10-K 1 d30273.htm 10-K



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X]  
  Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For The Fiscal Year Ended: December 31, 2012.

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 000-51907

Independence Bancshares, Inc.
(Exact name of registrant as specified in its charter)

South Carolina
           
20-1734180
(State or other jurisdiction of incorporation or organization)
           
(I.R.S. Employer Identification No.)
 
500 E. Washington Street, Greenville
           
29601
(Address of principal executive offices)
           
(Zip Code)
864-672-1776
 
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
 


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 Website, 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 (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]

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

Large accelerated filer  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 Act). Yes o  No [X]

The estimated aggregate market value of the Common Stock held by non-affiliates (shareholders holding less than 5% of an outstanding class of stock, excluding directors and executive officers) of the Company on December 31, 2012 was $1,751,553. This calculation was based upon an estimate of the fair market value of the Common Stock of $.161 per share, which was the price of the last trade of which management was aware prior to June 30, 2012.

The number of shares outstanding of the issuer’s common stock, as of March 27, 2013, was 19,733,760.

DOCUMENTS INCORPORATED BY REFERENCE

None.





PART I

Item 1. Business.

This report, including information included or incorporated by reference in this document, 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. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated 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. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in our forward-looking statements include, but are not limited, to the following:

•  
  our ability to comply with our Consent Order (as defined below), including the capital directive therein, and potential regulatory actions if we fail to comply;

•  
  examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets;

•  
  changes in economic conditions resulting in, among other things, a deterioration in credit quality;

•  
  credit losses as a result of declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

•  
  credit losses due to loan concentration;

•  
  changes in the amount of our loan portfolio collateralized by real estate and weakness in the real estate market;

•  
  the rate of delinquencies and amount of loans charged-off;

•  
  the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

•  
  the rate of loan growth in recent years and the lack of seasoning of our loan portfolio;

•  
  our ability to attract and retain key personnel;

•  
  our ability to retain our existing customers, including our deposit relationships;

•  
  increases in competitive pressure in the banking and financial services industries;

•  
  adverse changes in asset quality and resulting credit risk related losses and expenses;

•  
  changes in the interest rate environment which could reduce anticipated or actual margins;

•  
  changes in political conditions or the legislative or regulatory environment, including governmental initiatives affecting the financial services industry;

•  
  changes occurring in business conditions and inflation;

•  
  changes in access to funding or increased regulatory requirements with regard to funding;

•  
  changes in deposit flows;

•  
  changes in technology;

•  
  increased cybersecurity risks, including potential business disruptions or financial losses;

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•  
  changes in monetary and tax policies; and

•  
  changes in accounting policies and practices.

If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, or implied or projected by, such forward-looking statements. For information with respect to factor that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part 1, Item 1A of this Annual Report on Form 10-K. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Annual Report on Form 10-K. We make these forward-looking statements as of the date of this document, and we do not intend, or assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements.

General

Independence Bancshares, Inc. (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Banking and Branching Efficiency Act of 1996, and to own and control all of the capital stock of Independence National Bank (the “Bank”). Our Bank is a national association organized under the laws of the United States and provides community banking services to consumers and small- to mid-size businesses, principally in Greenville County, South Carolina. The Bank opened for business on May 16, 2005.

Recent Developments

On December 31, 2012, we issued 17,648,750 shares of common stock at a price of $0.80 per share to certain accredited and unaccredited investors, including members of our board of directors, for gross proceeds of approximately $14.1 million (the “Private Placement”). Upon closing the Private Placement, we made a capital contribution of $2.25 million to the Bank in order to increase the Bank’s capital levels above the amounts specified in the Bank’s consent order (the “Consent Order”) with the Office of the Comptroller of the Currency (the “OCC”). The Company also paid Hovde Securities, LLC, a FINRA registered broker-dealer, a cash payment of approximately $532,000, which represented a 6% commission of some of the gross proceeds from the Private Placement. We plan to provide our current shareholders with an opportunity to purchase up to approximately 2.35 million shares of our common stock through a follow-on public offering at the same offering price of $0.80 per share that we offered to the investors in the Private Placement. In addition, we granted registration rights to the investors in the Private Placement.

We intend to use the remaining proceeds of the Private Placement and from the follow-on public offering to our shareholders to explore payments and transaction services business opportunities, using our national bank charter, our management team, and our competitive focus. To the extent we propose to offer these services through the Bank, under the Consent Order, the Bank must obtain approval from the OCC in order to expand our business model to take advantage of these opportunities. There can be no assurance that the Bank will receive approval or be successful in implementing the steps necessary to expand its business model. Regardless of whether we expand our business model, we will continue serving as a full-service traditional community bank, fulfilling the financial needs of individuals and small business owners in our existing market area. We will continue to provide traditional checking and savings products and commercial, consumer and mortgage loans to the general public, as well as ATM and online banking services, commercial cash management, remote deposit capture, safe deposit boxes, bank official checks, traveler’s checks, and wire transfer capabilities.

We intend to augment our board of directors and management team with senior industry professionals with banking, payment, credit, technology and wireless telecommunications expertise who will work with our current directors and executive officers to manage the implementation of our payments and transaction services business and to provide oversight to the Bank in core operating areas. In August 2012, we engaged

2




Gordon A. Baird as a consultant to the Company and the Bank to advise us with respect to the development of our payments and transaction services business, and effective December 31, 2012, Mr. Baird joined the Company as its chief executive officer and a director. Lawrence R. Miller stepped down from his role as the Company’s president and chief executive officer but continues as the president and chief executive officer of the Bank.

Mr. Baird has had an extensive career in banking and financial services, as well as in building new financial services businesses. He began his career in 1990 at John Hancock Real Estate Finance and continued it at State Street Bank and Trust Company and Citigroup Global Markets, Inc. Mr. Baird also served as an operating advisor to Thomas H. Lee Partners from January 2011 until December 31, 2012. In addition, he founded MPIB Holdings LLC in July 2011 to develop the business plan, contracts, technology strategy, regulatory plan and marketing efforts for a global digital payments and transaction services, mobile banking and finance business. Mr. Baird also serves as the chairman of the audit committee and as a board member of the Macquarie Global Infrastructure Total Return Fund, a NYSE-listed investment company. Mr. Baird is a chartered financial analyst, a member of the New York Security Analyst Society, and a graduate of Emory University.

As noted above, Mr. Baird founded MPIB Holdings, LLC (“MPIB”) in July 2011 to focus on digital payments, mobile banking and consumer finance. Since that time, MPIB has been developing a business model for transaction and payment services and holding discussions regarding the business with retailers and other potential customers. We are currently negotiating an arm’s-length agreement with MPIB under which we would obtain the right to acquire MPIB or its assets, including its intellectual property, customer agreements and relationships. Any such acquisition would be subject to our obtaining any required regulatory approvals. If we are able to negotiate an agreement with MPIB on terms that we find acceptable, we hope to acquire the exclusive option to purchase MPIB or its assets in return for an upfront fee and certain earnout payments, the terms of which are still being negotiated. It is expected that any upfront fee would not exceed $7 million, and any earnout payments would not exceed 7% of the revenue generated by any digital payments business over a period of not longer than seven years. Further, we anticipate that any such earnout payments would only be due once our digital payments business has generated revenue over a minimum threshold. We would also anticipate receiving a license to use MPIB’s intellectual property and other assets on an interim basis, for no additional fees, until we elect whether to exercise our purchase option. We anticipate that if any proposed changes to our business model do not receive regulatory approval, or we enter into a license agreement but elect not to exercise an option to purchase MPIB’s intellectual property, any temporary license would terminate.

Subject to regulatory approval, we also expect to appoint Robert B. Willumstad and Alvin G. Hageman as new members of the board of directors of the Company, with Mr. Willumstad becoming the new chairman. Mr. Willumstad has over 35 years of experience in the banking and financial services industry, and he presently serves as a partner with Brysam Global Partners, a specialty private equity firm that focuses in financial services, which he co-founded in 2005. Mr. Willumstad also previously served as the chairman, and briefly as chief executive officer, of American International Group until 2008. Prior to that, he held positions as president and chief operating officer, as well as a director, at Citigroup. Mr. Willumstad also served for over 20 years with Chemical Bank in various capacities of operations, retail banking and computer systems. Previously, Mr. Hageman spent 25 years at Citigroup managing multiple Citigroup regional offices and ultimately co-headed the Global Securitization, Asset-backed and Mortgage Group, while located in New York, London, Tokyo, and Hong Kong. In addition to Mr. Willumstad and Mr. Hageman, we anticipate adding other individuals to our board of directors and management team, including a chief operations officer and one or more senior technology professionals, to support both the payments business and our traditional banking business.

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Community Banking Services

Market

Our primary focus and target market is to fulfill the financial needs of small business owners, the legal community, the medical community, insurance agencies, and clients owning and developing income producing properties primarily in the City of Greenville and the broader Greenville metropolitan area. In the past, we have also focused on real estate developers, including clients involved in residential construction and acquisition/development; however due to the current real estate market, we have limited our focus in these areas over the last several years. We intend to use our “closeness” to the market via local ownership, quick response time, pricing discretion, person to person relationships and an experienced, well known senior management team in leveraging our market share in the greater Greenville area while looking for ways to differentiate the Bank from our competition.

Location and Service Area

Our primary market is Greenville County, which is located in the upstate region of South Carolina. The cities of Fountain Inn, Greenville, Greer, Mauldin, Simpsonville, and Travelers Rest make up Greenville County. The Greenville metropolitan area, positioned on the I-85 corridor, is home to one of the nation’s largest concentrations of international investment. Greenville County has a population of approximately 450,000, with a five-year projected growth rate of almost 2%. The area’s demographics have changed considerably over the past 10 years and currently over 19,000 businesses are operating within the county limits.

Our main office is located in Greenville, one block off a major artery, and provides excellent visibility for the Bank. We also have full-service branches on Wade Hampton Boulevard in Taylors, South Carolina and in Simpsonville, South Carolina. These branch offices have extended the market reach of our Bank and have increased our personal service delivery capabilities to all of our customers. We plan to continue to take advantage of existing contacts and relationships with individuals and companies in this area to more effectively market the community banking services of the Bank.

Competition

The Greenville market is highly competitive, with all of the largest banks in the state, as well as super regional banks, represented in our market area. The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits. In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies. Size gives larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina. As a result, we do not generally attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and individuals. We believe we have competed effectively in this market by offering quality and personal service.

Banking Services

The Bank is primarily engaged in the business of accepting demand and time deposits and providing commercial, consumer and mortgage loans to the general public. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to a maximum amount, which is currently set at $250,000 per depositor. Other services which the Bank offers include online banking, commercial cash management, remote deposit capture, safe deposit boxes, bank official checks, traveler’s checks, and wire transfer capabilities.

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Credit Cards

Independence National Bank offers MasterCard branded credit cards for personal and business clients in coordination with a third party vender known as Card Assets, LLC. Credit cards are offered with no annual fee and have reward options available for cash back or reward points redeemable for airfare, merchandise and gift cards. Clients enjoy the freedom of MasterCard acceptance worldwide with available 24/7 customer support as well as protection and security services.

Merchant Services

Independence National Bank offers merchant transaction processing and equipment for clients in coordination with a third party vender known as Merchants’ Choice Payment Solutions. Clients enjoy the capability, as well as the specialized equipment, to accept popular debit and credit card transactions to conduct business with speed, ease and security. Clients are able to accept payments from Visa, MasterCard, American Express and Discover. Equipment and services available include POS terminals, wireless units, web based processing, on-line debit and TeleCheck services.

Lending Activities

General. We emphasize a range of lending services, including commercial, real estate, and equity-line consumer loans to 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 area. The larger, well-established banks in our service area make proportionately more loans to medium- to large-sized businesses than we do. Our small- to medium-sized borrowers may be less able to withstand competitive, economic, and financial conditions than larger borrowers. Our underwriting standards vary for each type of loan, as described below. We compete for these loans with competitors who are well established in our service area and have greater resources and lending limits.

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 client lending limits, a multi-layered approval process for larger loans, documentation examination, and follow-up procedures for 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 considered by an executive officer with a higher lending limit, executive officers combining authority or the directors’ loan committee. We do not make any loans to any director or executive officer of the Bank unless the loan is approved by the full Board of Directors of the Bank and is on terms not more favorable than would be available to a person not affiliated with the Bank.

Credit Administration and Loan Review. We maintain a continuous loan review system. We also apply a credit grading system to each loan, and we use an independent consultant to review the loan files on a test basis to confirm our loan grading. 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.

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. These limits will increase or decrease in response to increases or decreases in the Bank’s level of capital. We are able to sell participations 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 clients requiring extensions of credit in excess of these limits.

Real Estate Mortgage Loans. The principal component of our loan portfolio is loans secured by real estate mortgages. We obtain a security interest in real estate whenever possible, in addition to any other

5




available collateral, in order to increase the likelihood of the ultimate repayment of the loan. At December 31, 2012, loans secured by first or second mortgages on real estate made up approximately 83% of our loan portfolio.

These loans will generally fall into one of four categories: commercial real estate loans, construction and development loans (including land loans), residential real estate loans, or home equity loans. Most of our real estate loans are secured by residential or commercial property. Interest rates for all categories may be fixed or adjustable, and will more likely be fixed for shorter-term loans. We generally charge an origination fee for each loan. Other loan fees consist primarily of late charge fees. 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, credit-worthiness, and ability to repay the loan.

•  
  Commercial Real Estate Loans. Commercial real estate 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 their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 85%. We generally require that debtor cash flow exceed 120% of monthly debt service obligations. We typically review all of the personal financial statements of the principal owners and require their personal guarantees. These reviews generally reveal secondary sources of payment and liquidity to support a loan request.

•  
  Construction and Development Real Estate Loans (Including Land Loans). We offer adjustable and fixed rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own home. The term of construction and development loans generally is limited to eighteen months, although payments may be structured on a longer amortization basis. Most loans will mature and require payment in full upon the sale of the property. We believe that construction and development loans generally carry a higher degree of risk than long term financing of existing properties. Repayment depends on the ultimate completion of the project and usually on the sale of the property. 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.

   
  We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We also may reduce risk by selling participations in larger loans to other institutions when possible.

•  
  Residential Real Estate Loans and Home Equity Loans. We generally do not originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. Generally, we limit the loan-to-value ratio on our residential real estate loans to 80%. We offer fixed and adjustable rate residential real estate loans with terms of up to 30 years. We typically offer these fixed rate loans through a third party rather than originating and retaining these loans ourselves. We typically originate and retain residential real estate loans only if they have adjustable rates. We also offer home equity lines of credit. Our underwriting criteria and the

6




  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 fifteen years or less. We generally limit the extension of credit to 90% of the available equity of each property, although we may extend up to 100% of the available equity.

Commercial Business Loans. We make loans for commercial purposes in various lines of businesses. Commercial 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 security may be difficult to assess and more likely to decrease than real estate.

Equipment loans typically will be made for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Generally, we limit the loan-to-value ratio on these loans to 80% or less. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange will generally be handled through a correspondent bank as agent for the Bank.

Consumer Loans. 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 terms negotiable. Our installment loans typically amortize over periods up to 60 months. We will offer consumer loans with a single maturity date when a specific source of repayment is available. We typically require monthly payments of interest and a portion of the principal on our revolving loan products. 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.

Deposit Services

Our principal source of funds is core deposits. We offer a full range of deposit services, including checking accounts, commercial accounts, NOW accounts, savings accounts, and time deposits of various types, ranging from daily money market accounts to long-term certificates of deposit. We solicit these accounts from individuals, businesses, associations, organizations and governmental authorities. Deposit rates are reviewed regularly by senior management of the Bank. We believe that the rates we offer are competitive with those offered by other financial institutions in our area.

Other Community Banking Services

We offer other community bank services including cashier’s checks, banking by mail, direct deposit, remote deposit capture, United States Savings Bonds, and travelers’ checks. We earn fees for most of these services, in addition to fees earned from debit and credit card transactions, sales of checks, and wire transfers. We are associated with the Plus and Star ATM networks, which are available to our clients throughout the country. We offer merchant banking and credit card services through a correspondent bank. We also offer internet banking services, bill payment services, and cash management services.

Market Share

As of June 30, 2012, the most recent date for which market data is available, total deposits in the Bank’s primary service area were over $11.2 billion, a decrease of approximately 13% from $12.9 billion as of June 30, 2011. At June 30, 2012, the Bank’s deposits represented 0.86% of the market, increasing from 0.78% at June 30, 2011.

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Mobile Payments Business

Our Strategy

With certain forms of digital payments in the United States growing, check usage decreasing, and more than half of consumer transactions in the United States still being initiated in cash, we believe there are great opportunities for specialized business efforts configured to service the digital payment and transaction services industry. We also believe the lower cost and deeper potential penetrations of mobile banking and payments enabled by smart phones will accelerate a shift toward mobile payments among the large unbanked/under-banked segment, which is estimated by the FDIC to include over 60 million consumers in the United States.

After we resolve our consent order and subject to obtaining any necessary regulatory approvals, we anticipate servicing telecommunications companies, consumer technology companies, retailers, and small to medium size banks and finance companies with an integrated, cost efficient gateway to a digital payments infrastructure. The markets in which we expect to compete are characterized by rapid technological change, shifting customer needs, and frequent new product introductions and enhancements by competitors. Our success will depend on our ability to respond rapidly to these changes with new business models, updated competitive strategies, new or enhanced products and services and other changes in the way we do business.

Research and Development

We have made and plan to continue to make substantial investments in research and development, and we expect to focus our future research and development efforts on enhancing existing products and services and on developing new products and services, including new mobile and global offerings. We also expect to continue to focus significant research and development efforts on ongoing projects to update the technology platforms for several of our offerings. There were no research and development expenses in 2012 and 2011.

Employees

As of March 27, 2013, we had 25 full-time employees and one part-time employee.

Corporate Information

Our corporate headquarters is located at 500 East Washington Street, Greenville, South Carolina, 29601, and our telephone number is (864) 672-1776. Our Bank website is located at www.independencenb.com. The information on our website is not incorporated by reference into this report.

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any reports, statements or other information that we file at the SEC’s public reference facilities at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at (800) SEC-0330 for further information regarding the public reference facilities. The SEC maintains a website, http://www.sec.gov, which contains reports, proxy statements and information statements and other information regarding registrants that file electronically with the SEC, including us. Our SEC filings are also available to the public from commercial document retrieval services.

You may also request a copy of our filings at no cost by writing to us at Independence Bancshares, Inc., 500 East Washington Street, Greenville, South Carolina, 29601, Attention: Ms. Martha L. Long, Chief Financial Officer, or calling us at: (864) 672-1776.

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Supervision and Regulation

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions on and provide for general regulatory oversight of virtually all aspects of our operations. These laws and regulations are generally intended to protect depositors, federal insurance deposit funds, and the banking system as a whole, not for the protection of shareholders. Changes in applicable laws or regulations may have a material effect on our business and prospects.

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. The following summary is qualified by reference to the statutory and regulatory provisions discussed.

Consent Order

On November 14, 2011, the Bank entered into the Consent Order with its primary regulator, the OCC, which, among other things, contains a requirement that the Bank maintain minimum capital levels that exceed the minimum regulatory capital ratios for “well-capitalized” banks. The minimum capital ratios for a bank are generally 8% for total capital, 4% for Tier 1 capital and 4% for leverage. To be eligible to be classified as “well-capitalized,” a bank must generally maintain a total capital ratio of 10% or more, a Tier 1 capital ratio of 6% or more, and a leverage ratio of 5% or more. The Consent Order required the Bank to achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012. The Bank did not achieve these higher capital requirements by March 31, 2012, and as a result, the OCC deemed the Bank not to be in compliance with a majority of the Articles in the Consent Order, all of which were dependent on the Bank achieving these higher capital requirements. On December 31, 2012, in connection with the closing of the Private Placement, the Company made a capital contribution of $2.25 million to the Bank. As a result, the Bank’s capital levels are now above the higher minimum capital levels imposed by the OCC in the Consent Order, and the Bank is in compliance with a majority of the Articles in the Consent Order. Nevertheless, as long as the higher minimum capital levels imposed by the Consent Order remain in effect, the Bank will not be deemed to be “well-capitalized”. As of December 31, 2012, the Bank was considered “adequately capitalized”.

The Consent Order also includes several specific requirements for the Bank which are designed to strengthen the Bank’s financial condition. The Board of Directors and management of the Bank have been aggressively working, and will continue to diligently work, to comply with all the requirements of the Consent Order. A summary of the requirements of the Consent Order and the Bank’s status on complying with the Consent Order is as follows:

Requirements of the Consent Order


  
Bank’s Compliance Status
The Compliance Committee, which was established by the Board of Directors pursuant to the Formal Agreement, shall continue to be responsible for monitoring and coordinating the Bank’s adherence to the provisions of the Consent Order. The Compliance Committee is required to meet at least monthly to review progress and status of actions needed to achieve full compliance with each article of the Consent Order and report this information to the Board.
           
The Bank is currently in compliance with this requirement of the Consent Order.

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Requirements of the Consent Order


  
Bank’s Compliance Status
Review and revise, within 60 days of the effective date of the Consent Order, the assessment of Board supervision being provided to the Bank, which was previously required and provided to the OCC under the Formal Agreement.
           
The Bank is currently in compliance with this requirement of the Consent Order.
Update, within 60 days of the effective date of the Consent Order, the written assessment of the capabilities of the Bank’s current management to perform present and anticipated duties and who have sufficient experience to address problem bank situations.
           
The Bank is currently in compliance with this requirement of the Consent Order.
Complete, within 90 days of the effective date of the Consent Order, a written analysis on the Board’s decision whether to sell, merge or liquidate the Bank or remain an independent national bank. In the event the Board decides the Bank is to remain independent, and the OCC has advised the Bank in writing that there is no supervisory objection to the Bank’s written analysis as outlined in the Consent Order, the Board must, within thirty (30) days thereafter, review and revise as necessary, and adopt, implement, and thereafter ensure Bank adherence to an updated written Strategic Plan for the Bank covering at least a three-year period.
           
We have completed all the requirements of this article, but we are considered to be in non-compliance until all articles are in compliance.
Achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012.
           
As a result of the capital contribution of $2.25 million from the Company to the Bank on December 31, 2012, we exceeded the required levels. However, we are not considered in compliance until the Bank returns to sustained core earnings.
Revise and revise as necessary, adopt, and implement, within 90 days of the effective date of the Consent Order, and thereafter ensure Bank adherence to a written Profit Plan to improve and sustain the earnings of the Bank.
           
The Bank has revised and submitted a new profit plan. The OCC says we will remain non-compliant until we have returned to sustained core earnings.
Review and revise as necessary, within 60 days of the effective date of the Consent Order, and thereafter maintain a comprehensive liquidity risk management program which assesses, on an ongoing basis, the Bank’s current and projected funding needs, and ensures that sufficient funds or access to funds exist to meet those needs.
           
The Bank is currently in compliance with this requirement of the Consent Order.

10



Requirements of the Consent Order


  
Bank’s Compliance Status
Develop and implement, within 90 days of the effective date of the Consent Order, and thereafter ensure Bank adherence to a written program to reduce the high level of credit risk in the Bank. The program shall include, but not be limited to procedures which strengthen credit underwriting; management of credit operations and the maintenance of an adequate, qualified staff in all loan functional areas; and loan collections. At least quarterly, the Board shall prepare a written assessment of the Bank’s credit risk, which shall evaluate the Bank’s progress under the aforementioned program.
           
The Bank has completed all requirements except the reduction of classified assets. Therefore, the OCC has deemed the Bank in non-compliance until the adversely classified index is lowered.
Extend credit, directly or indirectly, including renewals, modifications or extensions, to a borrower whose loans or other extensions of credit exceed $300,000 and are criticized by the OCC or any other bank examiner, only after the Board or designated committee finds that the extension of additional credit is necessary to promote the best interests of the Bank, the Bank has performed an appropriate written credit and collateral analysis, and the Board’s formal plan to collect or strengthen the criticized asset will not be compromised by the extension of additional credit.
           
The Bank is currently in compliance with this requirement of the Consent Order.
Continue to ensure adherence to the Bank’s comprehensive policy for determining the adequacy of the Bank’s allowance for loan losses in accordance with Generally Accepted Accounting Principles (“GAAP”).
           
The Bank is currently in compliance with this requirement of the Consent Order.
Review and revise as necessary, adopt, and implement, within 60 days of the effective date of the Consent Order, and thereafter ensure adherence to a written program to improve the Bank’s loan portfolio management.
           
The Bank is currently in compliance with this requirement of the Consent Order.
Review and revise as necessary, adopt, and implement, within 60 days of the effective date of the Consent Order, and thereafter ensure adherence to a written concentration management program to improve the Bank’s policies and procedures to control and monitor concentrations of credit.
           
The Bank is currently in compliance with this requirement of the Consent Order.
Obtain, within 60 days of the effective date of the Consent Order (and thereafter, within 60 days from the receipt of any Report of Examination or other applicable correspondence from the OCC or any internal or external loan review), current and complete credit information on all loans lacking such information, including those criticized by the OCC or any other bank examiner.
           
The Bank is currently in compliance with this requirement of the Consent Order.

11



Requirements of the Consent Order


  
Bank’s Compliance Status
Ensure, within 60 days of the effective date of the Consent Order (and thereafter, within 60 days from the receipt of any Report of Examination or other applicable correspondence from the OCC or any internal or external loan review), that proper collateral documentation is maintained on all loans and correct each collateral exception listed by the OCC or any other bank examiner.
           
The Bank is currently in compliance with this requirement of the Consent Order.
Effective immediately, the Bank may grant, extend, renew, alter or restructure any loan or other extension of credit only after: (1) documenting the specific reason or purpose for the extension of credit; (2) identifying the expected source of repayment in writing; (3) structuring the repayment terms to coincide with the expected source of repayment; (4) obtaining and analyzing current and satisfactory credit information, including cash flow analysis, where loans are to be repaid from operations; and (5) documenting, with adequate supporting material, the value of collateral and properly perfecting the Bank’s lien on it where applicable.
           
The Bank is currently in compliance with this requirement of the Consent Order.
 

We intend to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof, we believe we have submitted all documentation required as of this date to the OCC. We believe we are currently in compliance with the requirements of the Consent Order except for the parts dealing with asset quality and consequently, the impact that has on capital, strategic plan, and profitability. We are working to improve the quality of the Bank’s balance sheet by reducing our adversely classified index. This reduction can be achieved by enforcing our contractual rights under respective loan documents, the repossession and sale of related collateral, improving market conditions of the collateral or borrower status, the transfer of assets to the Company, or single or bulk asset sales of our classified assets. We intend to work with the OCC to determine how much of our adversely classified portfolio we may dispose of and when the disposition should be made to permit the Bank to be in compliance with this requirement and, ultimately, released from the Consent Order. However, the determination of our compliance will be made by the OCC, and there can be no assurance that the OCC will determine that we are in compliance with the provisions of the Consent Order as described above. Failure to meet the requirements of the Consent Order could result in additional enforcement remedies, including civil money penalties and/or sanctions as the OCC considers appropriate, which could have a material impact on our financial condition. In addition, the OCC may amend the Consent Order based on the results of their ongoing examinations of the Bank.

In connection with execution of the Consent Order, which supersedes the Formal Agreement, dated January 20, 2010, previously entered between the Bank and the OCC (the “Formal Agreement”), the OCC terminated the Formal Agreement, effective as of November 14, 2011.

Currently, the Company must obtain the prior written approval of the Federal Reserve Bank of Richmond before declaring or paying any dividends, directly or indirectly accepting dividends or any other form of payment representing a reduction in capital from the Bank, making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities, directly or indirectly, incurring, increasing or guaranteeing any debt, and directly or indirectly, purchasing or redeeming any shares of its stock. Pursuant to our plans to preserve capital, the Company has no plans to undertake any of the foregoing activities.

12



Regulatory Developments

The Congress, Treasury, and the federal banking regulators have taken broad actions since September 2008 to address the volatility and disruption in the U.S. banking system, including, among others, the enactment of the Emergency Economic Stabilization Act on October 3, 2008, and the American Recovery and Reinvestment Act on February 17, 2009. Some of the more recent actions that may have impact upon the Company and the Bank include the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and the Basel Committee on Banking Supervision’s new capital and liquidity requirements for banking organizations (“Basel III”), which are described below.

On July 21, 2010, the U.S. President signed into law the Dodd-Frank Act, a comprehensive regulatory framework intended to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act created a new Financial Stability Oversight Council to identify systemic risks in the financial system and to recommend to the federal regulators new and increasingly strict rules for capital, leverage, liquidity, risk management, and other requirements. In addition, the Dodd-Frank Act also created a new independent federal regulator to be responsible for implementing, examining, and enforcing compliance with federal consumer financial laws. While some of the provisions of the Dodd-Frank Act were effective immediately, many of the provisions of the Dodd-Frank Act have delayed effective dates and require many new rules to be made by various federal regulatory agencies over the next several years. Accordingly, much uncertainty remains as to the ultimate impact of the Dodd-Frank Act until final rulemaking is complete, which could have a material adverse impact either on the financial services industry as a whole or on our business, financial condition, results of operations, and cash flows. The following discussion summarizes certain significant aspects of the Dodd-Frank Act that are most relevant to the Company and the Bank:

•  
  The Dodd-Frank Act requires the Federal Reserve Board to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.

•  
  The Dodd-Frank Act permanently increased the maximum deposit insurance amount for financial institutions to $250,000 per depositor and extended unlimited deposit insurance to noninterest bearing transaction accounts through December 31, 2012. The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. In addition, the Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Effective as of July 21, 2011, the Dodd-Frank Act eliminated the federal statutory prohibition against the payment of interest on business checking accounts.

•  
  The Dodd-Frank Act requires publicly traded companies to give shareholders a nonbinding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The new legislation also authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the institution is publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

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•  
  Effective as of July 21, 2011, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto.

•  
  The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.

•  
  Effective as of July 21, 2012, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates. The Dodd-Frank Act applies Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. Historically, an exception has existed that exempts covered transactions between depository institutions and their financial subsidiaries from the 10% of capital and surplus limitation set forth in Section 23A. However, the Dodd-Frank Act eliminated this exception for covered transactions entered into after July 21, 2012. Effective as of July 21, 2011, the Dodd-Frank Act also prohibits an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

•  
  The Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer. Effective on October 1, 2011, the Federal Reserve Board set new caps on interchange fees at $0.21 per transaction, plus an additional five basis-point charge per transaction to help cover fraud losses. An additional $0.01 per transaction is allowed if certain fraud-monitoring controls are in place. While the restrictions on interchange fees do not apply to banks that, together with their affiliates, have assets of less than $10 billion, such as the Company, the new restrictions could negatively impact bank card services income for smaller banks if the reductions that are required of larger banks cause industry-wide reduction of swipe fees.

•  
  As noted above, the Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Depository institutions with less than $10 billion in assets, such as the Bank, will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act also authorizes 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 Dodd-Frank Act,

14




  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. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. On January 10, 2013, the CFPB published final rules to, among other things, define “qualified mortgage” and 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 the loan’s monthly payments. For example, the rules 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 provide further examples of third-party documents that may be relied on for such verification, such as government records and check-cashing or funds-transfer service receipts. The new rules will take effect on January 10, 2014. The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

Internationally, both the Basel Committee on Banking Supervision and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and liquidity buffers within the banking system. On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with full implementation by January 2019. In December 2010, the Basel Committee issued the Basel III rules text, outlining the details and timelines of global regulatory standards on bank capital adequacy and liquidity. On June 7, 2012, the Federal Reserve requested comment on three proposed rules that, taken together, would establish an integrated regulatory capital framework implementing the Basel III rules in the United States. As proposed, the U.S. implementation of Basel III would lead to significantly higher capital requirements and more restrictive leverage and liquidity ratios than those currently in place. The proposed rules indicated that the final rule would become effective on January 1, 2013, and the changes set forth in the final rules would be phased in from January 1, 2013 to January 1, 2019. However, due to the volume of public comments received, the final rule did not go into effect on January 1, 2013. The ultimate impact of the U.S. implementation of the new capital and liquidity standards on the Company and the Bank is currently being reviewed and is dependent upon the terms of the final regulations, which may differ from the proposed regulations. At this point, we cannot determine the ultimate effect that any financial regulations, if enacted, would have upon our earnings or financial condition. In addition, important questions remain as to how the numerous capital and liquidity mandates of the Dodd-Frank Act will be integrated with the requirements of Basel III.

Although it is likely that further regulatory actions may arise as the federal government continues to attempt to address the economic situation, 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 in the future.

Independence Bancshares, Inc.

We own 100% of the outstanding capital stock of the Bank, and therefore we are considered to be 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. Moreover, as a bank holding company of a bank located in South Carolina, we also are subject to the South Carolina Banking and Branching Efficiency Act.

15



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; and

•  
  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.

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

•  
  factoring accounts receivable;

•  
  making, acquiring, brokering or servicing loans and usual related activities;

•  
  leasing personal or real property;

•  
  operating a non-bank depository institution, such as a savings association;

•  
  trust company functions;

•  
  financial and investment advisory activities;

•  
  conducting discount securities brokerage activities;

•  
  underwriting and dealing in government obligations and money market instruments;

•  
  providing specified management consulting and counseling activities;

•  
  performing selected data processing services and support services;

•  
  acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

•  
  performing selected insurance underwriting activities.

As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In summary, a financial holding company can engage in activities that are financial in nature or incidental or complimentary 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 financial holding company status, each insured depository institution we control would have to be well capitalized, well managed, and have at least a satisfactory rating under the Community Reinvestment Act (discussed below).

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

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 acquires 25% or more of any class of voting securities of a bank holding company. Following the relaxing of these restrictions by the Federal Reserve in September 2008, control will be rebuttably presumed to exist if a person acquires more than 33% of the total

16




equity of a bank or bank holding company, of which it may own, control or have the power to vote not more than 15% of any class of voting securities.

Source of Strength. In accordance with Federal Reserve Board policy, we are required to act 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. Under the Federal Deposit Insurance Corporate Improvement Act of 1991 (“FDICIA”), to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” within the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

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 non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of a bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.

In addition, the “cross guarantee” provisions of the Federal Deposit Insurance Act require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC’s claim for damages is superior to claims of shareholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision would give depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of the Bank.

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.

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 “Independence National Bank.” 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. 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.

Dividends. Since the Company is a bank holding company, its ability to declare and pay dividends is dependent on certain federal and state regulatory considerations, including the guidelines of the Federal

17




Reserve. The Federal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The Federal Reserve’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Further, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

In addition, since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it, which is also subject to regulatory restrictions as described below in “Independence National Bank — Dividends.”

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 South Carolina Board of Financial Institutions (the “S.C. Board”). We are not required to obtain the approval of the S.C. 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 obtain approval from the S.C. Board prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

Independence National Bank

The Bank operates as a national banking association incorporated under the laws of the United States and subject to examination by the OCC. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to a maximum amount, which is currently $250,000 per depositor. The OCC 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.

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The OCC requires that the Bank maintain specified ratios of capital to assets and imposes limitations on the Bank’s aggregate investment in real estate, bank premises, and furniture and fixtures. Two categories of regulatory capital are used in calculating these ratios — Tier 1 capital and total capital. Tier 1 capital generally includes common equity, retained earnings, a limited amount of qualifying preferred stock, and qualifying minority interests in consolidated subsidiaries, reduced by goodwill and certain other intangible assets, such as core deposit intangibles, and certain other assets. Total capital generally consists of Tier 1 capital plus Tier 2 capital, which includes the allowance for loan losses, preferred stock that did not qualify as Tier 1 capital, certain types of subordinated debt and a limited amount of other items.

The Bank is required to calculate three ratios: the ratio of Tier 1 capital to risk-weighted assets, the ratio of total risk-based capital (the sum of Tier 1 capital plus the allowance for loan and lease losses limited to 1.25% of risk-weighted assets) to risk-weighted assets, and the “leverage ratio,” which is the ratio of Tier 1 capital to average assets on a non-risk-adjusted basis. For the two ratios of capital to risk-weighted assets, certain assets, such as cash and U.S. Treasury securities, have a zero risk weighting. Others, such as commercial and consumer loans, have a 100% risk weighting. Some assets, notably purchase-money loans secured by first-liens on residential real property, are risk-weighted at 50%. Assets also include amounts that represent the potential funding of off-balance sheet obligations such as loan commitments and letters of credit. These potential assets are assigned to risk categories in the same manner as funded assets. The total assets in each category are multiplied by the appropriate risk weighting to determine risk-adjusted assets for the capital calculations.

The minimum capital ratios for both the Company and the Bank are generally 8% for total capital, 4% for Tier 1 capital and 4% for leverage. To be eligible to be classified as “well-capitalized,” the Bank must generally maintain a total capital ratio of 10% or more, a Tier 1 capital ratio of 6% or more, and a leverage ratio of 5% or more. Certain implications of the regulatory capital classification system are discussed in greater detail below.

Pursuant to the Consent Order with the OCC, the Bank must achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012. The Bank did not meet these higher minimum capital ratios by March 31, 2012; however, on December 31, 2012, the Company made a capital contribution of $2.25 million to the Bank in order to increase the Bank’s capital levels above the higher minimum capital ratios required by the Consent Order. Nevertheless, as long as the higher minimum capital ratios imposed by the Consent Order remain in effect, the Bank will not be deemed to be “well-capitalized” regardless of its capital levels. As of December 31, 2012, the Bank was considered “adequately capitalized”. See additional discussion below under Part I, Item 7, “Capital Resources.”

Prompt Corrective Action. As an insured depository institution, the Bank is required to comply with the capital requirements under the Federal Deposit Insurance Act and the OCC’s prompt corrective action 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 (i) having a total capital ratio of 10% or greater, (ii) having a Tier 1 capital ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any formal 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 (i) having a total capital ratio of 8% or greater, (ii) having a Tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

19



•  
  Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a Tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.

•  
  Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a Tier 1 capital ratio of less than 3% or (iii) having 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 having a ratio of tangible equity to total assets that is equal to or less than 2%.

If the OCC 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 is not well capitalized, it cannot accept brokered time deposits without prior regulatory approval, and if approval is granted, it cannot offer an effective yield in excess of 75 basis points on interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area or the national rate paid on deposits of comparable size and maturity for deposits accepted outside a bank’s normal market area. Because the Bank is no longer deemed to be well capitalized, the Bank cannot renew, rollover or accept brokered time deposits unless it receives prior OCC approval.

If the Bank becomes less than adequately capitalized, it would become subject to increased regulatory oversight and would be increasingly restricted in the scope of its permissible activities. The Bank would be required to adopt a capital restoration plan acceptable to the OCC that is subject to a limited performance guarantee by the Company. 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. 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, the appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution. Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. 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 capital distribution would cause the Bank to become undercapitalized, it could not pay a management fee or dividend to us.

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As of December 31, 2012, the Bank was considered to be adequately capitalized by the OCC due to the higher minimum capital ratio requirements contained in the Consent Order. See additional discussion below under Part I, Item 7, “Capital Resources.”

Standards for Safety and Soundness. The Federal Deposit Insurance Act (“FDIA”) also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Under the regulations, if the OCC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the OCC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

Regulatory Examination. The OCC requires the Bank to prepare annual reports on the Bank’s financial condition and to conduct an annual audit of its financial affairs in compliance with its minimum standards and procedures. 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 federal banking 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 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 federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

•  
  internal controls;

•  
  information systems and audit systems;

•  
  loan documentation;

•  
  credit underwriting;

•  
  interest rate risk exposure; and

•  
  asset quality.

Insurance of Accounts and Regulation by the FDIC. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006. 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. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

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FDIC insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds 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.

Transactions with Affiliates and Insiders. 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. 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.

As noted above, effective as of July 21, 2012, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A to include mutual funds advised by a depository institution or its affiliates. The Dodd-Frank Act applies Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. Historically, an exception has existed that exempts covered transactions between depository institutions and their financial subsidiaries from the 10% of capital and surplus limitation set forth in Section 23A. However, the Dodd-Frank Act eliminates this exception for covered transactions entered into after July 21, 2012. Effective as of July 21, 20111, the Dodd-Frank Act also prohibits an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

Dividends. The Company’s principal source of cash flow, including cash flow to pay dividends to its shareholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s

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payment of dividends to the Company. As a general rule, the amount of a dividend may not exceed, without prior regulatory approval, the sum of net income in the calendar year to date and the retained net earnings of the immediately preceding two calendar years. A depository institution may not pay any dividend if payment would cause the institution to become undercapitalized or if it already is undercapitalized. The OCC may prevent the payment of a dividend if it determines that the payment would be an unsafe and unsound banking practice. The OCC also has advised that a national bank should generally pay dividends only out of current operating earnings.

Further, under the terms of the Consent Order, we were required to present a dividend policy to the OCC that permits the declaration of a dividend only when the Bank is in compliance with its approved Capital Plan, with the aforementioned restrictions, and upon receipt of no supervisory objection by the OCC. Currently, the Company also has to obtain the prior written approval of the Federal Reserve Bank of Richmond before declaring or paying any dividends.

Branching. National banks are required by the National Bank Act to adhere to branch office banking laws applicable to state banks in the states in which they are located. Under current South Carolina law, the Bank may open branch offices throughout South Carolina with the prior approval of the OCC. In addition, with prior regulatory approval, the Bank is 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 that state would permit a bank chartered by that state to open a de novo branch.

Community Reinvestment Act. The Community Reinvestment Act requires that the OCC evaluate the record of the Bank 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 the Bank. As of June 11, 2007, the date of the most recent examination, the Bank received a satisfactory rating.

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. As of December 31, 2012, the Company did not have any financial subsidiaries.

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;

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•  
  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 such federal laws.

The deposit operations of the Bank also are subject to:

•  
  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.

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 and foreign 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 in 2006. 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.

USA PATRIOT Act/Bank Secrecy Act. The USA PATRIOT Act amended, in part, the Bank Secrecy Act and provides 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 if a bank believes 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 FBI can send to the banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. 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 the FBI.

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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. 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. The OCC and the federal banking agencies have prescribed standards for maintaining the security and confidentiality of consumer information. The Bank is subject to such standards, as well as standards for notifying consumers in the event of a security breach.

In addition, pursuant to the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) and the implementing regulations of the federal banking agencies and the Federal Trade Commission, the Bank is required to have in place an “identity theft red flags” program to detect, prevent, and mitigate identity theft. The Bank has implemented an identity theft red flags program designed to meet the requirements of the FACT Act and the joint final rules. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, which is one of 12 regional FHLBs that administer home financing credit for depository institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Financing Board. All advances from the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.

Item 1A. Risk Factors.

The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently now to us or that we currently deem immaterial may also impact our business operations. If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected.

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Risks Related to Our Business

Our failure to comply with provisions of our Consent Order with the OCC could subject us to further enforcement action and reputational damage.

On November 14, 2011, the Bank entered into the Consent Order with the OCC which, among other things, contains a requirement that the Bank minimum capital levels exceed the minimum regulatory capital ratios for “well capitalized” banks. The minimum capital ratios for a bank are generally 8% for total capital, 4% for Tier 1 capital and 4% for leverage. To be eligible to be classified as “well capitalized,” a bank must generally maintain a total capital ratio of 10% or more, a Tier 1 capital ratio of 6% or more, and a leverage ratio of 5% or more. The Consent Order required the Bank to achieve and maintain Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012. With funds from the Private Placement, the Company made a capital contribution of $2.25 million to the Bank on December 31, 2012. As a result, the Bank’s capital levels are now above the minimum amounts specified in the Consent Order. However, as we are still subject to the Consent Order, the OCC has the authority to subject us to further enforcement remedies, including civil money penalties or other sanctions the OCC considers appropriate. Further, as long as the Consent Order remains in place, the Bank will not be deemed “well capitalized” regardless of its capital levels.

If we fail to comply with the terms of the Consent Order, the OCC has the authority to subject us to a cease and desist order with more restrictive terms, to impose civil money penalties on us and our directors and officers, and, under certain circumstances, to remove directors and officers from their positions with the Bank, which could have a material adverse effect on our business.

We may be required to raise additional capital in the future but that capital may not be available when it is needed.

We are required by regulatory authorities to maintain certain levels of capital considered adequate to support our operations. Our ability to raise additional capital, when needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to meet the higher minimum capital ratios in the Consent Order could be materially impaired.

If we do not generate positive cash flow and earnings, there will be an adverse effect on our future results of operations.

For the years ended December 31, 2012 and 2011, we incurred net losses of $613,036 and $2.1 million, respectively. In light of the current economic environment, significant additional provisions for loan losses may be necessary to supplement the allowance for loan losses in the future. As a result, we may incur significant additional credit costs in 2013, which could adversely impact our financial condition, results of operations, and the value of our common stock.

If our nonperforming assets increase, our earnings will be adversely affected.

At December 31, 2012, our nonperforming assets (which consist of nonaccrual loans and other real estate owned) totaled $9.2 million, or 7.4% of total assets. At December 31, 2011, our nonperforming assets were $10.4 million, or 9.3% of total assets. Our nonperforming assets adversely affect our net income in various ways:

•  
  We do not record interest income on nonaccrual loans or real estate owned.

•  
  We must provide for probable loan losses through a current period charge to the provision for loan losses.

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•  
  Noninterest expense increases when we must write down the value of properties in our other real estate owned portfolio to reflect changing market values.

•  
  There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to other real estate owned.

•  
  The resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity.

If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our results of operations.

If we are unable to generate additional noninterest income, it could have a material adverse effect on our business.

In order to thrive in a competitive community banking market, we will need to general additional sources of noninterest income. For the years ended December 31, 2012 and 2011, we generated noninterest income of $466,273 and $217,545, respectively. Our largest component of noninterest income is residential loan origination fees. Due to the changes in mortgage loan underwriting and compensation regulations, as well as customer demand, there can be no assurance that the Bank will continue to generate additional residential loan origination fees.

We intend to enhance our ability to generate additional noninterest income, including through offering consumer finance, payments, and mobile banking services. We also expect to offer other products and services which may include secured credit cards, general purpose reloadable prepaid cards, loyalty cards and services. To the extent we propose to offer these services through the Bank, under our Consent Order, the Bank must obtain OCC approval to expand its existing business model, and there can be no assurance that the Bank will receive OCC approval or be successful in implementing the steps necessary to expand its business model. If we are unable to generate additional noninterest income by expanding our business model or through other means, it could have a material adverse effect on our business.

We have sustained losses from a decline in credit quality and may see further losses.

Our ability to generate earnings is significantly affected by our ability to properly originate, underwrite and service loans. We have sustained losses primarily because borrowers, guarantors or related parties have failed to perform in accordance with the terms of their loans and we failed to detect or respond to deterioration in asset quality in a timely manner. We could sustain additional losses for these reasons. Further problems with credit quality or asset quality could cause our interest income and net interest margin to further decrease, which could adversely affect our business, financial condition and results of operations. We have recently identified credit deficiencies with respect to certain loans in our loan portfolio which are primarily related to the downturn in the real estate industry. As a result of the decline of the residential housing market, property values for this type of collateral have declined substantially. In response to this determination, we increased our loan loss reserve throughout 2010 and 2011 to a total loan loss reserve of $2.1 million, or 2.74% of gross loans, at December 31, 2011 to address the risks inherent within our loan portfolio. Throughout 2012, we consistently applied our formulaic methodology in calculating the reserve, and because charge offs are beginning to drop, our reserve is gradually matching the experience factors. At December 31, 2012, our loan loss reserve was $1.9 million, or 2.64% of gross loans. Although credit quality indicators generally have showed signs of stabilization, further deterioration in the South Carolina real estate market as a whole or individual deterioration in the financial condition of our borrowers may cause management to adjust its opinion of the level of credit quality in our loan portfolio. Such a determination may lead to an additional increase in our provisions for loan losses, which could also adversely affect our business, financial condition, and results of operations.

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Negative developments in the financial industry and credit markets, and the impact of new legislation in response to these developments, may negatively impact our operations

Negative developments that began in the latter half of 2007 and that have continued through 2012 in the global credit and securitization markets have resulted in unprecedented volatility and disruption in the financial markets and a general economic downturn. As a result, bank regulatory agencies have been active in responding to concerns and trends identified in examinations, including by issuing a historically high number of formal enforcement orders over the past three years. In addition, significant new federal laws and regulations relating to financial institutions have been adopted, including, without limitation, the EESA, the ARRA, and the Dodd-Frank Act. Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation and bank examination practices in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance. We can provide no assurance regarding the manner in which any new laws and regulations will affect us.

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

As of December 31, 2012, approximately 83% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case 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 continued weakening of the real estate market in our primary market area has resulted in an increase in the number of borrowers who have defaulted on their loans and a reduction in the value of the collateral securing their loans, which in turn has adversely affected our profitability and asset quality. 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 capital 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.

Our decisions regarding the allowance for loan losses and credit risk may materially and adversely affect our business.

Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:

•  
  the duration of the credit;

•  
  credit risks of a particular customer;

•  
  changes in economic and industry conditions; and

•  
  in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including:

•  
  an ongoing review of the quality, mix, and size of our overall loan portfolio;

•  
  historical loan loss experience;

•  
  evaluation of economic conditions;

•  
  regular reviews of loan delinquencies; and

•  
  the amount and quality of collateral, including guarantees, securing the loans.

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The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. See “Allowance for Loan Losses” in Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” located elsewhere in this report for further discussion related to our process for determining the appropriate level of the allowance for loan losses.

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 our regulatory capital. We have made loans that exceed our internal guidelines to a limited number of our customers who have significant liquid assets, net worth, and amounts on deposit with the Bank. As of December 31, 2012, approximately $3.6 million of our loans, or 31.8% of our Bank’s regulatory capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines. In addition, supervisory limits on commercial loan-to-value exceptions are generally set at 30% of our Bank’s capital. At December 31, 2012, $2.3 million of our commercial loans, or 20.0% of our Bank’s regulatory capital, exceeded the supervisory loan-to-value ratio. The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

Continuation of the economic downturn could reduce our customer base, our level of deposits, and demand for financial products such as loans.

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan portfolio. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed. A continuation of the economic downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately 90% of our interest income for the year ended December 31, 2012. If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.

Changes in economic conditions, in particular an economic slowdown in South Carolina, could materially and negatively affect our business.

Our business is directly impacted by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control. Any further deterioration in economic conditions,

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whether caused by national or local concerns, in particular any further economic slowdown in South Carolina, could result in the following consequences, any of which could hurt our business materially: loan delinquencies may increase; problem assets and foreclosures may increase; demand for our products and services may decrease; low cost or noninterest bearing deposits may decrease; and collateral for loans made by us, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans. The State of South Carolina and certain local governments in our market area continue to face fiscal challenges upon which the long-term impact on the State’s or the local economy cannot be predicted.

Our small- to medium-sized business target markets may have fewer financial resources to weather a downturn in the economy.

We target the banking and financial services needs of small- and medium-sized businesses. These businesses generally have fewer financial resources in terms of capital borrowing capacity than larger entities. If general economic conditions continue to negatively impact these businesses in the markets in which we operate, our business, financial condition, and results of operation may be adversely affected.

Lack of seasoning of our loan portfolio may increase the risk of credit defaults in the future.

Due to our relatively short operating history, all of the loans in our loan portfolio and our lending relationships are of relatively recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.

We depend on the accuracy and completeness of information about customers and counterparties and our financial condition could be adversely affected if we have been provided misleading information.

In deciding whether to extend credit or to enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information, which we do not independently verify. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to customers, we may assume that a customer’s audited financial statements conform with generally accepted accounting principles (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.

Changes in interest rates affect our interest margins, which can adversely affect our profitability.

Our results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve. Our profitability depends to a significant extent on our net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Interest rates are highly sensitive to many factors beyond our control, including general economic conditions and policies of various governmental and regulatory agencies. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the interest paid on deposit and borrowings, but those changes could also affect our ability to originate loans and obtain deposits. Our net interest income will be

30




adversely affected if market interest rates change such that the interest paid on deposits and borrowings increases faster than interest earned on loans and investments.

We may not be able to adequately anticipate and respond to changes in market interest rates.

We may be unable to anticipate changes in market interest rates, which are affected by many factors beyond our control including but not limited to inflation, recession, unemployment, money supply, monetary policy, and other changes that affect financial markets both domestic and foreign. Our net interest income is affected not only by the level and direction of interest rates, but also by the shape of the yield curve and relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth, customer loan and deposit preferences, and the timing of changes in these variables. In the event rates increase, our interest costs on liabilities may increase more rapidly than our income on interest earning assets, resulting in a deterioration of net interest margins. As such, fluctuations in interest rates could have significant adverse effects on our financial condition and results of operations.

In addition, our mortgage operations provide a portion of our noninterest income. We generate mortgage revenues primarily from gains on the origination of residential mortgage loans pursuant to programs currently offered by Fannie Mae, Ginnie Mae or Freddie Mac. In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors, which would decrease mortgage revenues in noninterest income. In addition, our results of operations are affected by the amount of noninterest expenses associated with mortgage activities, such as salaries and employee benefits, other loan expense, and other costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations.

Competition with other financial institutions may have an adverse effect on our ability to retain and grow our client base, which could have a negative effect on our financial condition or results of operations.

The banking and financial services industry is very competitive and includes services offered from other banks, savings and loan associations, credit unions, mortgage companies, other lenders, and institutions offering uninsured investment alternatives. Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to compete with us. The financial services industry has and is experiencing an ongoing trend towards consolidation in which fewer large national and regional banks and other financial institutions are replacing many smaller and more local banks. These larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources and a wider geographic presence or greater accessibility. In some instances, these larger entities operate without the traditional brick and mortar facilities that restrict geographic presence. Some competitors have more aggressive marketing campaigns and better brand recognition, and are able to offer more services, more favorable pricing or greater customer convenience than the Bank. In addition, competition has increased from new banks and other financial services providers that target our existing or potential customers. As consolidation continues among large banks, we expect other smaller institutions to try to compete in the markets we serve. This competition could reduce our net income by decreasing the number and size of the loans that we originate and the interest rates we charge on these loans. Additionally, these competitors may offer higher interest rates, which could decrease the deposits we attract or require us to increase rates to retain existing deposits or attract new deposits.

Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations which could increase our cost of funds.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge as part of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking.

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Technological developments have allowed competitors, including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers. If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in the industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.

Liquidity needs could adversely affect our results of operations and financial condition.

Our primary funding sources are customer deposits and loan repayments. Deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Scheduled loan repayments are a relatively stable source of funds; however, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors outside of our control, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Those sources may include borrowings from the Federal Home Loan Bank or Federal Reserve Bank, federal funds lines of credit from correspondent banks and brokered deposits, to the extent allowable by regulatory authorities. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if we were to experience atypical deposit withdrawal demands, increased loan demand or if regulatory decisions should limit available funding sources such as brokered deposits. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should those sources not be adequate.

Higher FDIC deposit insurance premiums and assessments could adversely impact our financial condition.

Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC. Although we cannot predict what the insurance assessment rates will be in the future, either a deterioration in our 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.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

Negative public opinion could damage our reputation and adversely impact earnings.

Reputation risk, or the risk to our business, earnings and capital from negative public opinion, is inherent in our operations. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action and adversely impact our results of operations. Although we take steps to minimize

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reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business.

Our operational or security systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, deposit, loan, and other systems. While we have 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. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

Our controls and procedures may fail or be circumvented.

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

Risks Related to Our Mobile Payments Business

We may face regulatory restrictions in expanding our business model.

We intend to expand our business model to include both traditional community banking services as well as opportunities in consumer finance, transaction processing services, digital payments and mobile banking. However, the Bank must obtain OCC approval to expand its business model and there can be no assurances that the Bank will receive OCC approval. Even if the Bank receives OCC approval to expand its business model, there can be no assurances that the Bank will be successful in implementing the steps necessary to expand its business model. Revenues, if any, from the expanded business model may occur materially later than initial expenses from the implementation of the expanded business model. As a result, the Company may incur material operating losses during the development of the expanded business model, and these expenses may not be recouped if we are unsuccessful in implementing the expanded business model. In addition, we will remain subject to supervision by the OCC, and this supervision could affect our ability to expand our business model. For example, the OCC could limit our growth if it believes we are growing too quickly or without sufficient internal controls, or it could limit the expansion of our business model if it were to conclude that we lack appropriate risk management practices and other assessment tools.

The market for mobile payments and digital commerce may not develop as we expect.

Although we believe that mobile payments may be a large market opportunity with potential for growth over the next five years, there can be no assurances that this industry will develop in the manner that we anticipate or, if it does, that the revenue opportunity will be significant. We will be operating from an unproven business model, and there can be no assurances that any or all of our strategies will be successful.

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We may not succeed in executing key contracts that we will need to expand our business model.

We are currently negotiating an arm’s-length agreement with MPIB under which we would obtain the right to acquire MPIB or its assets, including its intellectual property, customer agreements and relationships. Any such acquisition would be subject to our obtaining any required regulatory approvals. There can be no assurances that we will be able to negotiate an agreement with MPIB on terms that we find acceptable or that the agreement will receive any necessary regulatory approval. Without this agreement, our ability to expand our business in transaction processing services, digital payments and mobile banking would be significantly diminished. We also plan to enter into agreements with customers and other key vendors. We will need these agreements to implement our new business model, but there are no assurances that we will reach satisfactory agreements with these parties.

We may not be able to attract and retain qualified personnel.

We anticipate that the success of implementing our expanded business model will be largely dependent upon our additions of new executive management team members, including Gordon A. Baird, who was recently appointed as the Company’s Chief Executive Officer and as a director. We will also need to attract other senior industry professionals with extensive banking, payment, credit, technology and wireless telecommunications expertise to join our board of directors and executive management team, and we may lack the capital or other resources necessary to recruit these professionals. If we fail to attract and retain these industry professionals, we may not be able to expand our business model to include consumer finance, payments and mobile banking services, which could have a material adverse effect on our business, financial condition, and results of operations. Moreover, even if we are able to grow and expand our management team by attracting these industry professionals, the resources required to retain these employees may adversely affect our operating margins.

We may not be able to manage our growth, which may adversely affect our results of operations and financial condition.

Although we intend to develop our new business model in a controlled and measured manner, even modest success will nevertheless result in a significant increase in our size. There is a risk we will not be successful in expanding our business model at acceptable risk levels and upon acceptable terms or in managing the costs and implementation risks associated with the expanded business model.

We will need to raise additional capital in order to implement the expanded business model and that capital may not be available on favorable terms, if at all.

We intend to use the proceeds of the offering for general corporate purposes, including but not limited to pay expenses related to the development of future business opportunities. Future business opportunities are intended to include both traditional community banking services as well as opportunities in consumer finance, transaction processing services, digital payments and mobile banking. However, we will need a substantial amount of additional capital in order to actually implement our new business model and to support our growth and operations. Our ability to raise additional capital in the future will depend on a number of factors, including conditions in the capital markets, which are outside of our control. There is a risk we will not be able to raise capital when needed or on favorable terms. If we cannot raise additional capital when needed, we will not be able to implement our new business model, and we will also be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These restrictions could result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition and results of operations.

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We intend to outsource some of our essential services to third-party providers who may terminate their agreements with us, resulting in interruptions to our banking operations.

If we expand our business to include mobile payment solutions, we expect that we will obtain essential technological and customer services support for the systems we use from third-party providers. We also outsource our check processing, check imaging, electronic bill payment, statement rendering, internal audit and other services to third-party vendors. Our agreements with each service provider are generally cancelable without cause by either party upon specified notice periods. If one of our third-party service providers terminates its agreement with us and we are unable to replace it with another service provider, our operations may be interrupted. If an interruption were to continue for a significant period of time, our earnings could decrease, we could experience losses, and we could lose customers.

We will need to adequately protect our brand and the intellectual property rights related to our products and services and avoid infringing on the property rights of others.

Our brand will be important to our business, and we intend to use trademark restrictions and other means to protect it. Our business would be harmed if we were unable to protect our brand against infringement and its value was to decrease as a result.

We will rely on a combination of trademark and copyright laws, trade secret protection and confidentiality and license agreements to protect the intellectual property rights related to our products and services. We may unknowingly violate the intellectual property or other proprietary rights of others, and thus may be subject to claims by third parties. If so, we may be required to devote significant time and resources to defending against these claims or to protecting or enforcing our own rights. Some of our intellectual property rights may not be protected by intellectual property laws, particularly in foreign jurisdictions. The loss of our intellectual property or the inability to secure or enforce our intellectual property rights or to defend successfully against an infringement action could harm our business, results of operations, financial condition and prospects.

Our business is subject to laws and regulations regarding privacy, data protection, and other matters. Many of these could result in claims, changes to our business practices, increased cost of operations, or otherwise harm our business.

We are subject to a variety of laws and regulations in the United States that involve matters central to our business, including user privacy, electronic contracts and other communications, consumer protection, taxation, and online payment services. These U.S. federal and state laws and regulations, which can be enforced by private parties or government entities, are constantly evolving and can be subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. For example, the interpretation of some laws and regulations that govern mobile payments is unsettled and developments in this area could affect the manner in which market and sell our products and services. These existing and proposed laws and regulations can be costly to comply with and can delay or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to inquiries or investigations, claims or other remedies, including fines or demands that we modify or cease existing business practices.

If our security is breached, our business could be disrupted, our operating results could be harmed, and customers could be deterred from using our products and services.

Our business relies on the secure electronic transmission, storage, and hosting of sensitive information, including financial information and other sensitive information relating to our customers. As a result, we face the risk of a deliberate or unintentional incident involving unauthorized access to our computer systems that could result in misappropriation or loss of assets or sensitive information, data corruption, or other disruption

35




of business operations. In light of this risk, we have devoted significant resources to protecting and maintaining the confidentiality of our information, including implementing security and privacy programs and controls, training our workforce, and implementing new technology. We have no guarantee that these programs and controls will be adequate to prevent all possible security threats. We believe that any compromise of our electronic systems, including the unauthorized access, use, or disclosure of sensitive information or a significant disruption of our computing assets and networks, would adversely affect our reputation and our ability to fulfill contractual obligations, and would require us to devote significant financial and other resources to mitigate such problems, and could increase our future cyber security costs. Moreover, unauthorized access, use, or disclosure of such sensitive information could result in contractual or other liability. In addition, any real or perceived compromise of our security or disclosure of sensitive information may result in lost revenues by deterring customers from using or purchasing our products and services in the future or prompting them to use competing service providers.

Risks Related to the Legal and Regulatory Environment

We are subject to extensive regulation that could limit or restrict our activities, have an adverse impact on our operations, and impose financial requirements or limitations on the conduct of our business.

We are subject to Federal Reserve regulation. The Bank is subject to extensive regulation, supervision, and examination by our primary federal regulators, the OCC and the FDIC, the regulating authority that insures customer deposits. Also, as a member of the FHLB, the Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Regulation by these agencies is intended primarily for the protection of our depositors and the Deposit Insurance Fund and not for the benefit of our shareholders. The Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against the Bank under these laws could have a material adverse effect on our results of operations.

Further, changes in laws, regulations and regulatory practices affecting the financial services industry could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

Financial reform legislation enacted by the U.S. Congress and further changes in regulation to which we are exposed will result in additional new laws and regulations that are expected to increase our costs of operations.

The Dodd-Frank Act has and will continue to significantly change bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

The Dodd-Frank Act also created the Bureau of Consumer Financial Protection and gives it broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Additionally,

36




the Bureau of Consumer Financial Protection has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.

Proposals for further regulation of the financial services industry are continually being introduced in the U.S. Congress. The agencies regulating the financial services industry also periodically adopt changes to their regulations. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. In addition, it is expected that such regulatory changes will increase our operating and compliance costs. We can provide no assurance regarding the manner in which any new laws and regulations will affect us.

The short-term and long-term impact of the changing regulatory capital requirements and anticipated new capital rules is uncertain.

On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced an agreement to a strengthened set of capital requirements for internationally active banking organizations in the U.S. and around the world, known as Basel III. Basel III calls for increases in the requirements for minimum common equity, minimum Tier 1 capital and minimum total capital for certain systemically important financial institutions, to be phased in over time until fully phased in by January 1, 2019. Any regulations adopted for systemically significant institutions may also be applied to or otherwise impact other financial institutions such as the Company or the Bank.

Various provisions of the Dodd-Frank Act increase the capital requirements of bank holding companies, such as the Company, and non-bank financial companies that are supervised by the Federal Reserve Board. The leverage and risk-based capital ratios of these entities may not be lower than the leverage and risk-based capital ratios for insured depository institutions. While the Basel III changes and other regulatory capital requirements will likely result in generally higher regulatory capital standards, it is difficult at this time to predict how any new standards will ultimately be applied to the Company and the Bank.

In addition, in the current economic and regulatory environment, regulators of banks and bank holding companies have become more likely to impose capital requirements on bank holding companies and banks that are more stringent than those required by applicable existing regulations.

The application of more stringent capital requirements for the Company and the Bank could, among other things, result in lower returns on invested capital, require the issuance of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements.

Risks Related to Our Common Stock

We are a holding company and depend on the Bank for dividends, distributions, and other payments.

Substantially all of our activities are conducted through the Bank, and consequently, as the parent company of the Bank, we receive substantially all of our revenue as dividends from the Bank. The Bank is currently prohibited from paying dividends to the Company without prior approval from the OCC. In addition, the Company is currently prohibited from paying dividends without the prior approval Federal Reserve Bank of Richmond. There can be no assurance such approvals would be granted or with regard to how long these restrictions will remain in place. In the future, any declaration and payment of cash dividends will be subject to the board’s evaluation of the Company’s operating results, financial condition, future growth plans, general business and economic conditions, and tax and other relevant considerations. The payment of cash dividends by the Company in the future will also be subject to certain other legal and regulatory limitations (including the requirement that the Company’s capital be maintained at certain minimum levels) and ongoing review by the Company’s banking regulators.

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We may raise additional capital, which could adversely affect the market price of our common stock.

We are not restricted from issuing additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, common stock, or from issuing additional shares of common stock. We frequently evaluate opportunities to access the capital markets, taking into account our regulatory capital ratios, financial condition, and other relevant considerations. Subject to market conditions, we may take further actions to raise additional capital. Such actions could include, among other things, the issuance of additional shares of common stock or preferred stock in public or private transactions in order to increase our capital levels above the requirements for a “well capitalized” institution established by the federal bank regulatory agencies as well as other regulatory targets. These issuances would dilute ownership interests of our shareholders and could dilute the per share book value of our common stock. In addition, new investors could have rights, preferences, and privileges senior to our common stock, which may also adversely impact our current shareholders.

We may issue additional shares of common stock to our executive officers, other employees, and directors as equity compensation, which may reduce certain shareholders’ ownership in the Company.

On February 27, 2013, we adopted a new equity incentive plan, the Independence Bancshares, Inc. 2013 Equity Incentive Plan (the “2013 Incentive Plan”), and we amended the Independence Bancshares, Inc. 2005 Stock Incentive Plan (the “2005 Incentive Plan”) to cap the number of shares issuable thereunder. The 2013 Incentive Plan reserves 2,466,720 shares for the issuance of equity compensation awards, including stock options, to our executive officers, other employees, and directors and includes an evergreen provision that provides that the number of shares of common stock available for issuance under the 2013 Incentive Plan automatically increases each time the Company issues additional shares of common stock so that the number of shares available for issuance under the 2013 Incentive Plan (plus any shares reserved under the 2005 Incentive Plan) continues to equal 20% of the Company’s total outstanding shares on an as-diluted basis. The 2013 Incentive Plan is an omnibus plan and therefore also provides for the issuance of other equity compensation, including restricted stock and stock appreciation rights, to our employees and directors. We anticipate that we will grant awards for virtually all of these shares to our executive officers, other employees, and directors over the next two years.

There is no public market for our shares.

There is currently no established market for our common stock, and we have no current plans to list our stock on NASDAQ or any other exchange. For these reasons, we do not expect a liquid market for our common stock to develop for several years, if at all.

The Company’s securities are not FDIC insured.

The Company’s securities, including the outstanding shares of common stock, are not savings or deposit accounts or other obligations of the Company and are not insured by the Deposit Insurance Fund, the FDIC, or any other governmental agency, and therefore are subject to investment risk, including the possible loss of the entire investment.

Item 1B. Unresolved Staff Comments.

Not Applicable.

Item 2. Properties.

Our principal executive offices consist of 6,500 square feet of leased space in downtown Greenville, South Carolina. The Bank has two branch offices located in Taylors, South Carolina, and Simpsonville, South Carolina. We lease our Greenville and Taylors offices. We believe these premises will be adequate for present and anticipated needs and that we have adequate insurance to cover our owned and leased premises. For each

38




property that we lease, we believe that upon expiration of the lease we will be able to extend the lease on satisfactory terms or relocate to another acceptable location.

Item 3. Legal Proceedings.

In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

Item 4. Mine Safety Disclosures.

Not Applicable.

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

Common Stock Market Prices and Dividends

We are currently quoted on the OTC Bulletin Board under the symbol “IEBS” and have a sponsoring broker-dealer to match buy and sell orders for our common stock. Although we are quoted on the OTC Bulletin Board, the trading markets on the OTC Bulletin Board lack the depth, liquidity, and orderliness necessary to maintain a liquid market. We have no current plans to seek listing on any stock exchange, and we do not expect to qualify for listing on NASDAQ or any other exchange for at least several years. The OTC Bulletin Board prices are quotations, which reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.

There is currently no established public trading market in our common stock and trading and quotations of our common stock have been limited and sporadic. However, the Company was able to successfully close a private placement offering and as a result, there were 17,648,750 shares of additional common stock were issued on December 31, 2012, as discussed below. Because there has not been an established market for our common stock, we may not be aware of all prices at which our common stock has been traded. We have not determined whether the trades of which we are aware were the result of arm’s-length negotiations between the parties. Based on information available to us from a limited number of sellers and purchasers of common stock who have engaged in privately negotiated transactions of which we are aware, there were approximately 268,083 shares of stock traded in 2012 ranging from $0.11 to $0.90. These trades occurred throughout the year.

As of March 27, 2013, there were 19,733,760 shares of common stock outstanding held by approximately 620 shareholders of record. We issued 2,085,010 shares of common stock at $10.00 per share in our initial public offering, which was completed in May 2005. The remaining 17,648,750 shares were issued at $0.80 per share to certain accredited and unaccredited investors in the Private Placement, which closed in December 2012.

We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future, we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay dividends depends on the ability of the Bank to pay dividends to us. As a national bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, the Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the Bank’s net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the OCC will be required if the total of all dividends declared in any calendar year by the Bank exceeds the Bank’s net profits to date for that year combined with its retained net profits for the preceding two years less any required transfers to surplus. The OCC also has the authority under federal law to enjoin a national bank from engaging in what in its opinion

39




constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances. Further, under the terms of the Consent Order, we were required to present a dividend policy to the OCC that permits the declaration of a dividend only when the Bank is in compliance with its approved Capital Plan, with the aforementioned restrictions, and upon receipt of no supervisory objection by the OCC. Currently, the Company also has to obtain the prior written approval of the Federal Reserve Bank of Richmond before declaring or paying any dividends.

Equity Based Compensation Plan Information

The following table sets forth equity based compensation plan information at December 31, 2012:

Plan Category
        Number of securities
to be issued
upon exercise of
outstanding options,
warrants and rights
(a)
    Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
    Number of securities
remaining available for
future issuance under
equity compensation plans (c)
(excluding securities
reflected in column(a))
Equity compensation plans approved by security holders
                                                       
2005 Incentive Plan (1)
                 473,505          $ 2.75             1,993,215   
Equity compensation plans not approved by security holders (2)
                                               2,466,720   
Organizer warrants (3)
                 337,500          $ 10.00                
Total
                 811,005          $ 5.77             4,459,935   
 
(1)  
  At our annual meeting of shareholders held on May 16, 2006, our shareholders approved the 2005 Incentive Plan. The 260,626 of shares of common stock initially available for issuance under the 2005 Incentive Plan automatically increased to 2,466,720 shares on December 31, 2012, such that the number of shares available for issuance continued to equal 12.5% of our total outstanding shares.

(2)  
  In February 2013, our board of directors adopted the 2013 Incentive Plan pursuant to which 2,466,720 shares of common stock may be issued. Our board of directors intends to submit the 2013 Incentive Plan to the shareholders of the Company for their consideration at the 2013 annual shareholders’ meeting.

(3)  
  Each of our organizers received, for no additional consideration, a warrant to purchase one share of common stock for $10.00 per share for each share purchased during our initial public offering up to a maximum of 25,000 warrants. The warrants are represented by separate warrant agreements. The warrants vested six months from the date our Bank opened for business, or May 16, 2005, and they are exercisable in whole or in part until May 16, 2015. The warrants may not be assigned, pledged, or hypothecated in any way. The 337,500 of shares issued pursuant to the exercise of such warrants are transferable, subject to compliance with applicable securities laws. If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the Bank to obtain additional capital, the warrants will be forfeited, if not immediately exercised.

On July 26, 2005, the Company adopted the 2005 Incentive Plan for the benefit of the directors, officers and employees. The 2005 Incentive Plan initially reserved up to 260,626 shares of the Company’s common stock for the issuance of stock options and contained evergreen provision, which provided that the maximum number of shares to be issued under the 2005 Incentive Plan would automatically increase each time the Company issues additional shares of common stock such that the total number of shares issuable under the 2005 Incentive Plan would at all times equal 12.5% of the then outstanding shares of common stock. Accordingly, with the closing of the Private Placement on December 31, 2012, the number of shares reserved for the issuance of stock options under the 2005 Incentive Plan increased from 260,626 shares to 2,466,720 shares. The Board may grant up to 2,466,720 options at an option price per share not less than the fair market value on the date of grant.

40



In February 2013, our board of directors adopted the 2013 Incentive Plan. The 2013 Incentive Plan is an omnibus equity incentive plan which provides for the granting of various types of equity compensation awards, including stock options, restricted stock, and stock appreciation rights, to the Company’s employees and directors. Initially, the maximum number of shares of common stock that may be issued under the 2013 Incentive Plan will be 2,466,720, and such number will automatically adjust each time the Company issues additional shares of common stock so that the number of shares of common stock available for issuance under the 2013 Incentive Plan (plus the 2,466,720 shares reserved for issuance under the 2005 Incentive Plan) continues to equal 20% of the Company’s total outstanding shares, assuming all shares under the 2005 Incentive Plan and the 2013 Incentive Plan are exercised. Our board of directors intends to submit the 2013 Incentive Plan to the shareholders of the Company for their consideration at the 2013 annual shareholders’ meeting.

See Item 8. Financial Statements and Supplementary Data, Note 1, Summary of Significant Accounting Policies, and Note 15, Equity Based Compensation, for a discussion regarding matters related to our equity based compensation.

Item 6. Selected Financial Data.

Not applicable.

Item 7. Management’s Discussion and Analysis or Plan of Operation.

Overview

We derive the majority of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income earned on our interest-earning assets, such as loans and investments, and the expense cost of our interest-bearing liabilities, such as deposits. 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.

At December 31, 2012, we had total assets of $124.9 million, an increase of $12.6 million, or 11.2%, from total assets of $112.3 million at December 31, 2011. This increase in assets was driven by the increase in cash as a result of funds received related to the capital raise of $14.1 million. Total assets at December 31, 2012 consisted of cash and due from banks of $20.1 million; federal funds sold of $2.5 million, investment securities available for sale of $25.5 million, non-marketable equity securities of $735,300, property and equipment of $2.2 million, other real estate owned and repossessed assets of $4.5 million, and loans net of allowances for loan losses of $68.5 million and accrued interest receivable and other assets of $845,247. Total liabilities at December 31, 2012 were $104.3 million compared to $103.9 million at December 31, 2011, an increase of $448,400, or 0.4%. At December 31, 2012, liabilities consisted of deposits of $96.4 million, FHLB Advances of $7.0 million, securities sold under agreements to repurchase of $108,680, and accrued interest payable and other liabilities of $811,812. Shareholders’ equity at December 31, 2012 was $20.6 million, compared to $8.4 million at December 31, 2011, an increase of $12.1 million or 144%. This increase was primarily a result of the issuance of common stock and paid-in-capital from the private placement offering, partially offset by a decrease in the unrealized gain on investment securities and the recognition of a net loss of $613,036.

Our net loss for the year ended December 31, 2012 was $613,036, or $0.29 per share, a decrease of $1.5 million, or 70.5%, compared to a net loss of $2.1 million for the year ended December 31, 2011, or $1.00 per share. This decrease in net loss for the year was primarily driven by an increase in net interest income due to a decrease in interest expense and provision expense, increases in mortgage origination income and decreases in professional fees and real estate owned activity, which includes expenses to carry other real estate, gains and losses on sales of other real estate, and write-downs on real estate owned. Included in gains and losses on sales of other real estate owned activity is a $521,613 gain on the sale of a piece of property in February

41




2012 which was originally purchased by the Bank to be used as a future headquarters. Each of these components is discussed in greater detail below.

We have included a number of tables to assist in our description of our results of operations. For example, the “Average Balances” table shows the average balance during 2012 and 2011 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we have channeled a substantial percentage of our earning assets into our loan portfolio. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included a table to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, and 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 establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expenses, in the following discussion.

Markets in the United States and elsewhere have experienced extreme volatility and disruption for the last several years. These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes; and have resulted in substantially increased market volatility, loss of investor confidence and severely constrained credit and capital markets, particularly for financial institutions. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. Dramatic slowdowns in the housing industry, with falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions. Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance. The following discussion and analysis describes our performance in this challenging economic environment.

Throughout our discussion we have identified significant factors that we believe have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

Critical Accounting Policies

We have adopted various 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 Note 1 to our audited consolidated financial statements as of December 31, 2012.

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 judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

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Allowance for Loan Losses

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.

Other Real Estate Owned and Repossessed Assets

Real estate and other property acquired in settlement of loans is recorded at the lower of cost or fair value less estimated selling costs, establishing a new cost basis when acquired. Fair value of such property is reviewed regularly and write-downs are recorded when it is determined that the carrying value of the property exceeds the fair value less estimated costs to sell. Recoveries of value are recorded only to the extent of previous write-downs on the property in accordance with FASB ASC Topic 360 “Property, Plant, and Equipment”. Write-downs or recoveries of value resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are charged against income. Costs relating to the development and improvement of such properties are capitalized.

Income Taxes

We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our consolidated financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.

Results of Operations

Net Interest Income

Net interest income is the Company’s primary source of revenue. Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on the Company’s interest-earning assets and the rates paid on its interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of its interest-earning assets and interest-bearing liabilities. Net interest income was $3.3 million for the year ended December 31, 2012, a slight increase of $46,698, or 1.4%, over net interest income of $3.2 million in 2011. Total interest

43




income decreased by $498,521, or 10.5%, during the year, primarily due to a decrease in interest income on loans, partially offset by an increase in interest earned on investments.

Our consolidated net interest margin for the year ended December 31, 2012 was 3.28%, a 23 basis point increase over the net interest margin for the year ended December 31, 2011 of 3.05%. The net interest margin is calculated as net interest income divided by year-to-date average earning assets. Earning assets averaged $100 million in 2012, a decrease of $6.0 million, or 5.7%, from $105.8 million in 2011. This decrease in earning assets is due to the $12.9 million decrease in net loans between years partially offset by the increase in investment securities available for sale of approximately $7.2 million. During 2009, we adopted measures to promote the long term stability of the Bank. These measures included restructuring the balance sheet to focus on credit quality and management of our funding sources to increase liquidity and the net interest margin. As a result, average gross loans decreased in both 2011 and 2012, with funds from net loan payoffs used to repay FHLB advances as well as to strengthen our liquidity position though cash and the investment securities portfolio.

Our yield on earning assets decreased during the year, moving to 4.25% for the year ended December 31, 2012 from 4.48% for the year ended December 31, 2011. This decrease is largely attributable to the fact that two loans returned to accrual in 2011, and positively impacted the yield. In addition, our loan portfolio continues to experience payoffs as borrowers find other lenders willing to lend at reduced rates, thus creating higher levels of investments (a lower earning asset) and cash (a very low- to non-earning asset).

These decreases were coupled with a decrease in the cost of interest-bearing liabilities, which moved to 1.01% for the year ended December 31, 2012 from 1.50% for the year ended December 31, 2011. The decline in this area was a result of several factors, including a reduction in average brokered time deposits less than $100,000, which decreased $14.3 million during the year, and the repricing of deposits, specifically money market accounts and retail time deposits, which decreased to a rate of .70% and 1.00%, respectively, for the year ended December 31, 2012 from 1.04% and 1.45%, respectively, for the year ended December 31, 2011. In pricing deposits, we considered our liquidity needs, the direction and levels of interest rates and local market conditions. At times, higher rates are paid initially to attract deposits. Borrowings averaged $7.1 million for the year ended December 31, 2012, remaining relatively constant from $7.1 million for the year ended December 31, 2011. Our net interest spread was 3.25% for 2012 compared to 2.98% in 2011. 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.

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. The net amount of capitalized loan fees are amortized into interest income on loans.

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        For the Year Ended December 31,    
        2012
    2011
   
        Average
Balance
    Income/
Expense
    Yield/
Rate
    Average
Balance
    Income/
Expense
    Yield/
Rate
Interest-earning assets:
                                                                                                       
Federal funds sold and other
              $ 10,121,669          $ 46,094             0.46 %         $ 10,350,570          $ 47,463             0.46 %  
Investment securities
                 16,675,781             398,368             2.39 %            9,474,991             271,708             2.87 %  
Loans (1)
                 72,988,554             3,798,694             5.20 %            85,977,604             4,422,505             5.14 %  
Total interest-earning assets
                 99,786,004             4,243,156             4.25 %            105,803,165             4,741,676             4.48 %  
Non-interest-earning assets
                 11,787,915                                           11,232,260                                   
Total assets
              $ 111,573,919                                        $ 117,035,425                                   
 
Interest-bearing liabilities:
                                                                                                       
NOW accounts
              $ 6,212,595          $ 22,330             0.36 %         $ 5,898,868          $ 37,590             0.64 %  
Savings & money market
                 39,825,189             277,265             0.70 %            35,379,750             369,018             1.04 %  
Time deposits (excluding brokered time deposits)
                 37,843,752             379,428             1.00 %            33,786,878             489,333             1.45 %  
Brokered time deposits
                 4,452,306             98,568             2.21 %            18,773,100             403,964             2.15 %  
Total interest-bearing deposits
                 88,333,842             777,591             0.88 %            93,838,596             1,299,905             1.39 %  
Borrowings
                 7,118,431             189,199             2.66 %            7,114,735             212,103             2.98 %  
Total interest-bearing liabilities
                 95,452,273             966,790             1.01 %            100,953,331             1,512,008             1.50 %  
Non-interest-bearing liabilities:
                                                                                                       
Non-interest-bearing deposits
                 7,298,777                                           6,454,449                                   
Other non-interest-bearing liabilities
                 225,344                                           233,012                                   
Shareholders’ equity
                 8,597,525                                           9,394,633                                   
Total liabilities and shareholders’ equity
              $ 111,573,919                                        $ 117,035,425                                   
Net interest spread
                                               3.25 %                                          2.98 %  
Net interest income/margin
                             $ 3,276,366             3.28 %                        $ 3,229,668             3.05 %  
 


(1)  
  Nonaccrual loans are included in average balances for yield computations.

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        For the Year Ended December 31,    
        2010
   
        Average
Balance
    Income/
Expense

Yield/
Rate

   
Interest-earning assets:
                                       
Federal funds sold and other
              $ 10,446,624          $ 50,507   
0.48%
   
Investment securities
                 8,926,372             272,886   
3.06%
   
Loans (1)
                 99,938,312             4,792,133   
4.80%
   
Total interest-earning assets
                 119,311,308             5,115,526   
4.29%
   
Non-interest-earning assets
                 11,815,712                   
Total assets
              $ 131,127,020                   
 
Interest-bearing liabilities:
                                       
NOW accounts
              $ 5,803,292          $ 40,227   
0.69%
   
Savings & money market
                 32,648,911             533,784   
1.63%
   
Time deposits (excluding brokered time deposits)
                 29,852,690             598,109   
2.00%
   
Brokered time deposits
                 32,632,177             861,341   
2.64%
   
Total interest-bearing deposits
                 100,937,070             2,033,461   
2.01%
   
Borrowings
                 10,040,743             379,260   
3.78%
   
Total interest-bearing liabilities
                 110,977,813             2,412,721   
2.17%
   
Non-interest-bearing liabilities:
                                       
Non-interest-bearing deposits
                 5,155,967                   
Other non-interest-bearing liabilities
                 279,569                   
Shareholders’ equity
                 14,713,671                   
Total liabilities and shareholders’ equity
              $ 131,127,020                   
Net interest spread
                                     
2.12%
   
Net interest income/margin
                             $ 2,702,805   
2.27%
   
 


(1)  
  Nonaccrual loans are included in average balances for yield computations.

Rate/Volume Analysis

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set 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.

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        2012 Compared to 2011
   
        Total
Change
    Change in
Volume
    Change in
Rate
Interest-earning assets:
                                                       
Federal funds sold and other
              $ (1,369 )         $ (1,044 )         $ (325 )  
Investment securities
                 126,659             178,228             (51,569 )  
Loans
                 (623,810 )            (675,444 )            51,634   
Total interest income
                 (498,520 )            (498,260 )            (260 )  
 
Interest-bearing liabilities:
                                                       
Interest-bearing deposits
                 (522,314 )            (218,995 )            (303,319 )  
Borrowings
                 (22,904 )            110              (23,014 )  
Total interest expense
                 (545,218 )            (218,885 )            (326,333 )  
 
Net Interest Income
              $ 46,698          $ (279,375 )         $ 326,073   
 
        2011 Compared to 2010
   
        Total
Change
    Change in
Volume
    Change in
Rate
Interest-earning assets:
                                                       
Federal funds sold and other
              $ (3,044 )         $ (461 )         $ (2,583 )  
Investment securities
                 (1,178 )            16,254             (17,432 )  
Loans
                 (369,628 )            (701,443 )            331,815   
Total interest income
                 (373,850 )            (685,650 )            311,800   
 
Interest-bearing liabilities:
                                                       
Interest-bearing deposits
                 (733,556 )            (204,665 )            (528,891 )  
Borrowings
                 (167,157 )            (97,005 )            (70,152 )  
Total interest expense
                 (900,713 )            (301,670 )            (599,043 )  
 
Net Interest Income
              $ 526,863          $ (383,980 )         $ 910,843   
 

Provision for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as a non-cash expense to our statement of operations. We review our loan portfolio at least quarterly 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 “Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

We recorded a net recovery of provision for loan losses of $22,000 for the year ended December 31, 2012, a decrease of $752,000, or 103% from provision for loan losses of $730,000 for the year ended December 31, 2011. The decrease in provision for loan losses is due to the decrease in loan balances. In addition, over the last year, we have seen a decrease in the amount of charge-offs and specific reserves needed due to the apparent stabilization of nonperforming loans. The allowance as a percentage of gross loans decreased to 2.64% at December 31, 2012 from 2.74% at December 31, 2011. This decline is due to payoffs in our commercial real estate portfolio which carries a higher historical loss ratio and consequently a higher reserve factor within our allowance model. Specific reserves were $442,396 on impaired loans of $8.5 million as of December 31, 2012 compared to specific reserves of approximately $563,675 on impaired loans of $8.9 million as of December 31, 2011. As of December 31, 2012, the general reserve allocation was 2.28% of gross loans not impaired compared to 2.27% as of December 31, 2011. The provision for loan losses is discussed further below under “Provision and Allowance for Loan Losses.”

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Non-interest Income

Non-interest income for the year ended December 31, 2012 was $466,273, an increase of 114.3% from non-interest income of $217,545 for the year ended December 31, 2011. Our largest component of non-interest income is from proceeds received from sales of securities of 7,477,874 for a total gain of $225,086. In addition, we received residential loan origination fees, which were $169,812 for 2012, or approximately 36.4% of total non-interest income. Residential loan origination fees increased by approximately $90,205, or 88.3%, during the year due to the changes in mortgage loan underwriting and compensation regulations as well as customer demand.

For the year ended December 31, 2012, service fees on deposit accounts totaled $40,657, a decrease of $8,423, or 26.1%, from 2011 due to a decrease in NSF charges as a result of changes in our client base. Other income was $30,718 for 2012, a decrease of $25,625, or 45.5%, compared to $56,343 for the year ended December 31, 2011. Other income includes ATM surcharges, wire fees, and commissions on insurance referrals. Also included in other income for the year ended December 31, 2011 was $28,795 in rental income related to the lease of our land at South Irvine Street which was sold February 2012.

Non-interest Expenses

The following table sets forth information related to our non-interest expenses for the years ended December 31, 2012 and 2011.

        2012
    2011
Compensation and benefits
              $ 2,006,078          $ 1,700,040   
Real estate owned activity
                 43,272             596,319   
Occupancy and equipment
                 522,932             571,351   
Insurance
                 455,174             431,737   
Data processing and related costs
                 333,334             300,785   
Professional fees
                 719,276             859,880   
Marketing
                 83,480             83,127   
Telephone and supplies
                 61,869             64,504   
Other
                 152,260             188,466   
Total non-interest expenses
              $ 4,377,675          $ 4,796,209   
 

Non-interest expenses decreased by $418,534, or 8.8%, for the year ended December 31, 2012. This decrease was primarily due to a decrease in professional fees, occupancy and equipment and real estate owned activity, partially offset by an increase in compensation and benefits. The decrease in professional fees of $140,604 is the result of charges incurred directly related to recapitalization efforts and compliance with the Consent Order incurred during 2011. During 2012, real estate owned activity decreased by $553,047 due to the successful sale of a piece of land we were going to use for corporate headquarters which produced a gain of $521,613. Write-downs and losses are charged against income, if necessary, as a result of our regular review of the fair value of repossessed property. Occupancy and equipment decreased primarily due to decreases in depreciation expense as a result of items reaching the end of their useful lives. Compensation and benefits increased due to $168,750 in expense incurred related to the additional stock options granted during 2012 and the filling of open positions in 2012.

Income Tax Expense

No income tax benefit or expense was recognized for the year ended December 31, 2012 or 2011. Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. During our

48




September 30, 2010 quarterly analysis of the valuation allowance recorded against our deferred tax assets, we determined that it was not more likely than not that our deferred tax assets will be recognized in future years due to the continued decline in credit quality and the resulting impact on net interest margin, increased net losses, and negative impact on capital as a result of provision for loan losses and write-downs on other real estate owned, and booked a 100% valuation allowance against the deferred tax asset. We will continue to analyze our deferred tax assets and related valuation allowance each quarter taking into account performance compared to forecast and current economic or internal information that would impact forecasted earnings.

Balance Sheet Review

Investments

The purpose of the investment portfolio is to provide liquidity and stable returns through the purchase of high quality investment securities. At December 31, 2012, our investment portfolio of $25.5 million represented approximately 20.4% of total assets. The portfolio increased from $12.6 million at December 31, 2011, or 11.2% of total assets. Increases in investment balances during 2012 were due to the purchase of new investment securities with excess liquidity, offset by normal investment maturities and repayments. At December 31, 2012 and 2011, we held government-sponsored enterprise securities, mortgage-backed securities, non-taxable and taxable municipal bonds as investment securities available for sale. The amortized costs and the fair value of our investments at December 31, 2012, 2011, and 2010 are shown in the following table.

        2012
    2011
    2010
   
        Amortized
Cost

    Fair
Value

    Amortized
Cost

    Fair
Value

    Amortized
Cost

    Fair
Value

Available for Sale
                                                                                                      
Government-sponsored enterprises
              $ 1,000,000          $ 1,001,783          $ 2,000,000          $ 2,000,879          $ 5,000,000          $ 4,975,716   
Government-sponsored mortgage-backed
                 13,970,527             13,943,118             7,086,422             7,237,440             5,226,829             5,289,427   
Municipals, tax-exempt
                 9,168,199             9,175,589                                                       
Municipals, taxable
                 1,333,217             1,363,625             3,407,028             3,383,085             373,291             387,590   
Total
              $ 25,471,943          $ 25,484,115          $ 12,493,450          $ 12,621,404          $ 10,600,120          $ 10,652,733   
 

Contractual maturities and yields on our investment securities available for sale at December 31, 2012 are shown in the following table. Expected maturities may differ from contractual maturities as 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
Available for Sale
                                                                                                                                                                      
Government- sponsored enterprises
              $              %         $ 1,000,000             .74 %         $              %         $              %         $ 1,000,000             .74 %  
Government-sponsored mortgage-
backed
                                                                                               13,970,527             3.68             13,970,527             3.68   
Municipals, tax-exempt
                                                                     2,050,898             1.97             7,117,301             2.77             9,168,199             2.59   
Municipals, taxable
                                                                     505,044             3.02             828,173             2.85             1,333,217             3.34   
Total
              $              %         $ 1,000,000             .74 %         $ 2,555,942             2.18 %         $ 21,916,001             3.38 %         $ 25,471,943             3.16 %  
 

49



At December 31, 2012 and 2011, we also held non-marketable equity securities, which consisted of Federal Reserve Bank stock of $251,800 and $271,550, respectively, and Federal Home Loan Bank stock of $483,500 and $646,800, respectively. These investments are carried at cost, which approximates fair maket value.

Loans

Since loans typically provide higher interest yields than other types of interest-earning assets, a significant percentage of our earning assets are invested in our loan portfolio. Average loans for the year ended December 31, 2012 were $73 million, a decrease of $13.0 million, or 15.1%, compared to average loans of $86.0 million for the year ended December 31, 2011. Before allowance for loan losses, gross loans outstanding at December 31, 2012 were $70.4 million, or 56.4% of total assets, compared to $76.9 million, or 68.5% of total assets at December 31, 2011. Because assets increased dramatically on the last day of the year from the capital infusion (approximately $14 million in cash), our loans as a percentage of total assets dropped.

The principal component of our loan portfolio is loans secured by real estate mortgages. Most of our real estate loans are secured by residential or commercial property. We do not generally originate traditional long term residential mortgages, 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 80%.

The following table summarizes the composition of our loan portfolio as of December 31, 2012, 2011, 2010, 2009 and 2008.

        2012
    2011
   
        Amount
    % of
Total

    Amount
    % of
Total

Real Estate:
                                                                       
Commercial
              $ 24,845,155             35.3 %         $ 27,608,938             35.9 %  
Construction and development
                 12,299,452             17.5             13,073,899             17.0   
Single and multifamily residential
                 21,294,926             30.2             23,360,151             30.4   
Total real estate loans
                 58,439,533             83.0             64,042,988             83.3   
Commercial business
                 10,915,768             15.5             11,346,361             14.8   
Consumer — other
                 1,128,544             1.6             1,574,865             2.0   
Deferred origination fees, net
                 (102,099 )            (0.1 )            (74,853 )            (0.1 )  
Gross loans, net of deferred fees
                 70,381,746             100.0 %            76,889,361             100.0 %  
Less allowance for loan losses
                 (1,858,416 )                           (2,110,523 )                  
Total loans, net
              $ 68,523,330                         $ 74,778,838                   
 

50



        2010
    2009
   
        Amount
    % of
Total

    Amount
    % of
Total

Real Estate:
                                                                       
Commercial
              $ 34,017,993             36.0 %         $ 33,995,883             31.5 %  
Construction and development
                 19,209,473             20.3             28,325,005             26.2   
Single and multifamily residential
                 27,408,007             29.0             28,729,683             26.7   
Total real estate loans
                 80,635,473             85.3             91,050,571             84.4   
Commerical business
                 12,262,223             13.0             15,161,839             14.0   
Consumer — other
                 1,659,570             1.8             1,937,553             1.8   
Deferred origination fees, net
                 (92,025 )            (0.1 )            (172,494 )            (0.2 )  
Gross loans, net of deferred fees
                 94,465,241             100.0 %            107,977,469             100.0 %  
Less allowance for loan losses
                 (3,062,492 )                           (1,847,513 )                  
Total loans, net
              $ 91,402,749                         $ 106,129,956                   
 
        2008
   
        Amount
    % of
Total

   
Real Estate:
                                                                       
Commercial
              $ 38,977,019             31.5 %                                               
Construction and development
                 31,205,453             25.3                                   
Single and multifamily residential
                 31,226,994             25.3                                   
Total real estate
                 101,409,466             82.1                                   
Commerical business
                 20,053,376             16.2                                   
Consumer — other
                 2,187,326             1.8                                   
Deferred origination fees, net
                 (202,414 )            (0.1 )                                  
Gross loans
                 123,447,754             100.0 %                                  
Less allowance for loan losses
                 (1,611,977 )                                                  
Total loans, net
              $ 121,835,777                                                   
 

The largest component of our loan portfolio at year-end was commercial real estate loans, which represented 35.3% of the portfolio. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration of certain types of collateral. Refer to Item 1, “Lending Activities”, for a detailed discussion regarding the risks inherent in each loan category noted above. Due to the short time our portfolio has existed, the current mix may not be indicative of the ongoing portfolio mix.

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 which 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.

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The following table summarizes the loan maturity distribution by type and related interest rate characteristics at December 31, 2012.

        One year
or less

    After one
but within
five years

    After five
years

    Total
Real Estate:
                                                                       
Commercial
              $ 6,741,119          $ 16,663,203          $ 1,440,833          $ 24,845,155   
Construction and development
                 7,850,172             4,449,280                          12,299,452   
Single and multifamily residential
                 5,928,674             8,939,057             6,427,195             21,294,926   
Total real estate
                 20,519,965             30,051,540             7,868,028             58,439,533   
Commercial business
                 4,978,599             4,879,159             1,058,010             10,915,768   
Consumer — other
                 421,795             694,582             12,167             1,128,544   
Gross loans
              $ 25,920,359          $ 35,625,281          $ 8,938,205          $ 70,483,845   
Deferred origination fees, net
                                                              (102,099 )  
Gross loans, net of deferred fees
                                                           $ 70,381,746   
Loans maturing — after one year with
                                                                       
Fixed interest rates
                                                           $ 16,819,601   
Floating interest rates
                                                           $ 27,743,885   
 

Loan Performance and Asset Quality

The downturn in general economic conditions over the past three plus years has resulted in increased loan delinquencies, defaults and foreclosures within our loan portfolio. The declining real estate market has had a significant impact on the performance of our loans secured by real estate. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure. Although the real estate collateral provides an alternate source of repayment in the event of default by the borrower, in our current market the value of the collateral has deteriorated during the time the credit is extended. There is a risk that this trend will continue, which could result in additional losses of earnings and increases in our provision for loan losses and loans charged-off.

Past due payments are often one of the first indicators of a problem loan. We perform a continuous review of our past due report in order to identify trends that can be resolved quickly before a loan becomes significantly past due. We determine past due and delinquency status based on the contractual terms of the note. When a borrower fails to make a scheduled loan payment, we attempt to cure the default through several methods including, but not limited to, collection contact and assessment of late fees.

Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal. Foregone interest income related to nonaccrual loans equaled $364,856 and $511,224 for the years ended December 31, 2012 and 2011, respectively. No interest income was recognized on nonaccrual loans during 2012 and 2011. At both December 31, 2012 and 2011, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments.

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The following table summarizes delinquencies and nonaccruals, by portfolio class, as of December 31, 2012, 2011, 2010, 2009, and 2008.

        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2012
                                                                                                      
30–59 days past due
              $ 46,178          $           $           $           $ 9,316          $ 55,494   
60–89 days past due
                                                                     1,541             1,541   
Nonaccrual
                 719,260             3,710,587             331,000                                       4,760,847   
Total past due and nonaccrual
                 765,438             3,710,587             331,000                          10,857             4,817,882   
Total debt restructurings
                 1,175,843                          1,314,205                                           2,490,048   
Current
                 19,353,645             8,588,865             23,199,950             10,915,768             1,117,687             63,175,915   
Total loans
              $ 21,294,926          $ 12,299,452          $ 24,845,155          $ 10,915,768          $ 1,128,544          $ 70,483,845   
 
        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2011
                                                                                                      
30–59 days past due
              $ 760,086          $ 516,483          $           $ 66,500          $           $ 1,343,069   
60–89 days past due
                                                                     14,358             14,358   
Nonaccrual
                 1,558,914             3,128,943             354,990                                       5,042,847   
Total past due and nonaccrual
                 2,319,000             3,645,426             354,990             66,500             14,358             6,400,274   
Total debt restructurings
                 1,348,775                                                                 1,348,775   
Current
                 19,692,376             9,428,473             27,253,948             11,279,861             1,560,507             69,215,165   
Total loans
              $ 23,360,151          $ 13,073,899          $ 27,608,938          $ 11,346,361          $ 1,574,865          $ 76,964,214   
 

        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2010
                                                                                                      
30–59 days past due
              $ 16,902          $           $ 428,273          $ 1,409          $ 7,576          $ 454,160   
60–89 days past due
                              145,718             97,680                                       243,398   
Nonaccrual
                 3,098,499             8,069,557             861,432                                       12,029,488   
Total past due and nonaccrual
                 3,115,401             8,215,275             1,387,385             1,409             7,576             12,727,046   
Total debt restructurings
                 1,272,614                                                                 1,272,614   
Current
                 23,019,992             10,994,198             32,630,608             12,260,814             1,651,994             80,557,606   
Total loans
              $ 27,408,007          $ 19,209,473          $ 34,017,993          $ 12,262,223          $ 1,659,570          $ 94,557,266   
 

53



        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2009
                                                                                                      
30–59 days past due
              $           $ 452,199          $           $ 21,718          $ 7,358          $ 481,275   
60–89 days past due
                                                        16,116                          16,116   
Nonaccrual
                 1,648,091             4,448,852             623,750                                       6,720,693   
Total past due and nonaccrual
                 1,648,091             4,901,051             623,750             37,834             7,358             7,218,084   
Total debt restructurings
                                                                                     
Current
                 27,038,540             23,423,954             33,415,185             15,124,005             1,930,195             100,931,879   
Total loans
              $ 28,686,631          $ 28,325,005          $ 34,038,935          $ 15,161,839          $ 1,937,553          $ 108,149,963   
 
        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2008
                                                                                                      
30–59 days past due
              $           $ 809,210          $ 642,914          $ 63,882          $           $ 1,516,006   
60–89 days past due
                 274,928             1,164,718             341,921                                       1,781,567   
Nonaccrual
                                           394,950                                       394,950   
Total past due and nonaccrual
                 274,928             1,973,928             1,379,785             63,882                          3,692,523   
Total debt restructurings
                                                                                     
Current
                 30,952,066             29,231,525             37,597,234             19,989,494             2,187,326             119,957,645   
Total loans
              $ 31,226,994          $ 31,205,453          $ 38,977,019          $ 20,053,376          $ 2,187,326          $ 123,650,168   
 

Total delinquent and nonaccrual loans decreased from $6.4 million at December 31, 2011 to $4.8 million at December 31, 2012, a decrease of $1.6 million or 24.7%. This decrease was a result of movement in nonaccrual loans to other real estate owned, which decreased by $282,000 from 2011 to 2012 and due to a decrease in loans past due 30-59 days of $1.3 million as discussed below. Nonaccrual decreases were seen in single and multifamily residential real estate loans due to successful foreclosure of the properties collateralizing these loans and their transfer to other real estate owned. Nonaccrual increases were seen in both construction and development and commercial real estate loans. At December 31, 2012, nonaccrual loans represented 6.8% of gross loans. Loans past due 30-89 days are considered potential problem loans and amounted to $57,035 at December 31, 2012 compared to $1.4 million at December 31, 2011. The decrease in 30-89 delinquent loans is due to two larger loans in the process of renewal as of December 31, 2011 being successfully renewed under normal terms, including principal and interest payments, in January 2012.

Another method used to monitor the loan portfolio is credit grading. As part of the loan review process, loans are given individual credit grades, representing the risk we believe is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. The following table summarizes management’s internal credit risk grades, by portfolio class, as of December 31, 2012 and 2011.

54



        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2012
                                                                                                       
Pass Loans (Consumer)
              $ 11,422,022          $ 696,905          $ 139,012          $ 113,288          $ 1,128,544          $ 13,499,771   
Grade 1 — Prime
                                                        308,750                          308,750   
Grade 2 — Good
                                           230,280             107,938                          338,218   
Grade 3 — Acceptable
                 2,117,292             348,161             10,556,916             1,989,425                          15,011,794   
Grade 4 — Acceptable w/Care
                 4,659,260             6,027,262             12,273,743             8,333,192                          31,293,457   
Grade 5 — Special Mention
                 1,061,367             95,941                          63,175                          1,220,483   
Grade 6 — Substandard
                 2,034,985             5,131,183             1,645,204                                       8,811,372   
Grade 7 — Doubtful
                                                                                     
Total loans
              $ 21,294,926          $ 12,299,452          $ 24,845,155          $ 10,915,768          $ 1,128,544          $ 70,483,845   
 
        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2011
                                                                                                       
Pass Loans (Consumer)
              $ 13,448,213          $ 668,187          $ 38,122          $           $ 1,499,204          $ 15,653,726   
Grade 1 — Prime
                                                        308,750                          308,750   
Grade 2 — Good
                                           1,303,456             131,153                          1,434,609   
Grade 3 — Acceptable
                 1,982,863             393,526             11,335,186             4,927,092                          18,638,667   
Grade 4 — Acceptable w/Care
                 5,214,948             5,094,973             12,431,878             5,912,866                          28,654,665   
Grade 5 — Special Mention
                 1,108,603             103,036             317,477             66,500                          1,595,616   
Grade 6 — Substandard
                 1,605,524             6,814,177             2,182,819                          75,661             10,678,181   
Grade 7 — Doubtful
                                                                                     
Total loans
              $ 23,360,151          $ 13,073,899          $ 27,608,938          $ 11,346,361          $ 1,574,865          $ 76,964,214   
 

Loans graded one through four are considered “pass” credits. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. At December 31, 2012, approximately 86% of the loan portfolio had a credit grade of “pass” compared to 84% at December 31, 2011. For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

Loans with a credit grade of five are not considered classified; however they are categorized as a special mention or watch list credit, and are considered potential problem loans. This classification is utilized by us when we have an initial concern about the financial health of a borrower. These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “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 determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of December 31, 2012, we had loans totaling $1.2 million on the watch list compared to $1.6 million as of December 31, 2011.

Loans graded six or greater are considered classified credits. At December 31, 2012 and 2011, classified loans totaled $8.8 million and $10.7 million, respectively, with the vast majority of these loans being collateralized by real estate. Classified credits are evaluated for impairment on a quarterly basis.

55



A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan-by-loan basis by calculating either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The resultant shortfall is charged to provision for loan losses and is classified as a specific reserve. When an impaired loan is ultimately charged-off, the charge-off is taken against the specific reserve.

At December 31, 2012, impaired loans totaled $8.5 million, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral. Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower. During 2012, the average recorded investment in impaired loans was $8.7 million compared to $11.3 million during 2011. As of December 31, 2012 and December 31, 2011, we had loans totaling approximately $317,180 and $1.8 million, respectively that were classified in accordance with our loan rating policies but were not considered impaired. The following table summarizes information relative to impaired loans, by portfolio class, at December 31, 2012 and 2011.

        Unpaid
principal
balance

    Recorded
investment

    Related
allowance

    Average
impaired
investment

    Interest
income

December 31, 2012
                                                                                      
With no related allowance recorded:
                                                                                       
Single and multifamily residential real estate
              $ 91,859          $ 91,859          $           $ 91,342          $ 5,405   
Construction and development
                 2,478,357             2,315,396                          2,233,267             108,322   
Commercial real estate — other
                 1,314,205             1,314,205                          1,277,725             72,967   
Commercial
                                                                        
Consumer
                                                                        
With related allowance recorded:
                                                                                       
Single and multifamily residential real estate
                 2,029,076             1,943,127             159,979             1,466,570                
Construction and development
                 3,596,136             2,498,606             248,417             3,359,431             58,301   
Commercial real estate — other
                 331,000             331,000             34,000             318,679                
Commercial
                                                                        
Consumer
                                                                        
Total:
                                                                                       
Single and multifamily residential real estate
                 2,120,935             2,034,986             159,979             1,557,912             5,405   
Construction and development
                 6,074,493             4,814,002             248,417             5,592,698             166,623   
Commercial real estate — other
                 1,645,205             1,645,205             34,000             1,596,404             72,967   
Commercial
                                                                        
Consumer
                                                                        
 
              $ 9,840,633          $ 8,494,193          $ 442,396          $ 8,747,014          $ 244,995   

56



        Unpaid
principal
balance

    Recorded
investment

    Related
allowance

    Average
impaired
investment

    Interest
income

December 31, 2011
                                                                                      
With no related allowance recorded:
                                                                                       
Single and multifamily residential real estate
              $ 91,195          $ 91,195          $           $ 106,348          $    
Construction and development
                 2,215,234             2,215,234                          1,910,774             75,449   
Commercial real estate — other
                 404,502             354,990                          780,124                
Commercial
                                                        18,453                
Consumer
                                                                        
With related allowance recorded:
                                                                                       
Single and multifamily residential real estate
                 1,600,279             1,514,330             141,830             2,001,323                
Construction and development
                 6,038,519             4,598,943             383,421             6,078,709             100,694   
Commercial real estate — other
                                                        404,916             9,907   
Commercial
                                                        18,453                
Consumer
                 75,661             75,661             38,424             15,132                
Total:
                                                                                       
Single and multifamily residential real estate
                 1,691,474             1,605,525             141,830             2,107,671                
Construction and development
                 8,253,753             6,814,177             383,421             7,989,483             176,143   
Commercial real estate — other
                 404,502             354,990                          1,185,040             9,907   
Commercial
                                                        36,906                
Consumer
                 75,661             75,661             38,424             15,132                
 
              $ 10,425,390          $ 8,850,353          $ 563,675          $ 11,334,232          $ 186,050   
 

TDRs are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.

As a result of adopting the amendments in ASU 2011-02, we reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are TDRs under the amended guidance. We did not identify any new TDRs during our assessment as a result of the amended guidance. However, there were two commercial real estate loans and one single family loan modified during the year ended December 31, 2012 totaling $2.5 million (pre-modification investment equaling post-modification investment). Two of these loans were modified with a term concession and the third was modified with a rate concession.

At December 31, 2012, the principal balance of TDRs totaled $2.5 million. All TDRs were considered classified, and impaired at December 31, 2012. No TDRs went into default during the year ended December 31, 2012. A TDR can be removed from “troubled” status once there is sufficient history of demonstrating the borrower can service the credit under market terms. We currently consider sufficient history to be approximately six months.

57



Provision and Allowance for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. At December 31, 2012, the allowance for loan losses was $1.9 million, or 2.64% of gross loans, compared to $2.1 million at December 31, 2011, or 2.74% of gross loans. This decrease in the allowance for loan losses is due to charge-offs taken against specific reserves, as well as payoffs in our commercial real estate portfolio, which carries a higher historical loss ratio and, consequently, a higher reserve factor within our allowance model.

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. We strive to follow a comprehensive, well-documented, and consistently applied analysis of our loan portfolio in determining an appropriate level for the allowance for loan losses. 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 what we believe are all significant factors that impact 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 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.

Our allowance for loan losses consists of both specific and general reserve components. The specific reserve component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. Loans determined to be impaired are excluded from the general reserve calculation described below and evaluated individually for impairment. Impaired loans totaled $8.5 million at December 31, 2012, with an associated specific reserve of $442,396. See above discussion under “Loan Performance and Asset Quality” for additional information related to impaired loans.

The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. The total general reserve is based upon the individual loan categories and their historical loss factors over an eight quarter moving average, adjusted for other risk factors as well. Therefore, the general allocation will move among the categories depending on if some loss factors increased while others decreased. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.

58



The following table summarizes activity related to our allowance for loan losses for the years ended December 31, 2012, 2011, 2010, 2009, and 2008 by portfolio segment.

        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2012
                                                                                                      
Allowance for loan losses:
                                                                                                       
Balance, beginning of year
              $ 576,669          $ 688,847          $ 347,061          $ 412,808          $ 85,138          $ 2,110,523   
Provision for loan losses
                 88,351             402,724             (233,315 )            (361,805 )            82,046             (22,000 )  
Loan charge-offs
                 (55,330 )            (18,461 )            (49,999 )            (15,443 )            (93,883 )            (233,116 )  
Loan recoveries
                 1,886                                       1,123                          3,009   
Net loans charged-off
                 (53,444 )            (18,461 )            (49,999 )            (14,320 )            (93,883 )            (230,107 )  
Balance, end of year
              $ 611,576          $ 1,073,110          $ 63,747          $ 36,683          $ 73,301          $ 1,858,416   
Individually reviewed for impairment
              $ 159,979          $ 248,417          $ 34,000          $           $           $ 442,396   
Collectively reviewed for impairment
                 451,597             824,693             29,747             36,683             73,301             1,416,020   
Total allowance for loan losses
              $ 611,576          $ 1,073,110          $ 63,747          $ 36,683          $ 73,301          $ 1,858,416   
Gross loans, end of period:
                                                                                                       
Individually reviewed for impairment
              $ 2,034,985          $ 4,814,002          $ 1,645,204          $           $           $ 8,494,191   
Collectively reviewed for impairment
                 19,259,941             7,485,450             23,199,951             10,915,768             1,128,544             61,989,654   
Total gross loans
              $ 21,294,926          $ 12,299,452          $ 24,845,155          $ 10,915,768          $ 1,128,544          $ 70,483,845   
 
        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2011
                                                                                                       
Allowance for loan losses:
                                                                                                       
Balance, beginning of year
              $ 859,255          $ 1,365,914          $ 473,504          $ 306,791          $ 57,028          $ 3,062,492   
Provision for loan losses
                 122,733             739,248             (59,736 )            (107,334 )            35,089             730,000   
Loan charge-offs
                 (405,319 )            (1,416,315 )            (66,707 )            (764 )            (6,979 )            (1,896,084 )  
Loan recoveries
                                                        214,115                          214,115   
Net loans charged-off
                 (405,319 )            (1,416,315 )            (66,707 )            213,351             (6,979 )            (1,681,969 )  
Balance, end of year
              $ 576,669          $ 688,847          $ 347,061          $ 412,808          $ 85,138          $ 2,110,523   
Individually reviewed for impairment
              $ 141,830          $ 383,421          $           $           $ 38,424          $ 563,675   
Collectively reviewed for impairment
                 434,839             305,426             347,061             412,808             46,714             1,546,848   
Total allowance for loan losses
              $ 576,669          $ 688,847          $ 347,061          $ 412,808          $ 85,138          $ 2,110,523   
Gross loans, end of period:
                                                                                                       
Individually reviewed for impairment
              $ 1,605,525          $ 6,814,177          $ 354,990          $           $ 75,661          $ 8,850,353   
Collectively reviewed for impairment
                 21,754,626             6,259,722             27,253,948             11,346,361             1,499,204             68,113,861   
Total gross loans
              $ 23,360,151          $ 13,073,899          $ 27,608.938          $ 11,346,361          $ 1,574,865          $ 76,964,214   
 

59



        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2010
                                                                                                       
Allowance for loan losses:
                                                                                                       
Balance, beginning of year
              $ 391,719          $ 911,974          $ 131,914          $ 360,156          $ 51,750          $ 1,847,513   
Provision for loan losses
                 1,045,037             1,107,585             379,289             531,119             11,970             3,075,000   
Loan charge-offs
                 (578,132 )            (653,645 )            (37,699 )            (624,484 )            (6,692 )            (1,900,652 )  
Loan recoveries
                 631                                        40,000                          40,631   
Net loans charged-off
                 (577,501 )            (653,645 )            (37,699 )            (584,484 )            (6,692 )            (1,860,021 )  
Balance, end of year
              $ 859,255          $ 1,365,914          $ 473,504          $ 306,791          $ 57,028          $ 3,062,492   
Individually reviewed for impairment
              $ 551,415          $ 768,358          $ 251,971          $           $           $ 1,571,744   
Collectively reviewed for impairment
                 307,840             597,556             221,533             306,791             57,028             1,490,748   
Total allowance for loan losses
              $ 859,255          $ 1,365,914          $ 473,504          $ 306,791          $ 57,028          $ 3,062,492   
Gross loans, end of period:
                                                                                                       
Individually reviewed for impairment
              $ 3,098,498          $ 8,215,275          $ 1,470,903          $           $           $ 12,784,676   
Collectively reviewed for impairment
                 24,309,509             10,994,198             32,547,090             12,262,223             1,659,570             81,772,590   
Total gross loans
              $ 27,408,007          $ 19,209,473          $ 34,017,993          $ 12,262,223          $ 1,659,570          $ 94,557,266   
 
        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2009 (1)
                                                                                                      
Allowance for loan losses:
                                                                                                       
Balance, beginning of year
              $ 329,244          $ 850,286          $ 57,781          $ 327,136          $ 47,530          $ 1,611,977   
Provision for loan losses
                 106,069             293,031             74,133             309,021             429,746             1,212,000   
Loan charge-offs
                 (43,594 )            (231,343 )                         (276,001 )            (425,588 )            (976,526 )  
Loan recoveries
                                                                     62              62    
Net loans charged-off
                 (43,594 )            (231,343 )                         (276,001 )            (425,526 )            (976,464 )  
Balance, end of year
              $ 391,719          $ 911,974          $ 131,914          $ 360,156          $ 51,750          $ 1,847,513   
Individually reviewed for impairment
              $ 165,577          $ 42,393          $           $           $           $ 207,970   
Collectively reviewed for impairment
                 226,142             869,581             131,914             360,156             51,750             1,639,543   
Total allowance for loan losses
              $ 391,719          $ 911,974          $ 131,914          $ 360,156          $ 51,750          $ 1,847,513   
Gross loans, end of period:
                                                                                                       
Individually reviewed for impairment
              $ 1,648,091          $ 5,015,444          $           $           $           $ 6,663,535   
Collectively reviewed for impairment
                 27,038,540             23,309,561             34,038,935             15,161,839             1,937,553             101,486,428   
Total gross loans
              $ 28,686,631          $ 28,325,005          $ 34,038,935          $ 15,161,839          $ 1,937,553          $ 108,149,963   
 

60



        Single and
multifamily
residential
real estate

    Construction
and
development

    Commercial
real estate —
other

    Commercial
business

    Consumer
    Total
December 31, 2008 (1)
                                                                                                      
Allowance for loan losses:
                                                                                                       
Balance, beginning of year
              $ 207,892          $ 729,018          $ 22,781          $ 284,770          $ 39,030          $ 1,283,491   
Provision for loan losses
                 121,352             121,268             35,000             77,930             8,500