market Risk 59
     
Item 8. Financial Statements and Supplementary Data F1-F41
     
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 60
     
Item 9A. Controls and Procedures. 60
     
Item 9B. Other Information. 60
     
PART III - PROXY INFORMATION  
     
Item 10. Directors, Executive Officers and Corporate Governance 61-63
     
Item 11. Executive Compensation 64-68
     
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 69
     
Item 13. Certain Relationships and Related Transactions, and Director Independence 70
     
Item 14. Principal Accounting Fees and Services 71
     
PART IV - EXHIBITS  
     
Item 15. Exhibits and Financial Statement Schedules 72-74

 

This statement has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation.

1
 

Cautionary Note Regarding Forward-Looking Statements

 

This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of the words “may,” “should,” “predict,” “project,” “potential,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions. These forward-looking statements include statements related to what will happen if we are unable to continue as a going concern, our ability to develop strategies to eliminate uncertainty related to liquidity, capital and profitability, our expectation regarding economic growth in our markets, our belief that the diversity of economic activity in our markets will mitigate economic volatility and reduce our risk of loss, the effectiveness of our credit administration and risk management programs, our expectations related to our loan portfolio, our expectation that a significant portion of unfunded commitments related to consumer equity lines of credit will not be funded, our belief that the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, as well as statements related to the anticipated effects on results of operations and financial condition from expected developments or events. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those projected in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. Potential risks and uncertainties include, but are not limited to those described below and those described under Item 1A - “Risk Factors”:

 

  · our ability to pay the interest in arrears on the outstanding junior subordinated debentures, which failure to pay could result in the holders of the junior subordinated debentures pursuing certain legal rights against the Company, including, but not limited to, forcing the Company into bankruptcy;
  · our efforts to raise capital or find a merger partner may not be successful;
  · our ability to achieve compliance with our Consent Order and potential regulatory actions if we fail to achieve compliance;
  · general economic conditions (both generally and in our markets) may be less favorable than expected, resulting in, among other things, a continued deterioration in credit quality, a further reduction in demand for credit and/or a further decline in real estate values;
  · a general decline in the real estate and lending market, particularly in our market areas, could negatively affect our financial results;
  · the results of our most recent external, independent review of our credit risk assets may not accurately predict the adverse effects on our financial condition if the economy were to deteriorate;
  · our ability to maintain appropriate levels of capital, including the potential that the regulatory agencies may require higher levels of capital above the standard regulatory-mandated minimums;
  · our ability to complete the sale of our Other Real Estate Owned properties, specifically at values equal to or above the currently recorded loan balances which could result in additional write downs;
  · the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
  · increased funding costs due to market illiquidity, increased competition for funding, and /or increased regulatory requirements with regard to funding;
  · changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board;
  · legislative or regulatory changes, including changes in accounting standards and compliance requirements, may adversely affect the businesses in which we are engaged;
  · competitive pressures among depository and other financial institutions may increase significantly;
  · changes in the interest rate environment may reduce margins or the volumes or values of the loans we make;
  · competitors may have greater financial resources and develop products that enable those competitors to compete more successfully than we can;
  · our ability to attract and retain key personnel can be affected by the increased competition for experienced employees in the banking industry;
  · adverse changes may occur in the bond and equity markets;
2
 
  · war or terrorist activities may cause further deterioration in the economy or cause instability in credit markets;
  · economic, governmental or other factors may prevent the projected population, residential and commercial growth in the markets in which we operate; and
  · we will or may continue to face the risk factors discussed from time to time in the periodic reports we file with the SEC.

 

We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements whether as a result of new information, future events, or otherwise.

 

PART I

 

Item 1. Business

 

General Overview

 

Tidelands Bancshares, Inc. (the “Company”) is a South Carolina corporation organized in 2002 to serve as the holding company for Tidelands Bank (the “Bank”), a state-chartered banking association under the laws of South Carolina headquartered in Mount Pleasant, South Carolina. We opened Tidelands Bank in October 2003 and operate seven full service banking offices located along the coast of South Carolina. We are primarily engaged in the business of accepting demand, savings and time deposits insured by the FDIC and providing commercial, consumer and mortgage loans to the general public. Since our inception, we have focused on serving the banking needs of professionals, entrepreneurs, small business owners and their family members in our South Carolina coastal markets. As of December 31, 2015, we had total assets of $466.2 million, net loans of $320.2 million, deposits of $420.5 million and shareholders’ equity of $1.9 million.

 

In this report, unless the context indicates otherwise, all references to “we,” “us,” and “our” refer to Tidelands Bancshares, Inc. and our wholly-owned subsidiary, Tidelands Bank.

 

Financial and Regulatory Developments

 

Going Concern Considerations

 

We have prepared the consolidated financial statements contained in this Annual Report assuming that the Company will be able to continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. However, due to our financial results for the period ended December 31, 2015, and the other regulatory and other matters discussed herein, management continues to assess a number of factors including liquidity, capital, and profitability that affect our ability to continue as a going concern. Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. Although we are committed to developing strategies to eliminate the uncertainty surrounding each of these areas, the outcome of these developments cannot be predicted at this time. If we are unable to continue as a going concern, our shareholders will likely lose all of their investment in the Company. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2 -”Going Concern Considerations and Regulatory Matters” to our Consolidated Financial Statements of this Annual Report.

 

Event of Default on our Trust Preferred Securities

 

On March 8, 2016, we received notices of default from Wilmington Trust Company, in its capacity as Trustee, relating to the trust preferred securities of the statutory trusts previously formed by the Company and indicated below. The notices of default related specifically to (i) the Indenture dated February 22, 2006, between the Company and Wilmington Trust Company, related to the trust preferred securities of Tidelands Statutory Trust I under which the Company issued $8.0 million of Floating Rate Junior Subordinated Notes due 2036, and (ii) the Indenture dated June 20, 2008, between the Company and Wilmington Trust Company, related to the trust preferred securities of Tidelands Statutory Trust II under which the Company issued $6.0 million of Floating Rate Junior Subordinated Notes due 2038. We refer to the Floating Rate Junior Subordinated Notes due 2036 and the Floating Rate Junior Subordinated Notes due 2038 collectively herein as the junior subordinated debentures.

3
 

As permitted by the Indentures, we previously exercised our right to defer interest payments on the junior subordinated debentures for a period of five years. As provided in the notices of default, our right to defer such interest payments expired on December 30, 2015, at which time all deferred interest became due and payable. We did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under the Indentures. However, under the Indentures, the principal amount of the junior subordinated debentures, together with any premium and unpaid accrued interest, only becomes due upon such an event of default after the trustee, or the holders of not less than 25% of the applicable junior subordinated debentures outstanding, declares such amounts due and payable by written notice to the Company. As noted above, we received notices of default from Wilmington Trust Company on March 8, 2016, in its capacity as Trustee under the Indentures, declaring the entire principal amount of the junior subordinated debentures immediately due and payable, and, in accordance with the Indentures, demanding payment by the Company of the entire amount due and payable on the junior subordinated debentures. As of March 1, 2016, the total principal amount outstanding on the junior subordinated debentures plus accrued and unpaid interest was $18.3 million.

 

Written Agreement with Federal Reserve Board

 

On March 18, 2011, the Company entered into a written agreement (the “FRB Agreement”) with the Federal Reserve Bank of Richmond. The FRB Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. For additional discussion of the FRB Agreement please refer to the section entitled “Financial and Regulatory Developments” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report.

 

Consent Order with FDIC and South Carolina State Board

 

On June 1, 2010, the FDIC and the South Carolina State Board (the “State Board”) conducted their annual joint examination of the Bank. As a result of the examination, the Bank entered into a Consent Order, effective December 28, 2010 (the “Consent Order”), with the FDIC and the State Board. The Consent Order requires the Bank to take certain actions. For additional discussion of the Consent Order and our progress with respect to the same, please refer to the section entitled “Financial and Regulatory Developments” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report.

 

Our Market Area

 

Our primary market area is the South Carolina coast, including the Charleston, South Carolina (Charleston, Dorchester and Berkeley Counties), Myrtle Beach, South Carolina (Horry and Georgetown County) and Hilton Head, South Carolina (Beaufort and Jasper County) market areas. Our main office is located at 875 Lowcountry Blvd., Mount Pleasant, South Carolina.

 

The following table shows key demographic information about our market areas:

 

Tidelands Bank  Total Market Area 
   As of December 31, 2015   Total
Deposits in
           Projected   Median   Projected
Growth in
Median
 
Market  Retail   Net   Market   Deposit   2016   Population   Household   Household 
Area(1)  Deposits   Loans   Area(2)   Growth(3)   Population(4)   Growth(5)   Income(4)   Income(5) 
   ($ in millions)                         
Charleston (4 branches)     $215.6   $237.2   $11.4B   10.1%   750,593    8.47%  $54,619    7.57%
                                         
Hilton Head (1 branch)  $72.3   $20.5   $4.0B   12.5%   209,656    8.47%  $55,689    6.34%
Myrtle Beach (2 branches)  $132.6   $62.5   $7.1B   5.6%   433,835    9.50%  $44,461    4.64%
                                         
Total  $420.5   $320.2                               

 

 
(1)The Charleston, South Carolina market area is comprised of Charleston County, Dorchester County and Berkeley County; the Hilton Head, South Carolina market area is comprised of Beaufort County and Jasper County; and the Myrtle Beach, South Carolina market area is comprised of Horry County and Georgetown County.
 (2)Based on FDIC data as of June 30, 2015.
 (3) Based on FDIC data for the period June 30, 2014 through June 30, 2015.
 (4)

As of February 2016, per SNL Financial.

 (5) Projected for the period 2016-2021; per SNL Financial.
4
 

We believe that the Charleston, South Carolina economy is diverse and well positioned for continued economic growth and expansion. According to the Charleston Metro Chamber of Commerce, each year more than four million people visit Charleston because of its world class shopping, dining and historical attractions. For 20 consecutive years, readers of Condé Nast Traveler magazine honored Charleston as a Top 10 travel destination in the U.S. In 2014, Conde Nast honored Charleston with the No. 1 slot as the friendliest destination in the World.

 

Recent economic expansion in the manufacturing sector includes the Boeing 787 Dreamliner facility, GE Aviation and the SKF Group. Volvo is constructing a new assembly plant and Mercedes is expanding a current facility near Summerville to manufacture and assemble entire vehicles.

 

Charleston is also home to a number of academic institutions, including the Medical University of South Carolina, The Citadel, The College of Charleston, Charleston Southern University, Trident Technical College, and The Charleston School of Law. Charleston also hosts military installations for the U.S. Navy, Marine Corps, U.S. Air Force, U.S. Army and U.S. Coast Guard.

 

The Hilton Head/Bluffton, South Carolina market area, located in Beaufort County, approximately 20 miles north of Savannah, Georgia and 90 miles south of Charleston, South Carolina is an internationally recognized retirement and vacation destination famous for its championship golf courses, beaches and resorts. The Hilton Head Chamber of Commerce estimates that the year-round tourism industry accounts for more than 60% of local jobs and contributes in excess of $1.5 billion annually to the local economy.

 

The Myrtle Beach, South Carolina area, also known as South Carolina’s Grand Strand, is a 60-mile stretch of coastline extending from the South Carolina state line at Little River (Horry County) south to Pawleys Island, South Carolina (Georgetown County). The Myrtle Beach Chamber of Commerce estimated that over 17.1 million people visited the Grand Strand area and spent $4 billion or 30% of the state’s total travel dollars there in 2015. In 2015, the Travel Channel named Myrtle Beach as No. 2 among its top ten beaches in the U.S. In 2015 and 2014, Trip Advisor named Myrtle Beach one of the best family vacation spots. In 2015, the Myrtle Beach Boardwalk was awarded the prestigious Governor’s Cup as the state’s best tourism project.

 

Our Strengths

 

Since our founding in 2002, we have focused on our core operating strength of relationship banking. The cornerstone of our relationship banking model is the hiring and retention of professional banking officers who know their customers and focus on their customers’ banking needs. By leveraging our banking officers’ experience and personal contacts, we have been able to focus on building banking relationships with professionals, entrepreneurs, small business owners and their family members in our markets. This relationship banking model enables us to generate both repeat business from existing customers as well as new business from customer referrals.

 

We have assembled an experienced senior management team, combining extensive market knowledge with an entrepreneurial culture. The members of our management team have close ties to, and are actively involved in, the communities where we operate, which is critical to our relationship banking focus. We believe this team has implemented the necessary asset/liability processes to allow us to diversify our loan portfolio and increase retail deposits in our local markets. We are well positioned to enhance our franchise and our earnings stream.

 

We have established a community banking franchise consisting of seven full service banking offices in our markets along the coast of South Carolina. We have hired experienced local bankers to manage our locations.

 

We believe that our coastal markets need institutions that provide banking services to small businesses and local residents that larger financial institutions are not positioned to provide. Population growth projections for our markets suggest that there is substantial opportunity to capture additional market share and enhance franchise value.

 

Lending Activities

 

General. We emphasize a range of lending services, including commercial and residential real estate mortgage loans, real estate construction loans, commercial and industrial loans and consumer loans. Our customers are generally individuals and small to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in our market areas. We have focused our lending activities primarily on the professional market, including doctors, dentists and small business owners. At December 31, 2015, we had total loans of $324.2 million, representing 79.0% of our total earning assets. As of December 31, 2015, we had 19 nonaccrual loans totaling approximately $7.7 million, or 2.4% of total gross loans.

5
 

At December 31, 2015, our loan portfolio and nonperforming assets were comprised of the following:

 

   Loans   Nonperforming Assets 
  

Balance

December 31, 2015

  

 

% of

Loans

  

Non-

accrual

Loans

   Other Real Estate    Total
Non-performing


Assets
 
   (dollars in thousands) 
Real estate mortgage  $253,617    78.2%  $6,150   $4,751   $10,901 
Real estate construction   42,696    13.2%   1,179    7,914    9,093 
Commercial and industrial   23,978    7.4%   395    88    483 
Consumer   4,059    1.2%            
   $324,350    100.0%  $7,724   $12,753   $20,477 

 

Real Estate Mortgage Loans. Loans secured by real estate mortgages are the principal component of our loan portfolio. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower’s cash flow, creditworthiness and ability to repay the loan. We obtain a security interest in real estate whenever possible, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan.

 

As of December 31, 2015, loans secured by first or second mortgages on real estate comprised approximately $253.6 million, or 78.2%, of our loan portfolio. These loans will generally fall into one of two categories: residential real estate loans or commercial real estate loans.

 

·Residential Real Estate Loans. We generally originate and hold short-term first mortgages and traditional second mortgage residential real estate loans and home equity lines of credit. At December 31, 2015, residential real estate mortgage loans amounted to $99.7 million, or 30.9% of our loan portfolio. At the inception of the loan, we generally limit the loan-to-value ratio on our residential real estate loans to 85%. Our underwriting criteria for and the risks associated with, home equity loans and lines of credit are generally the same as those for first mortgage loans. Home equity lines of credit typically have terms of 15 years or less, and we generally limit the extension of credit to less than 75% of the available equity of each property.
·Commercial Real Estate Loans. At December 31, 2015, commercial real estate mortgage loans amounted to $154.0 million, or approximately 47.6% of our loan portfolio. These loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine the business risks and credit profile of each borrower. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 85%. In order to ensure secondary sources of payment and liquidity to support a loan request, we typically review all of the personal financial statements of the principal owners and require their personal guarantees.

Real Estate Construction Loans. We offer fixed and adjustable rate residential and commercial construction loans to owners and to consumers who wish to build their own homes. The term of our construction loans generally is limited to 12 months. Construction loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project. Specific risks include:

 

  · cost overruns;
  · mismanaged construction;
  · inferior or improper construction techniques;
  · economic changes or downturns during construction;
  · a downturn in the real estate market;
  · rising interest rates which may prevent sale of the property; and
  · failure to sell completed projects in a timely manner.
6
 

We attempt to reduce the risk associated with construction and development loans by obtaining personal guarantees and by keeping the loan-to-value ratio of the completed project at or below 85%. Generally, we do not have interest reserves built into loan commitments but require periodic cash payments for interest from the borrower’s cash flow. At December 31, 2015, real estate construction loans amounted to $42.7 million, or approximately 13.1% of our loan portfolio.

 

Residential Construction: Residential land loans are made to consumer borrowers for the purpose of financing land upon which to build a residential home. Residential land loans are reclassified as residential construction loans once construction of the residential home commences. These loans are further categorized as owner-occupied consumer, which is a loan to an individual who intends to occupy the finished home. At December 31, 2015, residential construction loans amounted to $27.8 million, or approximately 8.5% of our loan portfolio.

 

Commercial Construction: Commercial construction loans are made to the borrower for the purpose of financing the construction of a commercial development on a very limited basis. The majority of loans we made were to borrowers who intend to occupy the finished development (owner-occupied) or where the borrower intends to lease or sell the finished development (non owner-occupied). At December 31, 2015, these loans amounted to $14.9 million, or approximately 4.6% of our loan portfolio.

.

Commercial and Industrial Loans. At December 31, 2015, these loans amounted to $24.0 million, or 7.4% of our total loan portfolio. We make loans for commercial purposes in various lines of businesses, including the manufacturing industry, service industry and professional service areas. These loans are generally considered to have greater risk than first or second mortgages on real estate because these loans may be unsecured or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease than real estate.

 

Consumer Loans. At December 31, 2015, consumer loans amounted to $4.1 million, or 1.2% of our loan portfolio. We make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. Consumer loans are underwritten based on the borrower’s income, current debt level, past credit history and the availability and value of collateral. Consumer rates are both fixed and variable, with negotiable terms. Our installment loans typically amortize over periods up to 60 months. Although we typically require monthly payments of interest and a portion of the principal on our loan products, we will offer consumer loans with a single maturity date when a specific source of repayment is available. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value than real estate.

 

Loan Portfolio Composition. We provide loans for various uses, including commercial and residential real estate, business purposes, personal use, home improvement, automobiles, as well as letters of credit and home equity lines of credit. Historically, we have had a concentration of commercial real estate and acquisition, development and construction loans. We will also strive to continue to limit the amount of our loans to any single customer. At December 31, 2015, we had approximately 1,365 loans, with an average loan balance of approximately $238,000. Our 10 largest customer loan relationships represented approximately $45.6 million, or 14.1% of our loan portfolio. At December 31, 2015, our loan portfolio was positioned within our major markets as follows: Charleston – 74.0%; Myrtle Beach – 19.5%; Hilton Head – 6.5%. We believe that the diversity of economic activity in our primary markets will tend to mitigate economic volatility, which, together with the variety of purposes for which we make loans, will reduce our risks of loss.

 

Underwriting. When we opened our bank, we introduced a strong credit culture based on traditional credit measures and our veteran bankers’ intimate knowledge of our markets. We have a disciplined approach to underwriting and focus on multiple sources of repayment, including personal guarantees. Our underwriting standards vary for each type of loan. While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. We are permitted to hold loans that exceed supervisory guidelines up to 100% of bank capital, or $29.8 million at December 31, 2015. As such, $74.1 million, or 22.9%, of our loans had loan-to-value ratios that exceeded regulatory supervisory guidelines. In addition, supervisory limits on commercial loan-to-value exceptions are set at 30% of capital. At December 31, 2015, $48.3 million of our commercial loans, or 162.3% of the Bank’s capital, exceeded the supervisory loan-to-value ratio. The exceptions are approved based on a combination of debt service ability, liquidity and overall balance sheet strength of the borrower.

7
 

Loan Approval. Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer lending limits, a multi-layered approval process for larger loans, documentation examination and follow-up procedures for any exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds an individual officer’s lending authority, the loan request will be reviewed by an officer with a higher lending authority. Between the Chief Executive Officer, Chief Community Banker and Chief Credit Officer, any two may combine their authority to approve credits up to $1.5 million. If the loans exceed $1.5 million, then a loan committee comprised of the Chief Executive Officer and two outside directors may approve the loans up to 10% of the Bank’s capital and surplus. All loans in excess of this lending limit will be submitted for approval to the entire board of directors of the Bank. We do not make any loans to any director, executive officer, or principal shareholder, and the related interests of each, of the Bank unless the loan is approved by the disinterested members of the board of directors of the Bank and is on terms not more favorable to such person than would be available to a similarly situated person not affiliated with the Bank.

 

Credit Administration and Loan Review. We maintain a continuous loan review process. We apply a credit grading system to each loan, and utilize an independent consultant on an annual basis to review the loan underwriting on a test basis to confirm the grading of each loan. Each loan officer is responsible for each loan he or she makes, regardless of whether other individuals or committees joined in the approval. This responsibility continues until the loan is repaid or until the loan is officially assigned to another officer. We also maintain a separate construction loan management department that operates independently from our lenders and is responsible for authorizing draws and the continuing oversight during the construction process.

 

We believe that our robust credit administration and risk management programs that we implemented at the portfolio level have allowed us to identify problem areas and respond quickly, decisively, and aggressively. We have a special assets officer to manage problem loans. We have quarterly criticized/classified asset meetings between executive management and all lending officers. At the quarterly criticized/classified asset meetings, specific action plans are discussed with respect to each loan rated “special mention” or worse. We have also aggressively pursued updated appraisals.

 

Lending Limits. Our lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. This limit will increase or decrease as the Bank’s capital increases or decreases. Based upon the capitalization of the Bank at December 31, 2015, our legal lending limit was approximately $4.5 million. We expect to sell participations on a limited basis in our larger loans to other financial institutions, which allows us to manage the risk involved in these loans and to meet the lending needs of our customers requiring credit in excess of these limits.

 

Deposit Products

 

We offer a full range of deposit services that are typically available in most banks and savings institutions, including checking accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. Transaction accounts and time deposits are tailored to and offered at rates competitive to those offered in our primary market areas. In addition, we offer certain retirement account services, such as IRAs. We solicit accounts from individuals, businesses, associations, organizations and governmental authorities. Our total deposits decreased by $7.6 million from $428.1 million at December 31, 2014 to $420.5 million at December 31, 2015. Due to the Consent Order, we may not accept, renew or roll over brokered deposits unless a waiver is granted by the FDIC. As such, for each period presented, our retail deposits accounted for 100% of our deposit base and we have no wholesale deposits.

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The following table shows our deposit mix at December 31, 2015 and December 31, 2014:

 

   At December 31, 2015   At December 31, 2014   Year-Over-Year Change  

Average
Rate for
2015

 
Retail Deposits  Amount  

Percentage

of Total

   Amount  

Percentage

of Total

   Amount   Percentage    Percentage 
   (dollars in thousands)     
Noninterest bearing demand deposits  $34,104    8.1%  $26,743    6.2%  $7,361    27.5%    —%
Interest bearing demand deposits   37,022    8.8%   38,824    9.1%   (1,802)   (4.6%)   0.19%
Savings and money market accounts    105,964    25.2%   102,113    23.9%   3,851    3.8%   0.35%
Time deposits less than $100,000   88,747    21.1%   97,535    22.8%   (8,788)   (9.0%)   1.26%
Time deposits greater than $100,000   154,673    36.8%   162,899    38.0%   (8,226)   (5.0%)   1.36%
Total Retail Deposits   420,510    100.0%   428,114    100.0%   (7,604)   (1.8%)   0.89%
Total Wholesale Deposits        —%        —%        —%   %
Total Deposits  $420,510    100.0%  $428,114    100.0%  $(7,604)   (1.8%)   0.89%

 

Other Banking Services

 

We also offer other bank services including safe deposit boxes, traveler’s checks, direct deposit, United States Savings Bonds and banking by mail. We are associated with the Cirrus, Master-Money, NYCE, and Sum ATM networks, which are available to our customers throughout the country. We believe that by being associated with a shared network of ATMs, we are better able to serve our customers and are able to attract customers who are accustomed to the convenience of using ATMs. We also offer internet banking services, bill payment services, cash management services, remote deposit capture, ACH origination and mobile banking.

 

Competition

 

The banking business is highly competitive, and we experience competition in our market areas from many other financial institutions. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services rendered and the convenience of banking facilities. We compete with commercial banks, credit unions, savings institutions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our market areas and elsewhere.

 

As of June 30, 2015, there were 33 financial institutions in the Charleston, South Carolina market area, 25 in the Myrtle Beach, South Carolina market area and 22 in the Hilton Head, South Carolina market area. We compete with these institutions both in attracting deposits and in making loans. Many of our competitors are larger financial institutions that offer some services, such as extensive and established branch networks and trust services, which we do not provide. In addition, many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks.

 

Employees

 

As of December 31, 2015, we had 79 full-time employees and 3 part-time employees.

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SUPERVISION AND REGULATION

 

Both Tidelands Bancshares, Inc. and Tidelands Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic control or new federal or state legislation may have on our business and earnings.

 

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations. It is intended only to briefly summarize some material provisions.

 

On March 18, 2011, the Company entered into a written agreement (the “FRB Agreement”) with the Federal Reserve Bank of Richmond (“FRB”). The FRB Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. For additional discussion of the FRB Agreement please refer to the section entitled “Financial and Regulatory Developments” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report.

 

On December 28, 2010, the Bank entered into a consent order (the “Consent Order”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the South Carolina State Board of Financial Institutions (the “State Board”). The Board of Directors and management of the Bank have been aggressively working to address all the requirements of the Consent Order. For additional discussion of the Consent Order and our progress with respect to the same, please refer to the section entitled “Financial and Regulatory Developments” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report.

 

Legislative and Regulatory Initiatives to Address the Financial Crisis

 

Although the financial crisis has now passed, two legislative and regulatory responses - the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Basel III-based capital rules - will continue to have an impact on our operations.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act

 

On July 21, 2010, The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law, which, among other things, changed the oversight and supervision of banks, bank holding companies, and other financial institutions, revised minimum capital requirements, created a new federal agency to regulate consumer financial products and services and implemented changes to corporate governance and compensation practices. Several provisions affect us, including:

 

·Deposit Insurance Modifications. The Dodd-Frank Act modified the FDIC’s assessment base upon which deposit insurance premiums are calculated. The new assessment base equals our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The FDIC has continued to modify some of the rules on assessments. The Dodd-Frank Act also permanently raised the standard maximum federal deposit insurance limits from $100,000 to $250,000.
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·Creation of New Governmental Authorities. The Dodd-Frank Act created various new governmental authorities such as the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (the “CFPB”), an independent regulatory authority housed within the Federal Reserve. The CFPB has broad authority to regulate the offering and provision of consumer financial products. The CFPB officially came into being on July 21, 2011, and rulemaking authority for a range of consumer financial protection laws (such as the Truth in Lending Act, the Electronic Funds Transfer Act and the Real Estate Settlement Procedures Act, among others) transferred from the Federal Reserve and other federal regulators to the CFPB on that date. The act gives the CFPB authority to supervise and examine depository institutions with more than $10 billion in assets for compliance with these federal consumer laws. The authority to supervise and examine depository institutions with $10 billion or less in assets for compliance with federal consumer laws will remain largely with those institutions’ primary regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. The CFPB may participate in examinations of our subsidiary bank, which currently has assets of less than $10 billion, and could supervise and examine our other direct or indirect subsidiaries that offer consumer financial products or services. In addition, the act permits states to adopt consumer protection laws and regulations that are stricter than the regulations promulgated by the CFPB, and state attorneys general are permitted to enforce consumer protection rules adopted by the CFPB against certain institutions.

 

The Dodd-Frank Act also authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” CFPB rules now in effect specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating a loan’s monthly payments. The rules also extend the requirement that creditors verify and document a borrower’s income and assets to include all information that creditors rely on in determining repayment ability. The rules also define “qualified mortgages,” imposing both underwriting standards - for example, a borrower’s debt-to-income ratio may not exceed 43% - and limits on the terms of such loans. Points and fees are subject to a relatively stringent cap, and payments that may be made in the course of closing a loan are limited as well. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.

 

·Executive Compensation and Corporate Governance Requirements. The Dodd-Frank Act addresses many investor protections, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including the Company. The Dodd-Frank Act (1) grants shareholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires the SEC to adopt rules directing national securities exchanges to establish listing standards requiring all listed companies to adopt incentive-based compensation clawback policies for executive officers; and (4) provides the SEC with authority to adopt proxy access rules that would allow shareholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials. The SEC has completed the bulk (although not all) of the rulemaking necessary to implement these provisions.

 

Separately, the Dodd-Frank Act requires several federal agencies, including the banking agencies and the SEC, to jointly issue a rule restricting incentive compensation arrangements at financial institutions, including bank holding companies and banks. The agencies proposed a rule in 2011 but have yet to finalize it.

 

Basel Capital Standards

 

Regulatory capital rules released in July 2013 to implement capital standards referred to as Basel III and developed by an international body known as the Basel Committee on Banking Supervision, impose higher minimum capital requirements. The rules apply to all depository institutions, such as the Bank, and top tier bank holding companies with total consolidated assets of $1 billion or more. Bank holding companies with less than $1 billion in total consolidated assets, such as the Company, are not subject to the final rule. More stringent requirements are imposed on “advanced approaches” banking organizations—those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime. The requirements in the rule began to phase in on January 1, 2015 for the Bank. The requirements in the rule will be fully phased in by January 1, 2019.

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The rule includes certain new and higher risk-based capital and leverage requirements than those previously in place. Specifically, the following minimum capital requirements apply to the Bank:

 

  · a new common equity Tier 1 risk-based capital ratio of 4.5%;
  · a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);
  · a total risk-based capital ratio of 8% (unchanged from the former requirement); and
  · a leverage ratio of 4% (also unchanged from the former requirement)

 

Under the rule, Tier 1 capital is redefined to include two components: Common Equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital. Accumulated other comprehensive income (“AOCI”) is presumptively included in Common Equity Tier 1 capital and often would operate to reduce this category of capital.

 

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets.

 

In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in Common Equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.

 

Volcker Rule

 

Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds.” Proprietary trading is, in general, trading in securities on a short-term basis for a banking entity’s own account. Funds subject to the ownership and sponsorship prohibition are those not required to register with the SEC because they have only accredited investors or no more than 100 investors. While we continue to evaluate the impact of the final regulations, we do not currently anticipate that the Volcker Rule will have a material effect on our operations.

 

Tidelands Bancshares, Inc.

 

The Company owns 100% of the outstanding capital stock of the Bank, and therefore we are required to be registered as a bank holding company under the federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the “Federal Reserve”) under the Bank Holding Company Act and its regulations promulgated thereunder. As a bank holding company located in South Carolina, the South Carolina State Board of Financial Institutions also regulates and monitors all significant aspects of our operations.

 

Permitted Activities. Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities, banking or managing or controlling banks, furnishing services to or performing services for our subsidiaries, or any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

12
 

As a bank holding company, and once the FRB Agreement and Consent Order are terminated and we otherwise meet the necessary requirements, we can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities. We have not sought financial holding company status, but may elect such status in the future as our business matures. If we were to elect in writing for financial holding company status, we would be required to be well capitalized and well managed, and our subsidiary bank would also have to be well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act (discussed below).

 

Change in Control. In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company controls 25% or more of any class of our voting securities. A rebuttable presumption of control arises under the Change in Bank Control Act if a person or company controls 10% or more (but less than 25%) of any class of voting securities of an insured depository institution and either the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. We are an insured depository institution within the meaning of the Change in Bank Control Act, and our common stock is registered under Section 12 of the Securities Exchange Act of 1934. Accordingly, control is also presumed to exist, subject to rebuttal, if a person or company controls 10% or more of any class of our voting securities. Finally, under the Federal Reserve’s current policy guidelines, control is also presumed to exist for purposes of the Bank Holding Company Act, subject to rebuttal, if an investor controls one-third or more of our total equity (including any nonvoting equity held by the investor) or controls 15% or more of any class of our voting securities.

 

Source of Strength. The Dodd-Frank Act confirmed a longstanding Federal Reserve policy, that a bank holding company must serve as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which we might not otherwise do so. If the Bank were to become “undercapitalized” (see below “Tidelands Bank - Prompt Corrective Action”), we would be required to provide a guarantee of the Bank’s plan to return to capital adequacy. Additionally, under the Bank Holding Company Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the Bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition. Further, any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the Bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

 

On March 22, 2011, the Company entered into the FRB Agreement with the Federal Reserve Bank of Richmond. The FRB Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. Pursuant to the FRB Agreement, the Company agreed to seek the prior written approval of the Federal Reserve Bank of Richmond before (i) declaring or paying any dividends, (ii) directly or indirectly taking dividends or any other form of payment representing a reduction in capital from the Bank, (iii) directly or indirectly making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities, (iv) directly or indirectly incurring, increasing or guaranteeing any debt, or (v) directly or indirectly purchasing or redeeming any shares of its stock.

13
 

Capital Requirements. The Federal Reserve Board imposes certain capital requirements on the Bank holding company under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described below under “Tidelands Bank – Prompt Corrective Action.” Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. Our ability to pay dividends depends on the Bank’s ability to pay dividends to us, which is subject to regulatory restrictions as described below in “Tidelands Bank – Dividends.” We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws. Currently, the Company also has to obtain the prior written approval of the Federal Reserve Bank of Richmond before declaring or paying any dividends. .” Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements.

 

South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the State Board. We are not required to obtain the approval of the State Board prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must receive the State Board’s approval prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

 

Tidelands Bank

 

The Bank operates as a state bank incorporated under the laws of the State of South Carolina and is subject to examination by the State Board and the FDIC. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is currently $250,000 for each non-retirement depositor and $250,000 for certain retirement-account depositors.

 

The State Board and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

 

·security devices and procedures;
·adequacy of capitalization and loss reserves;
·loans;
·investments;
·borrowings;
·deposits;
·mergers;
·issuances of securities;
·payment of dividends;
·interest rates payable on deposits;
·interest rates or fees chargeable on loans;
·establishment of branches;
·corporate reorganizations;
·maintenance of books and records; and
·adequacy of staff training to carry on safe lending and deposit gathering practices.

 

The State Board requires the Bank to maintain specified capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, bank premises, and furniture and fixtures. The State Board also requires the Bank to prepare quarterly reports on the Bank’s financial condition in compliance with its minimum standards and procedures.

14
 

All insured institutions must undergo regular on site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The FDIC Improvement Act also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, and asset quality.

 

Prompt Corrective Action. As an insured depository institution, the Bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations thereunder, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:

 

·Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution is one that (i) has a total risk-based capital ratio of 10% or greater, and (ii) has a tier 1 risk-based capital ratio of 8% or greater, and (iii) has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, and (iv) has a leverage capital ratio of 5% or greater and (v) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.
·Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution is one that(i) has a total risk-based capital ratio of 8% or greater, and (ii) has a tier 1 risk-based capital ratio of 4% or greater and (iii) has a common equity Tier 1 risk-based capital ratio of 4.5% or greater, and (iv) has a leverage capital ratio of 4% or greater.
·Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution is one that (i) has a total risk-based capital ratio of less than 8% or (ii) has tier 1 risk-based capital ratio of less than 4%, or (iii) has a common equity Tier 1 risk-based capital ratio of less than 4.5% or greater, or (iv) has a leverage capital ratio of less than 4%.
·Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution is one that (i) has a total risk-based capital ratio of less than 6% or (ii) has a tier 1 capital ratio of less than 3%, or (iii) has a common equity Tier 1 risk-based capital ratio of less than 3%, or (iv)has a leverage capital ratio of less than 3%.
·Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution is one that has a ratio of tangible equity to total assets that is equal to or less than 2%.

 

If the FDIC determines, after notice and an opportunity for hearing, that the Bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the Bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

 

If a bank, such as the Bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. Even if approved, rate restrictions apply governing the rate the Bank may be permitted to pay on the brokered deposits. In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points over the “national rate” paid on deposits (including brokered deposits, if approval is granted for the Bank to accept them) of comparable size and maturity. The “national rate” is defined as a simple average of rates paid by insured depository institutions and branches for which data are available and is published weekly by the FDIC. Institutions subject to the restrictions that believe they are operating in an area where the rates paid on deposits are higher than the “national rate” can use the local market to determine the prevailing rate if they seek and receive a determination from the FDIC that it is operating in a high-rate area. Regardless of the determination, institutions must use the national rate to determine conformance for all deposits outside their market area.

15
 

Moreover, if the Bank becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC. The Bank also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

 

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such would cause the Bank to become undercapitalized, it could not pay a management fee or dividend to us.

 

As of December 31, 2015, the Bank was deemed to be “adequately capitalized.” As further described below, the Consent Order, among other things, requires the Bank to achieve Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets within 150 days from the effective date of the Consent Order. As of December 31, 2015, the Bank was not in compliance with the minimum capital requirements established in the Consent Order. Even if the Bank achieves compliance with the capital requirements in the Consent Order, until the Consent Order is terminated, the Bank will not be able to be regarded as “well capitalized,” regardless of its capital levels.

 

Transactions with Affiliates and Insiders. The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.

 

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the Bank’s capital and surplus.

 

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

16
 

Branching. Under current South Carolina law, the bank may open branch offices throughout South Carolina with the prior approval of the State Board. In addition, with prior regulatory approval, the Bank will be able to acquire existing banking operations in South Carolina. Furthermore, federal legislation permits interstate branching, including out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks. The Dodd-Frank Act removes previous state law restrictions on de novo interstate branching in states such as South Carolina. This change permits out-of-state banks to open de novo branches in states where the laws of the state where the de novo branch is to be opened would permit a bank chartered by that state to open a de novo branch.

 

Anti-Tying Restrictions. Under amendments to the Bank Holding Company Act and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the Bank, the Bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

 

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, a financial institution’s primary regulator, which is the FDIC for the Bank, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our bank. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

 

Finance Subsidiaries. Under the Gramm-Leach-Bliley Act (the “GLBA”), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible. The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the Bank’s assets and tangible equity for purposes of calculating the Bank’s capital adequacy. In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.

 

Consumer Protection Regulations. Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:

 

·The federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
·The Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
·The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
·The Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;
·The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
·The rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
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The deposit operations of the Bank also are subject to:

 

·the Federal Deposit Insurance Act, which, among other things, limits the amount of deposit insurance available per account to $250,000 and imposes other limits on deposit-taking;
·the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
·the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

 

Enforcement Powers. The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,375,000 a day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.

 

The number of government entities authorized to take action against Tidelands Bank has expanded under the Dodd-Frank Act. The FDIC continues to have primary enforcement authority over the Bank. In addition, the CFPB also has back-up enforcement authority with respect to the consumer protection statutes above. Specifically, the CFPB may request reports from and conduct limited examinations of the Bank in conducting investigations involving the consumer protection statutes. Further, state attorneys general may bring civil actions or other proceedings under the Dodd-Frank Act or regulations against state-chartered banks, including the Bank. Prior notice to the CFPB and the FDIC would be necessary for an action against the Bank. The CFPB may intervene in any of these actions.

 

Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions, foreign customers and other high risk customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA PATRIOT Act, enacted in 2001 and renewed through 2019, as described below. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions found to be violating these obligations.

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USA PATRIOT Act. The USA PATRIOT Act became effective on October 26, 2001and amended, in part, the Bank Secrecy Act. The USA Patriot Act provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

Under the USA PATRIOT Act, the Federal Crimes Enforcement Network (“FinCEN”) can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities or money laundering. The Bank can be requested, to search its records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact FinCEN.

 

The Office of Foreign Assets Control. The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

 

Privacy and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law.

 

Like other lending institutions, the Bank utilizes credit bureau data in its underwriting activities. Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.

 

Payment of Dividends. A South Carolina state bank may not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. The Bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the State Board, provided that the Bank received a composite rating of one or two at the last federal or state regulatory examination. The Bank must obtain approval from the State Board prior to the payment of any other cash dividends. In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. In addition, the Consent Order prohibits the Bank from declaring or paying any dividends or making any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities.

 

Check 21. The Check Clearing for the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check. Some of the major provisions include:

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·allowing check truncation without making it mandatory;
·demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;
·legalizing substitutions for and replacements of paper checks without agreement from consumers;
·retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;
·requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and
·requiring the re-crediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.

 

Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

 

Insurance of Accounts and Regulation by the FDIC. Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund.

 

Due to the large number of bank failures, and the FDIC’s new Temporary Liquidity Guarantee Program, the FDIC adopted a revised risk-based deposit insurance assessment schedule in February 2009, which raised deposit insurance premiums. The FDIC also implemented a five basis point special assessment of each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009, which special assessment amount was capped at 10 basis points times the institution’s assessment base for the second quarter of 2009. In addition, the FDIC required financial institutions like us to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 to re-capitalize the Deposit Insurance Fund. The FDIC may exercise its discretion as supervisor and insurer to exempt an institution from the prepayment requirement if the FDIC determines that the prepayment would adversely affect the safety and soundness of the institution. We did not request exemption from the prepayment requirement. During 2015, we expensed $1.1 million in deposit insurance.

 

FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds that were issued to resolve thrift failures in the 1980s. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

 

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the 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 or the OCC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management of the Bank is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

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Item 1A. Risk Factors.

Our business, financial condition, and results of operations could be harmed by any of the following risks, or other risks that have not been identified or which we believe are immaterial or unlikely. Shareholders should carefully consider the risks described below in conjunction with the other information in this Form 10-K and the information incorporated by reference in this Form 10-K, including our consolidated financial statements and related notes.

 

We are in default under the Indentures governing our junior subordinated debentures and the related trust preferred securities. As a result, the trustee has sent us notices of default declaring all principal and accrued interest, totaling $18.2 million at December 30, 2015, due and payable. The trustee is evaluating all courses of action as a result of the events of default, and we could be forced into involuntary bankruptcy.

 

We supported our growth through the issuance of trust preferred securities from two special purpose trusts and an accompanying sale of $14.4 million of junior subordinated debentures to these trusts. We conditionally guaranteed payment of the principal and interest on the trust preferred securities of these trusts.

 

Since December 30, 2010, we began exercising our right to defer all quarterly distributions on our junior subordinated debentures. We were permitted to defer these interest payments for up to 20 consecutive quarterly periods, although interest continued to accrue on the junior subordinated debentures and interest on such deferred interest also accrued and compounded quarterly from the date such deferred interest would have been payable were it not for the extension period. However, all of the deferred interest, including interest accrued on such deferred interest, became due and payable at the end of the deferral period, which was on December 30, 2015. We did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under the Indentures. As a result, on March 8, 2016, we received notices of default from the trustee related to the junior subordinated debentures accelerating all principal and accrued interest and demanding payment of all such amounts from the Company. At December 30, 2015, the aggregate principal amount of the junior subordinated debentures plus all accrued interest was $18.2 million. We will not be able to pay this amount if we are not able to raise additional capital. Even if we succeed in raising this capital, we will have to be released from the FRB Agreement or obtain approval from the Federal Reserve Bank of Richmond to make such a payment. The trustee is evaluating all courses of action as a result of the events of default, and we could be forced into involuntary bankruptcy. In the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock.

 

There is substantial doubt about our ability to continue as a going concern.

We have prepared our Consolidated Financial Statements contained in this Annual Report assuming that the Company will be able to continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. However, due to our financial results, and the other regulatory and other matters discussed herein, management continues to assess a number of factors including liquidity, capital, and profitability that affect our ability to continue as a going concern. Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. If we are unable to continue as a going concern, then our common shareholders will likely lose all of their investment in the Company, and the holders of our Series T Preferred Stock issued to the U.S. Treasury under the TARP program and our trust preferred securities, may lose all, or a material portion of, their investments.

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We have an immediate need to raise a material amount of additional capital. We have been trying to raise additional capital or find a merger partner for several years, with no success, and there are no assurances that we will be able to do so.

We have been seeking to raise additional capital or find a merger partner since the imposition of the Consent Order, and we are continuing to work diligently to do so. Our ability to raise additional capital will depend in part on conditions in the capital markets, which are outside our control, and on our financial performance. In addition, we have found it particularly difficult to attract investors given the amount of our outstanding senior equity, including the Series T Preferred Stock issued to the U.S. Treasury under the TARP program and the trust preferred securities that we have issued. At December 31, 2015, the amount of these outstanding senior securities was $20.1 million. Under Federal Reserve policy, any new capital issued by the Company will need to be common stock, which will be subordinate to these senior securities. Accordingly, it will be difficult for us to raise the additional capital that we need, even if we are able to negotiate reduced payments to these senior securities holders. If we are successful in raising additional capital, our existing shareholders’ percentage ownership interests will be diluted significantly. If we cannot find a merger partner or raise additional capital to meet the Company’s requirement to pay all principal and accrued interest on the junior subordinated debentures (which was recently accelerated by the trustee under the related Indentures), and meet the minimum capital requirements set forth under the Consent Order, or if we suffer a continued deterioration in our financial condition, we could be forced into involuntary bankruptcy by the trustee or the holders of the trust preferred securities, or we could be placed into a federal conservatorship or receivership by the FDIC. If this were to occur, then our common shareholders will likely lose all of their investment in the Company, and the holders of our Series T Preferred Stock issued to the U.S. Treasury under the TARP program and our trust preferred securities, may lose all, or a material portion of, their investments.

We are subject to a Consent Order that requires us to take certain actions.

 

On June 1, 2010, the FDIC and the State Board conducted their annual joint examination of the Bank. As a result of the examination, the Bank entered into a Consent Order, effective December 28, 2010, with the FDIC and the State Board, which contains, among other things, a requirement that our bank achieve and maintain minimum capital requirements that exceed the minimum regulatory capital ratios for “well capitalized” banks. Under this enforcement action, the Bank may no longer accept, renew, or roll over brokered deposits. In addition, under the Consent Order, we are required to obtain FDIC approval before making certain payments to departing executives and before adding new directors or senior executives. Our regulators have considerable discretion in whether to grant required approvals, and no assurance can be given that such approvals would be forthcoming. In addition, we are required to take certain other actions in the areas of capital, liquidity, asset quality, and interest rate risk management, as well as to file periodic reports with the FDIC and the State Board regarding our progress in complying with the Consent Order. Any material failure to comply with the terms of the Consent Order could result in further enforcement action by the FDIC. While we intend to take such actions as may be necessary to comply with the requirements of the Consent Order and subsequent FDIC guidance, to date, the Bank has failed to meet all of the requirements in the Consent Order, including the minimum capital requirements. For additional discussion of the Consent Order, please refer to the section entitled “Financial and Regulatory Developments” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report.

 

Tidelands Bank may become subject to a federal conservatorship or receivership by the FDIC if it cannot comply with the Consent Order, or if its condition continues to deteriorate.

 

As noted above, the Bank executed a Consent Order with the FDIC and the State Board. The Consent Order requires the Bank to, among other things, implement a plan to achieve and maintain minimum capital requirements. The Bank is not currently in compliance with these minimum capital requirements. In addition, the condition of our loan portfolio may continue to deteriorate and thus continue to deplete our capital and other financial resources. Should we fail to achieve compliance with the capital requirements in the Consent Order, or suffer a continued deterioration in our financial condition, we may be subject to being placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver. If these events occur, we probably would suffer a complete loss of the value of our ownership interest in the Bank, and we subsequently may be exposed to significant claims by the FDIC. Federal conservatorship or receivership would also result in a complete loss of your investment.

 

Market conditions in our markets and economic trends may adversely affect our industry and our business.

 

Our business has been directly affected by market conditions, industry trends, legislative and regulatory changes, and changes in governmental monetary and fiscal policies. Competition among depository institutions for deposits and quality loans has increased significantly. The ability of banks and bank holding companies to raise capital or borrow in the debt markets has been greatly reduced in recent years. Difficult market conditions and the tightening of credit can lead to increased deficiencies in our loan portfolio and increased market volatility.

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Our future success significantly depends upon the growth in population, income levels, deposits and housing starts in the Charleston, Myrtle Beach and Hilton Head markets. Unlike many larger institutions, we are not able to spread the risks of unfavorable economic conditions across a large number of diversified economies and geographic locations. If the markets in which we operate do not grow as anticipated, our business could be negatively impacted.

 

A significant portion of our loan portfolio is secured by real estate, and events that negatively affect the real estate market could hurt our business.

 

As of December 31, 2015, approximately 78.2% of our loans were secured by real estate mortgages. The real estate collateral for these loans provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability, asset quality and ultimately our capital levels. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholder’s equity could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

 

We are exposed to higher credit risk by commercial real estate, commercial and industrial and construction lending.

 

Commercial real estate, commercial and industrial and construction lending usually involve higher credit risks than that of single-family residential lending. As of December 31, 2015, the following loan types accounted for the stated percentages of our total loan portfolio: commercial real estate – 47.6%, commercial and industrial – 7.4%, residential construction – 8.6%, and commercial construction – 4.6%. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.

 

Commercial and industrial loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the collateral securing the loans have the following characteristics: (a) they depreciate over time, (b) they are difficult to appraise and liquidate, and (c) they fluctuate in value based on the success of the business.

 

Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of the property construction (including interest), the availability of permanent take-out financing, and the builder’s ability to ultimately sell the property. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.

 

Commercial real estate, commercial and industrial and construction loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans.

 

As of December 31, 2015, our outstanding commercial real estate loans were equal to 399% of our total capital. The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for loan losses and capital levels as a result of commercial real estate lending growth and exposures.

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If our allowance for loan losses is not sufficient to cover actual loan losses, or if credit delinquencies increase, our losses could increase.

 

Our success depends, to a significant extent, on the quality of our assets, particularly loans. Like other financial institutions, we face the risk that our customers will not repay their loans, that the collateral securing the payment of those loans may be insufficient to assure repayment, and that we may be unsuccessful in recovering the remaining loan balances. The risk of loss varies with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan and, for many of our loans, the value of the real estate and other assets serving as collateral. Management makes various assumptions and judgments about the collectability of our loan portfolio after considering these and other factors. Based in part on those assumptions and judgments, we maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we also rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, delinquencies and nonaccruals, national and local economic conditions and other pertinent information, including the results of external loan reviews. Despite our efforts, our loan assessment techniques may fail to properly account for potential loan losses, and, as a result, our established loan loss reserves may prove insufficient. If we are unable to generate income to compensate for these losses, they could have a material adverse effect on our operating results.

 

In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Higher charge-off rates and an increase in our allowance for loan losses may hurt our overall financial performance and may increase our cost of funds. As of December 31, 2015, we had 19 loans on nonaccrual status totaling approximately $7.7 million, and our allowance for loan loss was $4.0 million. For the year ended December 31, 2015, we recorded $1.2 million as a provision for loan losses, compared to $71,000 in 2014. Our current and future allowances for loan losses may not be adequate to cover future loan losses given current and future market conditions.

 

Institution-specific and/or broader industry-wide events may trigger a reduction in the availability of funding needed for day-to-day operations, resulting in a liquidity crisis.

 

We require a certain level of available funding each day to meet the liquidity demands of our operations. These demands include funding for new loan production, funding available for customer withdrawal requests and maturing time deposits not being renewed, and funding for settlement of investment portfolio transactions. Both institution specific events such as deterioration in our credit ratings resulting from a weakened capital position or from lack of earnings and industry-wide events such as a collapse of credit markets may result in a reduction of available funding sources sufficient to cover the liquidity demands. Such a crisis could significantly jeopardize our ability to continue operations.

A return of recessionary conditions could result in increases in our level of nonperforming loans and/or reduced demand for our products and services, which could have an adverse effect on our results of operations.

Economic recession or other economic problems, including those affecting our South Carolina markets, but also those affecting the U.S. or world economies, could have a material adverse impact on the demand for our products and services. Since the conclusion of the last recession, economic growth has been slow and uneven, and unemployment levels remain high. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. If economic conditions deteriorate, or if there are negative developments affecting the domestic and international credit markets, the value of our loans and investments may be harmed, which in turn would have an adverse effect on our business, financial condition, results of operations and the price of our common stock.

Our common stock is not listed for trading on any national securities exchange and, therefore, there is a limited public trading market for our common stock.

 

Our common stock is not listed for trading on any national securities exchange, and we presently do not intend to apply to list our common stock on any national securities exchange at any time in the foreseeable future. Our stock is currently quoted on the OTC Pink Marketplace under the symbol “TDBK “. Trading of securities on the OTC market is generally limited and is effected on a less regular basis than other exchanges, such as NASDAQ or the NYSE. Consequently, the liquidity of our common stock and our investors’ ability to sell shares of our common stock may be limited. This limited market may restrict our investors’ ability to sell shares of our common stock at a desirable or stable price , or at all, at any one time.

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Because of our participation in the U.S. Treasury Department’s Capital Purchase Program (“CPP”), we are subject to several restrictions including restrictions on compensation paid to our executives and other employees.

 

In December 2008, as part of the Capital Purchase Program established by the U.S. Treasury under the Emergency Economic Stabilization Act of 2008, we entered into a Letter Agreement and Securities Purchase Agreement with Treasury (collectively, the “CPP Purchase Agreement”) pursuant to which we issued and sold to Treasury (i) 14,448 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series T (the “Series T Preferred Stock”), and (ii) a ten-year warrant to purchase up to 571,821 shares of our common stock (the “CPP Warrant”) with an initial exercise price of $3.79 per share. Under the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity we issued or may issue to the Treasury, including the common stock we may issue under the CPP Warrant. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive and the next 20 most highly compensated employees based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives and the next five most highly compensated employees; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.

 

Legislation or regulatory changes could cause us to seek to repurchase the Series T preferred stock and CPP warrant that we sold to the U.S. Treasury under the Capital Purchase Program.

 

Legislation and regulation that have been adopted after we closed on our sale of Series T Preferred Stock and the CPP warrant to the U.S. Treasury for $14.4 million under the CPP on December 19, 2008, or any legislation or regulations that may be implemented in the future, may have a material effect on the terms of our CPP transaction with the Treasury. If we determine that any such legislation or any regulations alter the terms of our CPP transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then we may seek to unwind, in whole or in part, the CPP transaction by repurchasing some or all of the Series T preferred stock or CPP warrant that we sold to the U.S. Treasury. If we were to repurchase all or a portion of the Series T preferred stock or CPP warrant, then our capital levels could be materially reduced.

 

A large percentage of the loans in our portfolio currently include exceptions to our loan policies and supervisory guidelines.

 

All of the loans that we make are subject to written loan policies adopted by our board of directors and to supervisory guidelines imposed by our regulators. Our loan policies are designed to reduce the risks associated with the loans that we make by requiring our loan officers, before closing a loan, to take certain steps that vary depending on the type and amount of the loan. These steps include making sure the proper liens are documented and perfected on property securing a loan, and requiring proof of adequate insurance coverage on property securing loans. Loans that do not fully comply with our loan policies are known as “exceptions.” We generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines. We categorize exceptions as policy exceptions, financial statement exceptions and collateral exceptions. Interagency guidelines for real estate lending policies allow institutions to originate loans in excess of the supervisory loan to value limits; however, the aggregate amount of such loans should not exceed 100% of total capital.

 

As of December 31, 2015, approximately $68.0 million of our loans, or 228.5% of our bank’s capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines. In addition, supervisory limits on commercial loan to value exceptions are set at 30% of a bank’s capital. At December 31, 2015, $45.4 million of our commercial loans, or 152.5% of our bank’s capital, exceeded the supervisory loan to value ratio. As of December 31, 2015, approximately 8.5% of the loans in our portfolio included collateral exceptions to our loan policies. As a result of these exceptions, those loans may have a higher risk of loss than the other loans in our portfolio that fully comply with our loan policies. In addition, we may be subject to regulatory action by federal or state banking authorities if they believe the number of exceptions in our loan portfolio represents an unsafe banking practice.

25
 

Our net interest income could be negatively affected by changes in interest rates, recent developments in the credit and real estate markets and competition in our primary market area.

 

As a financial institution, our earnings significantly depend upon our net interest income, which is the difference between the income that we earn on interest-earning assets, such as loans and investment securities, and the expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve’s fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and net income.

 

Interest rates remained steady for 2015 and 2014 with only one increase of 25 basis points in December of 2015. Approximately 28.3% of our loans were variable rate loans at December 31, 2015. The interest rates on a significant segment of these loans decrease when the Federal Reserve reduces interest rates. However the interest that we earn on our assets may not change in the same amount or at the same rates as the interest rates we must pay on our sources of funds. Accordingly, increases in interest rates may reduce our net interest income due to increasing costs of funds. In addition, an increase in interest rates may decrease the demand for loans. Furthermore, increases in interest rates will add to the expenses of our borrowers, which may adversely affect their ability to repay their loans with us.

 

An increase in nonperforming loans and an increase in interest rates could cause additional pressure on net interest income in future periods. This reduction in net interest income may also be exacerbated by the high level of competition that we face in our primary market areas. Any significant reduction in our net interest income could negatively affect our business and could have a material adverse effect on our capital, financial condition and results of operations.

 

Higher FDIC Deposit Insurance premiums and assessments that we are required to pay could have an adverse effect on our earnings and our ability to pay our liabilities as they come due.

 

Although we cannot predict what the FDIC insurance assessment rates will be in the future, further deterioration in either risk-based capital ratios or adjustments to the base assessment rates could have a material adverse impact on our business, financial condition, results of operations, and cash flows.

 

Liquidity risks could affect operations and jeopardize our financial condition.

 

The goal of liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities and withdrawals, and other cash commitments under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this goal, our asset/liability committee establishes liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding sources.

 

Liquidity is essential to our business. An inability to raise funds through traditional deposits, borrowings, the sale of securities or loans, issuance of additional equity securities, and other sources could have a substantial negative impact on our liquidity. Our access to funding sources in amounts adequate to finance our activities and with terms acceptable to us could be impaired by factors that impact us specifically or the financial services industry in general. Factors that could detrimentally impact access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated, a change in our status from well-capitalized to adequately capitalized, or regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets and negative views and expectations about the prospects for the financial services industry.

26
 

Traditionally, the primary sources of funds of our bank subsidiary have been customer deposits and loan repayments. Due to the Consent Order, we may not accept brokered deposits unless a waiver is granted by the FDIC. Although we currently do not utilize brokered deposits as a funding source, if we were to seek to use such funding source, there is no assurance that the FDIC will grant us the approval, when requested. These restrictions could have a substantial negative impact on our liquidity. Additionally, we are restricted from offering an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on their website. Secondary sources of liquidity may include proceeds from the Federal Home Loan Bank (the “FHLB”) advances and federal funds lines of credit from correspondent banks. The Bank’s credit risk rating at the FHLB has been negatively impacted, resulting in more restrictive borrowing requirements. Because we are adequately capitalized, we are required to pledge additional collateral for FHLB advances.

 

We actively monitor the depository institutions that hold our federal funds sold and due from banks cash balances. We cannot provide assurances that access to our cash and cash equivalents and federal funds sold will not be impacted by adverse conditions in the financial markets. Our emphasis is primarily on safety of principal, and we diversify cash, due from banks, and federal funds sold among counterparties to minimize exposure relating to any one of these entities. We routinely review the financials of our counterparties as part of our risk management process. Balances in our accounts with financial institutions in the U.S. may exceed the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if the correspondent financial institutions fail.

 

There can be no assurance that our sources of funds will be adequate for our liquidity needs, and we may be compelled to seek additional sources of financing in the future. Specifically, we may seek additional debt in the future to achieve our business objectives. There can be no assurance that additional borrowings, if sought, would be available to us or, if available, would be on favorable terms. Bank and holding company stock prices have been negatively impacted by the recent adverse economic conditions, as has the ability of banks and holding companies to raise capital or borrow in the debt markets. If additional financing sources are unavailable or not available on reasonable terms, our business, financial condition, results of operations, cash flows, and future prospects could be materially adversely impacted.

 

We depend on key individuals, and our continued success depends on our ability to identify and retain individuals with experience and relationships in our markets. The loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.

 

Thomas H. Lyles, our president and chief executive officer has contributed significantly to our business. If we lose the services of Mr. Lyles, he would be difficult to replace, and our business and development could be materially and adversely affected.

 

To succeed in our markets, we must identify and retain experienced key management members with local expertise and relationships in these markets. We expect that competition for qualified management in our markets will be intense and that there will be a limited number of qualified persons with knowledge of and experience in the community banking industry in these markets. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy requires both management and financial resources and is often lengthy. Our inability to identify, recruit and retain talented personnel to manage our offices effectively would limit our growth and could materially adversely affect our business, financial condition and results of operations. The loss of the services of several key personnel could adversely affect our strategy and prospects to the extent we are unable to replace them.

 

We face strong competition for customers, which could prevent us from obtaining customers or may cause us to pay higher interest rates to attract customer deposits.

 

The banking business is highly competitive, and we experience competition in our markets from many other financial institutions. Customer loyalty can be easily influenced by a competitor’s new products, especially offerings that could provide cost savings or a higher return to the customer. Moreover, this competitive industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.

27
 

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services that we do not provide, such as extensive and established branch networks and trust services. We also compete with local community banks in our market. We may not be able to compete successfully with other financial institutions in our market, and we may have to pay higher interest rates to attract deposits, accept lower yields on loans to attract loans and pay higher wages for new employees, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.

 

We may not be able to compete with our larger competitors for larger customers because our lending limits are lower than theirs.

 

We are limited in the amount we can loan a single borrower by the amount of the Bank’s capital. Our legal lending limit is 15% of the Bank’s capital and surplus, or $4.5 million at December 31, 2015. This is significantly less than the limit for our larger competitors and may affect our ability to seek relationships with larger businesses in our market areas. We expect to sell participations only on a limited basis going forward.

 

We will face risks with respect to future expansion and acquisitions or mergers.

 

Although we do not have any current plans to do so, we may seek to acquire other financial institutions or parts of those institutions. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:

 

  · the time and expense associated with identifying and evaluating potential acquisitions and merger partners;
  · using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or assets;
  · diluting our existing shareholders in an acquisition;
  · the time and expense associated with evaluating new markets for expansion, hiring experienced local management and opening new offices, as there may be a substantial time lag between these activities before we generate sufficient assets and deposits to support the costs of the expansion;
  · taking a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s attention being diverted from the operation of our existing business;
  · the time and expense associated with integrating the operations and personnel of the combined businesses;
  · creating an adverse short-term effect on our results of operations; and
  · losing key employees and customers as a result of an acquisition that is poorly received.

 

Although our management team has acquisition experience at other institutions, we have never acquired another institution before, so we lack experience as an organization in handling any of these risks. There is also a risk that any expansion effort will not be successful.

 

The accuracy of our financial statements and related disclosures could be affected because we are exposed to conditions or assumptions different from the judgments, assumptions or estimates used in our critical accounting policies.

 

The preparation of financial statements and related disclosure in conformity with accounting principles generally accepted in the United States of America requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which we summarize in this Annual Report on Form 10-K for the year ended December 31, 2015, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates about the future that materially impact our consolidated financial statements and related disclosures. For example, material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions and other factors impacting the level of probable inherent losses. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our audited consolidated financial statements and related disclosures.

28
 

The costs of being an SEC registered company are proportionately higher for smaller companies like Tidelands Bancshares because of the requirements imposed by the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. These regulations are applicable to our company. We have experienced, and expect to continue to experience, increasing compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act. These necessary costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.

We are exposed to the possibility that customers may prepay their loans to pay down loan balances, which could reduce our interest income and profitability.

Prepayment rates stem from consumer behavior, conditions in the housing and financial markets, general United States economic conditions, and the relative interest rates on fixed-rate and adjustable-rate loans. Therefore, changes in prepayment rates are difficult to predict. Recognition of deferred loan origination costs and premiums paid in originating these loans are normally recognized over the contractual life of each loan. As prepayments occur, the rate at which net deferred loan origination costs and premiums are expensed will accelerate. The effect of the acceleration of deferred costs and premium amortization may be mitigated by prepayment penalties paid by the borrower when the loan is paid in full within a certain period of time. If prepayment occurs after the period of time when the loan is subject to a prepayment penalty, the effect of the acceleration of premium and deferred cost amortization is no longer mitigated. We recognize premiums paid on mortgage-backed securities as an adjustment from interest income over the expected life of the security based on the rate of repayment of the securities. Acceleration of prepayments on the loans underlying a mortgage-backed security shortens the life of the security, increases the rate at which premiums are expensed and further reduces interest income. We may not be able to reinvest loan and security prepayments at rates comparable to the prepaid instrument particularly in a period of declining interest rates.

Given the geographic concentration of our operations, we could be significantly affected by any hurricane that affects coastal South Carolina.

 

Our operations are concentrated in and our loan portfolio consists almost entirely of loans to persons and businesses located in coastal South Carolina. The collateral for many of our loans consists of real and personal property located in this area, which is susceptible to hurricanes that can cause extensive damage to the general region. Disaster conditions resulting from any hurricane that hits in this area would adversely affect the local economies and real estate markets, which could negatively impact our business. Adverse economic conditions resulting from such a disaster could also negatively affect the ability of our customers to repay their loans and could reduce the value of the collateral securing these loans. Furthermore, damage resulting from any hurricane could also result in continued economic uncertainty that could negatively impact businesses in those areas. Consequently, our ability to continue to originate loans may be impaired by adverse changes in local and regional economic conditions in this area following any hurricane.

 

The ongoing implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 may have a material adverse effect on our operations.

 

The Dodd-Frank Act imposes significant regulatory and compliance changes. Although the full impact of the new requirements on our operations is unclear, the changes resulting from the Dodd Frank Act may impact the profitability of our business activities. The Dodd-Frank Act has required that we develop new and more extensive compliance policies and practices, and maintain higher capital and liquidity levels. These and other changes may adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make changes necessary to comply with these requirements at the expense of normal business operations. Failure to comply with the new requirements or with any future changes in laws or regulations may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws of regulations or their interpretations would have on us, these changes could be materially adverse to investors in our common stock.

29
 

The final Basel III capital rules generally require insured depository institutions and certain holding companies to hold more capital, which could adversely affect our financial condition and operations.

In July 2013, the federal banking agencies published new regulatory capital rules based on the international standards, known as Basel III, that had been developed by the Basel Committee on Banking Supervision. The new rules raised the risk-based capital requirements and revised the methods for calculating risk-weighted assets, usually resulting in higher risk weights. The new rules became effective as applied to the Bank on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019. Bank holding companies with less than $1.0 billion in total consolidated assets, such as the Company, are not subject to the Basel III rules.

 

The Basel III rules increase capital requirements and include two new capital measurements that will affect the Bank, a risk-based common equity Tier 1 ratio and a capital conservation buffer. Common Equity Tier 1 (CET1) capital is a subset of Tier 1 capital and is limited to common equity (plus related surplus), retained earnings, accumulated other comprehensive income and certain other items. Other instruments that have historically qualified for Tier 1 treatment, including noncumulative perpetual preferred stock, are consigned to a category known as Additional Tier 1 capital and must be phased out of CET1 over a period of nine years beginning in 2014. The rules permit bank holding companies with less than $15 billion in assets (such as us) to continue to include trust preferred securities and noncumulative perpetual preferred stock issued before May 19, 2010 in additional Tier 1 capital, but not CET1. Tier 2 capital consists of instruments that have historically been placed in Tier 2, as well as cumulative perpetual preferred stock.

 

Beginning on January 1, 2015, the Bank’s Basel III-based minimum risk-based capital requirements were (i) a CET1 ratio of 4.5%, (ii) a Tier 1 capital (CET1 plus Additional Tier 1 capital) of 6% (up from 4%) and (iii) a total capital ratio of 8% (unchanged from the former requirement). The Bank’s leverage ratio requirement will remain at the 4% level now required. Beginning in 2016, a capital conservation buffer will phase in over three years, ultimately resulting in a requirement of 2.5% on top of the CET1, Tier 1 and total capital requirements, resulting in a required CET1 ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%. Failure to satisfy any of these three capital requirements will result in limits on paying dividends, engaging in share repurchases and paying discretionary bonuses. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

In addition to the higher required capital ratios and the new deductions and adjustments, the final rules increased the risk weights for certain assets, meaning that we will have to hold more capital against these assets. For example, commercial real estate loans that do not meet certain new underwriting requirements must be risk-weighted at 150%, rather than the former requirement of 100%. We will also be required to hold capital against short-term commitments that are not unconditionally cancellable. All changes to the risk weights took effect in full in 2015.

 

In addition, in the current economic and regulatory environment, bank regulators may impose capital requirements that are more stringent than those required by applicable existing regulations. The application of more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital or additional capital conservation buffers, could result in management modifying our business strategy.

 

Our ability to pay dividends on our common stock is restricted.

 

Since our inception, we have not paid any cash dividends on our common stock, and we do not intend to pay cash dividends in the foreseeable future. The Company is a bank holding company that conducts substantially all of its operations through Tidelands Bank. As a result, our ability to make dividend payments on our common stock depends primarily on certain state and federal regulatory considerations and the receipt of dividends and other distributions from Tidelands Bank. The ability of Tidelands Bank to pay cash dividends to us is currently prohibited by the restrictions of the Consent Order. In addition, we are currently prohibited from declaring or paying any dividends under the FRB Agreement, without the prior written approval of the Federal Reserve. Also, as a result of the Company’s deferral of dividend payments on our Series T Preferred Stock issued to the U.S. Treasury pursuant to the CPP and deferral of interest payments on our junior subordinated debtentures, the Company is prohibited from paying any dividends on its common stock until all deferred payments have been made in full.

30
 

Banks and bank holding companies are also generally subject to certain regulatory restrictions on the payment of cash dividends. In addition, the Federal bank regulatory agencies have the authority to prohibit bank holding companies from engaging in unsafe or unsound practices in conducting their business. The payment of dividends could be deemed an unsafe or unsound practice, if such dividends are not supported by recent earnings or we or our subsidiary bank do not, in the view of the regulators, have sufficient capital. The ability of the Bank to pay cash dividends to us is also limited by its obligations to maintain sufficient capital and by other restrictions on its cash dividends that are applicable to South Carolina state banks and banks that are regulated by the FDIC. If we do not satisfy these regulatory requirements, we will be unable to pay cash dividends on our common stock.

 

The Series T Preferred Stock impacts net income available to our common shareholders and earnings per common share, and the CPP Warrant we issued to the U.S. Treasury may be dilutive to holders of our common stock.

 

The dividends declared on the Series T Preferred Stock issued to the U.S. Treasury through the Capital Purchase Program will reduce the net income available to common shareholders and our earnings per common share. Notably, because we did not redeem the Series T Preferred Stock prior to the fifth anniversary of the issuance date, the cost of this capital increased on May 15, 2014 from 5.0% per annum (approximately $722,000 annually) to 9.0% per annum (approximately $1.3 million annually). Also, we have been forced to defer and accrue quarterly dividend payments to the U.S. Treasury and, thus, as noted above, we are prohibited from paying dividends on our common stock until all deferred dividends on the Series T Preferred Stock are paid in full. The Series T Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company. 

 

Additionally, the ownership interest of the existing holders of our common stock will be diluted to the extent the CPP Warrant we issued to the U.S. Treasury in conjunction with the sale of the Series T Preferred Stock is exercised. The 571,821 shares of common stock underlying the CPP Warrant represent approximately 11.8% of the shares of our common stock outstanding as of March 21, 2016 (including the shares issuable upon exercise of the CPP Warrant in total shares outstanding). Although Treasury has agreed not to vote any of the shares of common stock it receives upon exercise of the CPP Warrant, a transferee of any portion of such warrant or of any shares of common stock acquired upon exercise of such warrant is not bound by this restriction.

 

We must respond to rapid technological changes, which may be more difficult or expensive than anticipated.

 

If our competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, our existing product and service offerings, technology and systems may become obsolete. Further, if we fail to adopt or develop new technologies or to adapt our products and services to emerging industry standards, we may lose current and future customers, which could have a material adverse effect on our business, financial condition and results of operations. The financial services industry is changing rapidly, and to remain competitive, we must continue to enhance and improve the functionality and features of our products, services and technologies. These changes may be more difficult or expensive than we anticipate.

 

A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.

 

We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, and terrorists, activists, and other external parties. As customer, public, and regulatory expectations regarding operational and information security have increased, our operating systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting, and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunication outages; natural disasters such as hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and as described below, cyber attacks.

31
 

As noted above, our business relies on our digital technologies, computer and email systems, software and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our customers’ devices may become the target of cyber attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our customers’ or other third parties’ confidential information. Third parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide service or security solutions for our operations, and other unaffiliated third parties could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

 

While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As a result, cyber security and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputation damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material effect on our results of operations or financial condition.

We face a risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations and corresponding enforcement proceedings.

The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (which we refer to as the “PATRIOT Act”) and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and to file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

 

Item 1B. Unresolved Staff Comments.

 

Not applicable

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Item 2. Properties.

 

The following table sets forth the location of our main banking office, branch banking offices and operations center, as well as certain information relating to these facilities.

 

Type of Office  Location  Year Opened  Total Retail
Deposits as of
December 31, 2015
   Leased or Owned
Main Office
  875 Lowcountry Boulevard in Mount Pleasant, South Carolina
  2004  $97,325,119   Leased
               
Summerville Branch Office
  1510 Trolley Road in Summerville, South Carolina  2007  $53,307,236   Owned
               
Myrtle Beach Branch Office
  1312 Professional Drive in Myrtle Beach, South Carolina  2007  $69,943,506   Leased
               
Park West Branch Office - Mount Pleasant
  1100 Park West Blvd. in Mount Pleasant, South Carolina  2007  $21,404,425   Owned
               
West Ashley Branch Office - Charleston
  946 Orleans Road in Charleston, South Carolina  2007  $43,605,687   Leased
               
Bluffton Branch Office
  52 Burnt Church Road in Bluffton, South Carolina  2008  $72,313,804   Leased
               
Murrells Inlet Branch Office
  11915 Plaza Drive in Murrells Inlet, South Carolina  2008  $62,610,205   Leased
               
Operations Center  840 Lowcountry Boulevard in Mount Pleasant, South Carolina
  2007   N/A   Owned
               
Executive Office
Building
  830 Lowcountry Boulevard in Mount Pleasant, South Carolina
  2011   N/A   Owned
               
Okatie Crossing
ATM Site
  15 Baylor Brooke Drive in Bluffton, South Carolina
  2014   N/A   Owned
33
 

Item 3. Legal Proceedings.

 

From time to time, we are involved in routine legal matters incidental to our business. In the opinion of management, the ultimate resolution of such matters will not have a material adverse effect on our financial position, results of operations or liquidity.

 

Item 4. Mine Safety Disclosures

 

Not applicable

34
 

PART II

 

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

 

Market for Common Shares

 

Our stock is currently quoted on the OTC Pink Marketplace under the symbol “TDBK”. As of March 15, 2016; we had approximately 473 shareholders of record.

 

The following table shows the reported high and low bid quotations for shares of our common stock for the periods indicated. The stated high and low bid quotations reflect inter-dealer prices, without retail markup, markdown or commission, and may not represent actual transactions.

 

   High   Low 
2015          
Fourth Quarter  $0.33   $0.18 
Third Quarter   0.37    0.12 
Second Quarter   0.50    0.26 
First Quarter   0.48    0.36 
           
2014          
Fourth Quarter  $0.44   $0.33 
Third Quarter   0.53    0.41 
Second Quarter   0.50    0.33 
First Quarter   0.50    0.30 

 

Dividends

 

We have not declared or paid any cash dividends on our common stock since our inception. Under the terms of the FRB Agreement, the Company is currently prohibited from declaring or paying any dividends without the prior written approval of the Federal Reserve Bank of Richmond. In addition, because the Company is a legal entity separate and distinct from the Bank and has little direct income itself, the Company relies on dividends paid to it by the Bank in order to pay dividends on its common stock. As a South Carolina state bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. The Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital. In addition, the ability of the Bank to pay cash dividends to us is also currently prohibited by the restrictions of the Consent. Order with the FDIC and the State Board. Further, as a result of the Company’s deferral of dividend payments on its Series T Preferred Stock issued to the U.S. Treasury pursuant to the CPP and deferral of interest payments on its junior subordinated debentures, the Company is prohibited from paying any dividends on its common stock until all deferred payments have been made in full

 

As a result of these restrictions on the Company, including the restrictions on the Bank’s ability to pay dividends to the Company, the Company does not anticipate paying dividends for the foreseeable future, and all future dividends will be dependent on the Company’s financial condition, results of operations, and cash flows, as well as capital regulations and dividend restrictions from the Federal Reserve Bank of Richmond, the FDIC, and the State Board.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

As of December 31, 2015, the Company had no equity compensation plans pursuant to which any of the Company’s securities remain available for future issuance.

 

Item 6. Selected Financial Data.

 

Not required

35
 

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

 

The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes included elsewhere in this report. Our discussion and analysis for the years ended December 31, 2015 and 2014 is based on our audited financial statements for such periods. The following discussion describes our results of operations for the year ended December 31, 2015 as compared to December 31, 2014, and analyzes our financial condition as of December 31, 2015 as compared to December 31, 2014.

 

Overview

 

We were incorporated in January 2002 to organize and serve as the holding company for Tidelands Bank. As of December 31, 2015, we had total assets of $466.2 million, total gross loans of $324.2 million, total deposits of $420.5 million, and total shareholders’ equity of $1.9 million.

 

The following table sets forth selected measures of our financial performance for the periods indicated.

 

   For the Years Ended December 31, 
   2015   2014 
   (dollars in thousands) 
Net loss available to common shareholders  $(3,521)  $(1,830)
Total assets   466,235    475,581 
Total net loans   320,166    313,247 
Total deposits   420,510    428,114 
Shareholders’ equity   1,947    5,341 

 

Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest, and advances from the Federal Home Loan Bank of Atlanta (the “FHLB”). Consequently, one of the key measures of our success is net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and advances from the FHLB. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread.

 

We have included a number of tables to assist in our description of these measures. For example, the “Average Balances, Income and Expenses, and Rates” table shows for the periods indicated the average balance for each category of our assets and liabilities, as well as the average yield we earned or the average rate we paid with respect to each category. A review of this table shows that our loans historically have provided higher interest yields than our other types of interest-earning assets, which is why we have invested a substantial percentage of our earning assets into our loan portfolio. Similarly, the “Rate/Volume Analysis” table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included a discussion to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, our deposits and other borrowings.

 

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses against our operating earnings for each period. In the “Loans” and “Allowance for Loan Losses and Provisions” sections below, we have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.

 

In addition to earning interest on our loans and investments, we earn income through fees and other charges to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the “Noninterest Income” and “Noninterest Expense” sections below.

36
 

Critical Accounting Policies

 

We have adopted accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2015.

 

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

 

We believe other real estate is a critical accounting policy that requires significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our other real estate include judgments about the estimated value of the property, the impact of current events, and conditions and other factors impacting the value. Under different conditions or using different assumptions, the actual value of other real estate determined by us may be different from management’s estimates provided in our consolidated financial statements.

 

Financial and Regulatory Developments

 

Going Concern Considerations

 

We have prepared the consolidated financial statements contained in this Annual report assuming that the Company will be able to continue as going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. However, due to our financial results for the period ended December 31, 2015, and the other regulatory and other matters discussed herein, management continues to assess a number of factors including liquidity, capital, and profitability that affect our ability to continue as a going concern. Our financial statements do not include any adjustments that might be necessary if we are unable continue as a going concern. Although we are committed to developing strategies to eliminate the uncertainty surrounding each of these areas, the outcome of these developments cannot be predicted at this time. If we are unable to continue as a going concern, our shareholders will likely lose all of their investment in the Company. See Note 2 -”Going Concern Considerations and Regulatory Matters” to our Consolidated Financial Statements of this Annual Report.

 

Event of Default on our Trust Preferred Securities

 

On March 8, 2016, we received notices of default from Wilmington Trust Company, in its capacity as Trustee, relating to the trust preferred securities of the statutory trusts previously formed by the Company and indicated below. The notices of default related specifically to (i) the Indenture dated February 22, 2006, between the Company and Wilmington Trust Company, related to the trust preferred securities of Tidelands Statutory Trust I under which the Company issued $8.0 million of Floating Rate Junior Subordinated Notes due 2036, and (ii) the Indenture dated June 20, 2008, between the Company and Wilmington Trust Company, related to the trust preferred securities of Tidelands Statutory Trust II under which the Company issued $6.0 million of Floating Rate Junior Subordinated Notes due 2038. We refer to the Floating Rate Junior Subordinated Notes due 2036 and the Floating Rate Junior Subordinated Notes due 2038 collectively herein as the junior subordinated debentures.

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As permitted by the Indentures, we previously exercised our right to defer interest payments on the junior subordinated debentures for a period of five years. As provided in the notices of default, our right to defer such interest payments expired on December 30, 2015, at which time all deferred interest became due and payable. We did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under the Indentures. However, under the Indentures, the principal amount of the junior subordinated debentures, together with any premium and unpaid accrued interest, only becomes due upon such an event of default after the trustee, or the holders of not less than 25% of the applicable junior subordinated debentures outstanding, declares such amounts due and payable by written notice to the Company. As noted above, we received notices of default from Wilmington Trust Company on March 8, 2016, in its capacity as Trustee under the Indentures, declaring the entire principal amount of the junior subordinated debentures immediately due and payable, and, in accordance with the Indentures, demanding payment by the Company of the entire amount due and payable on the junior subordinated debentures. As of March 1, 2016, the total principal amount outstanding on the junior subordinated debentures plus accrued and unpaid interest was $18.3 million.

 

Written Agreement with the Federal Reserve Board

 

As reported in our Current Report on Form 8-K filed on March 22, 2011, the Company entered into a written agreement (the “FRB Agreement”) with the Federal Reserve Bank of Richmond (“FRB”) on March 18, 2011. The FRB Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. The Bank’s lending and deposit operations continue to be conducted in the usual and customary manner, and all other products, services and hours of operation remain the same. All Bank deposits will remain insured by the FDIC to the maximum extent allowed by law.

 

Pursuant to the FRB Agreement, the Company agreed to seek the prior written approval of the FRB before (i) declaring or paying any dividends, (ii) directly or indirectly taking dividends or any other form of payment representing a reduction in capital from the Bank, (iii) directly or indirectly making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities, (iv) directly or indirectly incurring, increasing or guaranteeing any debt, or (v) directly or indirectly purchasing or redeeming any shares of its stock.

Pursuant to its plans to preserve capital and to inject more capital into the Bank, the Company has no plans to undertake any of the foregoing activities.

 

The Company submitted, and the FRB approved, a written plan designed to maintain sufficient capital at the Company on a consolidated basis. Although the FRB Agreement does not contain specific target capital ratios or specific timelines, the plan must address the Company’s and Bank’s current and future capital requirements, the adequacy of the Bank’s capital, the source and timing of additional funds to satisfy the Company’s and the Bank’s future capital requirements, and supervisory requests for additional capital at the Bank or the supervisory action imposed on the Bank.

 

The Company also agreed to comply with certain notice provisions set forth in the Federal Deposit Insurance Act and Board of Governors’ Regulations in appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position. The Company is also required to comply with certain restrictions on indemnification and severance payments pursuant to the Federal Deposit Insurance Act and FDIC regulations. The Company is providing quarterly progress reports on all provisions of the FRB Agreement.

 

Consent Order with the FDIC and the South Carolina State Board

 

On June 1, 2010, the FDIC and the South Carolina State Board (the “State Board”) conducted their annual joint examination of the Bank. As a result of the examination, the Bank entered into a Consent Order, effective December 28, 2010 (the “Consent Order”), with the FDIC and the State Board. The Consent Order requires the Bank to, among other things, take the following actions:

 

·Establish, within 60 days from the effective date of the Consent Order, a board committee to monitor compliance with the Consent Order, consisting of at least four members of the board, three of whom shall not be officers of the Bank. This requirement has been completed by the Bank.
38
 
·Develop, within 60 days from the effective date of the Consent Order, a written management plan that addresses specific areas in the Joint Report of Examinations dated as of June 1, 2010. This requirement has been completed by the Bank.

 

·Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers and provide prior notification and approval for any new directors or senior executive officers. This requirement has been completed by the Bank.

 

·Achieve and maintain, within 150 days from the effective date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. The Bank is in the process of complying with this requirement.

 

·Establish, within 60 days from the effective date of the Consent Order, a written capital plan to include a contingency plan in the event the Bank fails to maintain minimums, submit an acceptable capital plan as required by the Consent Order, or implement or adhere to the capital plan to which supervisory authorities have taken no objections. Such contingency plan must include a plan to sell or merge the Bank. The Bank must implement the contingency plan upon written notice from the Regional Director. This requirement has been completed by the Bank.

 

·Adopt and implement, within 60 days from the effective date of the Consent Order, a written plan addressing liquidity, contingency funding, and asset /liability management. This requirement has been completed by the Bank.

 

·Eliminate, within 30 days from the effective date of the Consent Order, by charge-off or collection, all assets or portions of assets classified “Loss,” and during the Consent Order, within 30 days of receipt of any Report of Examination, eliminate by collection, charge-off, or other proper entry, the remaining balance of any assets classified as “Loss” and 50% of those assets classified “Doubtful”. This requirement has been completed by the Bank. The Bank is in compliance with this continuing requirement.

 

·Submit, within 60 days from the effective date of the Consent Order, a written plan to reduce the Bank’s risk exposure in relationships with assets in excess of $500,000 criticized as “Substandard” in the Report of Examination. The plan must require a reduction in the aggregate balance of assets criticized as “Substandard” in accordance with the following schedule: (i) within 180 days, a reduction of 25% in the balance of assets criticized “Substandard; (ii) within 360 days, a reduction of 45% in the balance of assets criticized “Substandard; (iii) within 540 days, a reduction of 60% in the balance of assets criticized “Substandard; and (iv) within 720 days, a reduction of 70% in the balance of assets criticized “Substandard.” The Bank is in compliance with this ongoing requirement.

 

·Not extend any additional credit to 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,” and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or in part, “Substandard,” and is uncollected, unless the Bank’s board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank. The Bank is in compliance with this requirement.

 

·Prepare and submit, within 90 days from the effective date of the Order, a plan consisting of long term goals designed to improve the condition of the Bank and its viability, and strategies for achieving those goals. The plan must cover minimum of three years and provide specific objectives for asset growth, market focus, earnings projections, capital needs, and liquidity position. The Bank is in compliance with this requirement.

 

·Adopt, within 60 days from the effective date of the Consent Order, an effective internal loan review and grading system to provide for the periodic review of the Bank’s loan portfolio in order to identify and categorize the Bank’s loans, and other extensions of credit which are carried on the Bank’s books as loans, on the basis of credit quality. This requirement has been completed by the Bank.
39
 
·Perform, within 60 days from the effective date of the Consent Order, a risk segmentation analysis with respect to the Bank’s concentrations of credit and develop a written plan to reduce any segment of the portfolio which the supervisory authorities deem to be an undue concentration of credit in relation to Tier 1 capital. The Bank is working to reduce concentrations within required thresholds.

 

·Review and establish, within 60 days from the effective date of the Consent Order, a policy to ensure the adequacy of the Bank’s allowance for loan and lease losses, which must provide for a review of the Bank’s allowance for loan and lease losses at least once each calendar quarter. This requirement has been completed by the Bank.

 

·Formulate and implement, within 60 days from the effective date of the Consent Order, a written plan to improve and sustain Bank earnings, which shall include (i) goals and strategies for improving and sustaining earnings; (ii) major areas and means by which to improve operating performance; (iii) realistic and comprehensive budget; (iv) budget review process to monitor income and expenses to compare with budgetary projections; (v) operating assumptions forming the basis for, and adequately support, major projected income and expense components; and (vi) coordination of the Bank’s loan, investment, and operating policies and budget and profit planning with the funds management policy. The written plan must be evaluated at the end of each calendar quarter and record results and any actions taken by the Board in minutes. The Bank is in compliance with this ongoing requirement.

 

·Revise, adopt and implement, within 60 days of the effective date of the Consent Order, the Bank’s written asset/liability management policy to provide effective guidance and control over the Bank’s funds management activities, which shall also address all items of criticism set forth in the Joint Report of Examinations in June 2010. This requirement has been completed by the Bank.

 

·Develop and implement, within 60 days of the effective date of the Consent Order, a written policy for managing interest rate risk in a manner that is appropriate to the size of the Bank and the complexity of its assets. The policy shall comply with the Joint Inter-Agency Policy Statement on Interest Rate Risk. This requirement has been completed by the Bank.

 

·Eliminate or correct, within 30 days from the effective date of the Consent Order, all violations of law and regulation or contraventions of FDIC guidelines and statements of policy described in the Joint Report of Examinations in June 2010. This requirement has been completed by the Bank.

 

·Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities. The Bank is in compliance with this ongoing requirement.

 

·Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b), and, within 60 days of the effective date of the Consent Order, submit a written plan to the supervisory authorities for eliminating reliance on brokered deposits. This requirement has been completed by the Bank.

 

·Limit asset growth to 10% per annum. The Bank is in compliance with this ongoing requirement.

 

·Adopt, within 60 days of the effective date of the Consent Order, an employee compensation plan after undertaking an independent review of compensation paid to all the Bank’s senior executive officers, as defined at Section 301.101(b) of the FDIC Rules and Regulations. This requirement has been completed by the Bank.

 

·Furnish, within 30 days from the end of the first quarter following the effective date of the Consent Order, and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order. The Bank is in compliance with this ongoing requirement.

 

We have taken actions to comply with the requirements of both the FRB Agreement and the Consent Order. All of the requirements of the Consent Order except for the following two have been completed: (1) capital levels are below the thresholds of 10% for Total Risk-Based Capital and 8% for Tier 1 Leverage Capital and (2) credit concentrations within the portfolio continue to decrease, but remain elevated.

40
 

 The Bank presents monthly updates to the Board of Directors regarding compliance with the FRB Agreement and the Consent Order, and quarterly updates to the regulators on all provisions. We continue to focus our efforts on meeting the objectives in these two documents designed to improve the Bank’s financial condition and enable the Bank to meet regulatory requirements.

 

The determination of our compliance with the regulatory requirements will be made by the FDIC and the South Carolina State Board. Failure to comply with the requirements could result in additional regulatory pressures and, if the Bank is unable to comply, could ultimately lead to further action by the FDIC including the Bank being taken into receivership by the FDIC.

41
 

Results of Operations

 

Income Statement Review

 

Summary

 

Our net loss available to common shareholders was approximately $3.5 million for the year ended December 31, 2015, compared to a net loss available to common shareholders of $1.8 million for the year ended December 31, 2014. The net loss after taxes for the year ended December 31, 2015 was $1.8 million compared to $431,000 for the year ended December 31, 2014. We recorded provisions for loan losses of $1.2 million and $71,000 for the years ended December 31, 2015 and 2014, respectively.

 

Net interest income before provision expense decreased $642,000 to $11.9 million for the year ended December 31, 2015, compared to $12.6 million for December 31, 2014. Noninterest income increased from $1.2 million for the year ended December 31, 2014 to $1.4 million for the year ended December 31, 2015. The increase in noninterest income is primarily attributable to an $83,000 increase in residential mortgage origination fees, a $93,000 increase in other service fees and commissions and an $83,000 increase in other income in 2015. Noninterest expense decreased $135,000 to $13.9 million for the year ended December 31, 2015, compared to $14.1 million for the year ended December 31, 2014.

 

Net Interest Income

 

During 2015, total assets were reduced by $9.3 million while gross loans increased by $6.2 million and deposits decreased by $7.6 million.

 

Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. The growth in our loan portfolio has historically been the primary driver of net interest income. We anticipate any growth in loans will result in growth in assets and net interest income.

 

Our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio. This strategy resulted in a significant portion of our assets being in higher earning loans rather than in lower yielding investments. At December 31, 2015, loans represented 69.6% of total assets, while securities and interest bearing balances represented 18.5% of total assets. While we focus on increasing the size of our loan portfolio, we also anticipate managing the size of the investment portfolio as investment yields become more attractive.

 

At December 31, 2015, retail deposits represented $420.5 million, or 92.6% of total funding, which includes total deposits plus borrowings. Borrowings represented $33.4 million, or 7.4% of total funding. We plan to continue to offer competitive rates on our retail deposit accounts, including investment checking, money market accounts, savings accounts and time deposits. Our goal is to maintain a higher percentage of assets being funded by retail deposits and to increase the percentage of low-cost transaction accounts to total deposits. No assurance can be given that these objectives will be achieved. We operate seven full service banking offices located along the South Carolina coast. We anticipate that our full service banking offices will assist us in meeting these objectives. We believe these strategies will provide us with additional customers and a lower alternative cost of funding.

 

Net interest income decreased $642,000 for the year ended December 31, 2015 as the result of a decrease in interest income of $792,000, which was offset by a decrease of $150,000 in funding costs as compared to the prior year period. For the years ended December 31, 2015 and 2014, average interest-bearing liabilities exceeded average interest-earning assets by $12.3 million and $19.2 million, respectively.

 

The current low interest rate environment has resulted in a decrease in both the yields on our variable rate assets and the rates that we pay for our short-term deposits and borrowings. The net interest margin decreased to 2.85% during the year ended December 31, 2015, as a result of the Bank’s lower rate and volume of interest earning assets. Our net interest margin for the year ended December 31, 2014 was 2.97%.

42
 


Years Ended December 31, 2015 and 2014

 

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated.

 

Average Balances, Income and Expenses, and Rates

 

 

(in thousands)

 

For the Year Ended

December 31, 2015

  

For the Year Ended

December 31, 2014

 
  

Average

Balance

  

Income/

Expense

   Yield/
Rate
  

Average

Balance

  

Income/

Expense

  

Yield/

Rate

 
     
Earning assets:                              
Interest bearing balances   $16,050   $80    0.50%  $14,681   $79    0.53%
Taxable investment securities    80,629    1,364    1.69%   81,978    1,655    2.02%
Loans receivable(1)    321,010    15,528    4.83%   326,503    16,030    4.91%
Total earning assets    418,000    16,972    4.06%   423,162    17,764    4.20%
                               
Nonearning assets:                              
Cash and due from banks    5,563              4,202           
Mortgage loans held for sale    184              185           
Premises and equipment, net    20,293              21,076           
Other assets    34,954              38,751           
Allowance for loan losses    (4,754)             (5,432)          
Total nonearning assets    56,239              58,782           
Total assets   $474,240             $481,944           
                               
Interest-bearing liabilities:                              
Interest bearing transaction accounts   $37,085    71    0.19%  $38,745    81    0.21%
Savings & money market    106,274    372    0.35%   98,291    344    0.35%
Time deposits less than $100,000    93,025    1,175    1.26%   101,080    1,248    1.23%
Time deposits greater than $100,000    160,458    2,176    1.36%   168,073    2,245    1.33%
Securities sold under repurchase agreement    10,000    446    4.46%   10,000    445    4.45%
Advances from FHLB    9,000    361    4.01%   11,762    369    3.14%
Junior subordinated debentures    14,434    449    3.12%   14,434    468    3.24%
ESOP borrowings             — %   19         — %
Federal funds purchased   5         — %   8        0.56%
Other borrowings            %           %
Total interest-bearing liabilities    430,281    5,050    1.17%   442,412    5,200    1.18%
                               
Noninterest-bearing liabilities:                              
Demand deposits    30,087              25,615           
Other liabilities    9,804              7,833           
Shareholders’ equity    4,068              6,084           
                               
Total liabilities and shareholders’ equity   $474,240             $481,944           
Net interest income        $11,922             $12,564      
Net interest spread              2.89%             3.02%
Net interest margin              2.85%             2.97%
(1) Includes nonaccruing loans                         

  

Our net interest spread was 2.89% and 3.02% for the years ended December 31, 2015 and 2014, respectively. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities.

 

Net interest income, the largest component of our income, was $11.9 million and $12.6 million for the years ended December 31, 2015 and 2014, respectively. The decrease in 2015 was a result of lower income and volume on bonds and loans and was partially offset by lower volumes in interest bearing liabilities.

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Interest income for the year ended December 31, 2015 was $17.0 million, consisting primarily of $15.5 million on loans, $1.4 million on investments, and $43,000 on interest bearing balances, and $37,000 in other interest income. Interest income for the year ended December 31, 2014 was $17.8 million, consisting primarily of $16.0 million on loans, $1.7 million on investments, and $36,000 on interest bearing balances, and $42,000 in other interest income. Interest and fees on loans represented 91.5% and 90.2% of total interest income for the years ended December 31, 2015 and 2014, respectively. Income from investments, interest bearing, and other interest income represented 8.5% and 9.8%, of total interest income for the years ended December 31, 2015 and 2014, respectively. The high percentage of interest income from loans related to our strategy to maintain a significant portion of our assets in higher earning loans compared to lower yielding investments. Average loans represented 76.9% and 77.2% of average interest-earning assets for the years ended December 31, 2015 and 2014, respectively.

 

During 2015, we focused on local retail deposits. Under the Consent Order, we may not accept brokered deposits unless a waiver is granted by the FDIC. In 2015, we strategically lowered some of our rates which led to a decrease in our overall cost of funding by $150,000. Interest expense for the year ended December 31, 2015 was approximately $5.0 million, consisting primarily of $3.8 million related to deposits, $361,000 related to FHLB advances, $446,000 related to securities sold under repurchase agreements, and $450,000 related to junior subordinated debentures. Interest expense for the year ended December 31, 2014 was approximately $5.2 million, consisting primarily of $3.9 million related to deposits, $369,000 related to FHLB advances, $445,000 related to securities sold under repurchase agreements and $468,000 related to junior subordinated debentures. Interest expense on deposits for the years ended December 31, 2015 and 2014 represented 75.1% and 75.3%, respectively, of total interest expense, while interest expense on borrowings represented 24.9% and 24.7% respectively, of total interest expense. During the year ended December 31, 2015, average interest-bearing liabilities were lower by $12.1 million than for the same period in 2014.

 

Rate/Volume Analysis

 

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following table sets forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

 

  

Year Ended

December 31, 2015 vs. December 31, 2014

 
(in thousands)  Increase (Decrease) Due to 
    

 

Volume

    

 

Rate

    

Rate/

Volume

    

 

Total

 
Interest income                    
Loans   $(254)  $(252)  $4   $(502)
Taxable investment securities    (27)   (269)   4    (292)
Interest bearing balances    7    (5)       2 
Total interest income    (274)   (526)   8    (792)
                     
Interest expense                    
Deposits    (39)   (86)   1    (124)
Junior subordinated debentures        (19)       (19)
Advances from FHLB    (87)   103    (24)   (8)
Securities sold under repurchase
agreements
       1        1 
Federal funds purchased                 
ESOP borrowings                 
Total interest expense    (126)   (1)   (23)   (150)
Net interest income   $(148)  $(525)  $31   $(642)

 

Provision for Loan Losses

 

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of operations. We review our loan portfolio monthly to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Balance Sheet Review – Allowance for Loan Losses and Provisions” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

44
 

Included in the statement of operations for the years ended December 31, 2015 and 2014 is a noncash expense related to the provision for loan losses of approximately $1.2 million and $71,000, respectively. The allowance for loan losses was approximately $4.0 million and $4.7 million, as of December 31, 2015 and 2014, respectively. The allowance for loan losses as a percentage of loans was 1.25% at December 31, 2015 and 1.49% at December 31, 2014. At December 31, 2015, we had 19 nonaccrual loans totaling approximately $7.7 million compared to 24 loans totaling $6.8 million at December 31, 2014. For the year ended December 31, 2015, net charge offs totaled approximately $1.9 million compared to approximately $1.3 million for 2014.

 

Noninterest Income

 

The following table sets forth information related to our noninterest income:

 

   Years Ended December 31, 
   2015   2014 
   (in thousands) 
Service fees on deposit accounts   $40   $37 
Residential mortgage origination fees    273    190 
Gain (Loss) on sale of investment securities    6    (32)
Loss on sale of other assets    (69)   (5)
Other service fees and commissions    613    519 
Bank owned life insurance    424    430 
Other    91    11 
 Total noninterest income   $1,378   $1,150 

 

Noninterest income for the year ended December 31, 2015 was approximately $1.4 million, an increase of $228,000, compared to noninterest income of $1.1 million during the same period in 2014. The increase was primarily attributable to an increase in various fees.

 

Residential mortgage origination fees consist primarily of mortgage origination fees we receive on residential loans funded and closed by a third party. Residential mortgage origination fees were $273,000 and $190,000 for the years ended December 31, 2015 and 2014, respectively. The increase of $83,000 in 2015 related primarily to an increase in volume in the mortgage department.

 

Service fees on deposits consist primarily of service charges on our checking, money market, and savings accounts. Deposit fees were $40,000 and $37,000 for the years ended December 31, 2015 and 2014, respectively. Other service fees, commissions and the fee income received from customer non-sufficient funds (“NSF”) transactions were $613,000 and $519,000 for the years ended December 31, 2015 and 2014, respectively.

 

We also earned $424,000 and $430,000 in noninterest income received from bank owned life insurance for the years ended December 31, 2015 and 2014, respectively. Other income consists primarily of fees received on debit and credit card transactions, income from sales of checks, various settlements and the fees received on wire transfers. Other income was $91,000 and $9,000 each for the years ended December 31, 2015 and 2014.

45
 

Noninterest Expense

 

The following table sets forth information related to our noninterest expense.

   Years Ended December 31, 
   2015   2014 
   (in thousands) 
Salaries and benefits   $6,811   $6,082 
Occupancy    1,550    1,521 
Furniture and equipment expense    1,051    1,022 
Other real estate owned expense (profit)    (234)   728 
Professional fees    1,236    1,229 
Advertising and marketing    280    275 
Insurance    383    419 
FDIC assessment    1,084    1,074 
Data processing and related costs    772    811 
Telephone    208    201 
Postage    10    8 
Office supplies, stationery and printing    101    93 
Other loan related expense    229    189 
Other    454    416 
 Total noninterest expense   $13,935   $14,068 

 

We incurred noninterest expense of $13.9 million for the year ended December 31, 2015, compared to $14.1 million for the year ended December 31, 2014. For the year ended December 31, 2015, the $962,000 decrease in other real estate owned expenses, which was offset by an increase in salaries and benefits expenses of $735,000 and primarily accounted for the decrease in noninterest expense compared to the same period in 2014. For the year ended December 31, 2015, the remaining differences resulted primarily from increases of $40,000 in other loan expense, $30,000 in other expenses, and $29,000 in furniture and equipment expense.

 

Occupancy expense was $1.5 million and $1.5 million for the years ended December 31, 2015 and 2014, respectively. Our branch locations provide increased visibility and new customer traffic to the Bank. With these new customers, both loan and deposit accounts increase, and additional revenue is generated through interest income on loans and service charges on deposit accounts.

 

Salary and benefit expense was $6.8 million and $6.1 million for the years ended December 31, 2015 and 2014, respectively. Salaries and benefits represented 48.9% and 43.8% of our total noninterest expense for the years ended December 31, 2015 and 2014, respectively. This increase was mainly due to hiring additional lenders, branch managers and compliance staff. The increased staff cost of approximately $500,000 is partly due to the burden of additional regulations and compliance costs.

 

Data processing and related costs were $772,000 and $811,000 for the years ended December 31, 2015 and 2014, respectively. During the year ended December 31, 2015, our data processing costs for our core processing system were $576,000 compared to $706,000 for the year ended December 31, 2014. We have contracted with an outside computer service company to provide our core data processing services. A significant portion of the fee charged by our third party processor is directly related to the number of loan and deposit accounts and the related number of transactions.

 

We incurred income tax expense of $0 for the year ended December 31, 2015 compared to $4,000 for the same period in 2014. Management has determined that it is not likely that the deferred tax asset related to continuing operations at December 31, 2015 will be realized, and accordingly, has established a full valuation allowance.

46
 

Balance Sheet Review

 

General

 

At December 31, 2015, we had total assets of $466.2 million, consisting principally of $324.2 million in loans, $78.1 million in investment securities, $8.2 million in interest bearing balances, $19.7 million in net premises, furniture and equipment, $16.7 million in bank owned life insurance, $12.8 million in other real estate owned and $5.7 million in cash and due from banks. Our liabilities at December 31, 2015 totaled $464.3 million, consisting principally of $420.5 million in deposits, $10.0 million in securities sold under agreements to repurchase, $14.4 million in junior subordinated debentures, and $9.0 million in FHLB advances. At December 31, 2015, our shareholders’ equity was $1.9 million.

 

Investments

 

At December 31, 2015, the $78.1 million in our investment securities portfolio represented approximately 16.8% of our total assets, compared to $82.3 million, or 17.3% of total assets, at December 31, 2014. At December 31, 2015, we held U.S. treasuries, U.S. government agency securities, government sponsored enterprises, small business administration securities, and mortgage-backed securities with a fair value of $78.1 million and an amortized cost of $79.7 million for a net unrealized loss of $1.6 million. During 2015, we utilized the investment portfolio to provide additional income and to absorb liquidity. We anticipate maintaining an investment portfolio to provide both increased earnings and liquidity. As deposit growth outpaces our ability to lend to creditworthy customers, we anticipate maintaining the relative size of the investment portfolio and extinguishing other funding liabilities.

 

Contractual maturities and yields on our investments at December 31, 2015 are shown in the following tables. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   One year or less   After one year
through five years
   After five years
through ten years
   After ten years   Total 
   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield 
   (dollars in thousands) 
Available for Sale:                                                  
Government- sponsored enterprises  $    %  $11,961    1.16%  $    %  $1,813    3.08%  $13,774    1.41%
US Treasuries       %   4,475    1.07%       %       %   4,475    1.07%
SBA loan pools       %       %   921    2.15%   9,239    2.08%   10,160    2.08%
Mortgage-backed securities       %       %   102    1.18%   44,343    1.79%   44,445    1.79%
Total  $    %  $16,436    1.13%  $1,023    2.07%  $55,395    1.88%  $72,854    1.65%

 

   One year or less   After one year
through five years
   After five years
through ten years
   After ten years   Total 
   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield 
   (dollars in thousands) 
 Held to Maturity:                                                  
Government-sponsored enterprises  $    %  $    %  $2,005    2.34%  $1,006    3.30%  $3,011    2.66%
Mortgage-backed securities       %       %       %   1,237    2.66%   1,237    2.66%
SBA loan pools securities       %       %   1,006    2.28%       %   1,007    2.28%
Total  $    %  $    %  $3,011    2.32%  $2,243    2.95%  $5,255    2.59%

 

At December 31, 2015, our investments included government sponsored enterprises with fair values of approximately $16.8 million, U.S. treasuries with fair values of approximately $4.5 million, and small business administration surety bonds with fair values of approximately $11.2 million. Collateralized Mortgage Obligations (“CMO”) and Mortgage-backed securities consist of securities issued by the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation and Government National Mortgage Association with fair value of approximately $6.1 million, $16.2 million and $23.3 million, respectively.

47
 

Other nonmarketable equity securities at December 31, 2015 consisted of Federal Home Loan Bank stock with a cost of $832,800 and other investments of approximately $63,150.

 

The amortized costs and the fair value of our investments at December 31, 2015, 2014 and 2013 are shown in the following tables.

   December 31, 2015   December 31, 2014   December 31, 2013 
  

Amortized

Cost

  

Fair

Value

  

Amortized

Cost

  

Fair

Value

  

Amortized

Cost

  

Fair

Value

 
   (in thousands) 
Available for Sale:                              
US Treasuries   $4,474   $4,475   $4,461   $4,459   $   $ 
Government-sponsored enterprises    13,814    13,774    8,921    8,815    6,939    6,321 
SBA loan pools    10,372    10,160    11,394    11,106    12,093    11,275 
Mortgage-backed securities    45,815    44,445    59,311    57,882    67,143    63,244 
 Total   $74,475   $72,854   $84,087   $82,262   $86,175   $80.840 
                               

 

   December 31, 2015   December 31, 2014   December 31, 2013 
  

Amortized

Cost

  

Fair

Value

  

Amortized

Cost

  

Fair

Value

  

Amortized

Cost

  

Fair

Value

 
   (in thousands) 
Held to Maturity:                              
Government-sponsored enterprises   $3,011   $3,016   $   $   $   $ 
SBA loan pools    1,007    1,003                 
Mortgage-backed securities    1,237    1,203                 
 Total   $5,255   $5,222   $   $   $   $ 

 

Loans

 

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Average loans for the years ended December 31, 2015 and 2014 were $321.3 million and $326.5 million, respectively. Gross loans outstanding at December 31, 2015 and 2014 were $324.2 million and $318.1 million, respectively.

 

Loans secured by real estate mortgages are the principal component of our loan portfolio. Most of our real estate loans are secured by residential or commercial property. We do not generally originate traditional long term residential mortgages for the portfolio, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 85%. The current mix may not be indicative of the ongoing portfolio mix. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral.

48
 

The following table summarizes the composition of our loan portfolio:

 

   2015     2014   2013   2012   2011 
   (dollars in thousands) 
   Amount   % of Total   Amount   % of Total   Amount   % of Total   Amount   % of Total   Amount   % of Total 
Commercial                                                  
Commercial and industrial   $23,978    7.4%  $22,632    7.1%  $22,474    6.8%  $17,514    5.1%  $19,841    5.3%
Real Estate                                                  
Mortgage    253,617    78.3%   248,249    78.0%   255,091    77.1%   257,472    75.8%   278,532    73.4%
Construction    42,696    13.1%   44,388    14.0%   51,289    15.4%   61,828    18.2%   78,740    20.7%
Total real estate    296,313    91.4%   292,637    92.0%   306,380    92.5%   319,300    94.0%   357,272    94.1%
Consumer                                                  
Consumer    4,059    1.2%   2,818    0.9%   2,325    0.7%   3,058    0.9%   3,195    0.8%
Total gross loans    324,350    100.0%   318,087    100.0%   331,179    100.0%   339,872    100.0%   380,308    100.2%
  Deferred origination fees, net    (139)   (0.0%)   (90)   (0.0%)   (90)   (0.0%)   (144)   (0.0%)   (665)   (0.2%)
                                                   
Total gross loans, net of deferred fees    324,211    100.0%   317,997    100.0%   331,089    100.0%   339,728    100.0%   379,643    100.0%
Less – allowance for loan losses    (4,045)        (4,750)        (6,026)        (6,727)        (10,320)     
Total loans, net   $320,166        $313,247        $325,063        $333,001        $369,323      

 

Maturities and Sensitivity of Loans to Changes in Interest Rates

 

The information in the following table is based on the contractual maturities of individual loans, including loans that may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties. The following table summarizes the loan maturity distribution by type and related interest rate characteristics at December 31, 2015:

 

  

One year

or less

  

After one
but

within
five years

  

After five

years

   Total 
   (in thousands) 
Commercial   $6,548   $16,527   $903   $23,978 
Real estate    50,956    202,805    42,552    296,313 
Consumer    911    2,647    501    4,059 
Deferred origination fees, net    (34)   (103)   (2)   (139)
Total gross loans, net of deferred fees   $58,381   $221,876   $43,954   $324,211 
                     
Gross loans maturing after one year with:                    
Fixed interest rates                  $197,234 
Floating interest rates                   68,701 
Total                  $265,935 
49
 

Allowance for Loan Losses and Provisions

 

We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of operations. The allowance is maintained at a level deemed appropriate by management to provide adequately for known and inherent losses in the portfolio. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.

 

More specifically, in determining our allowance for loan losses, we review loans for specific and impaired reserves based on current appraisals less estimated closing costs. General and unallocated reserves are determined using historical loss trends applied to risk rated loans grouped by FDIC call report classification code. The general and unallocated reserves are calculated by applying the appropriate historical loss ratio to the loan categories grouped by risk rating (pass, special mention, substandard and doubtful). The quantitative value of the qualitative factors, as described below, is then applied to this amount to estimate the general and unallocated reserve for the specific loans within this rating category and particular loan category. Impaired loans are excluded from this analysis as they are individually reviewed for valuation. The sum of all such amounts determines our general and unallocated reserves.

 

We also track our portfolio and analyze loans grouped by call report categories. The first step in this process is to risk grade each and every loan in the portfolio based on a common set of parameters. These parameters include debt to worth, liquidity of the borrower, net worth, experience in a particular field and other factors. Weight is also given to the relative strength of any guarantors on the loan. We have retained an independent consultant to review the loan files on a test basis to confirm the loan grade assigned to the loan.

 

After risk grading each loan, we then use fourteen qualitative factors to analyze the trends in the portfolio. These fourteen factors include both internal and external factors. The internal factors considered are the concentration of credit across the portfolio, current delinquency ratios and trends, the experience level of management and staff, our adherence to lending policies and procedures, current loss and recovery trends, the nature and volume of the portfolio’s categories, current nonaccrual and problem loan trends, the quality of our loan review system, policy exceptions, value of underlying collateral and other factors which include insurance shortfalls, loan fraud and unpaid tax risk. The external factors considered are regulatory and legal factors and the current economic and business environment, which includes indicators such as national GDP, pricing indicators, employment statistics, housing statistics, market indicators, financial regulatory economic analysis, and economic forecasts from reputable sources. A quantitative value is assigned to current delinquency ratios and trends and the current nonaccrual and problem loan trends, which, when added together, creates a net qualitative weight. The net qualitative weight is then added to the loss ratio. Negative trends in the loan portfolio increase the quantitative values assigned to each of the qualitative factors and, therefore, increase the loss ratio. As a result, an increased loss ratio will result in a higher allowance for loan loss. For example, as delinquency ratios and trends increase, this qualitative factor’s quantitative value will increase, which will increase the net qualitative weight and the loss ratio (assuming all other qualitative factors remain constant). Similarly, positive trends in the nonaccrual and problem loans trends, will decrease the quantitative value assigned to this qualitative factor, thereby decreasing the net qualitative weight and the loss ratio(assuming all other qualitative factors remain constant). These factors are reviewed and updated by the Bank’s executive management on a quarterly basis to arrive at a consensus for our qualitative adjustments.

 

Our methodology for determining our historical loss ratio is to analyze the most recent losses because we believe this period encompasses the most appropriate time period. We use a fully migrated loss history for all loan pools and all risk grades. The resulting historical loss factor is used as a beginning point upon which we add our adjustments based on the qualitative factors discussed above. Once the qualitative adjustments are made, we refer to the final amount as the total factor. The total factor is then multiplied by the loans outstanding for the period ended, except for any loans classified as non-performing which are addressed specifically as discussed below, to estimate the general and unallocated reserves.

50
 

During the second quarter of 2015, the Company began using 12 quarters to measure historical losses rather than a 6 quarter period as used previously. The Company believes that the longer period used to determine historical losses captures a longer economic cycle, including periods of economic uncertainty that are unlike those the Company has experienced in the past three years. The Company also believes that using 12 quarters to measure historical losses is more indicative of the expected losses and risks inherent in the portfolio.

 

Separately, we review all impaired loans individually to determine a specific allocation for each. In our assessment of impaired loans, we consider the primary source of repayment when determining whether or not loans are collateral dependent. Impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. When management determines that a loan is impaired, the difference between our investment in the related loan and the present value of the expected future cash flows, or the fair value of the collateral, is then reserved for or charged against the allowance for loan losses.

 

Periodically, we adjust the amount of the allowance based on changing circumstances. We recognize loan losses to the allowance and add back subsequent recoveries. In addition, on a periodic basis we informally compare our allowance for loan losses to various peer institutions; however, we recognize that allowances will vary as financial institutions are unique in the make-up of their loan portfolios and customers, which necessarily creates different risk profiles for the institutions. There can be no assurance that loan charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

 

The general reserve decreased during 2015 due to lower loan balances, a substantial lowering of impaired loans, and substantially improved delinquency trends. Improving charge-offs the last three years compared to prior years has resulted in much lower historical loss ratios. These lower loss ratios resulted in a reduced requirement for our general reserve during 2015.

 

The following table summarizes the activity related to our allowance for loan losses.

 

   December 31, 
   2015   2014   2013   2012   2011 
   (dollars in thousands) 
Balance, beginning of year  $4,750   $6,026   $6,727   $10,320   $11,459 
Provision for loan losses   1,175    71    435    3,028    10,619 
Charge offs, Commercial and Industrial   (598)   (485)   (301)   (199)   (804)
Charge offs, Real Estate Mortgage   (1,799)   (548)   (1,625)   (3,801)   (8,025)
Charge offs, Real Estate Construction   (330)   (743)   (800)   (2,571)   (3,637)
Charge offs, Consumer   (1)   (3)   (66)   (312)   (30)
Recoveries, Commercial and Industrial   23    89    89    16    11 
Recoveries, Real Estate Mortgage   225    217    729    205    388 
Recoveries, Real Estate Construction   599    102    826    29    316 
Recoveries, Consumer   1    24    12    12    23 
Balance, end of year  $4,045   $4,750   $6,026   $6,727   $10,320 
                          
Total loans outstanding at end of period  $324,211   $317,996   $331,089   $339,728   $379,644 
Allowance for loan losses to gross loans   1.25%   1.49%   1.82%   1.98%   2.72%
Net charge-offs to average loans   0.58%   0.41%   0.33%   1.83%   2.86%
51
 

Nonperforming Assets

 

The following table sets forth our nonperforming assets.

 

   December 31, 
   2015   2014   2013   2012   2011 
   (dollars in thousands) 
Nonaccrual loans   $7,724   $6,839   $14,043   $23,118   $34,292 
Other real estate owned    12,753    17,519    18,693    22,647    18,906 
Accruing TDR’s    8,450    8,738    13,012    30,207    23,771 
Total nonperforming assets   $28,927   $33,096   $45,748   $75,972   $76,969 
                          
Nonperforming assets to total assets    6.20%   6.96%   9.40%   14.42%   14.41%

 

We experienced decreases in past due loans, impaired loans and other real estate owned during 2015.

 

The Bank had 19 loans on non-accrual status at December 31, 2015, totaling $7.7 million and 24 loans on nonaccrual status totaling $6.8 million at December 31, 2014. Of the 19 loans on nonaccrual status at December 31, 2015, it is anticipated that 15 loans totaling approximately $7.0 million will move to other real estate owned through foreclosure or through the Bank’s acceptance of a deed in lieu of foreclosure. An additional two loans amounting to approximately $576,000 are expected to be paid down or paid in full, one loan totaling approximately $55,000 will be charged-off, and one loan totaling approximately $78,000 is expected to move back to an accruing status. At December 31, 2015 and December 31, 2014, the allowance for loan losses was $4.0 million and $4.7 million, respectively, or 1.25% and 1.49%, respectively, of outstanding loans. At December 31, 2015 the Bank had 31 impaired loans totaling $16.9 million, which is a decrease of $6.8 million when compared to the year ended December 31, 2014. This decrease was primarily related to one loan that was renewed at current terms, a few loans that were paid out and multiple loans that were moved to other real estate owned. We remain committed to working with borrowers to help them overcome their difficulties and will review loans on a loan by loan basis.

 

To determine current collateral values we obtain new appraisals on loan renewals and potential problem loans. In the process of estimating collateral values for non-performing loans, management evaluates markets for stagnation or distress and discounts appraised values on a property by property basis. Currently, management does not review collateral values for properties located in stagnant or distressed residential areas if the loan is performing and not up for renewal.

 

As of December 31, 2015, we had 47 loans with a current principal balance of $19.6 million on the watch list, compared to 25 loans with a current principal balance of $13.9 million at December 31, 2014. The watch list is the classification utilized by us when we have an initial concern about the financial health of a borrower. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either move it to “substandard” or back to its original risk rating after a review of the information. There are times when we may leave the loan on the “watch list,” if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we want to review it on a more regular basis. Loans on the watch list are not considered “potential problem loans” until they are determined by management to be classified as substandard.

 

Loans past due 30-89 days amounted to $1.9 million at December 31, 2015 as compared to $1.8 million at December 31, 2014. Past due loans are often regarded as a precursor to further credit problems which would lead to future increases in nonaccrual loans and other real estate owned. At December 31, 2015, there were no loans past due greater than 90 days that were not already placed on nonaccrual. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is applied against the principal balance. During the years ended December 31, 2015 and 2014, the gross interest that we would have recorded if the loans were in current status was $243,000 and $113,000 respectively. Forgone interest income on impaired loans was $122,000 and $425,000 during the years ended December 31, 2015 and 2014, respectively.

52
 

Deposits

 

Our primary source of funds for loans and investments is our deposits. Due to the Consent Order, we may not accept brokered deposits unless a waiver is granted by the FDIC. We no longer have any brokered or wholesale deposits. Our loan-to-deposit ratio was 77.1% and 74.3% at December 31, 2015 and 2014, respectively. Although we currently do not utilize brokered deposits as a funding source, if we were to seek to begin using such funding source, there is no assurance that the FDIC will grant us the approval when requested. These restrictions could have a substantial negative impact on our liquidity. Additionally, we are restricted from offering an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on their website.

 

The following table shows the average balance amounts and the average rates paid on deposits held by us for the years ended December 31, 2015, 2014 and 2013.

 

   December 31, 2015   December 31, 2014     December 31, 2013 
   Amount   Rate   Amount   Rate   Amount   Rate 
   (dollars in thousands) 
Noninterest bearing demand deposits   $30,087      —%  $25,615      —%  $20,666      —%
Interest bearing demand deposits    37,085    0.19%   38,745    0.21%   49,957    0.39%
Savings and money market accounts    106,274    0.35%   98,291    0.35%   103,641    0.41%
Time deposits less than $100,000    93,025    1.26%   101,080    1.23%   104,943    1.25%
Time deposits greater than $100,000    160,458    1.36%   168,073    1.33%   168,166    1.37%
Total deposits   $426,929    0.89%  $431,804    0.91%  $447,373    0.95%

 

All of our time deposits are certificates of deposit. The maturity distribution of our time deposits of $100,000 or more at December 31, 2015, 2014 and 2013 was as follows:

   2015   2014      2013  
   (in thousands) 
Three months or less   $26,121   $18,904   $17,364 
Over three through six months    34,163    33,384    24,816 
Over six though twelve months    45,327    23,742    28,718 
Over twelve months    49,062    86,868    101,598 
Total   $154,673   $162,898   $172,496 

 

The decrease in time deposits of $100,000 or more for the year ended December 31, 2015 compared to the same period in 2014 resulted from our decision to focus on checking deposit growth. As of December 31, 2015, the Bank had $28.0 million in certificates of deposits greater than $250,000.

 

Borrowings and Other Interest-Bearing Liabilities

 

The following table outlines our various sources of borrowed funds during the years ended December 31, 2015 and 2014 and the amounts outstanding at the end of each period, the maximum amount for each component during the periods, the average amounts for each period, and the average interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown.

  

 

 

Ending

Balance

  

 

Period

End

Rate

  

Maximum

Month

End

Balance

  

 

Average

for the Period

Balance Rate

 
   (dollars in thousands) 
At or for the year ended December 31, 2015:                         
Securities sold under agreement to repurchase   $10,000    4.40%  $10,000   $10,000    4.46%
Advances from FHLB    9,000    3.96%   9,000    9,000    4.01%
Junior subordinated debentures    14,434    3.29%   14,434    14,434    3.12%
ESOP borrowings        %             —%
Federal funds purchased        %       8      —%
                          
At or for the year ended December 31, 2014:                         
Securities sold under agreement to repurchase   $10,000    4.40%  $10,000   $10,000    4.45%
Advances from FHLB    9,000    3.96%   13,000    11,762    3.14%
Junior subordinated debentures    14,434    3.20%   14,434    14,434    3.24%
ESOP borrowings        %       19      —%
Federal funds purchased        %       8    0.56%
53
 

We have exercised our right to defer distributions on the junior subordinated debentures (and the related trust preferred securities), during which time we cannot pay any dividends on our common stock. In addition, the Consent Order prohibits us from declaring or paying any dividends or making any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities.

 

Federal Home Loan Bank Advances, Fed Funds Lines of Credit and Federal Reserve Discount Window. 

 

Our other borrowings have traditionally included proceeds from FHLB advances and federal funds lines of credit from correspondent banks. At December 31, 2015, we had $9.0 million in total advances and lines outstanding from the FHLB with a remaining credit availability of $62.4 million and an excess lendable collateral value of approximately $2.0 million. As of December 31, 2015, we had $6.0 million fed funds line from Alostar Bank and a $5.0 million fed funds line from Raymond James. We also have credit availability through the Federal Reserve Discount Window. As of December 31, 2015, $132,000 was available based on qualifying collateral. The Federal Reserve Discount Window borrowing capacity has been curtailed to only overnight terms, contingent upon credit approval for each transaction. Availability of the Federal Reserve Discount Window may be terminated at any time by the Federal Reserve, and we can make no assurances that this funding source will continue to be available to us.

 

Capital Resources

 

Total shareholders’ equity was $1.9 million at December 31, 2015 and $5.3 million at December 31, 2014. The decrease is attributable to the net loss of $1.8 million for the year ended December 31, 2015, preferred stock dividends accrued of $1.7 million, offset by decrease of $127,000 in the fair value of available for sale securities. Since our inception, we have not paid any cash dividends on our common shares.

 

The following table shows the return on average assets (net loss divided by average total assets), return on average equity (net loss divided by average equity), and average equity to average assets ratio (average equity divided by average total assets) for the years ended December 31, 2015, 2014 and 2013:

 

   2015   2014   2013 
Return on average assets    (0.38%)   (0.09%)   (0.20%)
Return on average equity    (44.49%)   (7.08%)   (13.71%)
Average equity to average assets ratio    0.86%   1.26%   1.47%

 

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, 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 practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1250%. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets. Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. The Company and the Bank are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.

54
 

In July 2013, the federal bank regulatory agencies issued a final rule that has revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with certain standards that were developed by Basel III and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, such as the Bank, top-tier bank holding companies with total consolidated assets of $1 billion or more, and top-tier savings and loan holding companies, which we refer to below as “covered” banking organizations. Bank holding companies with less than $1 billion in total consolidated assets, such as the Company, are not subject to the final rule.

 

Beginning on January 1, 2015, the Bank became subject to the provisions of the new capital rules under Basel III, which revises Prompt Corrective Action (“PCA”) capital category thresholds to reflect new capital ratio requirements and introduces a Common Equity Tier 1 (“CET1”) ratio as a new PCA capital category threshold. Under the new rules, the minimum capital requirements for the Bank are now (i) a CET1 ratio of 4.5%, (ii) a Tier 1 risk-based capital ratio (CET1 plus Additional Tier 1 capital) of 6% (up from 4%) and (iii) a total risk-based capital ratio of 8% (which is unchanged from the prior requirement). The Bank is also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio. Under the revised PCA requirements, our leverage ratio will remain at the 4% level previously required. Beginning in 2016, a capital conservation buffer will phase in over three years, ultimately resulting in a requirement of 2.5% on top of the CET1, Tier 1 and total capital requirements, resulting in a required CET1 ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%.

 

Effective January 1, 2015, to be considered “well-capitalized” a bank is required to maintain a leverage capital ratio of at least 5%, a CET1 ratio of at least 6.5%, a Tier 1 risk-based capital ratio of at least 8%, and a total risk-based capital ratio of at least 10%. In addition, an institution (such as the Bank) cannot be considered well-capitalized if it is subject to any order or written directive to meet and maintain a specific capital level for any capital measure (such as the Consent Order). Under the Consent Order, the Bank is required to achieve and maintain Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets by May 27, 2011. As of December 31, 2015, the Bank is not in compliance with the capital requirements established in the Consent Order.

 

Tidelands Bancshares, Inc.

 

The following table sets forth the Company’s various capital ratios at December 31, 2015 and 2014.

 

 

   2015   2014 
Common Equity Tier 1    (3.22%)   N/A 
Leverage ratio    0.84%   1.81%
Tier 1 risk-based capital ratio    1.10%   2.45%
Total risk-based capital ratio    2.20%   4.91%

 

Tidelands Bank

 

The following table sets forth the Bank’s various capital ratios at December 31, 2015 and 2014. At December 31, 2015, the Bank was considered adequately capitalized.

 

 

   2015   2014 
Common Equity Tier 1    7.19%   N/A 
Leverage ratio    5.47%   5.67%
Tier 1 risk-based capital ratio    7.19%   7.70%
Total risk-based capital ratio    8.33%   8.95%
55
 

On February 22, 2006, Tidelands Statutory Trust (“Trust I”), a non-consolidated subsidiary of the Company, issued and sold floating rate capital securities of the trust, generating net proceeds of $8.0 million. The trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The junior subordinated debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. On October 10, 2006, we closed a public offering in which 1,200,000 shares of our common stock were issued at a purchase price of $15.00 per share. Net proceeds after deducting the underwriter’s discount and expenses were $16.4 million.

 

On June 20, 2008, Tidelands Statutory Trust II (“Trust II”), a non-consolidated subsidiary of the Company, issued and sold fixed/floating rate capital securities of the trust, generating proceeds of $6.0 million. Trust II loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The junior subordinated debentures qualify as Tier 1capital under Federal Reserve Board guidelines.

 

On December 19, 2008, we entered into the CPP Purchase Agreement with the U.S. Treasury, pursuant to which the Company issued and sold to Treasury (i) 14,448 shares of the Company’s Series T Preferred Stock, having a liquidation preference of $1,000 per share, and (ii) a ten-year warrant to purchase up to 571,821 shares of the Company’s common stock, par value $0.01 per share, at an initial exercise price of $3.79 per share, for an aggregate purchase price of $14,448,000 in cash. The Series T Preferred Stock qualifies as Tier 1 capital under Federal Reserve Board guidelines and was entitled to cumulative dividends at a rate of 5% per annum for the first five years, and beginning with the May 15, 2014 dividend date, is now entitled to a cumulative dividend at a rate of 9% per annum.

 

The Company began deferring dividend payments on the Series T Preferred Stock beginning with the dividend payment date of November 15, 2010. Although the Company is permitted to defer dividend payments, the dividend is a cumulative dividend and failure to pay dividends for six dividend periods triggered board appointment rights for the holder of the Series T Preferred Stock. The Company deferred its seventh dividend payment in May 2012. As such, the Treasury has appointed an observer to our Board of Directors. As of December 31, 2015, the amount of cumulative unpaid dividends on the Series T Preferred Stock was $5,462,068.

 

In December 2010, we began exercising our right to defer all quarterly distributions on our junior subordinated debentures related to our trust preferred securities of Trust I and Trust II. We were permitted to defer these interest payments for up to 20 consecutive quarterly periods, although interest continued to accrue on the junior subordinated debentures and interest on such deferred interest also accrued and compounded quarterly from the date such deferred interest would have been payable were it not for the extension period. However, all of the deferred interest, including interest accrued on such deferred interest, became due and payable at the end of the deferral period, which was on December 30, 2015. We did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under the Indentures. As a result, on March 8, 2016, we received notices of default from the trustee related to the junior subordinated debentures accelerating all principal and accrued interest and demanding payment of all such amounts from the Company. As of December 31, 2015, the total principal amount outstanding on the junior subordinated debentures plus accrued and unpaid interest was $18.2 million. All deferred distributions will continue to accrue interest and are cumulative. Therefore, in accordance with generally accepted accounting principles, the Company will continue to accrue the monthly cost of the trust preferred securities as it has since issuance.

 

We continue to search for additional capital, and we are also searching for a potential merger partner. Although we are pursuing both of these approaches simultaneously, there can be no assurances that we will either raise additional capital or find a merger partner. If we continue to decrease the size of the Bank or can maintain the Bank’s profitability, then we could achieve the capital ratios required under the Consent Order with less additional capital, although prospective investors would likely require us to raise materially more capital than these minimums, including sufficient funds to repay the Series T Preferred Stock and repay our junior subordinated debentures in full, including all accrued and unpaid interest. Under Federal Reserve policy, any new capital issued by the Company will likely be common stock, which will be subordinate to our senior securities, including the Series T Preferred Stock and junior subordinated debentures. Accordingly, it will be difficult for us to raise the additional capital that we need, even if we are able to negotiate reduced payments to these senior securities holders. In addition, any additional capital that we are able to raise will be highly dilutive to our existing common shareholders. There are no assurances that we will be able to raise this capital or find a merger partner.

56
 

If we cannot find a merger partner or raise additional capital to meet the Company’s requirement to repay the junior subordinated debentures in full, plus all accrued and unpaid interest, as demanded by the trustees recent notices of default on the junior subordinated debentures, and meet the minimum capital requirements set forth under the Consent Order, or if we suffer a continued deterioration in our financial condition, we could be forced into involuntary bankruptcy by the trustee or the holders of the trust preferred securities, or we could be placed into a federal conservatorship or receivership by the FDIC. If this were to occur, then our common shareholders will likely lose all of their investment in the Company, and the holders of our Series T Preferred Stock and junior subordinated debentures may lose all, or a material portion of, their investment in the Company. Our auditors have noted that the uncertainty of our ability to obtain sufficient capital raises substantial doubt about our ability to continue as a going concern. Please refer to Note 2 – “Going Concern Considerations and Regulatory Matters, “located in the notes to our consolidated financial statements.

 

Effect of Inflation and Changing Prices

 

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.

 

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

 

Off-Balance Sheet Risk

 

Commitments to extend credit are agreements to lend to a customer as long as the customer has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2015, unfunded commitments to extend credit were $19.1 million. A significant portion of the unfunded commitments related to consumer equity lines of credit. Based on historical experience, we anticipate that a significant portion of these lines of credit will not be funded. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

 

At December 31, 2015, there were commitments totaling approximately $502,000 under letters of credit. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.

 

Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements, or transactions that could result in liquidity needs or other commitments that significantly impact earnings.

 

Market Risk

 

Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.

 

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” and net interest income simulations. Interest sensitivity gap is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive. We are currently liability sensitive on a cumulative basis over the one year and three year horizon.

57
 

Approximately 28.3% of our loans were variable rate loans at December 31, 2015 and 73.2% of interest-bearing liabilities reprice within one year. However, interest rate movements typically result in changes in interest rates on assets that are different in magnitude from the corresponding changes in rates paid on liabilities. While a smaller portion of our loans reprice within a year, a larger majority of our deposits will reprice within a 12-month period. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

 

Liquidity and Interest Rate Sensitivity

 

The Company

 

Prior to the recent economic downturn, the Company, if needed, would have relied on dividends from the Bank as its primary source of liquidity. Currently, however, the Company has no available sources of liquidity. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company to meet its obligations, including paying dividends. In addition, the terms of the Consent Order previously discussed further limits the Bank’s ability to pay dividends to the Company to satisfy its funding needs. Unless the Company is able to raise capital, it will have no means of satisfying its funding needs. In addition, the Company will also need to raise additional capital to increase the Bank’s capital levels to meet the standards set forth by the FDIC in the Consent Order. Receivership by the FDIC is based on the Bank’s capital ratios rather than those of the Company. As of December 31, 2015, the Bank is categorized as adequately capitalized, but is not in compliance with the capital requirements in the Consent Order.

 

The Company’s ability to raise capital will depend on conditions in the capital markets, which are outside of the control of management, as well as the Company’s financial condition, business plan, regulatory status, management, customer activity and market trends. There is a risk the Company will not be able to raise the capital it needs at all or upon favorable terms. If the Company cannot raise this additional capital, management will not be able to implement parts of its business objectives.

 

The Company began deferring the payments of interest on its outstanding junior subordinated debentures beginning with the scheduled payment date of December 30, 2010. Our ability to defer these interest payments was limited to no longer than 20 consecutive quarterly periods. The Company did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under the Indentures. As a result, on March 8, 2016, we received notices of default from the trustee related to the junior subordinated debentures accelerating all principal and accrued interest and demanding payment of all such amounts from the Company. As of December 31, 2015, the total principal amount outstanding on the junior subordinated debentures plus accrued and unpaid interest was $18.2 million. We will not be able to pay this amount if we are not able to raise a sufficient amount of additional capital. Even if we succeed in raising this capital, we will have to be released from the FRB Agreement or obtain approval from the Federal Reserve Bank of Richmond to make such a payment. The trustee is evaluating all courses of action as a result of the events of default, and we could be forced into involuntary bankruptcy. In the event of our bankruptcy, dissolution or liquidation, the holders of the trust preferred securities must be satisfied before any distributions can be made on our common stock.

58
 

The Bank

 

Liquidity is our ability to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

At December 31, 2015 and December 31, 2014, our liquid assets, which consist of cash and due from banks, amounted to $13.9 million and $21.3 million, or 3.0% and 4.5% of total assets, respectively. Our available-for-sale securities at December 31, 2015 and December 31, 2014 amounted to $72.9 million and $82.3 million, or 15.6% and 17.3% of total assets, respectively. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $17.7 million of these securities are pledged against outstanding debt or borrowing lines of credit. Therefore, the related debt would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

 

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the generation of deposits. In addition, we receive cash upon the maturity and sale of loans and the maturity of investment securities. We are also a member of the Federal Home Loan Bank of Atlanta, from which applications for borrowings can be made for leverage or liquidity purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances. As of December 31, 2015, the Bank had a line of credit with Alostar Bank of Commerce of $6.0 million, Raymond James of $5 million, and $132,000 with the Federal Reserve Bank. These credit lines are currently secured by $6.6 million, $0, and $412,000, respectively in bonds as of December 31, 2015. The Raymond James line of credit is required to be secured by bonds prior to any disbursements. A line of credit is also available from the FHLB with a remaining credit availability of $62.4 million and an excess lendable collateral value of approximately $2.0 million at December 31, 2015.

 

Management believes the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, but if the Bank is unable to meet its liquidity needs, then the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed conservator or receiver.

 

Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. The asset/liability committee monitors and considers methods of managing exposure to interest rate risk. The asset/liability committee is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

 

Item 7A: Quantitative and Qualitative Disclosure about Market Risk.

Not required.

59
 

Item 8: Financial Statements and Supplementary Data.

 

INDEX TO AUDITED FINANCIAL STATEMENTS

 

TIDELANDS BANCSHARES, INC. AND SUBSIDIARY
   
Report of Independent Registered Public Accounting Firm F-2
   
Consolidated Balance Sheets as of December 31, 2015 and 2014 F-3
   
Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 2015 and 2014. F-4
   
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2015 and 2014 F-5
   
Consolidated Statements of Cash Flows for the years ended December 31, 2015 and 2014 F-6
   
Notes to Consolidated Financial Statements F-7
F-1
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors

Tidelands Bancshares, Inc. and Subsidiary

Charleston, South Carolina

 

 

We have audited the accompanying consolidated balance sheets of Tidelands Bancshares, Inc. and Subsidiary as of December 31, 2015 and 2014, and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for the years 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 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 audit to obtain reasonable assurance about whether the 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 financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.


In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tidelands Bancshares, Inc. and Subsidiary as of December 31, 2015 and 2014, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

As discussed in Notes 2 and 11, as of December 31, 2015 the Company has deferred interest payments on its junior subordinated debentures since December 30, 2010. Under the terms of the debentures, the Company may defer payments for up to 20 consecutive quarters without creating a default. Payment for the 20th quarter interest deferral period was due December 30, 2015. The Company failed to make that payment, the trustees of the corresponding trusts, would have the right, after any applicable grace period, to declare a default and exercise various remedies, including demanding immediate payment in full of the entire balance of outstanding principal and accrued interest of the debentures and pursuing further remedies as a result of the default. The total principal amount outstanding of the debentures and accrued interest as of December 31, 2015 is $14.4 million and $3.2 million, respectively. Our opinion is not modified with respect to this matter.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, as of December 31, 2015, the Company has deferred interest payments on its junior subordinated debentures since December 30, 2010. Under the terms of the debentures, the Company may defer payments for up to 20 consecutive quarters without creating a default. Payment for the 20th quarter interest deferral period became due December 30, 2015. The Company failed to make that payment, and the trustees of the corresponding trusts, have the right, after any applicable grace period, to declare a default and exercise various remedies, including demanding immediate payment in full of the entire balance of outstanding principal and accrued interest of the debentures and pursuing further remedies as a result of the default. The total principal amount outstanding of the debentures an accrued interest as of December 31, 2015 is $14.4 million and $3.2 million, respectively. This consideration raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans are further discussed in Note 2. These consolidated financial statements do not include any adjustments that would be necessary should the Company be unable to continue as a going concern.

 

/s/ Elliott Davis Decosimo, LLC

 

Columbia, South Carolina

March 21, 2016

F-2
 

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Balance Sheets

  

 

December 31,

  

 

December 31,

 
   2015   2014 
Assets:          
Cash and cash equivalents:          
Cash and due from banks  $5,733,049   $4,327,269 
Interest bearing balances   8,155,490    16,958,000 
Total cash and cash equivalents   13,888,539    21,285,269 
Securities available-for-sale   72,854,275    82,261,996 
Securities held-to-maturity   5,254,558     
Nonmarketable equity securities   895,950    905,400 
Total securities   79,004,783    83,167,396 
Mortgage loans held for sale   704,250     
Loans receivable   324,211,251    317,996,474 
Less allowance for loan losses   4,045,227    4,749,537 
Loans, net   320,166,024    313,246,937 
Premises, furniture and equipment, net   19,734,679    20,760,992 
Accrued interest receivable   1,145,963    1,308,204 
Bank owned life insurance   16,709,143    16,285,081 
Other real estate owned   12,752,533    17,518,665 
Other assets   2,128,829    2,008,077 
Total assets  $466,234,743   $475,580,621 
           
Liabilities:          
Deposits:          
Noninterest-bearing transaction accounts  $34,104,265   $26,743,189 
Interest-bearing transaction accounts   37,022,130    38,824,146 
Savings and money market accounts   105,963,416    102,113,233 
Time deposits $100,000 and over   154,672,973    162,898,316 
Other time deposits   88,747,198    97,534,837 
Total deposits   420,509,982    428,113,721 
           
Securities sold under agreements to repurchase   10,000,000    10,000,000 
Advances from Federal Home Loan Bank   9,000,000    9,000,000 
Junior subordinated debentures   14,434,000    14,434,000 
Accrued interest payable   3,565,369    3,159,215 
Other liabilities   6,778,562    5,532,996 
Total liabilities   464,287,913    470,239,932 
           
Commitments and contingencies-Note 6, 17, and 22          
           
Shareholders’ equity:          
Preferred stock, $.01 par value and liquidation value per share of $1,000, 10,000,000 shares authorized, 14,448 issued and outstanding   14,448,000    14,448,000 
Common stock, $.01 par value, 75,000,000 shares authorized; 4,277,176 shares issued and outstanding   42,772    42,772 
Common stock-warrant, 571,821 shares outstanding   1,112,248    1,112,248 
Capital surplus   41,550,104    41,550,104 
Retained deficit   (54,201,346)   (50,680,789)
Accumulated other comprehensive loss   (1,004,948)   (1,131,646)
Total shareholders’ equity   1,946,830    5,340,689 
Total liabilities and shareholders’ equity  $466,234,743   $475,580,621 

 

See accompanying notes to the consolidated financial statements.

F-3
 

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Statements of Operations and Comprehensive Income (Loss)

For the years ended December 31, 2015 and 2015

 

  

 

2015

  

 

2014

 
Interest income:          
Loans, including fees  $15,527,444   $16,029,854 
Securities available-for-sale, taxable   1,295,382    1,655,425 
Securities held-to-maturity, taxable   68,665     
Interest bearing deposits   43,443    36,141 
Other interest income   36,806    42,399 
Total interest income   16,971,740    17,763,819 
Interest expense:          
Time deposits $100,000 and over   2,175,613    2,243,718 
Other deposits   1,617,648    1,673,691 
Other borrowings   1,256,725    1,282,304 
Total interest expense   5,049,986    5,199,713 
Net interest income   11,921,754    12,564,106 
Provision for loan losses   1,175,000    71,000 
Net interest income after provision for loan losses   10,746,754    12,493,106 
           
Noninterest income:          
Service charges on deposit accounts   39,889    37,450 
Residential mortgage origination income   273,013    190,220 
Gain (Loss) on sale of securities available-for-sale   6,053    (32,118)
Loss on sale and disposal of other assets   (68,649)   (5,076)
Other service fees and commissions   612,546    519,096 
Increase in cash surrender value of BOLI   424,062    429,933 
Other   91,449    8,666 
Total noninterest income   1,378,363    1,148,171 
Noninterest expense:          
Salaries and employee benefits   6,810,720    6,081,635 
Net occupancy   1,549,511    1,521,391 
Furniture and equipment   1,051,407    1,022,172 
Other real estate owned (profit) expense, net   (234,237)   727,795 
Other operating   4,757,471    4,714,824 
Total noninterest expense   13,934,872    14,067,817 
Loss before income taxes   (1,809,755)   (426,540)
Income tax expense       4,000 
Net loss  $(1,809,755)  $(430,540)
Preferred dividends accrued   1,710,803    1,399,052 
Net loss available to common shareholders  $(3,520,558)  $(1,829,592)
           
Comprehensive Income (loss)            
Net loss  $(1,809,755)  $(430,540)
Unrealized gain (loss) on securities available-for-sale   210,403    3,477,510 
Reclassification adjustment for realized (gain) loss on securities    (6,053)   32,118 
Tax effect   (77,652)   (1,333,659)
Comprehensive income (loss)  $(1,683,057)  $1,745,429 
Loss per common share          
Basic loss per common share  $(0.83)  $(0.43)
Diluted loss per common share  $(0.83)  $(0.43)
Weighted average common shares outstanding          
Basic   4,259,936    4,212,770 
Diluted   4,259,936    4,212,770 
           

See accompanying notes to the consolidated financial statements.

F-4
 

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

For the years ended December 31, 2015 and 2014

 

  

Preferred Stock

   Common
Stock
   Common Stock   Unearned
ESOP
   Capital   Retained   Accumulated
other C
omprehensive
    
   Shares   Amount   Warrants   Shares   Amount   Shares   Surplus   (Deficit)   income (loss)   Total 
Balance, December 31, 2013   14,448   $14,448,000   $1,112,248    4,277,176   $42,772   $(1,183,898)  $42,708,140   $(48,851,197)  $(3,307,615)  $4,968,450 
Repayment of ESOP borrowings   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

         (1,158,036)             (1,158,036)
Preferred stock dividends accrued                                      (1,399,052)        (1,399,052)
Allocation of unearned ESOP shares                            1,183,898                   1,183,898 
Net loss                                      (430,540)        (430,540)

Other comprehensive income

 

                                           2,175,969    2,175,969 
                                                        
Balance, December 31, 2014    14,448   $14,448,000   $1,112,248    4,277,176   $42,772   $   $41,550,104   $(50,680,789)  $(1,131,646)  $5,340,689 
    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

                          
Preferred stock dividends accrued                                      (1,710,802)        (1,710,802)
Net loss                                      (1,809,755)        (1,809,755)

Other comprehensive income

 

                                           126,698    126,698 
                                                        
Balance, December 31, 2015    14,448   $14,448,000   $1,112,248    4,277,176   $42,772   $   $41,550,104   $(54,201,346)  $(1,004,948)  $1,946,830 

 

See accompanying notes to the consolidated financial statements.

F-5
 

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows

For the years ended December 31, 2015 and 2014

         
   2015   2014 
Cash flows from operating activities:          
Net loss  $(1,809,755)  $(430,540)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:          
Provision for loan losses   1,175,000    71,000 
Depreciation and amortization of premises, furniture and equipment   1,222,970    1,161,067 
Discount accretion and premium amortization, net   375,298    396,123 
Proceeds from sale of residential mortgages held-for-sale   12,510,019    10,382,947 
Disbursements for residential mortgages held-for-sale   (13,214,269)   (10,382,947)
Decrease in accrued interest receivable   162,241    193,175 
Increase in accrued interest payable   406,153    467,198 
Increase in cash surrender value of life insurance   (424,062)   (429,933)
Gain from sale of other real estate owned   (880,375)   (399,812)
(Gain) Loss from sale of securities available-for-sale   (6,053)   32,118 
Loss from sale and disposal of other assets   68,299    5,076 
Decrease in carrying value of other real estate owned   54,797    574,244 
Increase in other assets   (198,404)   (146,034)
Decrease in other liabilities   (465,236)   (12,378)
Net cash provided (used) by operating activities   (1,023,377)   1,481,304 
Cash flows from investing activities:          
Purchases of securities available-for-sale   (10,999,216)   (10,720,979)
Purchases of securities held-to-maturity   (5,280,631)    
Proceeds from sales of securities available-for-sale   7,227,111    2,771,695 
Proceeds from calls, maturities, and paydowns of securities available-for-sale   13,028,386    9,979,470 
Proceeds from calls, maturities, and paydowns of securities held-to-maturity   22,069     
Net (increase) decrease in loans receivable   (9,846,434)   7,138,877 
Proceeds from sale of other real estate owned   7,344,057    5,605,556 
Purchase of premises, furniture and equipment, net   (264,956)   (865,253)
Net cash provided by investing activities   1,230,386    13,909,366 
Cash flows from financing activities:          
Net increase in demand deposits, interest-bearing transaction accounts and
savings accounts
   9,409,242    9,092,809 
Net decrease in certificates of deposit and other time deposits   (17,012,981)   (17,902,569)
Repayment of FHLB advances       (4,000,000)
Repayment of ESOP borrowings       (600,000)
Decrease in unearned ESOP shares       25,862 
Net cash used for financing activities   (7,603,739)