10-K 1 v402856_10k.htm 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

 

Annual Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

 

For the fiscal year ended: December 31, 2014 Commission File Number: 000-11448

 

NewBridge Bancorp

(Exact name of Registrant as specified in its Charter)

 

North Carolina   56-1348147
(State of Incorporation)   (I.R.S. Employer Identification No.)
     
1501 Highwoods Blvd., Suite 400    
Greensboro, North Carolina   27410
(Address of principal executive offices)   (Zip Code)

 

(336) 369-0900

(Registrant's telephone number, including area code)

 

 

 

Securities Registered Pursuant to Section 12(g) of the Securities Exchange Act of 1934:

 

    Name of each exchange
Title of each class   on which registered
Class A Common Stock, no par value per share   Nasdaq Global Select Market

 

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

 

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

The aggregate market value of the Registrant’s voting and nonvoting common equity held by non-affiliates of the Registrant, based on the average bid and asked price of such common equity on the last business day of the Registrant’s most recently completed second fiscal quarter, was approximately $294.0 million. As of March 11, 2015 (the most recent practicable date), the Registrant had 35,795,134 shares of Class A common stock outstanding and 3,186,748 shares of Class B common stock outstanding.

 

Documents incorporated by reference – Portions of the Proxy Statement for the 2015 Annual Meeting of Shareholders of NewBridge Bancorp (the “Proxy Statement”) are incorporated by reference into Part III hereof.

 

The Exhibit Index begins on page 123.

 

 
 

 

NewBridge Bancorp

Annual Report on Form 10-K for the fiscal year ended December 31, 2014

Table of Contents

 

Index     Page
       
PART I      
       
Item 1.   Business 4
Item 1A.   Risk Factors 15
Item 1B.   unresolved staff comments 25
Item 2.   Properties 25
Item 3.   Legal Proceedings 27
       
PART II      
       
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 28
Item 6.   Selected Financial Data 31
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk 59
Item 8.   Financial Statements and Supplementary Data 63
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 119
Item 9A.   Controls and Procedures 120
Item 9B.   Other Information 120
       
PART III      
       
Item 10.   Directors, Executive Officers And Corporate Governance 121
Item 11.   Executive Compensation 121
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 121
Item 13.   Certain Relationships and Related Transactions, and director independence 121
Item 14.   Principal Accounting Fees and Services 121
       
PART IV      
       
Item 15.   Exhibits and Financial Statement Schedules 122
    Signatures 128

 

2
 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements represent expectations and beliefs of NewBridge Bancorp (hereinafter referred to as the “Company”) including but not limited to the Company’s operations, performance, financial condition, growth or strategies. These forward-looking statements are identified by words such as “expects,” “anticipates,” “should,” “estimates,” “believes” and variations of these words and other similar statements. For this purpose, any statements contained in this Annual Report on Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. These forward-looking statements involve estimates, assumptions, risks and uncertainties that could cause actual results to differ materially from current projections depending on a variety of important factors, including without limitation:

 

  Revenues are lower than expected;

 

  Credit quality deterioration, which could cause an increase in the provision for credit losses;

 

  Competitive pressure among depository institutions increases significantly;

 

  Changes in consumer spending, borrowings and savings habits;

 

  Technological changes and security and operations risks associated with the use of technology;

 

  The cost of additional capital is more than expected;

 

  The interest rate environment could reduce interest margins;

 

  Asset/liability repricing risks, ineffective hedging and liquidity risks;

 

  Counterparty risk;

 

  General economic conditions, particularly those affecting real estate values, either nationally or in the market areas in which we do or anticipate doing business, are less favorable than expected;

 

  The effects of the Federal Deposit Insurance Corporation (“FDIC”) deposit insurance premiums and assessments;

 

  The effects of and changes in monetary and fiscal policies and laws, including the interest rate policies of the Board of Governors of the Federal Reserve System;

 

  Volatility in the credit or equity markets and its effect on the general economy;

 

  Demand for the products or services of the Company, as well as its ability to attract and retain qualified people;

 

  The costs and effects of legal, accounting and regulatory developments and compliance;

 

  Regulatory approvals for acquisitions cannot be obtained on the terms expected or on the anticipated schedule;

 

  The effects of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations, and the enactment of further regulations related to this Act;

 

  More stringent capital requirements effective January 1, 2015;

 

  Risks associated with the Company’s growth strategy, including acquisitions; and

 

  The effects of any intangible or deferred tax asset impairments that may be required in the future.

 

The Company cautions that the foregoing list of important factors is not exhaustive. See also “Risk Factors” which begins on page 15. The Company undertakes no obligation to update any forward-looking statement, whether written or oral, which may be made from time to time, by or on behalf of the Company.

 

3
 

 

PART I

 

Item 1.Business

 

General

 

The Company is a bank holding company incorporated under the laws of the State of North Carolina (“NC”) and registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company’s principal asset is stock of its banking subsidiary, NewBridge Bank (the “Bank”). Accordingly, throughout this Annual Report on Form 10-K, there are frequent references to the Bank. The principal executive offices of the Company and the Bank are located at 1501 Highwoods Boulevard, Suite 400, Greensboro, NC 27410. The telephone number is (336) 369-0900 and its website is www.newbridgebank.com. The Bank maintains operations facilities in Lexington and Reidsville, NC.

 

Business of Bank and Other Subsidiaries

 

Through its branch network, the Bank, a NC chartered member bank, provides a wide range of banking products to small to medium-sized businesses and retail clients in its market areas, including interest-bearing and noninterest-bearing demand deposit accounts, certificates of deposits, individual retirement accounts, overdraft protection, personal and corporate trust services, safe deposit boxes, online banking, corporate cash management, brokerage, financial planning and asset management, and secured and unsecured loans.

 

As of December 31, 2014, the Bank operated two active non-bank subsidiaries: LSB Properties, Inc. (“LSB Properties”) and Henry Properties, LLC (“Henry Properties”), which together own the real estate acquired in settlement of loans of the Bank.

 

The Company has one non-bank subsidiary, FNB Financial Services Capital Trust I (“FNB Trust”), a Delaware statutory trust, formed to facilitate the issuance of trust preferred securities. FNB Trust is not consolidated in the Company’s financial statements.

 

As part of its operations, the Company regularly holds discussions and evaluates the potential acquisition of, or merger with, various financial institutions and other businesses. The Company also periodically considers the potential disposition of certain assets, and the addition or disposition of branches. As a general rule, the Company only publicly announces any material acquisitions or dispositions once a definitive agreement has been reached.

 

The Company operates one reportable segment, the Bank. Reference is made to Item 8 – “Financial Statements and Supplementary Data.” Management believes that the Company is not dependent upon any single client, or a few clients, the loss of any one or more of which would have a material adverse effect on the Company’s operations.

 

Market Areas

 

The Bank’s primary market areas are the Piedmont Triad Region of NC, the Cape Fear Region of NC, which is comprised of the state’s five most southeastern counties, and two of North Carolina’s strongest growth market areas, Charlotte and Raleigh. On December 31, 2014, the Bank operated 40 branch offices in its four primary markets, which are also four of the largest markets in NC. The Bank also had loan production offices in Asheboro, Greensboro, Morganton, Raleigh, Southport and Winston-Salem, NC, and in Greenville and Charleston, SC. The following table lists the Bank’s branch offices as of December 31, 2014, categorized by market and city.

 

4
 

 

Charlotte: Piedmont Triad:
Charlotte (SouthPark) Lexington (five offices)
  Greensboro (four offices)
Raleigh: Winston-Salem (four offices)
Raleigh (two offices) Reidsville (two offices)
Cary Clemmons
Clinton Danbury
Fuqua Varina Eden
  High Point
Cape Fear: Jamestown
Wilmington (two offices) Kernersville
Burgaw King
Calabash Madison
Oak Island Thomasville
Shallotte Walkertown
Southport (two offices)  
Sunset Beach  

 

In October 2014, the Bank announced that it had entered into an agreement to acquire Premier Commercial Bank (“Premier”), a commercial bank headquartered in Greensboro, NC with one branch centrally located in Greensboro and residential mortgage origination offices in Greensboro, Charlotte, Raleigh, High Point, Kernersville and Burlington, NC. The acquisition was successfully completed on February 27, 2015. Following the acquisition, the Bank has 41 branch offices.

 

As of December 31, 2014, the Bank operated 25 branches and three loan production offices in the Piedmont Triad Region of North Carolina. The Piedmont Triad Region is a 12 county area, located in the interstate corridor between the Charlotte and Research Triangle metro areas, and has a combined population of approximately 1.6 million people. The Piedmont Triad Region includes the cities of Greensboro, Winston-Salem and High Point, respectively the third, fifth and ninth largest cities in NC.

 

The Piedmont Triad Region’s economy was built on the textile, furniture and tobacco industries. As these industries have contracted, the Piedmont Triad Region has transitioned to a more service-oriented economy by successfully diversifying into areas related to transportation, logistics, health care, education and technology. The Piedmont Triad International Airport is home to Honda Aircraft Company’s world headquarters and a national FedEx hub.

 

In addition to its strategic proximity to key markets, the Piedmont Triad Region has a well-defined transportation infrastructure, providing access to both global and national markets. Interstates 40, 85 and 77 provide both North-South and East-West routes. In addition, local manufacturers and distribution hubs will have direct access to both Midwest markets and additional Southeast ports when Interstates 73 and 74, which will bisect the Piedmont Triad Region, are completed. Moreover, extensive rail services are offered by Norfolk Southern, CSX and Amtrak, as well as a number of short-line railroads.

 

The Piedmont Triad Region is home to numerous institutions of higher education, including Wake Forest University, Wake Forest University Baptist Medical Center, North Carolina School of the Arts, Salem College and Winston-Salem State University (Winston-Salem); High Point University (High Point); the University of North Carolina at Greensboro, North Carolina A&T University, Elon University School of Law and the Joint School of Nanoscience and Nanoengineering (Greensboro); and a number of well-respected private colleges, as well as many community colleges and technical schools. All are recognized for academic excellence and enhance the Piedmont Triad Region’s business development efforts, particularly in the field of biotechnology.

 

As of December 31, 2014, the Bank operated nine branches and one loan production office in the Cape Fear Region. The Cape Fear Region is centered around Wilmington, the eighth largest city in NC. A historic seaport and a popular tourist destination, Wilmington has a diversified economy and is a major resort area, a light manufacturing center, a chemical manufacturing center and the distribution hub of southeastern NC. The city also serves as the retail and medical center for the region.

 

5
 

 

In addition to economic diversification, Wilmington has experienced extensive industrial development and growth in the service and trade sectors over the last 20 years. Companies in the Wilmington area produce fiber optic cables for the communications industry, aircraft engine parts, pharmaceuticals, nuclear fuel components and various textile products. The motion picture and television industries also have a significant presence in the area.

 

The total population of the Cape Fear Region is approximately 476,000. The area is served by Interstate 40 and U.S. Highways 17 and 74, major rail connections and national and regional airlines through facilities at Wilmington International Airport. Wilmington is also home to the Port of Wilmington, one of two deep-water ports in NC, and the University of North Carolina at Wilmington.

 

As of December 31, 2014, the Bank operated one branch in Charlotte. The office is located in Charlotte’s SouthPark neighborhood featuring one of the largest business districts in the State, as well as upscale shopping and residential areas.

 

Charlotte is the largest city in North Carolina and is within one of the fastest growing metropolitan statistical areas (“MSAs”) in the Southeast. The city is also considered one of the major banking centers in the country. The Charlotte-Concord-Gastonia MSA is the 23rd largest MSA in the nation. Mecklenburg County alone, where Charlotte is located, has grown more than 7.8% since 2010 and has a population of approximately 991,000.

 

As of December 31, 2014, the Bank operated five branches and one loan production office in the Raleigh Market. Raleigh is the capital of North Carolina, and the downtown Raleigh branch office is located just one block from the State Capitol.

 

Raleigh is the second largest city in North Carolina. The Raleigh-Cary MSA is the 47th largest MSA in the country and is one of the fastest growing MSAs. Raleigh is also one of the three cities that make up the area known as the Triangle (Raleigh, Durham and Chapel Hill). The Triangle is best known for Research Triangle Park and the three universities which anchor each of its cities: Duke University in Durham, The University of North Carolina in Chapel Hill, and North Carolina State University in Raleigh.

 

Management believes that unemployment data is the most significant indicator of the economic health of its market areas and monitors this data on a regular basis. As reflected in the following table, the unemployment rate in each of the Bank’s primary market areas was elevated from the end of 2008 through 2012 but showed significant improvement in 2013 and 2014. The table also shows the Bank’s nonperforming loans as a percentage of its total loans in each market as of December 31, 2014.

 

6
 

 

   Unemployment Rate(1)   As of December 31, 2014 
   December 31   Total
Loans(2)
   Non-
performing
Loans
   % of
Total
Loans
 
   2008   2009   2010   2011   2012   2013   2014   (dollars in thousands)     
Piedmont Triad:                                                  
Guilford County   8.3%   11.2%   10.1%   9.9%   9.5%   6.9%   5.3%  $222,313   $477    0.21%
Davidson County   9.7    13.4    11.1    10.5    10.1    6.9    5.3    128,843    1,691    1.31 
Rockingham County   10.1    12.6    12.1    11.4    10.6    7.5    5.9    58,716    510    0.87 
Forsyth/Stokes Counties   7.4    9.9    9.1    9.5    8.8    6.1    4.9    156,011    252    0.16 
Raleigh:                                                  
Wake County   5.9    8.5    8.0    7.7    7.3    5.0    4.1    295,329    59    0.02 
Charlotte:                                                  
Mecklenburg County   7.7    11.2    10.5    9.5    9.2    6.7    5.1    290,386    -    - 
Cape Fear   7.5    9.7    8.9    9.7    9.5    7.5    5.4    221,914    771    0.35 
Loan Production Offices   N/A    N/A    N/A    N/A    N/A    N/A    N/A    19,326    -    - 
Corporate Centers:                                                  
Mortgage Center   N/A    N/A    N/A    N/A    N/A    N/A    N/A    235,599    3,116    1.32 
Virginia Loans   N/A    N/A    N/A    N/A    N/A    N/A    N/A    4,795    247    5.15 
Credit Cards   N/A    N/A    N/A    N/A    N/A    N/A    N/A    7,853    -    - 
Other   N/A    N/A    N/A    N/A    N/A    N/A    N/A    163,321    89    0.05 

 

(1)Source: U.S. Bureau of Labor Statistics and North Carolina Department of Commerce.
(2)Excludes loans held for sale.

 

The following table reflects the Bank’s loans, deposits and branch locations in its four primary markets at December 31, 2014, and the Bank’s rank by deposit market share as of June 30, 2014 (dollars in thousands):

 

Market  Loans(1)(2)   Deposits(2)   Number of
Branches
   Deposit Market
Share Rank(3)
 
Piedmont Triad  $565,883   $969,966    25    2 
Raleigh   295,329    247,399    5    5 
Charlotte   290,386    23,366    1    14 
Cape Fear   221,914    257,750    9    3 

 

(1)Excludes loans held for sale.
(2)Excludes loans and deposits held in corporate centers and loan production offices.
(3)As of June 30, 2014, rank for community banks; excludes banks with more than $10 billion in assets.

 

Deposits

 

The Bank offers a variety of deposit products to small to medium-sized businesses and retail clients at interest rates generally competitive with those of other financial institutions. The table below sets forth the mix of depository accounts at the Bank as a percentage of total deposits of the Bank at the dates indicated.

 

   As of December 31 
   2014   2013   2012 
             
Noninterest-bearing demand   17.4%   15.5%   15.4%
Savings, NOW, MMI   52.6    55.4    59.5 
Certificates of deposit   30.0    29.1    25.1 
    100.0%   100.0%   100.0%

 

The Bank accepts deposits at its banking offices, most of which have automated teller machines (“ATMs”). Its memberships in multiple ATM networks allow clients access to their depository accounts from ATM facilities throughout the United States. Competitive fees are charged for the use of its ATM facilities by clients not having an account with the Bank. Deposit flows are controlled primarily through the pricing of deposits.

 

7
 

 

At December 31, 2014, the Bank had $385.0 million in certificates of deposit of $100,000 or more, including $294.1 million in certificates of deposit of $250,000 or more. It also utilizes brokered deposits and deposits obtained through the Certificate of Deposit Account Registry Service (“CDARS”), a service of Promontory InterFinancial Network, LLC, to supplement in-market deposits. The accompanying table presents the scheduled maturities of time deposits of $100,000 or more and $250,000 or more at December 31, 2014.

 

Scheduled maturity of time deposits  $100,000 or more   $250,000 or more 
(dollars in thousands)          
Less than three months  $175,549   $154,710 
Three through six months   111,602    95,124 
Seven through twelve months   52,039    32,296 
More than twelve months   45,810    11,955 
Total  $385,000   $294,085 

 

See also Note 7 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

 

Marketing

 

The Bank focuses its marketing efforts on small to medium-sized businesses, professionals and retail clients, and on achieving certain strategic objectives, including increasing noninterest income and growing core deposits and loans. The Bank promotes its brand through its association with the Greensboro minor league baseball team and ballpark (NewBridge Bank Park), traditional advertising and promotions, sponsorship of local events and other community-focused campaigns. The Bank also invests in bank-hosted events and client hospitality opportunities that foster relationship building and business development.

 

Competition

 

Commercial banking in North Carolina is extremely competitive. Many of the Bank’s competitors are significantly larger and have greater resources. The Bank encounters significant competition from a number of sources, including commercial banks, thrift institutions, credit unions and other financial institutions and financial intermediaries. The Bank competes in its market areas with some of the largest banking organizations in the Southeast and nationally, almost all of which have numerous branches in NC. Many of its competitors have substantially higher lending limits due to their greater total capitalization, and some perform functions for their clients that the Bank generally does not offer. The Bank primarily relies on providing quality products and services at a competitive price within its market areas. As a result of interstate banking legislation, the Bank’s market is open to future penetration by out-of-state banks thereby further increasing future competition.

 

As of June 30, 2014, the Bank competed with 33 commercial banks and savings institutions in the Piedmont Triad Region; 20 in the Cape Fear Region; 26 in Raleigh; and 24 in Charlotte. There are also a large number of competing credit unions in each market.

 

Employees

 

At December 31, 2014, the Company had a total of 487 employees, including 457 full time employees, all of whom were compensated by the Bank. None of the Company’s employees are represented by a collective bargaining unit, and the Company has not recently experienced any type of strike or labor dispute. The Company considers its relationship with its employees to be good.

 

Supervision and Regulation

 

Bank holding companies and commercial banks are extensively regulated under both federal and state law. The following is a brief summary of certain statutes and rules and regulations that affect or will affect the Company and the Bank. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company and the Bank. Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than shareholders of the Company. Statutes and regulations which contain wide-ranging proposals for altering the structures, regulations and competitive relationship of financial institutions are introduced regularly. The Company cannot predict whether, or in what form, any proposed statute or regulation will be adopted or the extent to which the business of the Company and the Bank may be affected by such statute or regulation.

 

8
 

 

General. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event the depository institution becomes in danger of default or in default. For example, to mitigate the risk of failure, holding companies are required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” with 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 bank’s total assets at the time the bank became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all applicable capital standards as of the time the bank fails to comply with such capital restoration plan. The Company, as a registered bank holding company, is subject to the regulation of the Board of Governors of the Federal Reserve System (“Federal Reserve”). Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve, under the BHCA, also has the authority to require a bank holding company to terminate any activity or to 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 and stability of any bank subsidiary of the holding company.

 

As a result of the Company’s ownership of the Bank, the Company is also registered under the bank holding company laws of North Carolina. Accordingly, the Company is also subject to supervision and regulation by the North Carolina Commissioner of Banks (the “Commissioner”). As a state chartered member bank, the Bank is also subject to the regulation of the Federal Reserve.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly changed bank regulation and has affected the lending, investment, trading and operating activities of depository institutions and their holding companies.

 

The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with extensive powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has 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. The Consumer Financial Protection Bureau also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, such as the Bank, will continue to be examined by their applicable federal bank regulators. The Dodd-Frank Act also gave state attorneys general the ability to enforce applicable federal consumer protection laws.

 

The Dodd-Frank Act broadened the base for FDIC assessments for deposit insurance and permanently increased the maximum amount of deposit insurance to $250,000 per depositor. The legislation also, among other things, requires originators of certain securitized loans to retain a portion of the credit risk, stipulates regulatory rate-setting for certain debit card interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contains a number of reforms related to mortgage originations. The Dodd-Frank Act increased the ability of shareholders to influence boards of directors by requiring companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to company executives, regardless of whether the company is publicly traded or not. Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates or require the implementing regulations and, therefore, their impact on our operations cannot be fully determined at this time. However, it is likely that the Dodd-Frank Act will increase the regulatory burden, compliance costs and interest expense for the Bank and the Company.

 

Capital Adequacy. The Company and the Bank must comply with the Federal Reserve’s established capital adequacy standards. The Federal Reserve has promulgated two basic measures of capital adequacy for bank holding companies: a risk-based measure and a leverage measure. A bank holding company must satisfy all applicable capital standards to be considered in compliance.

 

9
 

 

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, account for off-balance-sheet exposure and minimize disincentives for holding liquid assets.

 

Assets and off-balance-sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items. The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. At least half of total capital must be comprised of Tier I Capital, which is common stock, undivided profits, minority interests in the equity accounts of consolidated subsidiaries and noncumulative perpetual preferred stock, less goodwill and certain other intangible assets. The remainder may consist of Tier II Capital, which is subordinated debt, other preferred stock and a limited amount of loan loss reserves.

 

At December 31, 2014, the Company’s total risk-based capital ratio and its Tier I risk-based capital ratio were 12.23% and 10.36%, respectively. Neither the Company nor the Bank has been advised by any federal banking agency of any additional specific minimum capital ratio requirement applicable to it.

 

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier I Capital to average assets, less goodwill and certain other intangible assets, of 3% for bank holding companies that meet specified criteria. All other bank holding companies generally are required to maintain a minimum leverage ratio of 4%. The Company’s ratio at December 31, 2014, was 8.57%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a “tangible Tier I Capital leverage ratio” and other indications of capital strength in evaluating proposals for expansion or new activities. The Federal Reserve has not advised the Company of any additional specific minimum leverage ratio or tangible Tier I Capital leverage ratio applicable to it.

 

Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on taking brokered deposits and certain other restrictions on its business. As described below, the federal bank regulatory agencies can impose substantial additional restrictions upon FDIC-insured depository institutions that fail to meet applicable capital requirements.

 

The Federal Deposit Insurance Act (the “FDI Act”) requires the federal regulatory agencies to take “prompt corrective action” if a depository institution does not meet minimum capital requirements. The FDI Act establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.

 

The federal bank regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels applicable to FDIC-insured banks. The relevant capital measures are the Total Risk-Based Capital ratio, Tier I Risk-Based Capital ratio and the leverage ratio. Under the regulations, an FDIC-insured bank will be:

 

·“well capitalized” if it has a Total Risk-Based Capital ratio of 10% or greater, a Tier I Risk-Based Capital ratio of 6% or greater and a leverage ratio of 5% or greater and is not subject to any order or written directive by the appropriate regulatory authority to meet and maintain a specific capital level for any capital measure;
·“adequately capitalized” if it has a Total Risk-Based Capital ratio of 8% or greater, a Tier I Risk-Based Capital ratio of 4% or greater and a leverage ratio of 4% or greater (3% in certain circumstances) and is not “well capitalized;”
·“undercapitalized” if it has a Total Risk-Based Capital ratio of less than 8%, a Tier I Risk-Based Capital ratio of less than 4% or a leverage ratio of less than 4% (3% in certain circumstances);
·“significantly undercapitalized” if it has a Total Risk-Based Capital ratio of less than 6%, a Tier I Risk-Based Capital ratio of less than 3% or a leverage ratio of less than 3%; and

 

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·“critically undercapitalized” if its tangible equity is equal to or less than 2% of average quarterly tangible assets.

 

An institution may be downgraded to, or deemed to be in, a capital category that is lower than is indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. At December 31, 2014, the Bank was deemed to be “well capitalized.”

 

The FDI Act generally prohibits an FDIC-insured bank from making a capital distribution (including payment of a dividend) or paying any management fee to its holding company if the bank would thereafter be “undercapitalized.” “Undercapitalized” banks are subject to growth limitations and are required to submit a capital restoration plan. The federal regulators may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the bank’s capital. In addition, for a capital restoration plan to be acceptable, the bank’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of: (i) an amount equal to 5% of the bank’s total assets at the time it became “undercapitalized;” and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”

 

“Significantly undercapitalized” insured banks may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets and the cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator. A bank that is not “well capitalized” is also subject to certain limitations relating to brokered deposits.

 

The regulatory capital framework under which the Company and the Bank operate is changing in significant respects as a result of the Dodd-Frank Act, which was enacted in July 2010, and other regulations, including the separate regulatory capital requirements put forth by the Basel Committee on Banking Supervision, commonly known “Basel III.” Prior to January 1, 2015, the Company and the Bank were governed by a set of capital rules that the Federal Reserve have had in place since 1988, with some subsequent amendments and revisions.

 

On July 2, 2013, the Federal Reserve approved a final rule that establishes an integrated regulatory capital framework that addresses shortcomings in certain capital requirements. The rule, which became effective on January 1, 2015, implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act.

 

The major provisions of the new rule applicable to the Company and the Bank are:

 

·The new rule implements higher minimum capital requirements, includes a new common equity Tier I capital requirement, and establishes criteria that instruments must meet in order to be considered common equity Tier I capital, additional Tier I capital, or Tier II capital. These enhancements will both improve the quality and increase the quantity of capital required to be held by banking organizations, better equipping the U.S. banking system to deal with adverse economic conditions. The new minimum capital to risk-weighted assets (RWA) requirements are a common equity Tier I capital ratio of 4.5% and a Tier I capital ratio of 6.0%, which is an increase from 4.0%, and a total capital ratio that remains at 8.0%. The minimum leverage ratio (Tier I capital to total assets) is 4.0%. The new rule maintains the general structure of the current prompt corrective action framework while incorporating these increased minimum requirements.
·The new rule improves the quality of capital by implementing changes to the definition of capital. Among the most important changes are stricter eligibility criteria for regulatory capital instruments that would disallow the inclusion of instruments such as trust preferred securities in Tier I capital going forward, and new constraints on the inclusion of minority interests, mortgage-servicing assets (MSAs), deferred tax assets (DTAs), and certain investments in the capital of unconsolidated financial institutions. In addition, the new rule requires that most regulatory capital deductions be made from common equity Tier I capital.

 

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·Under the new rule, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier I capital above its minimum risk-based capital requirements. This buffer will help to ensure that banking organizations conserve capital when it is most needed, allowing them to better weather periods of economic stress. The buffer is measured relative to RWA. Phase-in of the capital conservation buffer requirements will begin on January 1, 2016. Initially, the minimum capital conservation buffer will be 0.625%, rising to 2.5% on January 1, 2019. A banking organization that fails to satisfy the minimum capital conservation buffer requirements will be subject to increasingly stringent limits on capital distributions or discretionary bonus payments. When the new rule is fully phased in, the minimum capital requirements plus the capital conservation buffer will exceed the well-capitalized thresholds under the prompt corrective action framework.
·The new rule also increases the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

 

Dividend and Repurchase Limitations. Federal regulations provide that the Company must obtain Federal Reserve approval prior to repurchasing common stock for consideration in excess of 10% of its net worth during any 12 month period unless the Company (i) both before and after the redemption satisfies capital requirements for a “well capitalized” bank holding company; (ii) received a one or two rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues.

 

The ability of the Company to pay dividends or repurchase shares is dependent upon the Company’s receipt of dividends from the Bank. NC commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay. Also, an insured depository institution, such as the Bank, is prohibited from making distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations).

 

Deposit Insurance Assessments. The assessment paid by each Deposit Insurance Fund member institution is based on its relative risks of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. The Bank’s insurance assessment was $1.6 million in 2013 and 2014.

 

An institution’s supervisory subgroup category is based on the FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required. The FDIC may terminate insurance of deposits upon a finding that an institution has engaged in unsafe and 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.

 

The Dodd-Frank Act expands the base for FDIC insurance assessments, requiring that assessments be based on the average consolidated total assets less tangible equity capital of a financial institution. On February 7, 2011, the FDIC approved a final rule to implement the foregoing provision of the Dodd-Frank Act. Among other things, the final rule revises the assessment rate schedule to provide assessments ranging from 5 to 35 basis points, with the initial assessment rates subject to adjustments which could increase or decrease the total base assessment rates. The FDIC has three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points (or 50% of the initial base assessment rate) for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the TLGP) and subordinated debt; (ii) an increase for holding long-term unsecured or subordinated debt issued by other insured depository institutions known as the Depository Institution Debt Adjustment (the “DIDA”) and (iii) for institutions not well rated and well capitalized, an increase not to exceed 10 basis points for brokered deposits in excess of 10 percent of domestic deposits. To date, these changes have resulted in a reduction in the Bank’s insurance assessments, due in part to the Bank receiving a new rating in 2011, which further reduced the Bank’s assessments.

 

The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of the Financing Corporation (the “FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The Bank paid FICO assessments totaling approximately $123,000 in 2014 and $99,000 in 2013.

 

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Federal Home Loan Bank System. The Federal Home Loan Bank (“FHLB”) system provides a central credit facility for member institutions. As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta in an amount at least equal to 0.09% of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta. At December 31, 2014, the Bank was in compliance with these requirements.

 

Community Reinvestment Act (the “CRA”). The CRA requires federal bank regulatory agencies to encourage financial institutions to meet the credit needs of low and moderate-income borrowers in their local communities. An institution’s size and business strategy determines the type of examination that it will receive. Large, retail-oriented institutions are examined using a performance-based lending, investment and service test. Small institutions are examined using a streamlined approach. All institutions may opt to be evaluated under a strategic plan formulated with community input and pre-approved by the bank regulatory agency.

 

The CRA regulations provide for certain disclosure obligations. Each institution must post a notice advising the public of its right to comment to the institution and its regulator on the institution’s CRA performance and to review the institution’s CRA public file. Each lending institution must maintain for public inspection a file that includes a listing of branch locations and services, a summary of lending activity, a map of its communities and any written comments from the public on its performance in meeting community credit needs. The CRA requires public disclosure of a financial institution’s written CRA evaluations. This promotes enforcement of CRA requirements by providing the public with the status of a particular institution’s community reinvestment record.

 

The Gramm-Leach-Bliley Act made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made available to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the Gramm-Leach-Bliley Act may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a satisfactory CRA rating in its latest CRA examination. The Bank received a “Satisfactory” rating in its last CRA examination which was conducted during September 2011.

 

Changes in Control. The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or savings bank or merging or consolidating with another bank or financial holding company or savings bank holding company without prior approval of the Federal Reserve. Similarly, Federal Reserve approval (or, in certain cases, non-objection) must be obtained prior to any person acquiring control of the Company. Control is deemed to exist if, among other things, a person acquires 25% or more of any class of voting stock of the Company or controls in any manner the election of a majority of the directors of the Company. Control is presumed to exist if a person acquires 10% or more of any class of voting stock, the stock is registered under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”), and the acquiror will be the largest shareholder after the acquisition. The Company has only one class of voting stock (Class A common stock).

 

Federal Securities Law. The Company has registered a class of its common stock (Class A common stock) with the Securities and Exchange Commission (“SEC”) pursuant to Section 12(g) of the Exchange Act. As a result of such registration, the proxy and tender offer rules, insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to the Company.

 

Transactions with Affiliates. Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution, and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans to one borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The FDIC has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits on the amount a bank can loan to an executive officer.

 

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Loans to One Borrower. The Bank is subject to the loans to one borrower limits imposed by NC law, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any single borrower outstanding at one time and not fully secured by readily marketable collateral may exceed 15% of the Bank’s capital, as used in the calculation of its risk-based capital ratios, plus those portions of the Bank’s allowance for credit losses, deferred tax assets, and intangible assets that are excluded from the Bank’s capital. At December 31, 2014, this limit was $43.1 million. This limit is increased by an additional 10% of the Bank’s capital, or $28.8 million as of December 31, 2014, for loans and extensions of credit that are fully secured by readily marketable collateral.

 

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act, enacted in 1999 (the “GLB Act”), dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. In doing so, it increased competition in the financial services industry, presenting greater opportunities for our larger competitors, which were more able to expand their service and products than smaller, community-oriented financial institutions, such as the Bank.

 

USA Patriot Act of 2001. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls with respect to its private banking accounts involving foreign individuals and certain foreign banks; and (iii) to avoid establishing, maintaining, administering or managing correspondent accounts in the United States for, or on behalf of, foreign banks that do not have a physical presence in any country. The USA PATRIOT Act also requires the Secretary of the Treasury to prescribe by regulation minimum standards that financial institutions must follow to verify the identity of customers, both foreign and domestic, when a customer opens an account. In addition, the USA PATRIOT Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.

 

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 mandates for public companies such as NewBridge, a variety of reforms intended to address corporate and accounting fraud and provides for the establishment of the Public Company Accounting Oversight Board (the “PCAOB”) which enforces auditing, quality control and independence standards for firms that audit SEC-reporting companies. The Act imposes higher standards for auditor independence and restricts the provision of consulting services by auditing firms to companies they audit and requires that certain audit partners be rotated periodically. It also requires chief executive officers and chief financial officers, or their equivalents, to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement, and increases the oversight and authority of audit committees of publicly traded companies.

 

Limits on Rates Paid on Deposits and Brokered Deposits. FDIC regulations limit the ability of insured depository institutions to accept, renew or roll-over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in such depository institution’s normal market area. Under these regulations, “well capitalized” depository institutions may accept, renew or roll-over such deposits without restriction; “adequately capitalized” depository institutions may accept, renew or roll-over such deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates); and “undercapitalized” depository institutions may not accept, renew, or roll-over such deposits. Definitions of “well capitalized,” “adequately capitalized” and “undercapitalized” are the same as the definitions adopted by the federal banking agencies to implement the prompt corrective action provisions discussed above.

 

Taxation. Federal Income Taxation. Financial institutions such as the Company are subject to the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), in the same general manner as other corporations. The Bank computes its bad debt deduction under the specific chargeoff method.

 

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State Taxation. Under NC law, the Company and its subsidiaries are each subject to corporate income taxes at a 5.00% rate and an annual franchise tax at a rate of 0.15% of equity. During the third quarter of 2013, North Carolina reduced its corporate income tax rate from 6.90% to 6.00% effective January 1, 2014, and to 5.00% effective January 1, 2015. Further reductions to 4.00% on January 1, 2016, and 3.00% on January 1, 2017, are contingent upon the State meeting revenue targets.

 

Other. Additional regulations require annual examinations of all insured depository institutions by the appropriate federal banking agency and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards.

 

As a state-chartered member bank, the Bank is subject to examination by the Federal Reserve Bank of Richmond (the “Federal Reserve Bank”)and the Commissioner. In addition, it is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit, equal credit and fair credit reporting laws and laws relating to branch banking. The Bank, as an insured NC commercial bank, is prohibited from engaging as a principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the Deposit Insurance Fund and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.

 

As a Federal Housing Administration approved Title II supervised lender, the Bank is required to report to the Department of Housing and Urban Development (“HUD”) its annual, audited financial and non-financial information necessary for HUD to evaluate compliance with Federal Housing Administration recertification requirements.

 

Future Requirements. Statutes and regulations, which contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions, are introduced regularly. Neither the Company nor the Bank can predict whether or what form any proposed statute or regulation will be adopted or the extent to which the business of the Company or the Bank may be affected by such statute or regulation.

 

Available Information

 

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports available free of charge on its internet website www.newbridgebank.com as soon as reasonably practicable after the reports are electronically filed with the SEC. The Company’s Annual Report on Form 10-K and Quarterly Reports on Form 10-Q are also available on its internet website in interactive data format using the eXtensible Business Reporting Language (XBRL), which allows financial statement information to be downloaded directly into spreadsheets, analyzed in a variety of ways using commercial off-the-shelf software and used within investment models in other software formats. Any materials that the Company files with the SEC may be read and/or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. These filings are also accessible on the SEC’s website at www.sec.gov.

 

Additionally, the Company’s corporate governance policies, including the charters of the Audit and Risk Management, Compensation, and Corporate Governance and Nominating Committees, the Corporate Governance Guidelines, Code of Business Conduct and Ethics, and Code of Business Conduct and Ethics for CEO and Senior Financial Officers may also be found under the “Investor Relations” section of the Company’s website. A written copy of the foregoing corporate governance policies is available upon written request to the Company.

 

Item 1A.Risk Factors

 

An investment in the Company’s common stock is subject to risks inherent in the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision, you should carefully consider these risks and uncertainties, together with all of the other information included or incorporated by reference in this Annual Report on Form 10-K. These risks and uncertainties are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on, or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors.

 

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If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly, and you could lose all or part of your investment.

 

Risks Associated with Our Business

 

Financial reform legislation enacted by Congress and resulting regulations have increased, and are expected to continue to increase our costs of operations. Congress enacted the Dodd-Frank Act in 2010. This law has significantly changed the structure of the bank regulatory system and affects 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 implementing 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. Although many of these regulations have been promulgated, additional regulations are expected to be issued in 2015 and thereafter. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. This significant change to existing law has already had an adverse effect on our interest expense.

 

The Dodd-Frank Act requires publicly traded companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

 

The Dodd-Frank Act created the Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Bureau has 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. It also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

 

It is difficult to quantify what specific impact the Dodd-Frank Act and related regulations have had on the Company to date and what impact yet to be written regulations will have on us in the future. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

 

We are subject to extensive regulation and oversight, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory action. We are subject to extensive regulation and supervision, including examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on us if they determine, upon conclusion of their examination or otherwise, violations of laws with which we must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, consent orders, civil money penalties and termination of deposit insurance and bank closure. Enforcement actions may be taken regardless of the capital levels of the institutions, and regardless of prior examination findings. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective actions. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions, paying dividends or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. The imposition of regulatory sanctions, including monetary penalties, may have a material impact on our financial condition and results of operations and/or damage our reputation. In addition, compliance with any such action could distract management’s attention from our operations, cause us to incur significant expenses, restrict us from engaging in potentially profitable activities and limit our ability to raise capital.

 

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The Company will become subject to more stringent capital requirements, which may adversely impact our return on equity, require us to raise additional capital, or constrain us from paying dividends or repurchasing shares. In July 2013, the Federal Reserve approved a new rule that substantially amended the regulatory risk-based capital rules applicable to the Bank. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.

 

The final rule includes new minimum risk-based capital and leverage ratios, which became effective for the Bank and the Company on January 1, 2015, and revises the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital requirements will be: (i) a new common equity Tier I capital ratio of 4.5%; (ii) a Tier I to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier I leverage ratio of 4%. These rules also establish a “capital conservation buffer” of 2.5%, and will result in the following minimum ratios: (i) a common equity Tier I capital ratio of 7.0%, (ii) a Tier I to risk-based assets capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.

 

The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions constraining us from paying dividends or repurchasing shares if we were to be unable to comply with such requirements.

 

The Company may need additional access to capital, which it may be unable to obtain on attractive terms or at all. We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments, for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to it, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our stock price negatively affected.

 

If the Bank loses key employees with significant business contacts in its market areas, its business may suffer. The Bank’s success is largely dependent on the personal contacts of our officers and employees in its market areas. If the Bank loses key employees temporarily or permanently, this could have a material adverse effect on the business. The Bank could be particularly affected if its key employees go to work for competitors. The Bank’s future success depends on the continued contributions of its existing senior management personnel, many of whom have significant local experience and contacts in its market areas. The Bank has employment agreements or non-competition agreements with several of its senior and executive officers in an attempt to partially mitigate this risk.

 

The Company may not be able to implement aspects of its growth strategy. The Company’s growth strategy contemplates the future expansion of its business and operations both organically and by selective acquisitions of banks and the establishment of banking offices in its market areas and other markets in the Carolinas and Virginia. Implementing these aspects of the Company’s growth strategy depends, in part, on its ability to successfully identify acquisition opportunities and strategic partners that will complement its operating philosophy and to successfully integrate their operations with those of the Company, as well as generate loans and deposits of acceptable risk and expense. To successfully acquire or establish banks or banking offices, the Company must be able to correctly identify profitable or growing markets, as well as attract the necessary relationships and high caliber banking personnel to make these new banking offices profitable. In addition, the Company may not be able to identify suitable opportunities for further growth and expansion or, if it does, the Company may not be able to successfully integrate these new operations into its business.

 

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As consolidation of the financial services industry continues, the competition for suitable acquisition candidates may increase. The Company will compete with other financial services companies for acquisition opportunities, and many of these competitors have greater financial resources than the Company does and may be able to pay more for an acquisition than the Company is able or willing to pay.

 

The Company can offer no assurance that it will have opportunities to acquire other financial institutions or acquire or establish any new branches or loan production offices, or that it will be able to negotiate, finance and complete any opportunities available to it.

 

If the Company is unable to effectively implement its growth strategies, its business, results of operations and stock price may be materially and adversely affected.

 

Future expansion involves risks. The acquisition by the Company of other financial institutions or parts of those institutions, or the establishment of de novo branch offices and loan production offices, involves a number of risks, including the risk that:

 

·The Company may incur substantial costs in identifying and evaluating potential acquisitions and merger partners, or in evaluating new markets, hiring experienced local managers, and opening new offices;
·The Company’s estimates and judgments used to evaluate credit, operations, management and market risks relating to target institutions may not be accurate;
·The institutions the Company acquires may have distressed assets and there can be no assurance that the Company will be able to realize the value it predicts from those assets or that it will make sufficient provisions or have sufficient capital for future losses;
·The Company may be required to take writedowns or writeoffs, restructuring and impairment, or other charges related to the institutions it acquires that could have a significant negative effect on the Company’s financial condition and results of operations;
·There may be substantial lag-time between completing an acquisition or opening a new office and generating sufficient assets and deposits to support costs of the expansion;
·The Company may not be able to finance an acquisition, or the financing it obtains may have an adverse effect on its results of operations or result in dilution to its existing shareholders;
·The Company’s management’s attention in negotiating a transaction and integrating the operations and personnel of the combining businesses may be diverted from its existing business and the Company may not be able to successfully integrate such operations and personnel;
·If the Company experiences problems with system conversions, financial losses could be sustained from transactions processed incorrectly or not at all;
·The Company may not be able to obtain regulatory approval for an acquisition;
·The Company may enter new markets where it lacks local experience or that introduce new risks to its operations, or that otherwise result in adverse effects on its results of operations;
·The Company may introduce new products and services it is not equipped to manage or that introduce new risks to its operations, or that otherwise result in adverse effects on its results of operations;
·The Company may incur intangible assets in connection with an acquisition, or the intangible assets it incurs may become impaired, which results in adverse short-term effects on the Company’s results of operations;
·The Company may assume liabilities in connection with an acquisition, including unrecorded liabilities that are not discovered at the time of the transaction, and the repayment of those liabilities may have an adverse effect on the Company’s results of operations, financial condition and stock price; or
·The Company may lose key employees and customers.

 

The Company cannot assure you that it will be able to successfully integrate any banking offices that the Company acquires into its operations or retain the customers of those offices. If any of these risks occur in connection with the Company’s expansion efforts, it may have a material and adverse effect on the Company’s results of operations and financial condition.

 

18
 

 

New bank office facilities and other facilities may not be profitable. The Company may not be able to organically expand into new markets that are profitable for its franchise. The costs to start up bank branches and loan production offices in new markets, other than through acquisitions, and the additional costs to operate these facilities would increase the Company’s noninterest expense and may decrease its earnings. It may be difficult to adequately and profitably manage the Company’s growth through the establishment of bank branches or loan production offices in new markets. In addition, the Company can provide no assurance that its expansion into any such new markets will successfully attract enough new business to offset the expenses of their operation. If the Company is not able to do so, its earnings and stock price may be negatively impacted.

 

Acquisition of assets and assumption of liabilities may expose the Company to intangible asset risk, which could impact its results of operations and financial condition. In connection with any acquisitions, as required by accounting principles generally accepted in the United States (“GAAP”), the Company will record assets acquired and liabilities assumed at their fair value, and, as such, acquisitions may result in the Company recording intangible assets, including deposit intangibles and goodwill. The Company will perform a goodwill valuation at least annually to test for goodwill impairment. Impairment testing is a two-step process that first compares the fair value of goodwill with its carrying amount, and second measures impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill. Adverse conditions in its business climate, including a significant decline in future operating cash flows, a significant change in the Company’s stock price or market capitalization, or a deviation from the Company’s expected growth rate and performance may significantly affect the fair value of any goodwill and may trigger impairment losses, which could be materially adverse to the Company’s results of operations, financial condition and stock price.

 

The success of the Company’s growth strategy depends on the Company’s ability to identify and retain individuals with experience and relationships in the markets in which it intends to expand. The Company’s growth strategy contemplates that it may expand its business and operations to other markets in the Carolinas and Virginia through organic growth and selective acquisitions. The Company intends to primarily target market areas that it believes possess attractive demographic, economic or competitive characteristics. To expand into new markets successfully, The Company must identify and retain experienced key management members with local expertise and relationships in these markets. Competition for qualified personnel in the markets in which the Company may expand may be intense, and there may be a limited number of qualified persons with knowledge of and experience in the commercial banking industry in these markets. Even if the Company identifies individuals that it believes could assist it in establishing a presence in a new market, the Company may be unable to recruit these individuals away from other banks or be unable to do so at a reasonable cost. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out the Company’s strategy is often lengthy. The Company’s inability to identify, recruit and retain talented personnel to manage new offices effectively would limit its growth and could materially adversely affect its business, financial condition, results of operations and stock price.

 

Increases in FDIC insurance premiums may adversely affect the Company’s net income and profitability. The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are bank or financial institution failures that exceed the FDIC’s expectations, the Bank may be required to pay higher FDIC premiums than those currently in force. Any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.

 

We rely on dividends from the Bank. The Company is a separate and distinct legal entity from the Bank. Dividends received from the Bank are the principal source of funds to pay dividends on the Company’s common stock and interest and principal on its outstanding debt securities. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company. In the event the Bank were unable to pay dividends to the Company, the Company might not be able to service debt, pay obligations, or pay dividends on the Company’s common stock. Such an inability to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations. See Item 1 “Business – Supervision and Regulation” and Note 18 of the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K.

 

19
 

 

Our allowance for credit losses may be insufficient. All borrowers carry the potential to default, and our remedies to recover (seizure and/or sale of collateral, legal actions, guarantees, etc.) may not fully satisfy money previously lent. We maintain an allowance for credit losses, which is a reserve established through a provision for credit losses charged to expense, which represents management’s best estimate of probable credit losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated credit losses and risks inherent in the loan portfolio. The level of the allowance for credit losses reflects management’s continuing evaluation of industry concentrations; specific credit risks; credit loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for credit losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes 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 credit losses. In addition, bank regulatory agencies periodically review our allowance for credit losses and may require an increase in the provision for credit losses or the recognition of additional loan chargeoffs, based on judgments different than those of management. An increase in the allowance for credit losses results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our financial condition and results of operations.

 

If the value of real estate in the markets we serve were to decline, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us. At December 31, 2014, our loans secured by real estate totaled $1.58 billion, or 87.4% of total loans (excluding loans held for sale). A decline in local economic conditions in our markets could adversely affect the value of the real estate collateral securing our loans. A decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. See Allocation of Allowance for Credit Losses in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion related to the Bank’s process for determining the appropriate level of the allowance for possible credit losses. Additionally, a decrease in asset quality could require additions to our allowance for credit losses through increased provisions for credit losses, which would negatively impact our profits. Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies, and natural disasters.

 

Our commercial real estate lending may expose us to risk of loss and hurt our earnings and profitability. We regularly make loans secured by commercial real estate. These types of loans generally have higher risk-adjusted returns and shorter maturities than traditional one to four family residential mortgage loans. Further, loans secured by commercial real estate properties are generally for larger amounts and involve a greater degree of risk than one to four family residential mortgage loans. Payments on loans secured by these properties are often dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans is subject to adverse conditions in the real estate market or the local economy. Because of the recent general economic slowdown, these loans represent higher risk, could result in an increase in our total net chargeoffs and could require us to increase our allowance for credit losses, which could have a material adverse effect on our financial condition or results of operations. At December 31, 2014, our loans secured by commercial real estate totaled $736.9 million, which represented 40.8% of total loans (excluding loans held for sale). Of those loans, loans secured by owner-occupied commercial real estate totaled $310.0 million. While we seek to minimize risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses.

 

Our land acquisition, development and construction loans involve a higher degree of risk than other segments of our loan portfolio. A portion of our loan portfolio is comprised of land acquisition, development and construction loans. Construction financing typically involves a higher degree of credit risk than commercial real estate lending. Repayment of land acquisition, development and construction loans are dependent on the successful completion of the projects they finance. Risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property’s value at completion of construction and the bid price and estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment. When lending to builders, the cost of construction breakdown is provided by the builder, as well as supported by the appraisal. Although our underwriting criteria are designed to evaluate and minimize the risks of each construction loan, there can be no guarantee that these practices will safeguard against material delinquencies and losses to our operations. At December 31, 2014, we had loans of $168.1 million, or 9.3% of total loans outstanding (excluding loans held for sale), to finance land acquisition, development and construction, including $45.8 million of speculative residential construction and residential acquisition and development. At December 31, 2014, the Bank’s concentration levels of land acquisition, development and construction (the “AD&C portfolio”) loans and total commercial real estate loans were 63.82% and 256.55%, respectively, of total regulatory capital. The interagency regulatory guidance maximum concentrations are 100% and 300%, respectively.

 

20
 

 

The Bank is subject to interest rate risk. The Bank’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and investment securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Bank’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Bank receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Bank’s ability to originate loans and obtain deposits, (ii) the fair value of the Bank’s financial assets and liabilities, and (iii) the average duration of certain of the Bank’s interest-rate sensitive assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Bank’s net interest income and therefore earnings could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In addition, there are costs associated with the Bank’s risk management techniques, and these costs could be material. Fluctuations in interest rates are not predictable or controllable and, therefore, there can be no assurances of the Bank’s ability to continue to maintain a consistent, positive spread between the interest earned on the Bank’s earning assets and the interest paid on the Bank’s interest-bearing liabilities. See Item 7A Quantitative and Qualitative Disclosures about Market Risk for further discussion related to the Company’s management of interest rate risk.

 

Our hedging strategies may not be successful in mitigating our exposure to interest rate risk. We use derivative financial instruments, primarily consisting of interest rate swaps contracts, to limit our exposure to interest rate risk. No hedging strategy can completely protect us; the derivative financial instruments we elect may not have the effect of reducing our interest rate risks. Poorly designed strategies, improperly executed and documented transactions or inaccurate assumptions could actually increase our risks and losses. In addition, hedging strategies involve transaction and other costs. We cannot be assured that our hedging strategies and the derivatives that we use will adequately offset the risks of interest rate volatility or that our hedging transactions will not result in or magnify losses.

 

We may face increasing loan and investment yield pressures, which may, among other things reduce our profitability. The interest rate environment has been at a historically low level for an extended period of time. This has had a negative effect on our interest income and net interest margin as new loans and investments are made, or existing loans renewed and maturing investments replaced, at lower rates than those of the portfolios as a whole. If interest rates continue at these low levels, there likely will be further negative effect on interest income and the net interest margin.

 

We may face increasing deposit-pricing pressures, which may, among other things, reduce our profitability. Checking and savings account balances and other forms of deposits can decrease when our deposit clients perceive alternative investments, such as the stock market or other non-depository investments, as providing superior expected returns or seek to spread their deposits over several banks to maximize FDIC insurance coverage. Furthermore, technology and other changes have made it more convenient for bank clients to transfer funds into alternative investments, including products offered by other financial institutions or non-bank service providers. Increases in short-term interest rates could increase transfers of deposits to higher yielding deposits. Efforts and initiatives we undertake to retain and increase deposits, including deposit pricing, can increase our costs. When bank clients move money out of bank deposits in favor of alternative investments or into higher yielding deposits, or spread their accounts over several banks, we can lose a relatively inexpensive source of funds, thus increasing our funding costs.

 

21
 

 

The Company’s operating results and financial condition would likely suffer if there is a deterioration in the general economic condition of the areas in which the Bank does business. Unlike larger national or other regional banks that are more geographically diversified, the Bank primarily provides services to clients located in four principal market areas in NC. Because the Bank’s lending and deposit-gathering activities are concentrated in these markets, particularly the Piedmont Triad Region, the Bank will be affected by the business activity, population, income levels, deposits and real estate activity in these markets. Adverse developments in local industries have had and could continue to have a negative effect on the Bank’s financial condition and results of operations. Even though the Bank’s clients’ business and financial interest may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce the Bank’s growth rate, affect the ability of the Bank’s clients to repay their loans and generally affect the Company’s financial condition and results of operations. A decline in general economic conditions in the Bank’s market areas, caused by inflation, recession, higher unemployment or other factors which are beyond the Bank’s control would also impact these local economic conditions and could have an adverse effect on the Company’s financial condition and results of operations.

 

The Bank competes with much larger companies for some of the same business. The banking and financial services business in our market areas continues to be a competitive field and it is becoming more competitive as a result of changes in regulations, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers.

 

We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and clients with various bank and nonbank financial services providers, many of which are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services.

 

Negative publicity could damage our reputation. Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract clients and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, disclosure, sharing or inadequate protection of client information, criminal security breaches and from actions taken by government regulators and community organizations in response to that conduct.

 

The Bank is subject to environmental liability risk associated with lending activities. A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company’s financial condition and results of operations.

 

Financial services companies depend on the accuracy and completeness of information about clients and counterparties. In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of clients and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those clients, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

 

22
 

 

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows. Liquidity is essential to our business. Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital, possible acquisitions and other general corporate purposes. An inability to raise funds through deposits, borrowings, securities sold under repurchase agreements, the sale of loans and other sources could have a substantial negative effect on our liquidity. We do not anticipate that our retail and commercial deposits will be sufficient to meet our funding needs in the foreseeable future. We therefore rely on deposits obtained through intermediaries, FHLB advances, securities sold under agreements to repurchase and other wholesale funding sources to obtain the funds necessary to manage our balance sheet.

 

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general, including a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.

 

Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition. Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

 

From time to time the Financial Accounting Standards Board (the “FASB”) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.

 

The FASB is moving forward with its proposal to change the manner in which the allowance for credit losses is established and evaluated from the concept of incurred losses to that of expected losses. Management is in the process of evaluating this change in accounting standard on the Company’s financial position and results of operations. If the change results in a material increase in our allowance and future provisions for credit losses, this could have a material adverse effect on our financial condition and results of operations.

 

Impairment of investment securities, goodwill, certain other intangible assets, or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations. In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Under current accounting standards, certain other intangible assets with indeterminate lives are no longer amortized but, instead, are assessed for impairment periodically or when impairment indicators are present. Assessment of certain other intangible assets could result in circumstances where the applicable intangible asset is deemed to be impaired for accounting purposes. Under such circumstances, the intangible asset’s impairment would be reflected as a charge to earnings in the period during which such impairment is identified. In assessing the realizability of our deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and the corporate income tax rate during the periods in which those temporary differences become deductible. The value of our deferred tax assets reflects the current federal and state corporate income tax rates of approximately 35 percent and five percent, respectively. Failure to generate future taxable income in line with our current projections and/or a reduction in the corporate income tax rate could cause us to further impair our deferred tax assets, which impairment would be reflected as a charge to earnings in the period during which such impairment is identified. The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.

 

23
 

 

Technological advances impact the Bank’s business. The banking industry continues to undergo technological changes with frequent introductions of new technology-driven products and services. In addition to improving client services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Company’s future success will depend, in part, on our ability to address the needs of the Bank’s clients by using technology to provide products and services that will satisfy client demands for convenience as well as to create additional efficiencies in operations. Many competitors have substantially greater resources to invest in technological improvements. The Bank may not be able to effectively implement new technology-driven products and services or successfully market such products and services to its clients.

 

We rely on other companies to provide key components of our business infrastructure. Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our clients and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

 

Our information 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 or operational integrity of these systems could result in failures or disruptions in our client relationship management, general ledger, 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, we cannot make assurances 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 client business; result in expense to investigate, respond to, mitigate, and recover from the event; 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. The Company has not experienced any failure, interruption, or breach in security or operational integrity of our communications and information systems. The company has incurred immaterial expense due to well publicized external card breaches.

 

Unpredictable catastrophic events could have a material adverse effect on the Company. The occurrence of catastrophic events such as hurricanes, tropical storms, earthquakes, pandemic disease, windstorms, floods, severe winter weather (including snow, freezing water, ice storms and blizzards), fires and other catastrophes could adversely affect the Company’s consolidated financial condition or results of operations. Unpredictable natural and other disasters could have an adverse effect on the Bank in that such events could materially disrupt its operations or the ability or willingness of its clients to access the financial services offered by the Bank. The incidence and severity of catastrophes are inherently unpredictable. Although the Bank carries insurance to mitigate its exposure to certain catastrophic events, these events could nevertheless reduce the Company’s earnings and cause volatility in its financial results for any fiscal quarter or year and have a material adverse effect on the Company’s financial condition and/or results of operations.

 

Risks Related to our Common Stock

 

Our stock price can be volatile. Stock price volatility may make it more difficult for you to sell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

Actual or anticipated variations in quarterly results of operations;
Recommendations by securities analysts;
Operating results and stock price performance of other companies that investors deem comparable to us;
News reports relating to trends, concerns, and other issues in the financial services industry;
Perceptions in the marketplace regarding us and/or our competitors;
New technology used or services offered by competitors;
Significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors; and
Changes in government regulations.

 

24
 

 

General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of operating results.

 

The Company’s trading volume is low compared with larger national and regional banks. A class of the Company’s common stock (Class A common stock) is traded on the NASDAQ Global Select Market. However, the trading volume of the Company’s Class A common stock is relatively low when compared with larger companies listed on the NASDAQ, the NYSE or other consolidated reporting systems or stock exchanges. Thus, the market in the Company’s Class A common stock may be limited in scope relative to larger companies. In addition, the Company cannot say with any certainty that a more active and liquid trading market for its Class A common stock will develop.

 

The Company has outstanding subordinated debt, which ranks senior to our common stock. In 2005, the Company issued $25.8 million in subordinated debentures in connection with the issuance of trust preferred securities by its trust subsidiary. In 2014, the Company issued $15.5 million in subordinated notes. This subordinated debt ranks senior to our common stock. As a result, we must make dividend payments on the trust preferred securities and interest payments on the subordinated notes before any dividends can be paid on our common stock and, in the event of our liquidation, the holders of the trust preferred securities and the subordinated notes must be satisfied before any distributions can be made on our common stock.

 

There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock. We may issue additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.

 

We may issue additional debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in the event of liquidation, which could negatively affect the value of our common stock. In the future, we may issue additional debt or equity securities, including securities convertible into equity securities. In the event of our liquidation, the holders of our debt and preferred securities must be satisfied before any distributions can be made on our common stock. Because our decision to incur debt and issue securities in our future offerings will depend on market conditions and other factors beyond our control, we cannot predict or estimate with certainty the amount, timing or nature of our future offerings and debt financings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future.

 

Our common stock is not FDIC insured. The Company’s common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, holders of our common stock may lose some or all of their investment.

 

Item 1B.Unresolved Staff Comments

 

None

 

Item 2.Properties

 

The Company and the Bank’s executive offices are located at 1501 Highwoods Boulevard in Greensboro, NC. The Bank’s principal support and operational functions are located at 38 West First Avenue, Lexington, NC and 202 South Main Street in Reidsville, NC. On December 31, 2014, the Bank operated 40 branch offices in its four primary markets—Charlotte, Raleigh, the Cape Fear Region and the Piedmont Triad Region—and eight loan production offices. The locations of the Bank’s executive and banking offices, their form of occupancy, deposits as of December 31, 2014, and year opened, are provided in the accompanying table (dollars in thousands):

 

25
 

 

Location  Owned or Lease  Deposits   Year 
1501 Highwoods Boulevard, Greensboro, NC(1)  Leased  $-    2004 
38 West First Avenue, Lexington, NC(2)  Owned   168,318    1949 
202 South Main Street, Reidsville, NC(2)  Owned   57,329    1910 
301 East Fremont Street, Burgaw, NC  Leased   27,491    1999 
10231 Beach Drive Southwest, Calabash, NC(3)  Owned   37,699    1983 
2000 Regency Parkway, Cary, NC(4)  Leased   20,119    2013 
5925 Carnegie Boulevard, Charlotte, NC  Leased   4,404    2013 
2386 Lewisville-Clemmons Road, Clemmons, NC  Owned   20,515    2001 
1008 Sunset Avenue, Clinton, NC(4)  Owned   23,905    2010 
1101 North Main Street, Danbury, NC  Owned   22,957    1997 
801 South Van Buren Road, Eden, NC  Owned   32,540    1996 
210 North Main Street, Fuquay-Varina, NC(4)  Owned   55,210    2006 
4638 Hicone Road, Greensboro, NC  Owned   27,455    2000 
2132 New Garden Road, Greensboro, NC  Owned   42,869    1997 
201 North Elm Street, Greensboro, NC  Leased   13,110    2009 
3202 Randleman Road, Greensboro, NC  Owned   23,092    2000 
200 Westchester Drive, High Point, NC  Owned   17,912    2001 
120 East Main Street, Jamestown, NC  Owned   12,785    2004 
230 East Mountain Street, Kernersville, NC  Leased   12,234    1997 
647 South Main Street, King, NC  Owned   40,600    1997 
4481 Highway 150 South, Lexington, NC  Owned   27,211    2002 
298 Lowes Boulevard, Lexington, NC  Owned   31,118    2011 
6123 Old U.S. Highway 52, Lexington, NC  Owned   37,865    1958 
500 South Main Street, Lexington, NC(5)  Owned   -    2004 
605 North Highway Street, Madison, NC  Owned   19,636    1997 
4815 East Oak Island Drive, Oak Island, NC(3)  Owned   13,342    1986 
4505 Falls of Neuse Road, Raleigh, NC(4)  Leased   113,786    2006 
133 Fayetteville Street, Raleigh, NC  Leased   8,825    2013 
1646 Freeway Drive, Reidsville, NC  Owned   37,189    1972 
5074 Main Street, Shallotte, NC(3)  Owned   41,780    1999 
3020 George II Highway, Southport, NC(3)  Owned   12,100    2007 
101 North Howe Street, Southport, NC(3)  Owned   33,374    1981 
840 Sunset Boulevard North, Sunset Beach, NC(3)  Owned   14,169    2001 
919 Randolph Street, Thomasville, NC  Owned   34,210    1987 
3000 Old Hollow Road, Walkertown, NC  Leased   19,947    1997 
10335 North NC Highway 109, Winston-Salem, NC  Owned   28,420    1992 
3500 Old Salisbury Road, Winston-Salem, NC  Owned   36,286    1978 
11492 Old U.S. Highway 52, Winston-Salem, NC  Owned   31,934    1973 
161 South Stratford Road, Winston-Salem, NC  Leased   32,252    1997 
1001 Military Cutoff Road, Wilmington, NC  Leased   22,307    2006 
704 South College Road, Wilmington, NC  Leased   21,674    1997 

 

(1)Executive offices of the Company and the Bank.
(2)Serves as a full service branch as well as an operations center for the Bank.
(3)Branches acquired in Security Savings Bank, SSB acquisition on October 1, 2013.
(4)Branches acquired in CapStone Bank acquisition on April 1, 2014.
(5)This location is an express drive through facility that only processes transactions and does not open client accounts.

 

26
 

 

The Bank operates a loan production office within the Bank’s executive office and loan production offices in leased premises in Winston-Salem, Asheboro, Morganton and Raleigh, NC and in Charleston and Greenville, SC and in a premises in Southport, NC, which it owns. In addition, as of December 31, 2014, the Bank also operated nine offsite ATM machines in various locations throughout its markets.

 

Following the acquisition of Premier on February 27, 2015, the Bank assumed a leased property, from which it will operate a banking office previously operated by Premier.

 

Item 3.Legal Proceedings

 

In the ordinary course of operations, the Company and its subsidiaries are at times involved in legal proceedings. In the opinion of management, neither the Company nor its subsidiaries is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the fourth quarter of the Company’s fiscal year ended December 31, 2014.

 

27
 

 

PART II

 

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

 

Market Prices and Dividend Policies

 

A class of the Company’s common stock (Class A common stock) is traded on the Global Select Market of the NASDAQ Stock Market (“NASDAQ GSM”) under the symbol “NBBC.” The following table shows the high, low and closing sales prices of the Company’s common stock on the NASDAQ GSM, based on published financial sources, for each quarter within the last two fiscal years.

 

Quarter ended  High   Low   Close 
December 31, 2014  $8.98   $7.34   $8.71 
September 30, 2014   8.46    7.20    7.59 
June 30, 2014   8.69    6.99    8.06 
March 31, 2014   7.62    6.55    7.14 
                
December 31, 2013  $7.92   $6.40   $7.43 
September 30, 2013   9.17    5.96    7.29 
June 30, 2013   6.41    5.55    5.99 
March 31, 2013   6.48    4.50    5.89 

 

As of January 31, 2015, there were approximately 5,942 beneficial owners, including 3,068 holders of record, of the Company’s Class A common stock, and seven holders of record of the Company’s Class B common stock.

 

Holders of the Company’s common stock (Class A and Class B) are entitled to receive ratably such dividends as may be declared by the Company’s Board of Directors out of legally available funds. On February 18, 2015, the Company declared a $0.015 per share dividend payable April 15, 2015, to shareholders of record on March 16, 2015. This is the first cash dividend declared by the Company on its common stock since 2008. The ability of the Company’s Board of Directors to declare and pay dividends on its capital stock is subject to the terms of applicable North Carolina law and banking regulations. The Company may not pay dividends on its capital stock if it is in default or, where permitted, has elected to defer payments of interest under its junior subordinated debentures or subordinated notes. The declaration and payment of future dividends to holders of the Company’s common stock will also depend upon the Company’s earnings and financial condition, the capital requirements of the Company’s subsidiaries, regulatory conditions and other factors as the Company’s Board of Directors may deem relevant. For a further discussion as to restrictions on the Company and the Bank’s ability to pay dividends, please refer to “Item 1 – Supervision and Regulation”.

 

The following table sets forth certain information regarding shares issuable upon exercise of outstanding options and rights under equity compensation plans, and shares remaining available for future issuance under equity compensation plans, in each case as of December 31, 2014. Individual equity compensation arrangements are aggregated and included within this table.

 

28
 

 

           Number of Shares 
           Remaining Available 
           for Future Issuance 
           under Equity 
   Number of Shares to be   Weighted Average   Compensation Plans 
   Issued Upon Exercise of   Exercise Price of   (excluding shares 
   Outstanding Options,   Outstanding Options,   reflected in 
   Warrants and Rights   Warrants and Rights   column (a)) 
Plan Category  (a)   (b)   (c) 
Equity Compensation Plans                      
Approved by Shareholders             472,349 
Stock Options   985,071   $7.51      
Restricted Stock Units   395,852    -      
Equity Compensation Plans Not               
Approved by Shareholders   -    -    - 
Total   1,380,923   $5.36    472,349 

 

29
 

 

FIVE-YEAR STOCK PERFORMANCE TABLE

 

The following graph compares the cumulative total shareholder return on the Company’s common stock with the S&P 500 Index (U.S.) and the SNL Southeast Bank Index. The graph assumes that $100 was originally invested on December 31, 2009, and that all subsequent dividends were reinvested in additional shares.

 

 

NEWBRIDGE BANCORP

Comparison of Cumulative Total Shareholder Return

Years Ended December 31

 

   2009   2010   2011   2012   2013   2014 
                         
NewBridge Bancorp   100    212    174    209    334    392 
                               
SNL Southeast Bank Index(1)   100    97    57    94    128    144 
                               
S&P 500 Index   100    115    117    136    180    205 

 

(1)The SNL Southeast Bank Index is comprised of a peer group of 89 bank holding companies headquartered in Alabama, Arkansas, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, Virginia and West Virginia, whose common stock is traded on the NYSE, NYSE Amex or NASDAQ stock exchanges. The total five year return was calculated for each of the bank holding companies in the peer group taking into consideration changes in stock price, cash dividends, stock dividends and stock splits since December 31, 2009. The individual results were then weighted by the market capitalization of each company relative to the entire peer group. The total return approach and the weighting based upon market capitalization are consistent with the preparation of the S&P 500 total return index.

 

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Item 6.Selected Financial Data

 

The following table should be read in conjunction with “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation,” and “Item 8 - Financial Statements and Supplementary Data,” which begin on page 32 and page 63 below, respectively.

 

(dollars in thousands, except per share data)  Years Ended December 31 
   2014   2013   2012   2011   2010 
SUMMARY OF OPERATIONS                    
Interest income  $85,816   $68,819   $71,080   $79,445   $89,913 
Interest expense   7,145    5,643    7,514    12,319    20,454 
                          
Net interest income   78,671    63,176    63,566    67,126    69,459 
Provision for credit losses   883    2,691    35,893    16,785    21,252 
                          
Net interest income after provision for credit losses   77,788    60,485    27,673    50,341    48,207 
Noninterest income   16,713    17,454    16,888    18,393    21,323 
Noninterest expense   72,706    60,384    72,413    62,607    66,397 
                          
Income (loss) before income taxes   21,795    17,555    (27,852)   6,127    3,133 
Income tax expense (benefit)   7,819    (3,216)   (2,598)   1,449    (247)
                          
Net income (loss)   13,976    20,771    (25,254)   4,678    3,380 
Dividends and accretion on preferred stock   (337)   (1,854)   (2,918)   (2,917)   (2,919)
Net income (loss) available to common shareholders  $13,639   $18,917   $(28,172)  $1,761   $461 
                          
Cash dividends declared on common stock  $-   $-   $-   $-   $- 
                          
SELECTED YEAR END ASSETS AND LIABILITIES                         
Investment securities  $496,798   $368,866   $393,815   $337,811   $325,129 
Loans held for investment, net of unearned income   1,804,406    1,416,703    1,155,421    1,200,070    1,260,585 
Assets   2,520,232    1,965,232    1,708,707    1,734,564    1,809,891 
Deposits   1,832,564    1,553,996    1,332,493    1,418,676    1,452,995 
Shareholders’ equity   231,355    166,792    196,014    163,387    165,918 
                          
PERFORMANCE MEASURES                         
Net income (loss) to average total assets   0.60%   1.17%   (1.46)%   0.27%   0.18%
Net income (loss) to average shareholders’ equity   6.53    11.75    (15.18)   2.81    2.00 
Dividend payout   -    -    -    -    - 
Average shareholders’ equity to average total assets   9.18    9.94    9.65    9.51    8.81 
Average tangible shareholders’ equity to average tangible total assets   8.29    9.73    9.47    9.29    8.58 
                          
PER SHARE DATA                         
Earnings (loss) per share:                         
Basic  $0.39   $0.71   $(1.80)  $0.11   $0.03 
Diluted   0.38    0.65    (1.80)   0.11    0.03 
Cash dividends declared   -    -    -    -    - 
Book value at year end   6.22    5.33    5.58    7.09    7.25 
Tangible book value at year end   5.50    5.04    5.38    6.85    6.96 

 

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

 

The following presents management’s discussion and analysis of the Company’s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.

 

Executive Overview

 

The Company was formed in 2007 through a merger of equals between the two holding company parents of FNB Southeast founded in 1919 and Lexington State Bank founded in 1949, each with approximately $1 billion in total assets. Having achieved critical mass and established a new corporate identity, the Company planned to become an active acquirer in the Carolinas by combining with smaller commercial banks. Following the merger, however, the Company experienced a setback through the recession of 2008 as small businesses in the Piedmont Triad and the Company’s other markets suffered deep losses and unemployment escalated. Through successful execution of the Company’s business strategy, the Company resolved a significant portion of its asset problems at that time through a planned problem asset disposition in 2012, while concurrently raising capital to retire preferred shares issued under the U.S. Treasury’s TARP Program.

 

In 2013, the Company renewed its growth strategies and increased total assets 15%, including $140 million of organic loan growth and $122 million of acquired loan growth through its Security Savings Bank, SSB (“Security Savings”) acquisition. In 2014, the Company further increased assets an additional $555 million through a disciplined four-part strategy: focusing on organic in market expansion, expansion in select metropolitan de novo markets, the acquisition of CapStone Bank (“CapStone”) in the Raleigh market and the addition of an experienced team of bankers focused on middle market companies.

 

The Company’s business strategy follows three basic tenets: Quality, Profitability and Growth. Utilizing this strategy, the Company achieved record pre-tax earnings of $21.8 million in 2014, a 24% increase over 2013 results. Excluding acquisition-related costs and gains on sale of investments, pre-tax core net operating income totaled $26.9 million, a 41% increase over the same adjusted core net operating income for the prior year. Management regularly evaluates the Company’s performance using pre-tax core net operating income comparisons because of its focus on normalized operating performance metrics.

 

Pre-tax core net operating income        
         
(dollars in thousands)        
   Twelve Months Ended December 31 
   2014   2013 
Income before income tax  $21,795   $17,555 
Gain on sale of investment securities   -    (736)
Acquisition-related expenses   5,081    2,232 
Pre-tax core net operating income  $26,876   $19,051 

 

Net income available to common shareholders declined in 2014 to $13.6 million from $18.9 million in 2013 and earnings per diluted share declined from $0.65 in 2013 to $0.38 in 2014. The results for 2013 were affected by a tax benefit of $3.2 million that resulted from a reversal of a deferred tax valuation allowance of $10.0 million. The Company provided for income taxes in 2014 at an effective tax rate of 35.9%, resulting in an $11.0 million increase in tax provision from the prior year. Common shareholders further benefitted in 2014 by the Company’s decision to redeem the final $15.0 million of TARP preferred shares in March of 2014 following the redemption of 37,372 preferred shares in 2013. Dividends and accretion on preferred stock decreased 82% to $337,000 in 2014 from $1.9 million in 2013 as a result. Therefore, adjusting for the normalized tax rate and removing acquisition-related expenses and dividends and accretion on preferred stock, normalized diluted earnings per share improved 26% over the prior year.

 

32
 

 

   2014   2013         
(dollars and shares in thousands)  Actual   Actual   Var $   Var % 
                 
Non-GAAP Analysis                    
Income before income tax  $21,795   $17,555   $4,240    24.2%
Add acquisition-related expense   5,081    2,232    2,849    127.6%
Adjusted net income before tax   26,876    19,787    7,089    35.8%
Normalized tax provision   9,643    6,856    2,787    40.6%
Less preferred dividends   337    1,854    (1,517)   (81.8)%
Adjusted net income after tax & preferred dividend  $16,896   $11,077   $5,819    52.5%
Weighted average diluted shares   35,466    29,070    6,396    22.0%
Normalized diluted EPS  $0.48   $0.38   $0.10    26.3%
                     
GAAP Comparison                    
Income before income tax  $21,795   $17,555   $4,240    24.2%
Tax provision   7,819    (3,216)   11,035    (343.1)%
Net income   13,976    20,771    (6,795)   (32.7)%
Less preferred dividends   337    1,854    (1,517)   (81.8)%
Net income available to common shareholders  $13,639   $18,917   $(5,278)   (27.9)%
Weighted average diluted shares   35,466    29,070    6,396    22.0%
Diluted EPS  $0.38   $0.65   $(0.27)   (41.5)%

 

Quality. Over the past three years, one of the Company’s most significant accomplishments has been an aggressive reduction of its adversely classified assets.

 

In mid-2012 the Company formulated an asset disposition plan to resolve the lingering impact of the 2008 recession on its asset quality. Dispositions were made through direct negotiations with customers, direct sales of notes, auctions and sales of small pools of homogeneous assets. By year end 2012, the Company had reduced total classified assets by $96 million.

 

Asset quality trends continued to improve in 2013. Nonperforming loans declined 56% during the year to $9.4 million from $21.3 million at December 31, 2012. As a percentage of total assets, nonperforming loans represented 0.48% at December 31, 2013 compared to 1.25% at December 31, 2012. The allowance for credit losses to nonperforming loans improved to 261% at year end 2013 from 125% at year end 2012. Total nonperforming assets to total assets declined to 0.87% at December 31, 2013 from 1.56% at December 31, 2012.

 

Asset quality reflected continued improvement throughout 2014. The highlights of 2014 are as follows:

 

·Nonperforming loans declined to $7.2 million from $9.4 million the previous year;
·As a percentage of assets, nonperforming loans declined to 0.29% from 0.48%;
·Allowance for credit losses to nonperforming loans improved to 307% from 261%;
·Real estate acquired in settlement of loans decreased to $3.1 million from $7.6 million at December 31, 2013;
·Total nonperforming assets to total assets declined to 0.41% from 0.87%; and
·Net chargeoffs decreased to $3.3 million, or 0.20% of average loans held for investment, from $4.8 million, or 0.38% of average loans held for investment, in the prior year.

 

33
 

 

Profitability. The Company’s ability to achieve sustained profitability depends not only on the maintenance of a high level of asset quality but on careful management of interest income, interest expense and other expense. Management has implemented a number of steps to increase net interest and fee income, preserve an acceptable net interest margin and control our controllable expenses.

 

Our 2012 operating results reflected the impact of the implementation of the asset disposition plan. For the year 2012, the Company had a net loss of $25.3 million, which was anticipated.

 

The success of the asset disposition plan positioned the Company to achieve record earnings in 2013. In 2013, earnings to common shareholders totaled $18.9 million, provision for credit costs declined $33.2 million to $2.7 million, and loss on real estate acquired in settlement of loans improved $15.9 million to a gain of $126,000. Results for 2013 were positively affected by a tax benefit of $3.2 million that resulted from a reversal of a deferred tax asset valuation allowance of $10.0 million.

 

The Company produced solid operating results in 2014. The highlights of 2014 are as follows:

 

·Pre-tax earnings increased 24% for the year;
·Net interest income grew 25% to $78.7 million;
·Average earning assets increased $506.4 million;
·Provision for credit losses declined $1.8 million to $0.8 million;
·Wealth management revenues increased 13.6%;
·Noninterest-bearing deposits increased 33%, or $78.3 million;
·Total core deposits grew 16% and represented 70% of total deposits at year end;
·Average cost of borrowings was 0.99%, down from 1.50 % the previous year; and
·Realignment of our retail banking structure was equivalent to a 5% reduction in the Company’s work force.

 

Although noninterest expense increased $12.3 million, or 20.4%, in 2014 compared to 2013, the primary increases were in acquisition-related expenses and investments made to build our team of bankers and expand key offices and branches. Acquisition-related expense in 2014 was $5.1 million, compared to $2.2 million in 2013. Personnel expense increased 14.1%, and occupancy expense and furniture and equipment expense increased 16.7% and 8.7%, respectively. These expenditures have positioned the Company to drive increased revenue and maximize profitability.

 

Growth. The past three years have been transformative as the Company has become one of the largest community-focused banks in the Carolinas, both in asset size and geographical footprint. Our management philosophy focuses on promoting core organic growth with a disciplined acquisition strategy targeted at expanding the Company’s presence in select markets. The Company takes a balanced approach to promoting growth in valuable core transaction deposits, commercial and private bank lending and expansion of fee income services. Our goal is to provide excellence in value to our customers and shareholders as we grow.

 

Loan balances increased 5%, net of classified loans, in 2012. During the same year, our footprint was expanded into the Raleigh and Charlotte markets through loan production offices, and twelve senior level experienced community bankers were employed, including new market executives in the Piedmont Triad and Charlotte markets.

 

The Company experienced significant organic and acquired loan growth in 2013. Loan balances increased 22.6%, with organic loan growth totaling 12%, or $140 million, for the year. Expansion efforts were strengthened as our loan production offices in Charlotte and Raleigh became full-service bank locations. During 2013, the Security Savings acquisition was completed, and the CapStone acquisition was announced.

 

The growth of our balance sheet in 2014 was a visible indication of the Company’s significant expansion. The highlights for 2014 include:

 

·Total assets increased by $555.0 million, or 28%, to $2.52 billion;

 

34
 

 

·Total loans held for investment increased 27% to $1.80 billion, up from $1.42 billion the prior year, reflecting both acquired loans and organic growth;
·Acquired CapStone Bank resulting in expanded operations in Raleigh, NC;
·Established middle market banking group and reorganized commercial banking operation into specialized teams;
·Expanded array of treasury services and wealth management business;
·Opened Charleston and Greenville, SC loan production offices;
·Expanded operations in Charlotte and Winston-Salem, NC; and
·Announced planned acquisition of Premier Commercial Bank, a $168.7 million asset bank based in Greensboro, NC, to add commercial banking clients and assets in Greensboro and residential mortgage banking in several North Carolina markets.

 

Financial Condition at December 31, 2014 and 2013

 

The Company’s consolidated assets of $2.52 billion at year end 2014 reflect an increase of 28.2% from year end 2013. The increase reflects the combined result of the acquisition of CapStone on April 1, 2014, and organic and acquired loan growth. Total average assets increased 31.2% from $1.78 billion in 2013, to $2.33 billion in 2014, while average earning assets increased 31.0%, from $1.63 billion in 2013, to $2.14 billion in 2014. The increases in total average assets and average earning assets were primarily the result of an increase in loans outstanding.

 

Loans (excluding loans held for sale) increased $387.7 million during 2014, or 27.4%, compared to an increase of 22.6% in 2013. The Company’s success in expanding its loan portfolio is attributed to a balanced strategy of organic and acquired loan growth. In the fourth quarter of 2014, the middle market team, which focuses on commercial and industrial loan customers with revenues between $25 million and $250 million, was responsible for $99.7 million of loan growth, including $75.7 million of credit relationships previously existing with the team. Loans secured by real estate totaled $1.58 billion at year end 2014 and represented 87.4% of total loans (excluding loans held for sale), compared with 89.5% at year end 2013. Within this category, residential real estate loans increased 10.2% to $672.6 million, and land acquisition, development and construction loans increased 45.7% to $168.1 million. Commercial loans totaled $928.8 million at year end 2014, an increase of 41.5% from the end of 2013. Consumer loans decreased 1.0% during 2014, ending the year at $26.2 million.

 

Investment securities available for sale (at amortized cost) totaled $358.5 million at year end 2014, a 20.5% increase from $297.5 million at year end 2013. U.S. government agency securities totaled $49.6 million, or 13.8% of the available for sale portfolio, at year end 2014, compared to $49.1 million, or 16.5% of the portfolio one year earlier. Mortgage backed securities totaled $53.0 million, or 14.8% of the available for sale portfolio, at December 31, 2014, compared to $52.6 million, or 17.7% of the portfolio, at the previous year end. Available for sale state and municipal obligations totaled $33.9 million at year end 2014, and comprised 9.5% of the available for sale portfolio, compared to $15.8 million, or 5.3% of the portfolio, a year earlier. Corporate bonds totaled $178.8 million, or 49.9% of the available for sale portfolio at December 31, 2014, of which $50.0 million were covered bonds, compared to corporate bonds of $155.7 million, or 52.3% of the portfolio at December 31, 2013, of which $49.9 million were covered bonds. Collateralized mortgage obligations totaled $10.5 million, or 2.9% of the available for sale portfolio at year end 2014, compared to $6.6 million, or 2.2% of the portfolio, at the end of the previous year.

 

During 2014, the Company classified a number of its investment security purchases as held to maturity. The weighted average duration of investment securities classified as held to maturity does not exceed five years. The Company believes it has the capacity to hold these investments to maturity. Investment securities held to maturity (at amortized cost) totaled $130.7 million at year end 2014, a 94.2% increase from $67.3 million at year end 2013. U.S. government agency securities totaled $32.8 million, or 25.1% of the held to maturity portfolio, at year end 2014, compared to $28.7 million, or 42.7% of the portfolio, one year earlier. Mortgage backed securities totaled $54.3 million, or 41.6% of the held to maturity portfolio, at December 31, 2014, compared to $32.4 million, or 48.2% of the portfolio, at the previous year end. Held to maturity state and municipal obligations amounted to $1.2 million at year end 2014, and comprised 0.9% of the held to maturity portfolio, compared to $1.1 million, or 1.7% of the portfolio, a year earlier. Corporate bonds totaled $28.4 million, or 21.7% of the held to maturity portfolio at December 31, 2014, of which $5.0 million were covered bonds. There were no corporate bonds in the held to maturity portfolio at December 31, 2013. Subordinated debt issues totaled $14.0 million, or 10.7% of the held to maturity portfolio, at year end 2014, compared to $5.0 million, or 7.4% of the portfolio, one year earlier.

 

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The Company’s investment strategy is to achieve acceptable total returns through investments in securities with varying maturity dates, cash flows and yield characteristics. U.S. government agency securities are generally purchased for liquidity and collateral purposes, mortgage backed securities are purchased for yield and cash flow purposes, corporate bonds are purchased for yield, and longer maturity municipal bonds are purchased for yield and income tax advantage. The table “Investment Securities,” on page 54, presents the composition of the securities portfolio for the last three years, as well as information about cost and fair value. The table “Investment Securities Portfolio Maturity Schedule,” on page 56, presents the maturities, fair values and weighted average yields of the Company’s securities portfolio.

 

Total deposits increased $278.6 million to $1.83 billion at December 31, 2014, a 17.9% increase from a total of $1.55 billion one year earlier. The increase in deposits was primarily due to the acquisition of CapStone. Retail time deposits increased $7.6 million during 2014. Noninterest-bearing deposits increased $78.3 million during 2014 to $319.3 million.

 

To supplement core deposit growth, the Bank uses several different sources such as brokered certificates of deposit secured through broker/dealer arrangements and deposits obtained through the Certificate of Deposit Account Registry Service (“CDARS”), a service of Promontory InterFinancial Network, LLC. CDARS increased $53.3 million, from $143.3 million at year end 2013 to $196.6 million at year end 2014, while brokered deposits increased $36.0 million, from $13.4 million at year end 2013 to $49.4 million at year end 2014.

 

The Bank also has a credit facility available with the FHLB of Atlanta. The credit line at December 31, 2014 was $488.2 million, compared to $360.2 million at December 31, 2013. FHLB borrowings totaled $346.7 million at year end 2014. Based on collateral pledged, an additional $110.5 million of borrowings was available at year end 2014. At December 31, 2013, FHLB borrowings totaled $170.0 million, and an additional $91.3 million of borrowings available. In addition to the credit line at the FHLB of Atlanta, at December 31, 2014 the Bank had borrowing capacity at the Federal Reserve Bank totaling $4.3 million of which none was used and had federal funds lines of $89.8 million of which $29.5 million was outstanding at year end 2014. At December 31, 2013 the Bank had borrowing capacity at the Federal Reserve Bank totaling $3.9 million of which none was used and had federal funds lines of $30.0 million of which $13.0 million was outstanding at year end 2013. Management believes these credit lines are a cost effective and prudent alternative to deposit balances, affording the Bank additional flexibility because particular amounts, terms and structures may be selected to meet changing needs.

 

Financial Condition at December 31, 2013 and 2012

 

The Company’s consolidated assets of $1.97 billion at year end 2013 reflect an increase of 15.0% from year end 2012. The increase was primarily a result of the acquisition of Security Savings on October 1, 2013. Total average assets increased 3.1% from $1.72 billion in 2012, to $1.78 billion in 2013, while average earning assets increased 3.7%, from $1.58 billion in 2012, to $1.63 billion in 2013. The increases in total average assets and average earning assets were primarily the result of an increase in loans outstanding.

 

Loans (excluding loans held for sale) increased $261.3 million during 2013, or 22.6%, compared to a decrease of 3.7% in 2012, primarily due to organic loan growth and the acquisition of Security Savings. Loans secured by real estate totaled $1.27 billion at year end 2013 and represented 89.5% of total loans (excluding loans held for sale), compared with 87.5% at year end 2012. Within this category, residential real estate loans increased 21.7% to $610.2 million, and land acquisition, development and construction loans increased 52.5% to $115.4 million. Commercial loans totaled $656.4 million at year end 2013, an increase of 20.4% from the end of 2012. Consumer loans decreased 1.7% during 2013, ending the year at $26.4 million.

 

Investment securities available for sale (at amortized cost) totaled $297.5 million at year end 2013, a 21.5% decrease from $379.1 million at year end 2012. U.S. government agency securities totaled $49.1 million, or 16.5% of the available for sale portfolio, at year end 2013, compared to $67.1 million, or 17.7% of the portfolio one year earlier. Mortgage backed securities totaled $52.6 million, or 17.7% of the available for sale portfolio, at December 31, 2013, compared to $64.7 million, or 17.1% of the portfolio, at the previous year end. Available for sale state and municipal obligations totaled $15.8 million at year end 2013, and comprised 5.3% of the available for sale portfolio, compared to $18.0 million, or 4.7% of the portfolio, a year earlier. Corporate bonds totaled $155.7 million, or 52.4% of the available for sale portfolio at December 31, 2013, of which $49.9 million were covered bonds, compared to corporate bonds of $195.5 million, or 51.6% of the portfolio at December 31, 2012, of which $44.9 million were covered bonds. Collateralized mortgage obligations totaled $6.6 million, or 2.2% of the available for sale portfolio at year end 2013, compared to $10.4 million, or 2.7% of the portfolio, at the end of the previous year.

 

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During 2013, the Company classified a number of its investment security purchases as held to maturity. The weighted average life of investment securities classified as held to maturity does not exceed seven years. The Company believes it has the capacity to hold these investments to maturity. Investment securities held to maturity (at amortized cost) totaled $67.3 million at year end 2013. U.S. government agency securities totaled $28.7 million, or 42.7% of the held to maturity portfolio, at year end 2013. Mortgage backed securities totaled $32.4 million, or 48.2% of the held to maturity portfolio, at December 31, 2013. Held to maturity state and municipal obligations amounted to $1.1 million at year end 2013, and comprised 1.7% of the held to maturity portfolio. Corporate bonds totaled $5.0 million, or 7.4% of the held to maturity portfolio at December 31, 2013. The Company had no investment securities held to maturity at December 31, 2012.

 

Total deposits increased $221.5 million to $1.55 billion at December 31, 2013, a 16.6% increase from a total of $1.33 billion one year earlier. The increase in deposits was primarily due to the acquisition of Security Savings. Retail time deposits increased $20.6 million for the year. Noninterest-bearing deposits increased $35.0 million for the year to $241.0 million.

 

To supplement core deposit growth, the Bank uses several different sources such as brokered certificates of deposit secured through broker/dealer arrangements and deposits obtained through CDARS; CDARS increased $100.9 million, from $42.4 million at year end 2012 to $143.3 million at year end 2013, while brokered deposits decreased $4.3 million, from $17.7 million at year end 2012 to $13.4 million at year end 2013.

 

The Bank also has a credit facility available with the FHLB of Atlanta. The credit line at December 31, 2013 was $360.2, compared to $342.5 million at December 31, 2012. FHLB borrowings totaled $170.0 million at year end 2013. Based on collateral pledged, an additional $91.3 million of borrowings was available at year end 2013. At December 31, 2012, FHLB borrowings totaled $113.0 million, and an additional $95.3 million of borrowings was available. In addition to the credit line at the FHLB of Atlanta, at December 31, 2013 the Bank had borrowing capacity at the Federal Reserve Bank totaling $3.9 million of which none was used and had federal funds lines of $30.0 million of which $13.0 million was outstanding. At December 31, 2012, the Bank had borrowing capacity at the Federal Reserve Bank totaling $7.7 million and had federal funds lines of $25.0 million, of which there were no borrowings outstanding for either. Management believes these credit lines are a cost effective and prudent alternative to deposit balances, affording the Bank additional flexibility because particular amounts, terms and structures may be selected to meet changing needs.

 

Net Interest Income

 

As with most financial institutions, the primary component of the Company’s revenue is net interest income. Net interest income is the difference between interest income, principally from loans and investments, and interest expense on client deposits and borrowings. Changes in net interest income result from changes in volume and mix of the various interest-earning asset and interest-bearing liability components and changes in interest rates earned and paid. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Spread and margin are influenced by the levels and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities.

 

Average balances and net interest income analysis. The following table sets forth, for the years 2012 through 2014, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or rates, net interest income, net interest spread, and net interest margin. Average loans include nonaccruing loans, the effect of which is to lower the average yield.

 

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Average Balances and Net Interest Income Analysis

Fully taxable-equivalent basis(1) (dollars in thousands)

 

   2014   2013   2012 
       Interest           Interest           Interest     
   Average   Income/   Average   Average   Income/   Average   Average   Income/   Average 
   Balance   Expense   Yield/Rate   Balance   Expense   Yield/Rate   Balance   Expense   Yield/Rate 
                                     
Earning assets:                                             
Loans receivable(2)  $1,670,113   $71,230    4.26%  $1,247,095   $56,617    4.54%  $1,175,938   $57,676    4.90%
Taxable securities   411,464    12,908    3.14    355,864    11,239    3.16    357,463    12,492    3.49 
Tax-exempt securities(1)   29,010    1,492    5.14    15,519    1,115    7.18    17,502    1,119    6.39 
FHLB stock   13,057    463    3.55    7,631    195    2.56    7,323    122    1.67 
Federal Reserve Bank stock   1,731    102    5.89    -    -    -    -    -      
Interest-bearing bank balances   14,763    118    0.80    7,656    23    0.30    16,923    40    0.24 
                                              
Total earning assets   2,140,138    86,313    4.04    1,633,765    69,189    4.24    1,575,149    71,449    4.54 
                                              
Non-earning assets:                                             
Cash and due from banks   31,551              25,020              25,681           
Premises and equipment   45,436              37,327              36,284           
Other assets   139,170              108,266              117,213           
Allowance for credit losses   (23,745)             (26,309)             (29,872)          
                                              
Total assets  $2,332,550             $1,778,069             $1,724,455           
                                              
Interest-bearing liabilities:                                             
Savings deposits  $66,347   $36    0.05%  $51,197   $26    0.05%   $44,144    $26    0.06%
NOW deposits   478,188    893    0.19    425,435    709    0.17    428,299    1,242    0.29 
Money market deposits   392,322    780    0.20    339,664    602    0.18    365,718    1,204    0.33 
Time deposits   552,436    2,291    0.41    368,189    1,779    0.48    377,289    2,663    0.71 
Other borrowings   76,913    2,344    3.05    48,773    1,332    2.73    46,957    1,367    2.91 
FHLB Borrowings   241,945    801    0.33    120,136    1,195    0.99    79,941    1,012    1.27 
                                              
Total interest-bearing liabilities   1,808,151    7,145    0.40    1,353,394    5,643    0.42    1,342,348    7,514    0.56 
                                              
Other liabilities and shareholders’ equity:                                             
Demand deposits   294,704              228,635              196,365           
Other liabilities   15,537              19,302              19,362           
Shareholders’ equity   214,158              176,738              166,380           
                                              
Total liabilities and  shareholders’ equity  $2,332,550             $1,778,069             $1,724,455           
                                              
Net interest income and net interest margin(3)       $79,168    3.70%       $63,546    3.89%       $63,935    4.06%
                                              
Interest rate spread(4)             3.64%             3.82%             3.98%

 

(1)Income related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35%, and is then reduced by the non-deductible portion of interest expense. The adjustments made to convert to a fully taxable-equivalent basis were $497 for 2014, $370 for 2013 and $369 for 2012.

 

(2)Average loans receivable include nonaccruing loans and loans held for sale. Amortization of loan fees, net of deferred costs, and other loan-related fees of $(420), $136 and $600, for 2014, 2013 and 2012, respectively, are included in interest income. Also included in interest income for 2014 is $212 from interest rate cash flow hedges.

 

(3)Net interest margin is computed by dividing taxable-equivalent net interest income by average earning assets.

 

(4)Interest rate spread is computed by subtracting interest-bearing liability rate from earning asset yield.

 

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Volume and Rate Variance Analysis

 

The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table identifies (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) have been allocated, based on the absolute value, between changes attributable to volume and changes attributable to rate.

 

Volume and Rate Variance Analysis

Fully taxable-equivalent basis(1) (dollars in thousands)

 

   2014   2013 
   Volume   Rate   Total   Volume   Rate   Total 
   Variance(2)   Variance(2)   Variance   Variance(2)   Variance(2)   Variance 
                         
Interest income:                              
Loans receivable  $18,274   $(3,661)  $14,613   $3,346   $(4,405)  $(1,059)
Taxable investment securities   1,741    (72)   1,669    (57)   (1,196)   (1,253)
Tax-exempt investment securities(1)   761    (384)   377    (134)   130    (4)
FHLB stock   174    94    268    5    68    73 
Federal Reserve Bank stock   102    -    102    -    -    - 
Interest-bearing bank balances   34    61    95    (26)   9    (17)
Total interest income   21,086    (3,962)   17,124    3,134    (5,394)   (2,260)
                               
Interest expense:                              
Savings deposits   10    0    10    4    (4)   0 
NOW deposits   94    90    184    (8)   (525)   (533)
Money market deposits   104    74    178    (82)   (520)   (602)
Time deposits   796    (284)   512    (61)   (823)   (884)
Other borrowings   841    171    1,012    52    (87)   (35)
Borrowings from FHLB   719    (1,113)   (394)   438    (255)   183 
Total interest expense   2,564    (1,062)   1,502    343    (2,214)   (1,871)
                               
Increase (decrease) in net interest income  $18,522   $(2,900)  $15,622   $2,791   $(3,180)  $(389)

 

(1)Income related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35% and is then reduced by the non-deductible portion of interest expense.

 

(2)The volume/rate variance for each category has been allocated on a consistent basis between rate and volume variances, based on the percentage of rate, or volume, variance to the sum of the two absolute variances.

 

Results of Operations – Years Ended December 31, 2014 and 2013

 

Net income. Net income available to common shareholders for 2014 was $13.6 million, representing net income per diluted share of $0.38, compared to net income available to common shareholders of $18.9 million, or $0.65 per diluted share, the prior year. In 2013, the Company had a tax benefit of $3.2 million resulting from a deferred tax asset valuation allowance reversal of $10.0 million, $740,000 due to a NC corporate tax rate change, and a calculated tax provision of $6.1 million. In the second quarter of 2014, the Bank acquired CapStone, and in the Fall of 2014, established loan production offices in Greenville and Charleston, SC. Provision for credit losses was $883,000 in 2014 compared to $2.7 million in 2013. Results for 2014 included $5.1 million in acquisition-related expense, reflecting an increase of $2.9 million compared to $2.2 million in acquisition-related expense included in 2013. Net interest income for 2014 after provision for credit losses increased by $17.3 million, or 28.6%, as compared to 2013. The taxable-equivalent net interest margin decreased 19 basis points for 2014 to 3.70%, from 3.89% for 2013. Noninterest income decreased $741,000, or 4.2%, in 2014, while noninterest expense for 2014 increased $12.3 million, or 20.4%. Return on average assets for 2014 was 0.60% compared to 1.17% for 2013. Return on average shareholders' equity for 2014 was 6.53% compared to 11.75% in 2013.

 

Net interest income. Net interest income for 2014, on a taxable-equivalent basis, increased $15.6 million, or 24.6%, compared to 2013. Average earning assets for 2014 increased $506.4 million, or 31.0%, to $2.14 billion from $1.63 billion for the prior year. Average interest-bearing liabilities for 2014 increased $454.8 million, or 33.6%, to $1.81 billion, compared to $1.35 billion for 2013.

 

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The net interest margin for the year ended December 31, 2014 was 3.70%, down from 3.89% for the prior year. The decline in net interest margin was primarily a result of a lower yield on the loan portfolio. In 2014, the average yield on earning assets decreased by 20 basis points while the average rate on interest-bearing liabilities decreased by two basis points, which resulted in a decrease in the interest rate spread in 2014 of 18 basis points compared to the prior year.

 

The table, “Average Balances and Net Interest Income Analysis,” above summarizes net interest income and average yields earned, and rates paid for the years indicated, on a taxable-equivalent basis. The table, “Volume and Rate Variance Analysis” above presents the changes in interest income and interest expense attributable to volume and rate changes between the years indicated.

 

Provision for credit losses and allowance for credit losses. The Company recorded a $883,000 provision for credit losses during the year ended December 31, 2014, compared to a $2.7 million provision during the previous year. The Company’s allowance for credit losses was $22.1 million at December 31, 2014, compared to $24.6 million at December 31, 2013. The allowance for credit losses expressed as a percentage of total loans (excluding loans held for sale) decreased to 1.23% at December 31, 2014 from 1.73% at December 31, 2013. The allowance for credit losses expressed as a percentage of loans excluding purchased credit-impaired (“PCI”) loans and loans held for sale decreased to 1.28% at December 31, 2014 from 1.80% at December 31, 2013. The allowance for credit losses as a percentage of nonperforming loans was 306.60% at year end 2014, compared to 261.23% at year end 2013.

 

Noninterest income. In 2014, noninterest income decreased $741,000 to $16.7 million, or 4.2%, compared to 2013. In 2014, there were no gains on sale of investment securities, compared to pre-tax gains on sale of investment securities of $736,000 in 2013. In 2014, retail banking revenue increased $196,000 to $10.4 million, or 1.9%, for the year. Wealth management revenue increased 13.6% to $2.9 million for 2014 from $2.6 million in 2013 as the division increased trust assets under management to $233.6 million at December 31, 2014 from $222.5 million at December 31, 2013; included in revenue in 2014 were several one-time fees collected due to estate settlements. Mortgage banking revenue decreased $774,000, or 47.1%, for 2014 due to a lower level of mortgage loan production resulting from increases in interest rates.

 

Noninterest expense. In 2014, noninterest expense increased $12.3 million, or 20.4%, compared to 2013. The increase was due to several factors. Acquisition-related expense in 2014 was $5.1 million, compared to $2.2 million in 2013. Personnel expense increased 14.1% to $36.6 million, from $32.1 million in 2013. The increase in personnel expense is due primarily to hiring related to the new middle market banking group and reorganized commercial banking groups, to the expansion of the commercial banking team in Winston-Salem, NC, and to additional personnel resulting from the acquisition of Security Savings in October, 2013 and the acquisition of CapStone in April, 2014, partially offset by the workforce reduction resulting from a retail banking realignment announced in the second quarter of 2014. Occupancy expense increased $702,000, or 16.7%, to $4.9 million, and furniture and equipment expense increased $305,000, or 8.7%, to $3.8 million in 2014 from $4.2 million and $3.5 million, respectively, in 2013 due primarily to the acquisitions of Security Savings and CapStone. Real estate acquired in settlement of loans expense (benefit) increased to $870,000 in 2014, from $(126,000) in the same period last year. For the detailed change in other operating expense please see the table “Other Operating Expenses” in Note 13 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

 

Provision for income taxes. The Company recorded an income tax expense of $7.8 million in 2014, compared to an income tax benefit of $3.2 million in 2013. The Company’s effective tax rate was 35.9% in 2014 and (18.3)% in 2013. In 2013, the difference between the effective tax rate and the statutory rate was primarily a result of a decrease of $10.0 million in the valuation allowance against deferred tax assets.

 

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Results of Operations – Years Ended December 31, 2013 and 2012

 

Net income (loss). Net income available to common shareholders for 2013 was $18.9 million, representing net income per diluted share of $0.65, compared to net loss available to common shareholders of $28.2 million, or $1.80 per diluted share, the prior year. In 2013, the Company had a tax benefit of $3.2 million resulting from a deferred tax asset valuation allowance reversal of $10.0 million, $740,000 due to a NC corporate tax rate change, and a calculated tax provision of $6.1 million. In the fourth quarter of 2013, the Bank acquired Security Savings, and earlier in the year loan production offices in Charlotte and Raleigh became full service branches. The results for 2012 were largely impacted by the Company’s plan to accelerate the disposition of problem assets. Provision for credit losses was $2.7 million in 2013 compared to $35.9 million in 2012. Results for 2013 include $2.2 million in acquisition-related expense and a loan recourse obligation expense of $356,000, while results for 2012 included $1.8 million taken in the third quarter of 2012 for impairments on facilities related to branch offices closed or scheduled to be closed and for adjustments for various nonrecurring accruals, as well as a $10.0 million valuation allowance against the Company’s deferred tax asset. Net interest income for 2013 after provision for credit losses increased by $32.8 million, or 118.6%, as compared to 2012. The taxable-equivalent net interest margin decreased 17 basis points for 2013 to 3.89%, from 4.06% for 2012. Noninterest income increased $566,000, or 3.4%, in 2013, while noninterest expense for 2013 decreased $12.0 million, or 16.6%. Lower mortgage banking revenue, which declined $1.0 million from 2012, was partially offset by gains on sales of investment securities of $736,000. The decrease in noninterest expense is due to a net gain for real estate acquired in settlement of loans expense of $126,000 in 2013 compared to a net loss of $15.7 million in 2012. Return on average assets for 2013 was 1.17% compared to (1.46)% for 2012. Return on average shareholders' equity for 2013 was 11.75% compared to (15.18)% in 2012.

 

Net interest income. Net interest income for 2013, on a taxable-equivalent basis, decreased $389,000, or 0.6%, compared to 2012. Average earning assets increased $58.6 million, or 3.7%, to $1.63 billion from $1.58 billion for the prior year. Average interest-bearing liabilities for 2013 increased $11.0 million, or 0.8%, to $1.35 billion, compared to $1.34 billion for 2012.

 

The net interest margin for the year ended December 31, 2013 was 3.89%, down from 4.06% for the prior year. The decline in net interest margin was partially as a result of the disposition of high risk loans with high yields as a part of our asset disposition plan in late 2012. In 2013, the average yield on earning assets decreased by 30 basis points while the average rate on interest-bearing liabilities decreased by 14 basis points, which resulted in a decrease in the interest rate spread in 2013 of 16 basis points compared to the prior year.

 

The table, “Average Balances and Net Interest Income Analysis,” above summarizes net interest income and average yields earned, and rates paid for the years indicated, on a taxable-equivalent basis. The table, “Volume and Rate Variance Analysis” above presents the changes in interest income and interest expense attributable to volume and rate changes between the years indicated.

 

Provision for credit losses and allowance for credit losses. The Company recorded a $2.7 million provision for credit losses during the year ended December 31, 2013, compared to a $35.9 million provision during the previous year. The Company’s allowance for credit losses was $24.6 million at December 31, 2013, compared to $26.6 million at December 31, 2012. The allowance for credit losses expressed as a percentage of total loans (excluding loans held for sale) decreased to 1.73% at December 31, 2013 from 2.30% at December 31, 2012. The allowance for credit losses expressed as a percentage of loans excluding PCI loans and loans held for sale was 1.80% at December 31, 2013. There were no PCI loans at December 31, 2012. The allowance for credit losses as a percentage of nonperforming loans was 261.23% at year end 2013, compared to 124.93% at year end 2012.

 

Noninterest income. In 2013, noninterest income increased $566,000 to $17.5 million, or 3.4%, compared to 2012. Pre-tax gains on sale of investment securities totaled $736,000 in 2013, compared to $3,000 in 2012. In 2013, retail banking revenue increased $489,000 to $10.2 million, or 5.0%, due primarily to changes in the rate and fee structures the Bank applied to certain product offerings in the fourth quarter of 2012. Wealth management revenue increased 9.4% to $2.6 million for 2013 from $2.3 million in 2012 as the division increased trust assets under management to $222.5 million at December 31, 2013 from $189.9 million at December 31, 2012. Mortgage banking revenue decreased $1.0 million, or 37.6%, for 2013 due to a lower level of mortgage loan production resulting from increases in interest rates.

 

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Noninterest expense. In 2013, noninterest expense decreased $12.0 million, or 16.6%, compared to 2012. Real estate acquired in settlement of loans expense was a net gain of $126,000 in 2013 compared to a net loss of $15.7 million in 2012. Personnel expense in 2013 increased $2.8 million, or 9.4%, compared to 2012. The increase in personnel expense was due primarily to the hiring of commercial lenders in the Raleigh and Charlotte markets and the addition of key lending personnel in the Piedmont Triad Region as well as the fourth quarter additions resulting from the acquisition of Security Savings. The decrease in occupancy and other expenses was due primarily to one-time charges of $1.8 million taken in the third quarter of 2012 for impairments on facilities related to branch offices closed or scheduled to be closed and for adjustments for various nonrecurring accruals. In 2013, the Company recorded $2.2 million of acquisition-related costs, which included $2.0 million related to the acquisition of Security Savings and $260,000 related to the anticipated acquisition of CapStone. In addition, in 2013, the Company recorded a recourse obligation expense of $356,000 to cover estimated losses on nonperforming loans sold prior to September 2008. The Bank did not sell a significant number of mortgage loans prior to the recession of 2008 and does not anticipate any additional significant losses related to mortgage recourse obligations. Finally, operating costs were elevated due to the acquisition of Security Savings. For the detailed change in other operating expense please see the table “Other Operating Expenses” in Note 13 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

 

Provision for income taxes. The Company recorded an income tax benefit of $3.2 million in 2013, compared to an income tax benefit of $2.6 million in 2012. The Company’s effective tax rate was (18.3)% in 2013 and (9.3)% in 2012. In 2013, the difference between the effective tax rate and the statutory rate was primarily a result of a decrease of $10.0 million in the valuation allowance against deferred tax assets, while in 2012, the difference between the effective tax rate and the statutory rate was primarily a result of an increase of $10.0 million in the valuation allowance against deferred tax assets.

 

Liquidity and Cash Flow

 

Liquidity management refers to the policies and practices that ensure the Bank has the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Bank’s clients. Management measures our liquidity position by giving consideration to both on- and off-balance sheet sources of, and demands for, funds on a daily and other periodic bases. Deposit withdrawals, loan funding and general corporate activity create the primary needs for liquidity for the Bank. Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities, investments available for sale, loan repayments, loan sales, increases in deposits, and increases in borrowings from the FHLB of Atlanta secured with pledged loans and securities, and from correspondent banks under overnight federal funds credit lines and securities sold under repurchase agreements.

 

The Company (the holding company only) had sufficient cash and cash equivalents on hand at December 31, 2014 to provide for the Company’s anticipated obligations and service its debt for approximately two and a half years.

 

The investment portfolio at December 31, 2014 included securities with a par value of approximately $151.7 million with call features, whereby the issuers of such securities have the option to repay the securities before the contractual maturity dates.

 

The Bank has the ability to manage, within competitive and cost of funds constraints, increases in deposits within its market areas. The Bank utilizes CDARS and brokered deposits to supplement in-market deposit growth.

 

The Bank has established wholesale repurchase agreements with regional brokerage firms. The Bank can access this additional source of liquidity by pledging investment securities with the brokerage firms.

 

Liquidity is further enhanced by a line of credit with the FHLB of Atlanta of approximately $488.2 million, collateralized by FHLB stock, investment securities, qualifying residential one to four family first mortgage loans, qualifying multi-family first mortgage loans, qualifying commercial real estate loans, and qualifying home equity lines of credit and second mortgage loans. Based upon collateral pledged, as of December 31, 2014, the borrowing capacity under this line was $488.2 million, with $110.5 million available to be borrowed. The Bank provides various reports to the FHLB on a regular basis to maintain the availability of the credit line. Each borrowing request to the FHLB is initiated through an advance application that is subject to approval by the FHLB before funds are advanced under the line of credit. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $4.3 million of which none was used and has federal funds lines of $89.8 million of which $29.5 million was outstanding at December 31, 2014.

 

As presented in the Consolidated Statement of Cash Flows, the Company generated $17.4 million in operating cash flow during 2014, compared to $22.5 million in 2013 and $23.5 million in 2012. Accretion on acquired loans was $5.7 million in 2014 compared to $783,000 in 2013 and none in 2012. There was a deferred income tax expense of $7.3 million in 2014, compared to a deferred income tax benefit of $3.3 million in 2013 and $2.5 million in 2012. The significant difference in 2012 between net income and operating cash flow is the result of provision for credit losses and writedowns on real estate acquired in settlement of loans.

 

42
 

 

Cash used in investing activities in 2014 was $156.9 million, compared to cash used in investing activities of $60.7 million in 2013 and $27.4 million in 2012. Cash outflows for 2014 included a $101.6 million increase in the loan portfolio, including $75.7 million of credit relationships previously existing with the middle market team, compared to an increase of $141.3 million in 2013 and $56.3 million in 2012. Cash outflows for 2014 also included $111.5 million in purchases of securities, compared to $164.0 million in 2013 and $271.3 million in 2012. Cash inflows for 2014 included $35.8 million in proceeds from sales, maturities, prepayments and calls of investment securities, compared to $182.2 million in 2013 and $228.7 million in 2012. Cash inflows for 2014 also included $6.0 million in proceeds from sales of loans, compared to none in 2013 and $54.4 million in 2012.

 

Cash provided by financing activities was $140.4 million in 2014, compared to cash provided by financing activities of $32.0 million in 2013 and cash used in financing activities of $10.3 million in 2012. Cash inflows for 2014 included an increase of $5.8 million in deposits, compared to an increase of $53.3 million in deposits in 2013 and a net decrease in deposits of $86.2 million in 2012. During 2014, the Company had cash inflows of $147.7 million related to increased borrowing, compared to $25.7 million in 2013 and $26.3 million in 2012. In 2014, the Company had cash outflows of $15.0 million as a result of the redemption of the remaining 15,000 shares of preferred stock previously issued in connection with the U.S. Treasury’s TARP Program. In 2013 the Company had cash outflows of $37.5 million (including related expense of $100,000) as a result of the redemption of 37,372 shares of preferred stock and $7.8 million paid in connection with the repurchase of a stock warrant (the “Warrant”), both of which were previously issued in connection with the TARP Program. During 2012, the Company had a net cash inflow of $52.2 million from the issuance of preferred stock, which was subsequently converted to common stock.

 

Contractual Obligations and Commitments

 

In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, which may or may not require future cash outflows. Payments for borrowings do not include interest. Payments related to leases and service contracts are based on actual payments specified in the underlying contracts. The following table reflects the material contractual obligations of the Company outstanding as of December 31, 2014.

 

Contractual Obligations

(dollars in thousands)

 

   Payments Due by Period 
   Within One
Year
   One Year
to Three
Years
   Three Years
to Five
Years
   After
Five
Years
   Total 
                     
Federal funds purchased  $29,500   $-   $-   $-   $29,500 
FHLB borrowings   273,500    73,200    -    -    346,700 
Wholesale repurchase agreements   -    21,000    -    -    21,000 
Subordinated debt   -    -    -    15,500    15,500 
Junior subordinated notes   -    -    -    25,774    25,774 
Operating lease obligations   1,796    2,828    1,289    513    6,426 
Service contracts and purchase obligations   6,363    4,124    870    218    11,575 
Other long-term liabilities   2,041    490    587    2,230    5,348 
Total contractual cash obligations excluding deposits   313,200    101,642    2,746    44,235    461,823 
                          
Deposits   1,746,863    68,755    16,921    25    1,832,564 
Total contractual cash obligations  $2,060,063   $170,397   $19,667   $44,260   $2,294,387 

 

Capital Resources

 

Banks, bank holding companies, and financial holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve has minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are required to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines.

 

43
 

 

On November 30, 2012, the Company completed a private placement of Series B preferred stock and Series C preferred stock for an aggregate of $56.3 million. At a special meeting of shareholders on February 20, 2013, shareholders approved the conversion of up to 422,456 shares of Series B preferred stock and up to 140,217 shares of Series C preferred stock into shares of voting and nonvoting common stock, respectively, at a conversion rate of $4.40 per share. Articles of Amendment filed with the North Carolina Secretary of State on February 21, 2013, created a new class of nonvoting common stock designated “Class B common stock,” and redesignated the Company’s existing common stock as “Class A common stock.” The Class A common stock and the Class B common stock each have no par value per share. As a result, on February 22, 2013, the Series B preferred stock was converted into 9,601,262 shares of voting Class A common stock, and the Series C preferred stock was converted into 3,186,748 shares of nonvoting Class B common stock.

 

On May 15, 2013, the Company repurchased the Warrant issued and sold to the U.S. Treasury for its fair market value of $7,779,000. On June 3, 2013, the Company redeemed 37,372 of the Company’s 52,372 outstanding shares of Series A preferred stock at the liquidation price of $1,000 per share for a total of $37,372,000 plus $93,430 of accrued and unpaid dividends. On March 31, 2014, the Company redeemed all of its remaining 15,000 outstanding shares of Series A preferred stock at the liquidation price of $1,000 per share for a total of $15.0 million, plus $172,500 of accrued and unpaid dividends.

 

On March 14, 2014, the Company entered into a Subordinated Note Purchase Agreement with 14 accredited investors under which the Company issued an aggregate of $15.5 million of subordinated notes to the accredited investors, including several members of the Company’s Board of Directors. The subordinated notes have a maturity date of March 14, 2024 and bear interest, payable on the 1st of January and July of each year, commencing July 1, 2014, at a fixed interest rate of 7.25% per year. The subordinated notes are intended to qualify as Tier II capital for regulatory purposes.

 

On April 1, 2014, the Company completed its acquisition of CapStone, pursuant to which CapStone’s shareholders received 2.25 shares of the Company’s Class A common stock for each share of CapStone common stock. The Company issued 8,075,228 shares of Class A common stock (in exchange for 3,589,028 shares of CapStone common stock issued and outstanding as of the closing date) at a price of $7.14 per share, the closing stock price of the Class A common stock on March 31, 2014. The implied value of the consideration received by CapStone shareholders was $16.065 per share of CapStone common stock. The total purchase price was $62.3 million, including the conversion of 617,270 CapStone stock options having a fair value of $4.6 million. No cash was issued in the transaction other than an immaterial amount of cash paid in lieu of fractional shares.

 

As shown in Note 18 of the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K, the Company and the Bank both maintained capital levels exceeding the minimum levels required to be categorized as “well capitalized” for each of the three years presented.

 

In July 2013, the Federal Reserve approved a final rule implementing the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes. The final rule revises minimum capital requirements and adjusts prompt corrective action thresholds. The final rule revises the regulatory capital elements, adds a new common equity Tier I capital ratio, and increases the minimum Tier I capital ratio requirement. The rule also permits certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income and implements a new capital conservation buffer. The final rule took effect for community banks on January 1, 2015, subject to a transition period for certain parts of the rule. The Company has performed a preliminary evaluation of the impact of the final rule on its capital levels and anticipates that the Company and the Bank will continue to have capital levels exceeding the minimum levels for “well capitalized” banks and bank holding companies.

 

Lending Activities

 

General. The Bank offers a broad array of lending services, including construction, real estate, commercial and consumer loans, to small to medium-sized businesses, middle market businesses, real estate developers and retail clients that are located in or conduct a substantial portion of their business in the Bank’s market areas. The Bank’s total loans (excluding loans held for sale) at December 31, 2014 were $1.80 billion, or 71.6% of total assets. At December 31, 2014, the Bank had no large loan concentrations (exceeding 10% of its portfolio) in any particular industry, other than real estate. The Bank’s legal lending limit at December 31, 2014 was $43.1 million (absent fully marketable collateral), and the largest credit relationship was approximately $24.9 million.

 

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Loan Composition. The following table summarizes, at the dates indicated, the composition of the Bank’s loan portfolio and the related percentage composition (excluding loans held for sale).

 

Summary of Loan Portfolio

(dollars in thousands; excluding loans held for sale)

 

   December 31 
   2014   2013   2012   2011   2010 
       % Of       % Of       % Of       % Of       % Of 
       Total       Total       Total       Total       Total 
   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans 
Secured by owner-occupied nonfarm nonresidential properties  $309,982        $302,976        $247,628        $269,972        $222,889      
Secured by other nonfarm nonresidential properties   426,875         239,062         186,864         157,594         159,086      
Other commercial and industrial   191,904         114,402         110,850         119,877         134,011      
Total Commercial   928,761    51.5%   656,440    46.3%   545,342    47.2%   547,443    45.6%   515,986    40.9%
                                                   
Construction loans – 1 to 4 family residential   43,681         20,582         13,206         7,781         16,736      
Other construction and land development   124,428         94,814         62,460         81,630         122,382      
Total Real estate – construction   168,109    9.3    115,396    8.1    75,666    6.6    89,411    7.4    139,118    11.0 
                                                   
Closed-end loans secured by 1 to 4 family residential properties   406,272         358,332         277,820         287,268         304,640      
Lines of credit secured by 1 to 4 family residential properties   228,704         213,112         200,465         209,634         219,557      
Loans secured by 5 or more family residential properties   37,598         38,735         23,116         25,883         20,207      
Total Real estate – mortgage   672,574    37.3    610,179    43.1    501,401    43.4    522,785    43.6    544,404    43.2 
                                                   
Credit cards   7,656         7,659         7,610         7,649         7,749      
Other revolving credit plans   9,112         8,529         9,018         9,444         9,042      
Other consumer loans   9,396         10,249         10,263         17,648         36,224      
Total Consumer   26,164    1.4    26,437    1.9    26,891    2.3    34,741    2.9    53,015    4.2 
                                                   
Loans to other depository institutions   -         -         -         -         3,800      
All other loans   8,798         8,251         6,121         5,690         4,262      
Total Other   8,798    0.5    8,251    0.6    6,121    0.5    5,690    0.5    8,062    0.7 
                                                   
Total  $1,804,406    100.0%  $1,416,703    100.0%  $1,155,421    100.0%  $1,200,070    100.0%  $1,260,585    100.0%

 

The Company has no foreign loan activity.

 

Real estate loans. Loans secured by real estate totaled $1.58 billion, or 87.4% of total loans (excluding loans held for sale), at December 31, 2014. At year end 2014, the Bank had real estate loan relationships of various sizes ranging up to $16.0 million of outstanding balances and commitments up to $25.0 million, secured by office buildings, retail establishments, residential development and construction, warehouses, motels, restaurants and other types of property. Loan terms are typically limited to five years, with payments through the date of maturity generally based on a 15-20 year (15-30 year for owner-occupied single and multi-family properties) amortization schedule. Interest rates may be fixed or adjustable, based on market conditions, and the Bank generally charges an origination fee. Management has attempted to reduce credit risk in the real estate portfolio by emphasizing loans on properties where the loan to value ratio, established by independent appraisals, does not exceed 70% to 80%, and net projected cash flow available for debt service amounts to at least 120% to 135% of the debt service requirement. The Bank also generally requires personal guarantees and personal financial statements from the principal owners in such cases.

 

Real estate – mortgage. The Bank originates fixed and adjustable rate mortgages as well as Federal Housing Administration, Veterans Administration and U.S. Department of Agriculture government supported loans for resale into the secondary market. The Bank provides bank-held mortgage products to accommodate qualified borrowers who may or may not meet all the standards for a conventional secondary market mortgage. The Bank has little or no exposure to subprime lending. During 2014, the Bank originated $143.6 million of loans in these various categories. Also included in real estate mortgage loans are home equity revolving lines of credit, with $228.7 million outstanding as of December 31, 2014. On a quarterly basis, the Bank obtains current credit scores on all consumer purpose loans, including home equity revolving lines of credit, and using other factors such as past due counters, line utilization, and market area, the portfolio is subdivided for monitoring into those with high risk, medium risk, and low risk. The Bank recorded net chargeoffs from mortgage loans of $3.2 million during 2014, compared to $2.0 million in 2013 and $12.6 million in 2012.

 

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Real estate – construction loans. The Bank’s current lending strategy is to moderately increase exposure in this portfolio segment. The Bank expects that the majority of its new construction and development loans on commercial and residential projects will be in the range of $1.0 million to $5.0 million. At December 31, 2014 and 2013, the Bank held $168.1 million and $115.4 million, respectively, of such loans. To reduce credit risk associated with such loans, the Bank emphasizes properties with high quality credit anchor tenants and neighborhood centers that are substantially pre-leased, or residential projects that are substantially pre-sold and built in strong, proven markets. The loans on commercial projects must generally result in a loan to appraised value of 75% to 80% or less and a net cash flow to debt service of no less than 120% to 135%. The Bank typically requires a personal guarantee from the developer or builder. Loan terms are generally 12-18 months, although the Bank will make a “mini-permanent” loan for purposes of construction and development of up to a five year term. Rates can be either fixed or variable, and the Bank usually charges an origination fee. The Bank experienced net recoveries from real estate – construction loans of $0.5 million in 2014 and net chargeoffs of $0.8 million in 2013 and $8.4 million in 2012.

 

Commercial loans. The Bank makes loans for commercial purposes to various types of businesses. At December 31, 2014, the Bank held $928.8 million of commercial loans, or 51.5% of its total loan portfolio. Equipment loans are typically made on terms up to five years at fixed or variable rates, with the financed equipment pledged as collateral to the Bank. The Bank attempts to reduce its credit risk on these loans by limiting the loan to value percentage to 80%. Working capital loans are made on terms typically not exceeding one year. These loans may be secured or unsecured, but the Bank attempts to limit its credit risk by requiring the borrower to demonstrate its capacity to produce net cash flow available for debt service equal to 120% to 150% of its debt service requirements. The Bank experienced net chargeoffs from commercial loans of $0.1 million in 2014, $1.0 million in 2013, and $16.4 million in 2012.

 

Consumer loans. Using a centralized underwriting process, the Bank makes a variety of loans to individuals for personal and household purposes, including (i) secured and unsecured installment and term loans originated directly by the Bank; (ii) unsecured revolving lines of credit, and (iii) amortizing secured lot loans. Certain of the direct loans are secured by the borrowers’ residences. At December 31, 2014, the Bank held $26.2 million of consumer loans. During 2014, 2013, and 2012, the Bank experienced net consumer loan chargeoffs of $0.5 million, $0.7 million and $0.9 million, respectively.

 

Loan approval and review. When the aggregate outstanding loans to a single borrower or related entities exceed an individual officer’s lending authority, or the individual officer’s lending authority is not applicable to the contemplated transaction, the loan request must be considered and approved by an officer with a higher lending limit. All consumer purpose loan decisions are initiated through a centralized underwriting process. Commercial banking managers (“CBM”) can generally approve commercial relationships up to $1.0 million on a secured basis. If the lending request exceeds the CBM’s lending limit, the loan must be submitted to and approved by a senior credit officer. Generally, a senior credit officer has authority to approve commercial relationships up to $5.0 million on a secured basis. All loan relationships between $5.0 million and $7.5 million must be approved by the Chief Commercial Credit Officer (“CCCO”). All loans between $7.5 million and $12.5 million must be approved by the Chief Credit Officer (“CCO”). Loan relationships exceeding $12.5 million must be unanimously approved by a committee of the CCCO, the CCO, and the Bank’s Chief Executive Officer (“CEO”).

 

The Bank’s Loan Review Program is headed by the Loan Review Manager, who reports directly to the Credit Management Committee of the Bank’s Board of Directors. The Program includes the Annual Loan Review Coverage Plan which is approved by the Credit Management Committee and which stipulates a certain number of loan reviews to be completed by the Loan Review Manager and employees under his or her guidance. The Bank’s credit review system supplements its loan rating system, pursuant to which the Bank may place a loan on its criticized asset list or may classify a loan in one of various other classification categories. In addition, all loan officers are charged with the responsibility of reviewing their portfolios and making adjustments to the risk ratings as needed. The “Watch List Committee,” which includes the CCO, the Special Assets Manager and the Special Assets Officers, reviews all commercial loans graded special mention, substandard, doubtful and loss on a monthly basis, and provides a summary to the Credit Management Committee, also on a monthly basis.

 

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The Bank’s loan portfolio is analyzed on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. Past due loans are reviewed with varying frequency and at multiple levels. Its allowance for credit losses is also analyzed monthly by management. This analysis includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. A specified minimum percentage of loans in each adverse asset classification category, based on the probability of default and on the historical loss experience of the Bank in each such category, as well as other environmental factors such as the unemployment level or other economic conditions affecting that type of loan, are used to determine the adequacy of the Bank’s allowance for credit losses monthly. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. The provisions of Accounting Standards Codification (“ASC”) 310-10-35, “Receivables-Overall-Subsequent Measurement” are applied to individually significant loans. See Note 5 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

 

Loan Portfolio – Maturities and Interest Rate Sensitivities

(dollars in thousands, excluding loans held for sale)

 

   Maturity   Maturity Greater Than One Year 
   One Year
or Less
   Over One
Year to
Five Years
   Over
Five
Years
   Total   Fixed
Interest
Rate
   Floating or
Adjustable
Rate
 
Secured by owner-occupied nonfarm nonresidential properties  $33,896   $160,496   $115,590   $309,982   $255,860   $20,226 
Secured by other nonfarm nonresidential properties   16,415    292,514    117,946    426,875    290,635    119,825 
Other commercial and industrial   42,157    116,749    32,998    191,904    100,122    49,625 
Total Commercial   92,468    569,759    266,534    928,761    646,617    189,676 
                               
Construction loans – 1 to 4 family residential   40,550    2,852    279    43,681    3,131    - 
Other construction and land development   15,669    92,709    16,050    124,428    55,226    53,533 
Total Real estate – construction   56,219    95,561    16,329    168,109    58,357    53,533 
                               
Closed-end loans secured by 1 to 4 family residential properties   27,792    82,510    295,970    406,272    222,929    155,551 
Lines of credit secured by 1 to 4 family residential properties   3,176    34,181    191,347    228,704    624    224,904 
Loans secured by 5 or more family residential properties   6,120    24,066    7,412    37,598    23,711    7,767 
Total Real estate – mortgage   37,088    140,757    494,729    672,574    247,264    388,222 
                               
Credit cards   7,656    -    -    7,656    -    - 
Other revolving credit plans   3,227    1,134    4,751    9,112    2,586    3,299 
Other consumer loans   1,628    6,782    986    9,396    7,205    563 
Total Consumer   12,511    7,916    5,737    26,164    9,791    3,862 
                               
All other loans   572    3,022    5,204    8,798    8,225    1 
Total Other   572    3,022    5,204    8,798    8,225    1 
                               
Total  $198,858   $817,015   $788,533   $1,804,406   $970,254   $635,294 

 

Asset Quality

 

The Bank considers asset quality to be of primary importance and employs a formal internal loan review process to ensure adherence to its lending policy as approved by its Board of Directors. See “Lending Activities – Loan Approval and Review.” It is the responsibility of each commercial lending officer to assign an appropriate risk grade to every loan they originate. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, it is the lending officer’s responsibility to recommend appropriate changes in the borrower’s risk grade.

 

47
 

 

The following table summarizes, by internally assigned risk grade, the risk grade for loans for which the bank has assigned a risk grade. The remainder of the loan portfolio consists of non risk graded homogeneous types of loans. The following table reflects $57.4 million of PCI loans at December 31, 2014, resulting from the acquisitions of Security Savings on October 1, 2013 and CapStone on April 1, 2014. Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered credit impaired. Loans – excluding PCI at December 31, 2014, includes $121.4 million of risk graded loans from the acquisitions that are not PCI.

 

Risk Profile by Internally Assigned Risk Grade

(dollars in thousands)

 

   December 31 
   2014   2013 
       Special   Sub-               Special   Sub-         
Loans – excluding PCI  Pass   Mention   standard   Doubtful   Total   Pass   Mention   standard   Doubtful   Total 
Commercial  $858,218   $18,578   $12,717   $969   $890,482   $592,221   $30,962   $15,044   $302   $638,529 
Real estate – construction   148,226    1,144    88    60    149,518    82,483    8,628    2,288    -    93,399 
Real estate – mortgage   99,200    4,794    1,987    -    105,981    84,999    4,243    5,168    -    94,410 
Consumer   928    -    -    -    928    -    -    -    -    - 
Other   7,646    1,152    -    -    8,798    7,373    -    -    -    7,373 
Total  $1,114,218   $25,668   $14,792    $1,029   $1,155,707   $767,076   $43,833   $22,500   $302   $833,711 

 

   December 31 
   2014   2013 
       Special   Sub-               Special   Sub-         
PCI loans  Pass(1)   Mention   standard   Doubtful   Total   Pass   Mention   standard   Doubtful   Total 
Commercial  $27,766   $5,345   $3,205   $-   $36,316   $5,451   $4,831   $7,031   $135   $17,448 
Real estate – construction   2,838    1,248    339    -    4,425    1,568    1,743    731    198    4,240 
Real estate – mortgage   11,246    3,811    1,627    -    16,684    2,811    2,361    5,739    499    11,410 
Consumer   -    -    -    -    -    2    1    -    -    3 
Other   -    -    -    -    -    -    -    -    -    - 
Total  $41,850   $10,404   $5,171   $-   $57,425   $9,832   $8,936   $13,501   $832   $33,101 

 

   December 31 
   2014   2013 
       Special   Sub-               Special   Sub-         
Total loans  Pass   Mention   standard   Doubtful   Total   Pass   Mention   standard   Doubtful   Total 
Commercial  $885,984   $23,923   $15,922   $969   $926,798   $597,672   $35,793   $22,075   $437   $655,977 
Real estate – construction   151,064    2,392    427    60    153,943    84,051    10,371    3,019    198    97,639 
Real estate – mortgage   110,446    8,605    3,614    -    122,665    87,810    6,604    10,907    499    105,820 
Consumer   928    -    -    -    928    2    1    -    -    3 
Other   7,646    1,152    -    -    8,798    7,373    -    -    -    7,373 
Total  $1,156,068   $36,072   $19,963    $1,029   $1,213,132   $776,908   $52,769   $36,001    $1,134   $866,812 

 

(1)PCI loans in the Pass category are in the pre-watch risk grade, which is the lowest risk grade in the Pass category.

 

Allocation of Allowance for Credit Losses(1)

(dollars in thousands)

 

   December 31 
   2014   2013   2012   2011   2010 
       % Of       % Of       % Of       % Of       % Of 
       Total       Total       Total       Total       Total 
   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans 
Commercial  $11,155    50.4%  $11,480    46.8%  $12,314    46.2%  $16,366    56.7%  $14,788    51.4%
Real estate – construction   1,984    9.0    2,027    8.2    2,058    7.7    2,834    9.8    4,243    14.8 
Real estate – mortgage   8,459    38.3    10,479    42.7    11,673    43.8    8,669    30.1    8,483    29.5 
Consumer   421    1.9    469    1.9    466    1.8    898    3.1    1,202    4.2 
Other   93    0.4    95    0.4    119    0.5    77    0.3    36    0.1 
Total  $22,112    100.0%  $24,550    100.0%  $26,630    100.0%  $28,844    100.0%  $28,752    100.0%

 

(1)The allowance for credit losses has been allocated on an approximate basis. The allocation is not necessarily indicative of future losses.

 

The Bank’s loan review program is designed to evaluate the credit risk in its loan portfolio. Through this loan review process, the Bank maintains an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for credit losses. In establishing the appropriate classification for specific loans, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as special mention, substandard, doubtful or loss as described below, and reserves are allocated based on management’s judgment and historical experience.

 

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Special Mention – These loans have potential weaknesses, which may, if not corrected or reversed, weaken the bank's credit position at some future date. The loans may not currently show problems due to the borrower(s)’ apparent ability to service the debt, but special circumstances surround the loans of which the bank and management should be aware. This category may also include loans where repayment has not been satisfactory, where constant attention is required to maintain a set repayment schedule, or where terms of a loan agreement have been violated but the borrower still appears to have sufficient financial strength to avoid a lower rating. It also includes new loans that significantly depart from established loan policy and loans to weak borrowers with a strong guarantor.

 

Substandard – These are loans whose full final collectability may not appear to be a matter for serious doubt, but which nevertheless have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and require close supervision by management, such as unprofitable and/or undercapitalized businesses, inability to generate sufficient cash flow for debt reduction, deterioration of collateral and special problems arising from the particular condition of an industry. It also includes workout loans on a liquidation basis when a loss is not expected. Some of these loans are considered impaired.

 

Doubtful – These loans have all the weakness inherent in loans graded substandard with the added provision that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and value, highly questionable. In some instances, the extent of the potential loss is not currently determinable. Most of these loans are considered impaired.

 

Loss – These loans are considered uncollectible and will be charged off immediately. These loans may have some recovery or salvage value but can no longer be considered active assets.

 

The process of determining the allowance for credit losses is driven by the risk grade system and the loss experience on non risk graded homogeneous types of loans. The allowance for credit losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio. In determining the allowance for credit losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in the Bank’s market areas. For loans determined to be impaired, the impairment is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral, less selling and other handling costs, for collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to recognize changes to the allowance based on their judgments about information available to them at the time of their examinations. Loans are charged off when in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.

 

Management believes the allowance for credit losses of $22.1 million at December 31, 2014 is adequate to cover inherent losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus, there can be no assurance that credit losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting future operating results of the Bank.

 

49
 

 

The following table presents an analysis of the changes in the allowance for credit losses.

 

Analysis of Allowance for Credit Losses

(dollars in thousands)

 

   Beginning   Charge           Ending 
   Balance   Offs   Recoveries   Provision   Balance 
December 31, 2014                         
Loans – excluding PCI                         
Commercial  $11,480   $1,411   $1,368   $(282)  $11,155 
Real estate – construction   2,027    427    894    (510)   1,984 
Real estate – mortgage   10,479    4,607    1,433    1,154    8,459 
Consumer   469    868    356    464    421 
Other   95    -    36    (38)   93 
Total  $24,550   $7,313   $4,087   $788   $22,112 
                          
PCI loans                         
Commercial  $-   $62   $-   $62   $- 
Real estate – construction   -    -    -    -    - 
Real estate – mortgage   -    33    -    33    - 
Consumer   -    -    -    -    - 
Other   -    -    -    -    - 
Total  $-   $95   $-   $95   $- 
                          
Total loans                         
Commercial  $11,480   $1,473   $1,368   $(220)  $11,155 
Real estate – construction   2,027    427    894    (510)   1,984 
Real estate – mortgage   10,479    4,640    1,433    1,187    8,459 
Consumer   469    868    356    464    421 
Other   95    -    36    (38)   93 
Total  $24,550   $7,408   $4,087   $883   $22,112 
                          
December 31, 2013                         
Loans – excluding PCI                         
Commercial  $12,314   $2,212   $1,260   $118   $11,480 
Real estate – construction   2,058    1,308    496    781    2,027 
Real estate – mortgage   11,673    3,552    1,544    814    10,479 
Consumer   466    1,116    389    730    469 
Other   119