XNAS:CLBH Carolina Bank Holdings Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

S  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended      June 30, 2012                                             

or

£  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                              

 

Commission File Number:      000-31877                                                  

 

Carolina Bank Holdings, Inc.  
(Exact name of registrant as specified in its charter)

 

North Carolina 56-2215437  
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

101 North Spring Street, Greensboro, North Carolina 27401         
(Address of principal executive offices) (Zip Code)        

 

(336) 288-1898  
(Registrant’s telephone number, including area code)

 

n/a  
(Former name, former address and former fiscal year, if changed since last report)

 

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.            S Yes £ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes S No £

 

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

 

Large accelerated filer £ Accelerated filer £
   
Non-accelerated filer £ (Do not check if a smaller reporting company) Smaller reporting company S
     

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

£ Yes S No

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

There were 3,387,045 shares of the Issuer’s common stock, $1.00 par value per share, outstanding as of August 10, 2012.

 

 
 

 

CAROLINA BANK HOLDINGS, INC.

 

INDEX

 

  Page
   
PART I.      FINANCIAL INFORMATION  
   
Item 1. Financial Statements (unaudited) 2
   
Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011 2
   
Consolidated Statements of Income for the three and six months ended June 30, 2012 and 2011 3
   
Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and 2011 4
   
Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2012 5
   
Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011 6
   
Notes to Consolidated Financial Statements 7
   
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations   29
   
Item 4.  Controls and Procedures 37
   
PART II.      OTHER INFORMATION  
   
Item 1. Legal Proceedings 38
   
Item 3. Defaults Upon Senior Securities 38
   
Item 6. Exhibits 38
   
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
   
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act  
   
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350  

 

1
 

 

ITEM 1. Financial Statements

 

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Balance Sheets

 

   June 30,   December 31, 
   2012   2011* 
   (unaudited)     
   (in thousands, except share data) 
Assets          
Cash and due from banks  $5,842   $5,664 
Interest-bearing deposits with banks   70,321    7,647 
Securities available-for-sale, at fair value   44,870    42,208 
Securities held-to-maturity   312    392 
Loans held for sale   57,708    91,955 
Loans   459,144    487,031 
Less allowance for loan losses   (11,112)   (11,793)
Net loans   448,032    475,238 
Premises and equipment, net   17,434    17,442 
Other real estate owned   6,384    6,728 
Bank-owned life insurance   10,573    10,385 
Other assets   16,000    15,666 
Total assets  $677,476   $673,325 
           
Liabilities and Stockholders' Equity          
Deposits          
Non-interest bearing demand  $59,708   $57,475 
NOW, money market and savings   332,078    324,449 
Time   200,317    214,715 
Total deposits   592,103    596,639 
           
Advances from the Federal Home Loan Bank   3,029    3,075 
Securities sold under agreements to repurchase   5,103    1,536 
Subordinated debentures   19,526    19,489 
Other liabilities and accrued expenses   7,572    6,028 
Total liabilities   627,333    626,767 
           
Commitments  - Note O          
Stockholders' equity          
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding 16,000 shares   15,371    15,177 
Common stock, $1 par value; authorized 20,000,000 shares; issued and outstanding 3,387,045   3,387    3,387 
Common stock warrants   1,841    1,841 
Additional paid-in capital   15,888    15,870 
Retained earnings   12,019    9,132 
Stock in directors' rabbi trust   (899)   (875)
Directors' deferred fees obligation   899    875 
Accumulated other comprehensive income   1,637    1,151 
Total stockholders’ equity   50,143    46,558 
Total liabilities and stockholders’ equity  $677,476   $673,325 

 

* Derived from audited consolidated financial statements.

 

See accompanying notes to consolidated financial statements.

 

2
 

 

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Income (unaudited)

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
   (in thousands, except per share data) 
Interest income                    
Loans  $6,887   $6,899   $13,972   $14,049 
Investment securities, taxable   313    360    619    761 
Investment securities, non taxable   100    147    207    309 
Interest from deposits in banks   21    28    31    48 
Total interest income   7,321    7,434    14,829    15,167 
                     
Interest expense                    
NOW, money market, savings   521    638    1,069    1,298 
Time deposits   664    865    1,373    1,832 
Other borrowed funds   197    187    399    375 
Total interest expense   1,382    1,690    2,841    3,505 
                     
Net interest income   5,939    5,744    11,988    11,662 
Provision for loan losses   -    1,650    1,460    3,350 
Net interest income after provision for loan losses   5,939    4,094    10,528    8,312 
Non-interest income                    
Service charges   318    256    601    487 
Mortgage banking income   4,519    2,069    7,816    3,704 
Gain on sale of investment securities available-for-sale   -    114    -    211 
Gain (loss) on sale of other real estate owned   (2)   53    46    53 
Other   141    128    313    275 
Total non-interest income   4,976    2,620    8,776    4,730 
                     
Non-interest expense                    
Salaries and benefits   4,404    3,193    8,434    6,157 
Occupancy and equipment   677    558    1,359    1,196 
Professional fees   263    229    520    482 
Outside data processing   215    181    421    400 
FDIC insurance   207    334    422    719 
Advertising and promotion   205    143    380    230 
Stationery, printing and supplies   167    134    302    273 
Impairment of other real estate owned   310    1,423    606    1,423 
Other real estate owned expense   269    315    425    609 
Other   776    512    1,315    1,003 
Total non-interest expense   7,493    7,022    14,184    12,492 
                     
Income (loss) before income taxes   3,422    (308)   5,120    550 
Income tax expense (benefit)   1,154    (250)   1,624    (4)
Net income (loss)   2,268    (58)   3,496    554 
Dividends and accretion on preferred stock   307    292    609    580 
Net income (loss) available (allocable) to common stockholders  $1,961   $(350)  $2,887   $(26)
Net income (loss) per common share                    
Basic  $0.58   $(0.10)  $0.85   $(0.01)
Diluted  $0.58   $(0.10)  $0.85   $(0.01)

 

See accompanying notes to consolidated financial statements.

 

3
 

 

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (unaudited)

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
   (in thousands) 
                 
Net income (loss)  $2,268   $(58)  $3,496   $554 
                     
Other comprehensive income:                    
Investment securities available-for-sale:                    
Unrealized holding gains   200    624    736    1,024 
Tax effect   (68)   (212)   (250)   (348)
Reclassification of gains recognized in net income   -    (114)   -    (211)
Tax effect   -    39    -    72 
    132    337    486    537 
                     
Comprehensive income  $2,400   $279   $3,982   $1,091 

 

See accompanying notes to consolidated financial statements.

 

4
 

 

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statement of Stockholders' Equity (unaudited)

 

                       Stock in   Directors'   Accumulated     
           Common   Additional       Directors'   Deferred   Other     
   Preferred   Common   Stock   Paid-In   Retained   Rabbi   Fees   Comprehensive     
   Stock   Stock   Warrants   Capital   Earnings   Trust   Obligation   Income   Total 
   (in thousands)     
                                     
Balance, December 31, 2011  $15,177   $3,387   $1,841   $15,870   $9,132   $(875)  $875   $1,151   $46,558 
                                              
Net income   -    -    -    -    3,496    -    -    -    3,496 
Other comprehensive income, net of tax   -    -    -    -    -    -    -    486    486 
                                              
Directors' fees deferred less payment of deferred fees   -    -    -    -    -    (24)   24    -    - 
Stock options expensed   -    -    -    18    -    -    -    -    18 
Amortization of preferred stock discount   194    -    -    -    (194)   -    -    -    - 
Preferred stock dividends   -    -    -    -    (415)   -    -    -    (415)
                                              
Balance, June 30, 2012  $15,371   $3,387   $1,841   $15,888   $12,019   $(899)  $899   $1,637   $50,143 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

 

   Six Months 
   Ended June 30, 
   2012   2011 
   (in thousands) 
Cash flows from operating activities          
Net income  $3,496   $554 
Adjustments to reconcile net income to net cash provided by operating activities          
Provision for loan losses   1,460    3,350 
Depreciation   441    449 
Increase in cash surrender value of bank-owned life insurance   (188)   (190)
Stock-based compensation expense   18    18 
Deferred income tax (benefit)   758    (600)
Amortization (accretion), net   (35)   7 
Amortization of subordinated debt discount   37    37 
(Increase) decrease in fair value of loans held for sale   (51)   44 
Gain on sale of other real estate owned   (46)   (53)
Gain on sale of investments   -    (211)
Gain on sale of loans held for sale   (7,577)   (3,675)
Impairment of other real estate owned   606    1,423 
Proceeds from sale of loans held for sale   563,157    327,145 
Originations of loans held for sale   (521,282)   (309,060)
(Increase) decrease in other assets   (1,342)   1,297 
Increase in other liabilities and accrued expenses   1,544    331 
Net cash provided by operating activities   40,996    20,866 
           
Cash flows from investing activities          
Purchases of investment securities available-for-sale   (4,386)   (16,765)
Maturities and calls of securities available-for-sale   1,035    4,048 
Repayments from mortgage-backed securities available-for-sale   1,461    1,532 
Repayments from mortgage-backed securities held-to-maturity   79    83 
Net decrease in loans   23,375    5,559 
Proceeds from sales of investment securities   -    8,733 
Improvements to other real estate owned   (177)   - 
Purchases of premises and equipment   (433)   (163)
Proceeds from sales of other real estate owned   2,332    2,021 
Net cash provided by investing activities   23,286    5,048 
           
Cash flows from financing activities          
Net decrease in deposits   (4,536)   (22,735)
Net decrease in Federal Home Loan Advances   (46)   (44)
Increase in securities sold under agreements to repurchase   3,567    5,273 
Dividends paid   (415)   (400)
Net cash used for financing activities   (1,430)   (17,906)
           
Net increase in cash and cash equivalents   62,852    8,008 
Cash and cash equivalents at beginning of period   13,311    22,826 
Cash and cash equivalents at end of period  $76,163   $30,834 
           
Supplemental disclosure of cash flow information          
Cash paid during the period for interest  $2,953   $3,738 
Cash paid during the period for income taxes  $1,850   $400 
Supplemental disclosure of non-cash transactions          
Transfer of loans to other real estate owned  $2,371   $5,056 
Dividends declared but not paid  $405   $- 
Accretion of preferred stock discount  $194   $180 
Change in unrealized gains on securities available-for-sale  $736   $813 

 

See accompanying notes to consolidated financial statements.

 

6
 

 

Carolina Bank Holdings, Inc. and Subsidiary

Notes to Consolidated Financial Statements

 

Note A – Summary

 

Carolina Bank Holdings, Inc. (the “Holding Company” or the “Company”) is a North Carolina corporation organized in 2000. Effective October 31, 2000, pursuant to the plan of share exchange approved by the shareholders of Carolina Bank (the “Bank”), all of the outstanding shares of common stock of the Bank were exchanged for shares of common stock of the Holding Company. The Holding Company presently has no employees.

 

The Bank was incorporated in August 1996, and began banking operations in November 1996. It is engaged in lending and deposit gathering activities in Guilford, Alamance, Randolph and Forsyth Counties, North Carolina and operates under the laws of North Carolina, the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank has eight full-service banking locations, comprised of four in Greensboro and one in each of Asheboro, Burlington, High Point, and Winston-Salem. A wholesale mortgage division is located at the Greensboro corporate headquarters, and retail mortgage loan production offices are located in Burlington, Hillsborough, and Raleigh. The Raleigh loan production office was opened in March 2012 and is tentatively scheduled to close in the third quarter of 2012. All offices, except the Raleigh and Hillsborough mortgage loan production offices, are in the Piedmont Triad region of North Carolina.

 

The Holding Company files periodic reports with the Securities and Exchange Commission and is also subject to regulation by the Federal Reserve Board.

 

Note B – Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. All significant inter-company transactions and balances have been eliminated.

 

Note C – Basis of presentation

 

In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and six months ended June 30, 2012 and 2011, in conformity with accounting principles generally accepted in the United States of America. Operating results for the three and six months ended June 30, 2012 and 2011 are not necessarily indicative of the results that may be expected for annual future periods.

 

The organization and business of the Company, accounting policies followed, and other information are contained in the notes to the financial statements of the Company as of and for the years ended December 31, 2011 and 2010, filed with the Securities and Exchange Commission as part of the Company’s annual report on Form 10-K. These financial statements should be read in conjunction with the annual financial statements.

 

Note D - Use of estimates

 

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

7
 

 

Note E - Stock compensation plans

 

The Company’s shareholders approved the 2009 Omnibus Stock Ownership and Long Term Incentive Plan (“Omnibus Plan”) in 2009 to replace three expired stock option plans, a nonqualified plan for directors (Director Plan) and two incentive stock option plans for management and employees (Employee Plans). The Omnibus Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock, long-term incentive compensation units and stock appreciation rights to employees and directors. An aggregate of 500,000 shares of the Company’s common stock have been reserved for issuance under the terms of the Omnibus Plan.

 

There were no stock option grants in 2011 or the first six months of 2012. The fair value of employee plan options granted in December 2007 was $178,000, which is being expensed over a five year vesting period. Total expense related to the 2007 grants was $18,000 in the first six months of 2012 and 2011. At June 30, 2012, there was $18,000 of total unrecognized compensation cost related to unvested share-based compensation which is expected to be recognized over a weighted-average period of six months.

 

Note F - Earnings per share

 

Earnings per share has been determined on a basic basis and a diluted basis which considers potential stock issuances. For the three and six months ended June 30, 2012 and 2011, basic earnings per share has been computed based upon the weighted average common shares outstanding of 3,387,045.

 

The only potential issuances of Company stock are stock options granted to various officers of the Bank and a warrant to purchase common stock executed in conjunction with the issuance of preferred stock to the U.S. Treasury in 2009. The following is a summary of the diluted earnings per share calculation for the three and six months ended June 30, 2012 and 2011.

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
   (in thousands, except per share data) 
Net income (loss) available (allocable) to common stockholders  $1,961   $(350)  $2,887   $(26)
                     
Weighted average outstanding shares - basic   3,387    3,387    3,387    3,387 
Dilutive effect of stock options and warrants   -    -    -    - 
Weighted average shares - diluted   3,387    3,387    3,387    3,387 
                     
Diluted net income (loss) per share  $0.58   $(0.10)  $0.85   $(0.01)

 

For the three months ended June 30, 2012 and 2011, there were stock options and warrants covering 514,256 and 519,102 shares, respectively, that were excluded in computing diluted common shares outstanding given that they were anti-dilutive since the exercise price exceeded the average market price for the period.

 

8
 

 

Note G – Preferred stock and common stock warrants

 

In December 2008, the shareholders of the Company approved an amendment to the Articles of Incorporation authorizing the issuance of up to 1,000,000 shares of preferred stock, no par value. In January 2009, the Company issued 16,000 shares of preferred stock to the U.S. Treasury and received $16 million under the Treasury’s Capital Purchase Program. The Company granted a warrant to purchase 357,675 shares of common stock at a price of $6.71 per share to the U.S. Treasury as part of the preferred stock transaction. In accordance with accounting principles, the preferred stock and common stock warrant were valued independently and their relative fair market values were allocated to the $16 million received. Under the relative value method, $14,159,000 was allocated to the preferred stock and $1,841,000 to the common stock warrant. The discount of $1,841,000 on the preferred stock is accreted over five years using the effective yield method, thereby increasing preferred stock dividends. The accretion of the discount for the first six months of 2012 and 2011 was $194,000 and $180,000, respectively. Dividends at 5% per annum are payable quarterly for the first five years; the dividend increases to 9% per annum after the fifth year.

 

Note H – Subordinated debentures

 

In December 2004, the Company issued $10,310,000 of unsecured junior subordinated debentures which accrue and pay interest quarterly at three month LIBOR plus 2% per annum. These debentures were issued to Carolina Capital Trust, (“Carolina Trust”), a subsidiary of the Company. Carolina Trust acquired these debentures using the proceeds of its offerings of common securities to the Company and $10 million of Trust Preferred securities to outside investors. The Trust Preferred Securities currently qualify as Tier 1 capital under Federal Reserve Board guidelines. The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminates trust preferred securities as an element of Tier 1 capital for certain institutions. However, bank holding companies with assets of less than $15 billion as of December 31, 2009, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital. The Company therefore believes the Trust Preferred Securities will continue to qualify as Tier 1 capital. The Company has entered into contractual arrangements which, in the aggregate, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Carolina Trust under the Trust Preferred Securities. The Trust Preferred Securities are redeemable upon maturity of the debentures on January 7, 2035, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Carolina Trust in whole or in part at any time.

 

In the third quarter of 2008, Carolina Bank issued $9,300,000 of unsecured junior subordinated notes to outside investors which accrue and pay interest quarterly at three month LIBOR plus 4% per annum. The notes, net of unamortized expenses associated with the offering, equal to $9,216,000 and $9,179,000 at June 30, 2012 and December 31, 2011, respectively and qualify as Tier 2 capital for the Bank. The notes are redeemable upon maturity on September 30, 2018, or earlier at the Bank’s option, in whole or part subject to regulatory approval, beginning September 30, 2013. The expenses of the offering of $373,000 were capitalized at issue and are being amortized over sixty months. The notes are subordinate to the rights of payment to depositors, bankers’ acceptances, letters of creditors and general creditors.

 

Note I – Operating segments

 

The Company is considered to have three principal business segments in 2012 and 2011, the Commercial/Retail Bank, the Mortgage Division, and the Holding Company. The Mortgage Division began originating home mortgage loans through third parties and selling these loans to investors in late 2007. A retail mortgage operation was added to the mortgage division in July 2010. Financial performance, reflective of inter-company eliminations, for the three and six months ended June 30, 2012 and 2011, and selected balance sheet information, reflective of inter-company eliminations, at June 30, 2012 and 2011 for each segment is as follows:

 

9
 

 

   Three months ended June 30, 2012   Three months ended June 30, 2011 
   Commercial/Retail   Mortgage   Holding       Commercial/Retail   Mortgage   Holding     
   Bank   Division   Company   Total   Bank   Division   Company   Total 
   (in thousands)   (in thousands) 
Interest income  $6,614   $705   $2   $7,321   $7,179   $253   $2   $7,434 
Interest expense   614    703    65    1,382    1,385    247    58    1,690 
Net interest income   6,000    2    (63)   5,939    5,794    6    (56)   5,744 
Provision for loan losses   -    -    -    -    1,650    -    -    1,650 
Net interest income after provision for loan losses   6,000    2    (63)   5,939    4,144    6    (56)   4,094 
Non-interest income   457    4,519    -    4,976    551    2,069    -    2,620 
Non-interest expense   4,655    2,786    52    7,493    5,321    1,674    27    7,022 
Income (loss) before income taxes   1,802    1,735    (115)   3,422    (626)   401    (83)   (308)
Income tax (benefit) expense   509    684    (39)   1,154    (385)   163    (28)   (250)
Net income (loss)  $1,293   $1,051   $(76)  $2,268   $(241)  $238   $(55)  $(58)
                                         
Total Assets  $617,997   $59,141   $338   $677,476   $619,450   $40,426   $396   $660,272 
Net Loans   448,032    57,708    -    505,740    487,705    39,507    -    527,212 
Equity   1,935    1,693    46,515    50,143    280    383    44,328    44,991 

 

   Six months ended June 30, 2012   Six months ended June 30, 2011 
   Commercial/Retail   Mortgage   Holding       Commercial/Retail   Mortgage   Holding     
   Bank   Division   Company   Total   Bank   Division   Company   Total 
   (in thousands)   (in thousands) 
Interest income  $13,409   $1,416   $4   $14,829   $14,610   $553   $4   $15,167 
Interest expense   1,294    1,416    131    2,841    2,859    531    115    3,505 
Net interest income   12,115    -    (127)   11,988    11,751    22    (111)   11,662 
Provision for loan losses   1,460    -    -    1,460    3,350    -    -    3,350 
Net interest income after provision for loan losses   10,655    -    (127)   10,528    8,401    22    (111)   8,312 
Non-interest income   960    7,816    -    8,776    1,026    3,704    -    4,730 
Non-interest expense   9,091    5,020    73    14,184    9,354    3,086    52    12,492 
Income (loss) before income taxes   2,524    2,796    (200)   5,120    73    640    (163)   550 
Income tax (benefit) expense   589    1,103    (68)   1,624    (206)   257    (55)(4)     
Net income (loss)  $1,935   $1,693   $(132)  $3,496   $279   $383   $(108)  $554 
                                         
Total Assets  $617,997   $59,141   $338   $677,476   $619,450   $40,426   $396   $660,272 
Net Loans   448,032    57,708    -    505,740    487,705    39,507    -    527,212 
Equity   1,935    1,693    46,515    50,143    280    383    44,328    44,991 

 

The Mortgage Division has experienced strong growth in originations since its establishment in 2007 due to low interest rates and due to the purchase of a retail mortgage loan production office in July of 2010 and expansion of the retail mortgage operations in our branch offices. Originations and related fee income increased substantially in the first six months of 2012 over 2011 due to lower interest rates in 2012 and continued refinancing of older loans and lending for new home purchases. Our mortgage division was expanded in 2012 to manage the additional mortgage volume. Interest rate risk has been minimized by obtaining optional loan sales commitments when loan origination commitments are made or by entering into hedging transactions whereby mortgage backed securities are sold for the estimated closing value of loan commitments. Borrower fraud is a risk that has been minimized by prudent underwriting and by obtaining indemnification from the originating bank or broker for the risks the Company assumes. Warranty expenses and related warranty liabilities were established in 2009 to provide for potential claims that might arise from borrower fraud or underwriting errors. Warranty expenses were $163,000 and $98,000 for the three months ended June 30, 2012 and 2011, respectively, and were $291,000 and $207,000 for the six months ended June 30, 2012 and 2011, respectively. The warranty liability, which is available to fund future warranty claims, was $1,056,000 and $833,000 at June 30, 2012 and December 31, 2011, respectively. Six warranty claims totaling $449,000 have been paid since establishment of the mortgage division in 2007. In addition, three loans with a total current principal balance of $464,000 and fair value of $409,000 have been repurchased and are included in loans held for sale at fair value. Other real estate owned includes one residence valued at $106,000 which was repurchased due to warranty claims.

 

10
 

 

Note J - Securities

 

A summary of the amortized cost, gross unrealized gains and losses and estimated fair values of securities available-for-sale and held-to-maturity follows:

 

       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
       (in thousands)     
June 30, 2012                    
                     
Available for sale                    
Municipal securities  $16,081   $1,406   $17   $17,470 
FNMA, FHLMC, and GNMA mortgage-backed securities   12,040    970    -    13,010 
Corporate securities   14,004    57    78    13,983 
Unrestricted stock   266    141    -    407 
   $42,391   $2,574   $95   $44,870 
                     
Held to maturity                    
FNMA and GNMA mortgage-backed securities   312    26    -    338 
   $312   $26   $-   $338 
                     
December 31, 2011                    
                     
Available for sale                    
Municipal securities  $16,531   $1,236   $-   $17,767 
FNMA, FHLMC, and GNMA mortgage-backed securities   13,489    1,005    -    14,494 
Corporate securities   10,179    15    588    9,606 
Unrestricted stock   266    75    -    341 
   $40,465   $2,331   $588   $42,208 
                     
Held to maturity                    
FNMA and GNMA mortgage-backed securities   392    28    -    420 
   $392   $28   $-   $420 

 

11
 

 

The scheduled maturities of debt securities available-for-sale and held-to-maturity at June 30, 2012 were as follows:

 

   Available for Sale   Held to Maturity 
       Estimated       Estimated 
   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value 
       (in thousands)     
Due in one year or less  $-   $-   $-   $- 
Due from one to five years   10,573    10,556    -    - 
Due from five to ten years   5,812    6,294    -    - 
Over ten years   13,700    14,603    -    - 
Mortgage-backed securities   12,040    13,010    312    338 
   $42,125   $44,463   $312   $338 

 

Investments are periodically evaluated for any impairment which would be deemed other than temporary. Based upon these evaluations, the Company did not deem any debt securities to be impaired during 2011 or the first six months of 2012. The deterioration in value is primarily attributable to changes in market demand for corporate securities, not changes in the credit risk of the corporate issuers, and the Company expects these securities to be paid in full and that any temporary impairment will be fully recoverable prior to or at maturity.  The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a forecasted recovery or until maturity. Information pertaining to temporarily impaired securities with gross unrealized losses at June 30, 2012 and December 31, 2011, by category and length of time that individual securities have been in a continuous loss position follows:

 

   Less Than 12 Months   12 Months or Greater   Total 
   Number       Gross   Number       Gross   Number       Gross 
   of   Fair   Unrealized   of   Fair   Unrealized   of   Fair   Unrealized 
   Securities   Value   Losses   Securities   Value   Losses   Securities   Value   Losses 
   (dollars in thousands) 
June 30, 2012:                                             
Municipal securities   1   $597   $17    0   $-   $-    1   $597   $17 
Corporate securities   3    2,876    19    3    4,796    59    6    7,672    78 
Total   4   $3,473   $36    3   $4,796   $59    7   $8,269   $95 
                                              
December 31, 2011:                                             
Corporate securities   6   $8,142   $588    0   $-   $-    6   $8,142   $588 
Total   6   $8,142   $588    0   $-   $-    6   $8,142   $588 

 

12
 

 

Note K - Loans and allowance for loan losses

 

The activity in the allowance for loan losses for the first six months of 2012 and 2011 and related asset balances at June 30, 2012 and December 31, 2011 is summarized as follows:

 

   Construction &   Commercial   Home Equity   Residential   Commercial   Consumer         
   Development   Real Estate   Lines   Real Estate   & Industrial   & Other   Unallocated   Total 
  (in thousands) 
Allowance for loan losses:                                        
2012                                        
Beginning of year balance  $2,948   $3,690   $1,126   $994   $2,985   $46   $4   $11,793 
Provision for loan losses   (283)   1,416    186    37    (34)   74    64    1,460 
Charge-offs   (146)   (793)   (324)   (156)   (908)   (16)   -    (2,343)
Recoveries   9    100    -    5    87    1    -    202 
Balance at June 30,  $2,528   $4,413   $988   $880   $2,130   $105   $68   $11,112 
2011                                        
Beginning of year balance  $4,478   $3,364   $818   $846   $2,746   $79   $28   $12,359 
Provision for loan losses   3,440    1,161    698    896    708    (29)   (24)   6,850 
Charge-offs   (5,137)   (1,319)   (405)   (756)   (569)   (6)   -    (8,192)
Recoveries   167    484    15    8    100    2    -    776 
Balance at December 31,  $2,948   $3,690   $1,126   $994   $2,985   $46   $4   $11,793 
                                         
Balances at June 30, 2012                                        
Allowance for loan losses:                                        
Balance at June 30,  $2,528   $4,413   $988   $880   $2,130   $105   $68   $11,112 
Ending balance individually evaluated for impairment  $14   $1,552   $219   $216   $918   $-   $-   $2,919 
Ending balance collectively evaluated for impairment  $2,514   $2,861   $769   $664   $1,212   $105   $68   $8,193 
Loans Outstanding:                                        
Balance at June 30,  $58,932   $213,703   $66,168   $48,872   $65,533   $5,936   $-   $459,144 
Ending balance individually evaluated for impairment  $1,933   $24,628   $840   $5,561   $3,812   $7   $-   $36,781 
Ending balance collectively evaluated for impairment  $56,999   $189,075   $65,328   $43,311   $61,721   $5,929   $-   $422,363 
                                         
Balances at December 31, 2011                                        
Allowance for loan losses:                                        
Balance at December 31,  $2,948   $3,690   $1,126   $994   $2,985   $46   $4   $11,793 
Ending balance individually evaluated for impairment  $23   $595   $556   $165   $1,398   $-   $-   $2,737 
Ending balance collectively evaluated for impairment  $2,925   $3,095   $570   $829   $1,587   $46   $4   $9,056 
Loans Outstanding:                                        
Balance at December 31,  $51,383   $251,015   $66,172   $51,499   $60,863   $6,099   $-   $487,031 
Ending balance individually evaluated for impairment  $4,606   $27,183   $1,858   $5,978   $5,868   $10   $-   $45,503 
Ending balance collectively evaluated for impairment  $46,777   $223,832   $64,314   $45,521   $54,995   $6,089   $-   $441,528 

 

13
 

 

A loan is past due when the borrower has not made a payment by the contractual due date. The following table presents the carrying value of loans that are past due thirty days or more. Loans which are ninety days or more past due are generally on non-accrual status, at which time all accrued interest is removed from interest income, as shown in the following table:

 

                           Loans Past 
   Number of Days Past Due               Due 90 Days 
           90 Days   Total       Total   or More 
   30-59 Days   60-89 Days   or More   Past Due   Current   Loans   & Accruing 
   (in thousands) 
At June, 2012                                   
Real Estate Loans:                                   
Construction & development  $-   $-   $1,804   $1,804   $57,128   $58,932   $- 
Commercial real estate   -    -    12,301    12,301    201,402    213,703    - 
Home equity lines   60    -    697    757    65,411    66,168    - 
Residential real estate   -    230    3,689    3,919    44,953    48,872    - 
Total real estate   60    230    18,491    18,781    368,894    387,675    - 
Commercial & industrial   762    -    3,278    4,040    61,493    65,533    - 
Consumer & other   -    -    2    2    5,934    5,936    - 
Total loans  $822   $230   $21,771   $22,823   $436,321   $459,144   $- 
                                    
At December 31, 2011                                   
Real Estate Loans:                                   
Construction & development  $-   $-   $4,265   $4,265   $47,118   $51,383   $- 
Commercial real estate   -    -    12,513    12,513    238,502    251,015    - 
Home equity lines   300    -    791    1,091    65,081    66,172    - 
Residential real estate   369    3    3,770    4,142    47,357    51,499    - 
Total real estate   669    3    21,339    22,011    398,058    420,069    - 
Commercial & industrial   -    -    1,572    1,572    59,291    60,863    - 
Consumer & other   -    -    4    4    6,095    6,099    - 
Total loans  $669   $3   $22,915   $23,587   $463,444   $487,031   $- 

 

Loans are determined to be impaired when, based on current information and events, it is probable that all amounts will not be collected when due according to the contractual terms of the original loan agreement. At June 30, 2012 and December 31, 2011, the total recorded investment in impaired loans amounted to approximately $36,781,000 and $45,503,000, respectively. Of these impaired loans, $21,771,000 and $22,915,000 were on non-accrual at June 30, 2012 and December 31, 2011, respectively.

 

14
 

 

The recorded investment and related information for impaired loans is summarized as follows:

 

   Impaired Loans 
   At end of period   For Period Ended 
       Unpaid   Related   Average   Interest 
   Recorded   Principal   Loan Loss   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
June 30, 2012  (in thousands) 
With no related allowance recorded                         
Real Estate Loans:                         
Construction & development  $1,904   $1,974   $-   $2,072   $9 
Commercial real estate   18,315    19,431    -    19,611    540 
Home equity lines   444    644    -    645    10 
Residential real estate   4,084    4,392    -    4,407    52 
Total real estate   24,747    26,441    -    26,735    611 
Commercial & industrial   2,126    2,204    -    2,216    26 
Consumer & other   7    7    -    9    - 
Total loans   26,880    28,652    -    28,960    637 
With an allowance recorded                         
Real Estate Loans:                         
Construction & development   29    32    14    32    - 
Commercial real estate   6,313    6,848    1,552    6,857    233 
Home equity lines   396    417    219    414    7 
Residential real estate   1,477    1,493    216    1,511    37 
Total real estate   8,215    8,790    2,001    8,814    277 
Commercial & industrial   1,686    1,693    918    1,711    17 
Consumer & other   -    -    -    -    - 
Total loans   9,901    10,483    2,919    10,525    294 
Total impaired loans  $36,781   $39,135   $2,919   $39,485   $931 
December 31, 2011                         
With no related allowance recorded                         
Real Estate Loans:                         
Construction & development  $4,479   $5,473   $-   $5,352   $81 
Commercial real estate   22,967    23,551    -    23,297    846 
Home equity lines   533    555    -    542    20 
Residential real estate   4,929    5,448    -    5,727    173 
Total real estate   32,908    35,027    -    34,918    1,120 
Commercial & industrial   2,186    2,200    -    2,273    77 
Consumer & other   10    11    -    13    1 
Total loans   35,104    37,238    -    37,204    1,198 
With an allowance recorded                         
Real Estate Loans:                         
Construction & development   127    127    23    222    2 
Commercial real estate   4,216    4,226    595    4,339    246 
Home equity lines   1,325    1,336    556    1,319    77 
Residential real estate   1,049    1,057    165    1,070    61 
Total real estate   6,717    6,746    1,339    6,950    386 
Commercial & industrial   3,682    3,691    1,398    3,789    191 
Consumer & other   -    -    -    -    - 
Total loans   10,399    10,437    2,737    10,739    577 
Total impaired loans  $45,503   $47,675   $2,737   $47,943   $1,775 

 

15
 

 

Loans that are past due 90 days or more or where there is serious doubt as to collectability are placed on non-accrual status. Non-accrual loans are not returned to accrual status unless principal and interest are current and borrowers have demonstrated the ability to make contractual payments. Accrued interest is reversed through a charge to income when loans are placed on non-accrual and future payments on non-accrual loans are generally applied to principal. The following is a summary of non-accrual loans at June 30, 2012 and December 31, 2011:

 

   June 30,   December 31, 
   2012   2011 
   (in thousands) 
Real Estate Loans:          
Construction & development  $1,804   $4,265 
Commercial real estate   12,301    12,513 
Home equity lines   697    791 
Residential real estate   3,689    3,770 
Total real estate   18,491    21,339 
Commercial & industrial   3,278    1,572 
Consumer & other   2    4 
Total loans  $21,771   $22,915 

 

Loans are graded according to an internal loan rating classification system when originated. Loan grades are periodically re-evaluated during servicing, internal loan reviews, and external loan reviews. The general categories of the internal loan rating classification are:

·Pass - Acceptable loans
·Special Mention - Loans with potential identified weaknesses in administration or servicing.
·Criticized - Adversely classified loans with identified weaknesses, and potential or identified losses of principal and/or interest due.

 

The following is a breakdown of loans by the general categories of the internal rating system:

 

   Outstanding Loans at June 30, 2012 and December 31, 2011 
   Construction &   Commercial   Home Equity 
   Development   Real Estate   Lines of Credit 
   2012   2011   2012   2011   2012   2011 
   (in thousands) 
Pass  $52,152   $36,968   $179,402   $210,356   $63,511   $64,561 
Special Mention   2,772    1,083    4,625    9,099    661    214 
Criticized   4,008    13,332    29,676    31,560    1,996    1,397 
TOTAL  $58,932   $51,383   $213,703   $251,015   $66,168   $66,172 

 

   Residential   Commercial &   Consumer 
   Real Estate   Industrial   & Other 
   2012   2011   2012   2011   2012   2011 
   (in thousands) 
Pass  $40,042   $41,664   $59,089   $54,947   $5,855   $6,064 
Special Mention   1,111    802    1,090    646    22    25 
Criticized   7,719    9,033    5,354    5,270    59    10 
TOTAL  $48,872   $51,499   $65,533   $60,863   $5,936   $6,099 

 

16
 

 

Construction and development loans experienced a material improvement in loan rating classifications in the first six months of 2012 because a $5,022,000 development loan was upgraded to pass from criticized, principal payments were made on various criticized construction loans, and a criticized development loan of $1,409,000 was transferred to other real estate owned.

 

During 2012 and 2011, the Company restructured certain loans to improve the likelihood that the loans would be repaid in full under the modified terms in accordance with reasonable repayment schedules. Management evaluates each of these loans in accordance with generally accepted accounting principles to determine whether they should be reported as troubled debt restructurings. The Company adopted the amendments in Accounting Standards Update No. 2011-02 during the period ended September 30, 2011. As required, the Company reassessed all restructurings that occurred on or after the beginning of the 2011 fiscal year for identification as troubled debt restructurings. The Company did not identify as troubled debt restructurings any receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology.

 

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories:

·Rate Modification - A modification in which the interest rate is changed.

 

·Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

 

·Interest Only Modification – A modification in which the loan is converted to interest only payments for a period of time.

 

·Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

 

·Combination Modification – Any other type of modification, including the use of multiple categories above.

 

Available commitments for troubled debt restructurings outstanding as of June 30, 2012 totaled $143,000.

 

17
 

 

The following tables present troubled debt restructurings as of June 30, 2012 and December 31, 2011:

 

Troubled Debt Restructurings
   June 30, 2012 
       Non-Accrual   Total 
   Accrual Status   Status   Modifications 
   #   Amount   #   Amount   #   Amount 
   ($ in thousands) 
Real Estate Loans:                              
Construction & development   2   $341    8   $1,343    10   $1,684 
Commercial real estate   9    9,668    18    7,563    27    17,231 
Home equity lines   -    -    1    150    1    150 
Residential real estate   9    1,700    11    844    20    2,544 
Total real estate   20    11,709    38    9,900    58    21,609 
Commercial & industrial   4    493    5    2,083    9    2,576 
Consumer & other   1    4    -    -    1    4 
Total loans   25   $12,206    43   $11,983    68   $24,189 

 

   December 31, 2011 
       Non-Accrual   Total 
   Accrual Status   Status   Modifications 
   #   Amount   #   Amount   #   Amount 
   ($ in thousands) 
Real Estate Loans:                              
Construction & development   2   $349    6   $1,789    8   $2,138 
Commercial real estate   11    13,912    13    5,758    24    19,670 
Home equity lines   -    -    1    150    1    150 
Residential real estate   10    1,949    8    870    18    2,819 
Total real estate   23    16,210    28    8,567    51    24,777 
Commercial & industrial   10    2,286    2    493    12    2,779 
Consumer & other   1    6    -    -    1    6 
Total loans   34   $18,502    30   $9,060    64   $27,562 

 

The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

 

Troubled debt restructurings are classified as impaired loans when modified, and fair value calculations are performed to determine the specific reserves required in the allowance for loan losses related to these loans. Troubled debt restructurings can be removed from such status and returned to non-impaired status in years subsequent to restructure if the interest rate charged at restructure was greater than or equal to the rate charged for a new extension of credit with comparable risk and if the loan is performing and there is no available information to indicate that performance will not continue.

 

18
 

 

The following tables present newly restructured loans that occurred during the three and six months ended June 30, 2012 and 2011, respectively:

 

   New Troubled Debt Restructurings 
   Three Months Ended June 30, 2012 
   Rate   Term   Payment   Combination   Total 
   Modifications   Modifications   Modifications   Modifications   Modifications 
   #   Amount   #   Amount   #   Amount   #   Amount   #   Amount 
   ($ in thousands) 
Pre-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Construction & development   1   $32    1   $-    0   $-    0   $-    2   $32 
Commercial real estate   0    -    1    81    0    -    0    -    1    81 
Total real estate   1    32    2    81    0    -    0    -    3    113 
Commercial & industrial   0    -    0    -    0    -    0    -    0    - 
Total loans   1   $32    2   $81    0   $-    0   $-    3   $113 
                                                   
Post-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Construction & development   1   $29    1   $211    0   $-    0   $-    2   $240 
Commercial real estate   0    -    1    80    0    -    0    -    1    80 
Total real estate   1    29    2    291    0    -    0    -    3    320 
Commercial & industrial   0    -    0    -    0    -    0    -    0    - 
Total loans   1   $29    2   $291    0   $-    0   $-    3   $320 
                                                   
  Three Months Ended June 30, 2011  
Pre-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Commercial real estate   0   $-    0   $-    1   $1,298    3   $3,511    4   $4,809 
Residential real estate   0    -    0    -    0    -    1    625    1    625 
Total real estate   0    -    0    -    1    1,298    4    4,136    5    5,434 
Commercial & industrial   0    -    0    -    2    1,728    0    -    2    1,728 
Total loans   0   $-    0   $-    3   $3,026    4   $4,136    7   $7,162 
                                                   
Post-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Commercial real estate   0   $-    0   $-    1   $1,281    3   $3,512    4   $4,793 
Residential real estate   0    -    0    -    0    -    1    625    1    625 
Total real estate   0    -    0    -    1    1,281    4    4,137    5    5,418 
Commercial & industrial   0    -    0    -    2    1,636    0    -    2    1,636 
Total loans   0   $-    0   $-    3   $2,917    4   $4,137    7   $7,054 

 

19
 

 

The following tables present newly restructured loans that occurred during the six months ended June 30, 2012 and 2011, respectively:

 

   New Troubled Debt Restructurings 
   Six Months Ended June 30, 2012 
   Rate   Term   Payment   Combination   Total 
   Modifications   Modifications   Modifications   Modifications   Modifications 
   #   Amount   #   Amount   #   Amount   #   Amount   #   Amount 
   ($ in thousands) 
Pre-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Construction & development   1   $32    2   $-    0   $-    0   $-    3   $32 
Commercial real estate   0    -    1    81    1    123    0    -    2    204 
Total real estate   1    32    3    81    1    123    0    -    5    236 
Commercial & industrial   0    -    0    -    0    -    0    -    0    - 
Total loans   1   $32    3   $81    1   $123    0   $-    5   $236 
                                                   
Post-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Construction & development   1   $29    2   $523    0   $-    0   $-    3   $552 
Commercial real estate   0    -    1    80    1    121    0    -    2    201 
Total real estate   1    29    3    603    1    121    0    -    5    753 
Commercial & industrial   0    -    0    -    0    -    0    -    0    - 
Total loans   1   $29    3   $603    1   $121    0   $-    5   $753 
                                                   
  Six Months Ended June 30, 2011  
Pre-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Commercial real estate   0   $-    0   $-    3   $4,779    12   $8,725    15   $13,504 
Residential real estate   0    -    0    -    2    190    12    2,426    14    2,616 
Total real estate   0    -    0    -    5    4,969    24    11,151    29    16,120 
Commercial & industrial   0    -    0    -    3    1,813    1    68    4    1,881 
Total loans   0   $-    0   $-    8   $6,782    25   $11,219    33   $18,001 
                                                   
Post-Modification Outstanding Recorded Investment:                                                  
Real Estate Loans:                                                  
Commercial real estate   0   $-    0   $-    3   $4,757    12   $8,679    15   $13,436 
Residential real estate   0    -    0    -    2    188    12    2,408    14    2,596 
Total real estate   0    -    0    -    5    4,945    24    11,087    29    16,032 
Commercial & industrial   0    -    0    -    3    1,716    1    68    4    1,784 
Total loans   0   $-    0   $-    8   $6,661    25   $11,155    33   $17,816 

 

20
 

 

The following tables represent financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and six months ended June 30, 2012 and 2011, respectively:

 

TDRs with a payment default occurring within 12 months of restructure
   During the three months ended 
   June 30, 2012   June 30, 2011 
   #   Amount   #   Amount 
   ($ in thousands) 
Real Estate Loans:                    
Commercial real estate   1   $64    7   $2,658 
Residential real estate   0    -    7    906 
Total real estate   1    64    14    3,564 
Commercial & industrial   2    812    0    - 
Total loans   3   $876    14   $3,564 

 

TDRs with a payment default occurring within 12 months of restructure
   During the six months ended 
   June 30, 2012   June 30, 2011 
   #   Amount   #   Amount 
   ($ in thousands) 
Real Estate Loans:                    
Commercial real estate   4   $4,756    7   $2,658 
Residential real estate   0    -