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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended June 30, 2010

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 No. 0-24753

 

 

ECB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina   56-2090738

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Post Office Box 337, Engelhard, North Carolina 27824

(Address of principal executive offices) (Zip Code)

(252) 925-9411

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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  ¨    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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

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

On August 6, 2010, there were 2,849,841 outstanding shares of Registrant’s common stock.

This Form 10-Q has 45 pages.

 

 

 


Table of Contents

Table of Contents

 

Index    Begins
on Page

Part 1 – Financial Information

  

Item 1. Financial Statements:

  

Consolidated Balance Sheets at June 30, 2010 (unaudited) and December 31, 2009

   3

Consolidated Income Statements for Three and Six Months Ended June 30, 2010 and 2009 (unaudited)

   4

Consolidated Statements of Changes in Shareholders’ Equity for Six Months Ended June  30, 2010 and 2009 (unaudited)

   5

Consolidated Statements of Cash Flows for Six Months Ended June 30, 2010 and 2009 (unaudited)

   6

Notes to Consolidated Financial Statements

   7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   21

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   37

Item 4. Controls and Procedures

   37

Part II – Other Information

  

Item 1. Legal Proceedings

   38

Item 1A. Risk Factors

   38

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   38

Item 3. Defaults upon Senior Securities

   38

Item 4. Removed and Reserved

   38

Item 5. Other Information

   38

Item 6. Exhibits

   38

Signatures

   40

Exhibit Index

   41

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

June 30, 2010 and December 31, 2009

(Dollars in thousands, except per share data)

 

     June 30,
2010
    December 31,
2009*
 

Assets

    

Non-interest bearing deposits and cash

   $ 12,075      $ 9,076   

Interest bearing deposits

     867        870   

Overnight investments

     16,605        7,865   
                

Total cash and cash equivalents

     29,547        17,811   
                

Investment securities

    

Available-for-sale, at market value (cost of $263,225 and $237,594 at June 30, 2010 and December 31, 2009, respectively)

     268,064        239,332   

Loans held for sale

     1,584        —     

Loans

     570,174        577,791   

Allowance for loan losses

     (10,462     (9,725
                

Loans, net

     559,712        568,066   
                

Real estate and repossessions acquired in settlement of loans, net

     4,644        5,443   

Federal Home Loan Bank common stock, at cost

     5,116        5,116   

Bank premises and equipment, net

     25,294        25,329   

Accrued interest receivable

     4,647        4,967   

Bank owned life insurance

     8,805        8,657   

Other assets

     14,427        13,999   
                

Total

   $ 921,840      $ 888,720   
                

Liabilities and Shareholders’ Equity

    

Deposits

    

Demand, noninterest bearing

   $ 106,033      $ 93,492   

Demand, interest bearing

     205,263        141,956   

Savings

     22,017        19,595   

Time

     459,141        499,687   
                

Total deposits

     792,454        754,730   
                

Accrued interest payable

     1,017        1,121   

Short-term borrowings

     22,408        22,910   

Long-term obligations

     14,500        21,000   

Other liabilities

     4,543        4,584   
                

Total liabilities

     834,922        804,345   
                

Shareholders’ equity

    

Preferred stock, Series A

     17,205        17,122   

Common stock, par value $3.50 per share

     9,974        9,968   

Capital surplus

     25,836        25,803   

Warrants

     878        878   

Retained earnings

     30,069        29,555   

Accumulated other comprehensive income

     2,956        1,049   
                

Total shareholders’ equity

     86,918        84,375   
                

Total

   $ 921,840      $ 888,720   
                

Common shares outstanding

     2,849,841        2,847,881   

Common shares authorized

     10,000,000        10,000,000   

Preferred shares outstanding

     17,949        17,949   

Preferred shares authorized

     2,000,000        2,000,000   

 

* Derived from audited consolidated financial statements.

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Income Statements

For the three and six months ended June 30, 2010 and 2009

(Dollars in thousands, except per share data)

 

    

Three months ended

June 30,

   

Six months ended

June 30,

     2010    2009     2010    2009

Interest income:

          

Interest and fees on loans

   $ 7,790    $ 7,666      $ 15,422    $ 15,013

Interest on investment securities:

          

Interest exempt from federal income taxes

     490      332        952      651

Taxable interest income

     1,673      2,307        3,570      4,837

Dividend income

     7      —          34      30

Other interest income

     5      —          7      3
                            

Total interest income

     9,965      10,305        19,985      20,534
                            

Interest expense:

          

Deposits:

          

Demand accounts

     322      199        639      385

Savings

     15      11        27      22

Time

     2,412      3,173        4,901      6,768

Short-term borrowings

     61      112        117      308

Long-term obligations

     122      168        273      367

Other interest expense

     —        —          —        30
                            

Total interest expense

     2,932      3,663        5,957      7,880
                            

Net interest income

     7,033      6,642        14,028      12,654

Provision for loan losses

     1,780      2,000        4,780      2,750
                            

Net interest income after provision for loan losses

     5,253      4,642        9,248      9,904
                            

Noninterest income:

          

Service charges on deposit accounts

     893      916        1,716      1,792

Other service charges and fees

     433      350        698      617

Mortgage origination brokerage fees

     293      236        505      527

Net gain on sale of securities

     152      183        1,441      588

Income from bank owned life insurance

     74      82        148      164

Other operating income

     21      (4     26      11
                            

Total noninterest income

     1,866      1,763        4,534      3,699
                            

Noninterest expenses:

          

Salaries

     2,326      2,005        4,645      4,074

Retirement and other employee benefits

     712      702        1,442      1,453

Occupancy

     447      449        904      929

Equipment

     486      431        953      819

Professional fees

     211      102        499      399

Supplies

     68      55        120      111

Telephone

     157      138        340      290

FDIC insurance

     345      655        678      910

Other outside services

     110      97        228      240

Net cost of real estate and repossessions acquired in settlement of loans

     47      13        381      106

Other operating expenses

     1,007      808        1,964      1,569
                            

Total noninterest expenses

     5,916      5,455        12,154      10,900
                            

Income before income taxes

     1,203      950        1,628      2,703

Income tax expense

     246      150        184      650
                            

Net income

     957      800        1,444      2,053
                            

Preferred stock dividends

     224      224        448      406

Accretion of discount

     41      44        82      69
                            

Income available to common shareholders

   $ 692    $ 532      $ 914    $ 1,578
                            

Net income per share - basic

   $ 0.24    $ 0.19      $ 0.32    $ 0.55
                            

Net income per share - diluted

   $ 0.24    $ 0.19      $ 0.32    $ 0.55
                            

Weighted average shares outstanding - basic

     2,849,841      2,844,489        2,849,343      2,843,260
                            

Weighted average shares outstanding - diluted

     2,849,936      2,846,359        2,849,407      2,844,904
                            

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity

Six months ended June 30, 2010 and 2009

(Dollars in thousands, except per share data)

 

     Preferred
stock,
    Common Stock    Common
stock
    Capital    Retained    

Accumulated

other
comprehensive

    Comprehensive        
   Series A     Number    Amount    warrant     surplus    earnings     income     income     Total  

Balance January 1, 2009

   $ —        2,844,489    $ 9,956      —        $ 25,707    $ 31,026      $ 1,254        $ 67,943   

Unrealized loss, net of income tax benefit of $475

                    (759   $ (759     (759

Net income

                  2,053          2,053        2,053   
                           

Total comprehensive income

                    $ 1,294     
                           

Issuance of preferred stock in connection with Capital

                     

Purchase Program, net of discount on preferred stock

     17,067                         17,067   

Issuance of common stock warrants in connection with Capital Purchase Program

             882                 882   

Costs associated with issuance of preferred stock and common warrants

     (95           (4              (99

Stock based compensation

               39            39   

Preferred stock accretion

     69                   (69         —     

Cash dividends on preferred stock

                  (296         (296

Cash dividends ($0.365 per share)

                  (1,038         (1,038
                                                             

Balance June 30, 2009

   $ 17,041      2,844,489    $ 9,956    $ 878      $ 25,746    $ 31,676      $ 495        $ 85,792   
                                                             
     Preferred
stock,
    Common Stock    Common
stock
    Capital    Retained     Accumulated
other
comprehensive
    Comprehensive        
     Series A     Number    Amount    warrant     surplus    earnings     income     income     Total  

Balance January 1, 2010

   $ 17,122      2,847,881    $ 9,968    $ 878      $ 25,803    $ 29,555      $ 1,049        $ 84,375   

Unrealized gain, net of income tax expense of $ 1,193

                    1,907      $ 1,907        1,907   

Net income

                  1,444          1,444        1,444   
                           

Total comprehensive income

                    $ 3,351     
                           

Stock based compensation

               20            20   

Stock options exercised

     1,960      6        13            19   

Preferred stock accretion

     83                   (83         —     

Cash dividends on preferred stock

                  (448         (448

Cash dividends ($0.14 per share)

                  (399         (399
                                                             

Balance June 30, 2010

   $ 17,205      2,849,841    $ 9,974    $ 878      $ 25,836    $ 30,069      $ 2,956        $ 86,918   
                                                             

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Six months ended June 30, 2010 and 2009

(Dollar amounts in thousands)

 

     Six months ended
June 30,
 
     2010     2009  

Cash flows from operating activities:

    

Net income

   $ 1,444      $ 2,053   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     664        676   

Amortization of premium on investment securities, net

     688        489   

Provision for loan losses

     4,780        2,750   

Gain on sale of securities

     (1,441     (588

Stock based compensation

     20        39   

Decrease in accrued interest receivable

     320        86   

Loss on disposal of premises and equipment

     —          7   

Loss on sale of real estate and repossessions acquired in settlement of loans

     390        43   

Income from Bank owned life insurance

     (148     (164

Origination of loans held for sale

     (7,801     —     

Proceeds from sale of loans held for sale

     6,217        —     

Increase in other assets

     (178     (2,050

Decrease in accrued interest payable

     (104     (1,243

(Decrease) increase in other liabilities, net

     (916     1,118   
                

Net cash provided by operating activities

     3,935        3,216   
                

Cash flows from investing activities:

    

Proceeds from sales of investment securities classified as available-for-sale

     56,422        42,049   

Proceeds from maturities of investment securities classified as available-for-sale

     26,597        34,540   

Purchases of investment securities classified as available-for-sale

     (108,147     (123,961

Purchase of Federal Home Loan Bank common stock

     —          (1,257

Proceeds from disposal of premises and equipment

     —          (8

Purchases of premises and equipment

     (231     (278

Proceeds from disposal of real estate and repossessions acquired in settlement of loans and real estate held for sale

     1,963        272   

Net loan originations

     1,622        (34,450
                

Net cash (used) by investing activities

     (21,774     (83,093
                

Cash flows from financing activities:

    

Net increase in deposits

     37,724        74,315   

Net decrease in borrowings

     (7,002     (2,525

Dividends paid to common shareholders

     (718     (1,038

Dividends paid on preferred stock

     (448     (296

Net proceeds from issuance of common stock

     19        —     

Net proceeds from issuance of preferred stock

     —          17,850   
                

Net cash provided by financing activities

     29,575        88,306   
                

Increase in cash and cash equivalents

     11,736        8,429   

Cash and cash equivalents at beginning of period

     17,811        16,799   
                

Cash and cash equivalents at end of period

   $ 29,547      $ 25,228   
                

Cash paid during the period:

    

Interest

   $ 6,061      $ 9,123   

Taxes

     746        1,631   

Supplemental disclosures of noncash financing and investing activities:

    

Cash dividends declared but not paid

   $ 199      $ 519   

Unrealized gains (losses) on available-for-sale securities, net of deferred taxes

     1,907        (759

Transfer from loans to real estate and repossessions acquired in settlement of loans

     1,952        3,791   

Transfer from long-term to short-term borrowings

     6,500        5,000   

Payable, settlement for securities purchased

     —          (53,000

Transfer from investments to other assets

     250        —     

Transfer from real estate and repossessions acquired in settlement of loans to bank premises and equipment

     398        —     

See accompanying notes to consolidated financial statements.

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(1) Basis of Presentation

The consolidated financial statements include the accounts of ECB Bancorp, Inc. (“Bancorp”) and its wholly-owned subsidiary, The East Carolina Bank (the “Bank”) (Bancorp and the Bank collectively referred to hereafter as the “Company”). The Bank has one wholly-owned subsidiary, ECB Financial Services, Inc., which formerly provided courier services to the Bank but is currently inactive. All intercompany transactions and balances are eliminated in consolidation. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and the reported amounts of income and expenses for the periods presented. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and retirement plan costs. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties held as collateral for loans. Our retirement plans and other post-retirement benefit costs are actuarially determined based on assumptions on the discount rate, estimated future return on plan assets and the health care cost trend rate.

All adjustments considered necessary for a fair presentation of the results for the interim periods presented have been included (such adjustments are normal and recurring in nature). The notes to consolidated financial statements in Bancorp’s annual report on Form 10-K should be referenced when reading these unaudited interim consolidated financial statements. Operating results for the period ended June 30, 2010, are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

Reclassification

Certain reclassifications have been made to the prior period’s financial statements to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.

Subsequent Events

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the consolidated financial statements were issued.

(2) Net Income Per Share

Basic net income per share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. For purposes of basic net income per share, restricted stock is considered “contingently issuable” and is not included in the weighted average number of common shares outstanding.

Diluted net income per share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Restricted stock is considered outstanding for purposes of diluted net income per share. The amount of compensation cost attributed to future services and not yet recognized is considered “proceeds” using the treasury stock method. Restricted stock had no dilutive effect on earnings per share for the six or three-month periods ended June 30, 2010 and June 30, 2009.

In computing diluted net income per share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate diluted net income per share for the Company. For the six months ended June 30, 2010 and 2009, diluted weighted average shares outstanding increased by 64 and 1,644, respectively, due to the dilutive impact of options. Stock

 

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options increased diluted weighted average shares by 95 for the three months ended June 30, 2010 and 1,870 for the three months ended June 30, 2009. There were 55,375 and 53,675 anti-dilutive (not in the money) options outstanding for the six and three months ended June 30, 2010. There were 53,675 and 52,699 anti-dilutive (not in the money) options outstanding for the six and three months ended June 30, 2009. As of June 30, 2010 and 2009 the warrant, consisting of 144,984 shares issued to the U.S. Treasury Department was not included in the computation of net income per share for either the six or three-month period because its exercise price exceeded the market price of the Company’s stock on that date.

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Share for the six months ended June 30.

 

    

Six months ended June 30, 2010

(Dollars in thousands, except per share data)

     Income
(Numerator)
   Shares
(Denominator)
   Per
Share
Amount

Basic net income per share

   $ 914    2,849,343    $ 0.32
            

Effect of dilutive securities

     —      64   
              

Diluted net income per share

   $ 914    2,849,407    $ 0.32
                  
    

Six months ended June 30, 2009

(Dollars in thousands, except per share data)

     Income
(Numerator)
   Shares
(Denominator)
   Per
Share
Amount

Basic net income per share

   $ 1,578    2,843,260    $ 0.55
            

Effect of dilutive securities

     —      1,644   
              

Diluted net income per share

   $ 1,578    2,844,904    $ 0.55
                  

 

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Table of Contents

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Share for the three months ended June 30.

 

     Three months ended June 30, 2010
(Dollars in thousands, except per share data)
     Income
(Numerator)
   Shares
(Denominator)
   Per
Share
Amount

Basic net income per share

   $ 692    2,849,841    $ 0.24
            

Effect of dilutive securities

     —      95   
              

Diluted net income per share

   $ 692    2,849,936    $ 0.24
                  
     Three months ended June 30, 2009
(Dollars in thousands, except per share data)
     Income
(Numerator)
   Shares
(Denominator)
   Per
Share
Amount

Basic net income per share

   $ 532    2,844,489    $ 0.19
            

Effect of dilutive securities

     —      1,870   
              

Diluted net income per share

   $ 532    2,846,359    $ 0.19
                  

(3) Stock Compensation Plan

During 2008, the Company adopted the 2008 Omnibus Equity Plan (the “Plan”) which replaced the expired 1998 Omnibus Stock Ownership and Long-Term Incentive Plan. The Plan provides for the issuance of up to an aggregate of 200,000 shares of common stock of the Company in the form of stock options, restricted stock awards and performance share awards.

Stock based compensation is accounted for in accordance with FASB ASC Topic 718. Compensation cost charged to income was approximately $20 thousand and $39 thousand for the six months ended June 30, 2010 and 2009, respectively. No income tax benefit was recognized for stock based compensation, as the Company does not have any outstanding nonqualified stock options.

Stock Options

Under the Plan, stock options may be issued to employees as incentive stock options which qualify for special tax treatment under the Internal Revenue Code, or as nonqualified stock options. The terms and exercise prices of options, and the dates or schedules on which options vest or become exercisable, are established at the time the options are granted and may be different for each option. However, the term of an option may not exceed ten years, and the exercise price of each option may not be less than the fair market value of a share of common stock on the date the option is granted. It is the Company’s policy to issue new shares of stock to satisfy option exercises.

The weighted-average fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average estimated fair values of stock option grants and the assumptions that were used in calculating such fair values are based on estimates at the date of grant. There were no options granted during the six-month period ending June 30, 2010 and June 30, 2009.

A summary of option activity under the Plan as of June 30, 2010, and changes during the six-month period ended June 30, 2010 is presented below:

 

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     Options
Outstanding
   Weighted
Average
Exercise
Price
   Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value
     (Dollars in thousands, except per share data)

Outstanding at December 31, 2009

   57,335    $ 28.31      

Granted

   —      $ —        

Forfeited

   —      $ —        

Exercised

   1,960    $ 10.00      
                 

Outstanding at June 30, 2010

   55,375    $ 28.96    5.86 years    $ —  
                       

Exercisable at June 30, 2010

   42,011    $ 29.19    5.48 years    $ —  
                       

1,960 options were exercised during the first six months of 2010. Cash received for options exercised in 2010 was $19 thousand with an intrinsic value of $3 thousand. No options were exercised during the six-month period ended June 30, 2009.

Restricted Stock Awards

Restricted stock awards are subject to restrictions and the risk of forfeiture if conditions stated in the award agreement are not satisfied at the end of a restriction period. During the restriction period, restricted stock covered by the award will be held by the Company. If the conditions stated in the award agreement are satisfied at the end of the restriction period, the restricted stock will become unrestricted and the certificate evidencing the stock will be delivered to the employee.

There were no shares of non-vested restricted stock as of June 30, 2010 or December 31, 2009.

Unrecognized Compensation Cost

Anticipated total unrecognized compensation cost related to outstanding non-vested stock options will be recognized over the following periods:

 

     Stock Options
     (Dollars in thousands)

July 1 – December 31, 2010

   $ 16

2011

     21

2012

     8

2013

     2
      

Total

   $ 47

 

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(4) Postretirement Benefits

The Company has a postretirement benefit plan whereby the Company pays postretirement health care benefits for certain of its retirees that have met minimum age and service requirements. Net periodic postretirement benefit cost for the six- and three-month periods ended June 30, 2010 and 2009 includes the following components.

 

     Six months ended June 30,
(Dollars in thousands)
 
     2010     2009  

Components of net periodic cost:

    

Service cost

   $ 2      $ 2   

Interest cost

     21        24   

Prior service cost

     (4     (4
                

Net periodic postretirement benefit cost

   $ 19      $ 22   
                
     Three months ended June  30,
(Dollars in thousands)
 
     2010     2009  

Components of net periodic cost:

    

Service cost

   $ 1      $ 1   

Interest cost

     11        12   

Prior service cost

     (2     (2
                

Net periodic postretirement benefit cost

   $ 10      $ 11   

The Company expects to contribute $38 thousand to its postretirement benefit plan in 2010. No contributions were made in the first six months of 2010. For additional information related to the plan, refer to the Company’s Form 10-K for the year ended December 31, 2009.

(5) Investment Securities

The following is a summary of the securities portfolio by major classification:

 

     June 30, 2010
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair Value
     (Dollars in thousands)

Securities available-for-sale:

          

Government-sponsored enterprises and FFCB bonds

   $ 32,166    $ 1,012    $ —        $ 33,178

Obligations of states and political subdivisions

     49,356      1,592      (129     50,819

Mortgage-backed securities

     176,317      2,548      (57     178,808

Corporate Bonds

     5,386      42      (169     5,259
                            
   $ 263,225    $ 5,194    $ (355   $ 268,064
                            

 

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     December 31, 2009
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair Value
     (Dollars in thousands)

Securities available-for-sale:

  

Government-sponsored enterprises and FFCB bonds

   $ 36,141    $ 69    $ (367   $ 35,843

Obligations of states and political subdivisions

     45,242      997      (217     46,022

Mortgage-backed securities

     149,167      2,203      (569     150,801

Corporate Bonds

     6,044      —        (184     5,860

Equity securities

     1,000      —        (194     806
                            
   $ 237,594    $ 3,269    $ (1,531   $ 239,332
                            

Gross realized gains and losses on sales of securities for the three and six-month periods ended June 30, 2010 and June 30, 2009 were as follows:

 

     Six months ended June 30,
(Dollars in thousands)
 
     2010     2009  

Gross realized gains

   $ 1,457      $ 603   

Gross realized losses

     (16     (15
                

Net realized gains

   $ 1,441      $ 588   
                
     Three months ended June 30,
(Dollars in thousands)
 
     2010     2009  

Gross realized gains

   $ 168      $ 198   

Gross realized losses

     (16     (15
                

Net realized gains

   $ 152      $ 183   
                

Analysis of Certain Investments in Debt and Equity Securities for Other Than Temporary Impairment

The following table sets forth the amount of unrealized losses (that is, the amount by which cost or amortized cost exceeds fair value), and the related fair value of investments with unrealized losses, none of which are considered to be other than temporarily impaired. The table is segregated into investments that have been in continuous unrealized-loss position for less than 12 months from those that have been in a continuous unrealized-loss position for more than 12 months, as of June 30, 2010 and December 31, 2009:

 

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June 30, 2010

 

     Less Than 12 Months    12 Months or longer    Total
     Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
     (Dollars in thousands)

Obligations of states and political subdivisions

     4,312      31      3,094      98      7,406      129

Mortgage-backed securities

     21,685      56      2,663      1      24,348      57

Corporate bonds

     1,831      169      —        —        1,831      169
                                         

Total

   $ 27,828    $ 256    $ 5,757    $ 99    $ 33,585    $ 355
                                         

December 31, 2009

 

     Less Than 12 Months    12 Months or longer    Total
     Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
     (Dollars in thousands)

Government-sponsored enterprises and FFCB bonds

   $ 18,431    $ 367    $ —      $ —      $ 18,431    $ 367

Obligations of states and political subdivisions

     7,315      96      3,118      121      10,433      217

Mortgage-backed securities

     56,459      568      102      1      56,561      569

Corporate bonds

     3,354      154      2,505      30      5,859      184

Equity securities

     —        —        806      194      806      194
                                         

Total

   $ 85,559    $ 1,185    $ 6,531    $ 346    $ 92,090    $ 1,531
                                         

As of June 30, 2010 and December 31, 2009, management concluded that the unrealized losses presented above are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for a time necessary to recover their cost. The losses above, except for equity securities, are on debt securities that have contractual maturity dates and are primarily related to market interest rates. Municipal losses are also related to lack of liquidity and demand in the general investment market. All unrealized losses on investment securities are not considered to be other-than-temporary, because they are related to changes in interest rates, lack of liquidity and demand in the general investment market and do not affect the expected cash flows of the underlying collateral or the issuer. The Bank’s mortgage-backed securities are all backed by government sponsored enterprises or agencies. The Bank does not own any private label mortgage-backed securities.

At June 30, 2010 and December 31, 2009, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company was $5.1 million for both periods. On May 18, 2010, FHLB paid a dividend for the first quarter of 2010 with an annualized rate of 0.26%. The dividend rate was equal to average three-month LIBOR for the period of January 1, 2010 to March 31, 2010, and was applicable to capital stock held during that period. The FHLB also announced that it would not repurchase activity-based excess capital stock and would continue to evaluate on a quarterly basis whether to repurchase excess capital stock. Management believes that its investment in FHLB stock was not other-than-temporarily impaired as of June 30, 2010 or December 31, 2009. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a decrease in the value of the FHLB stock held by the Company.

 

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The aggregate amortized cost and fair value of the available-for-sale securities portfolio at June 30, 2010 by remaining contractual maturity are as follows:

 

     Amortized
Cost
   Fair
Value
     (Dollars in thousands)

Government-sponsored enterprises and FFCB bonds:

     

Due in one through five years

   $ 2,480    $ 2,502

Due in five through ten years

     27,575      28,513

Due after ten years

     2,111      2,163

Obligations of states and political subdivisions:

     

Due in one year or less

     978      999

Due in one through five years

     8,095      8,491

Due in five through ten years

     17,145      17,663

Due after ten years

     23,138      23,666

Mortgage-backed securities:

     

Due in five through ten years

     11,203      11,560

Due after ten years

     165,114      167,248

Corporate Bonds:

     

Due in one through five years

     853      857

Due in five through ten years

     4,533      4,402
             

Total securities

   $ 263,225    $ 268,064
             

Securities with an amortized cost of $156.8 million at June 30, 2010 are pledged as collateral. Of this total, amortized cost of $24.7 million and fair value of $25.7 million are pledged as collateral for FHLB advances.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at December 31, 2009 by remaining contractual maturity are as follows:

 

     Amortized
Cost
   Fair
Value
     (Dollars in thousands)

Government-sponsored enterprises and FFCB bonds:

     

Due in one through five years

   $ 7,152    $ 7,166

Due in five through ten years

     20,610      20,392

Due after ten years

     8,379      8,285

Obligations of states and political subdivisions:

     

Due in one year or less

     870      876

Due in one through five years

     7,006      7,343

Due in five through ten years

     17,997      18,448

 

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     Amortized
Cost
   Fair
Value

Due after ten years

     19,369      19,355

Mortgage-backed securities:

     

Due in five through ten years

     14,447      14,802

Due after ten years

     134,720      135,999

Corporate Bonds:

     

Due in five through ten years

     6,044      5,860

Equity securities:

     1,000      806
             

Total securities

   $ 237,594    $ 239,332
             

Securities with an amortized cost of $142.4 million at December 31, 2009 were pledged as collateral. Of this total, amortized cost of $55.6 million and fair value of $56.6 million were pledged as collateral for FHLB advances.

(6) Comprehensive Income (Loss)

A summary of comprehensive income (loss) is as follows:

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2010     2009     2010     2009  
     (Dollars in thousands)  

Net income

   $ 957      800      $ 1,444      $ 2,053   

Other comprehensive income (loss):

        

Unrealized gains (losses) arising during the period

     3,539      (1,770     4,541        (646

Tax benefit (expense)

     (1,363   682        (1,749     249   

Reclassification to realized gains

     (152   (183     (1,441     (588

Tax benefit

     59      70        556        226   
                              

Other comprehensive income (loss)

     2,083      (1,201     1,907        (759
                              

Total comprehensive income (loss)

   $ 3,040      (401   $ 3,351      $ 1,294   
                              

 

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(7) Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company.

In March 2010, guidance related to derivatives and hedging was amended to exempt embedded credit derivative features related to the transfer of credit risk from potential bifurcation and separate accounting. Embedded features related to other types of risk and other embedded credit derivative features are not exempt from potential bifurcation and separate accounting. The amendments were effective for the Company on July 1, 2010. These amendments will have no impact on the financial statements.

Income Tax guidance was amended in April 2010 to reflect an SEC Staff Announcement after the President signed the Health Care and Education Reconciliation Act of 2010 on March 30, 2010, which amended the Patient Protection and Affordable Care Act signed on March 23, 2010. According to the announcement, although the bills were signed on separate dates, regulatory bodies would not object if the two Acts were considered together for accounting purposes. This view is based on the SEC staff’s understanding that the two Acts together represent the current health care reforms as passed by Congress and signed by the President. The amendment had no impact on the financial statements.

In July 2010, the Receivables topic of the ASC was amended to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments will require the allowance disclosures to be provided on a disaggregated basis. The Company is required to begin to comply with the disclosures in its financial statements for the year ended December 31, 2010.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.

(8) Fair Value of Financial Instruments

Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at June 30, 2010 and December 31, 2009:

 

     June 30, 2010    December 31, 2009
     Carrying
Value
   Estimated Fair
Value
   Carrying
Value
   Estimated Fair
Value
     (Dollars in thousands)

Financial assets:

           

Cash and cash equivalents

   $ 29,547    $ 29,547    $ 17,811    $ 17,811

Investment securities

     268,064      268,064      239,332      239,332

FHLB stock

     5,116      5,116      5,116      5,116

Accrued interest receivable

     4,647      4,647      4,967      4,967

Net loans

     559,712      555,626      568,066      565,178

Loans held for sale

     1,584      1,584      —        —  

 

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Table of Contents
     June 30, 2010    December 31, 2009
     Carrying
Value
   Estimated Fair
Value
   Carrying
Value
   Estimated Fair
Value

Financial liabilities:

           

Deposits

   $ 792,454    $ 795,884    $ 754,730    $ 759,647

Short-term borrowings

     22,408      22,408      22,910      22,910

Accrued interest payable

     1,017      1,017      1,121      1,121

Long-term obligations

     14,500      15,427      21,000      21,210

The estimated fair values of net loans, deposits and long-term obligations are based on estimated cash flows discounted at market interest rates. The fair value of off-balance sheet financial instruments is considered immaterial. These off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1   

Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2   

Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3   

Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

There were no changes to the techniques used to measure fair value during the period.

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of

 

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interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2010, the majority of impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Real Estate and Repossessions Acquired in Settlement of Loans

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Assets recorded at fair value on a recurring basis

 

June 30, 2010

   Total    Level 1    Level 2    Level 3
     (Dollars in thousands)

Investment Securities Available-for-Sale

           

Government-sponsored enterprises and FFCB bonds

   $ 33,178    $ 2,500    $ 30,678    $ —  

Obligations of states and political subdivisions

     50,819      386      50,433      —  

Mortgage-backed securities

     178,808      73,059      105,749      —  

Corporate bonds

     5,259      —        3,428      1,831

Total Securities

   $ 268,064    $ 75,945    $ 190,288    $ 1,831

Total assets at fair value

   $ 268,064    $ 75,945    $ 190,288    $ 1,831

 

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December 31, 2009

   Total    Level 1    Level 2    Level 3
     (Dollars in thousands)

Investment Securities Available-for-Sale

           

Government-sponsored enterprises and FFCB bonds

     35,843      8,626      24,737      2,480

Obligations of states and political subdivisions

     46,022      4,506      41,516      —  

Mortgage-backed securities

     150,801      35,724      115,077      —  

Corporate bonds

     5,860      —        3,989      1,871

Equity securities

     806      806      —        —  

Total Securities

   $ 239,332    $ 49,662    $ 185,319    $ 4,351

Total assets at fair value

   $ 239,332    $ 49,662    $ 185,319    $ 4,351

Assets recorded at fair value on a nonrecurring basis

 

June 30, 2010

   Total    Level 1    Level 2    Level 3
     (Dollars in thousands)

Impaired Loans

  

Real estate—construction and land development

     9,244      —        8,610      634

Real estate—commercial, residential and other

     4,531      —        2,633      1,898

Commercial and all other loans

     30      —        —        30

Total impaired loans

   $ 13,805    $ —      $ 11,243    $ 2,562

Real estate and repossessions acquired in settlement of loans

           

Total real estate and repossessions acquired in settlement of loans

   $ 4,644    $ —      $ 1,538    $ 3,106

Total assets at fair value

   $ 20,033    $ —      $ 14,365    $ 5,668

December 31, 2009 (Dollars in thousands)

   Total    Level 1    Level 2    Level 3
     (Dollars in thousands)

Impaired Loans

           

Real estate—construction and land development

     6,882      —        5,510      1,372

Real estate—commercial, residential and other

     3,389      —        2,205      1,184

Commercial and all other loans

     2,304      —        —        2,304

Total impaired loans

   $ 12,575    $ —      $ 7,715    $ 4,860

Real estate and repossessions acquired in settlement of loans

           

Real estate and repossessions acquired in settlement of loans

   $ 5,438    $ 606    $ 1,657    $ 3,175

Total assets at fair value

   $ 18,013    $ 606    $ 9,372    $ 8,035

 

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As of June 30, 2010 there were $19.7 million of Level 2 investment securities available for sale that were reported as Level 1 as of December 31, 2009. The bonds were transferred from Level 1 to Level 2 during the first six months of 2010 because the December 31, 2009 pricing was based on the Company’s actual trades for the securities at initial purchase while the June 30, 2010 pricing was through a pricing system. The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2010 and 2009.

 

(Dollars in thousands)    Government-
sponsored
enterprises and
FFCB bonds
    Corporate
Bonds
    Available-for
Sale Debt
Securities
 

Balance, December 31, 2009

   $ 2,480      $ 1,871      $ 4,351   

Total gains or losses (realized/unrealized):

      

Included in earnings

     —          —          —     

Included in other comprehensive income

     —          (40     (40

Purchases, issuances, and settlements

         —     

Transfers in to/out of Level 3

     (2,480       (2,480

Balance, June 30, 2010

   $ —        $ 1,831      $ 1,831   

 

(Dollars in thousands)    Obligations of
states and
political
subdivisions
    Mortgage-
backed
securities
    Corporate
Bonds
   Available-for
Sale Debt
Securities
 

Balance, December 31, 2008

   $ 698      $ 8,374      $ 2,000    $ 11,072   

Total gains or losses (realized/unrealized):

         

Included in earnings

     —          —          —        —     

Included in other comprehensive income

     (97     —          —        (97

Purchases, issuances, and settlements

            —     

Transfers in to/out of Level 3

     —          (8,374        (8,374

Balance, June 30, 2009

   $ 601      $ —        $ 2,000    $ 2,601   

(9) Derivative Financial Instruments

At June 30, 2010 the Company’s only derivative instruments related to our residential mortgage lending activities. We are required to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings.

 

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(10) U.S. Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program

On January 16, 2009, the Company issued Series A Preferred Stock in the amount of $17,949,000 and a warrant to purchase 144,984 shares of common stock with an exercise price of $18.57 to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The Series A Preferred Stock qualifies as Tier 1 capital for purposes of regulatory capital requirements and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Prior to January 16, 2012, unless the Company has redeemed all of this preferred stock or the U.S. Treasury has transferred all of this preferred stock to a third party, the consent of the U.S. Treasury will be required to, among other things, increase common stock dividend above $0.1825 per share or repurchase common stock except in limited circumstances. In addition, until the U.S. Treasury ceases to own these securities sold under the TARP Capital Purchase Program, the compensation arrangements for senior executive officers must comply in all respects with the U.S. Emergency Economic Stabilization Act of 2008 and the rules and regulations thereunder.

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this Report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risk factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available through our Internet website at www.myecb.com or directly through the Commission’s website at www.sec.gov. Forward-looking statements in this Report may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, (a) pressures on our earnings, capital and liquidity resulting from current and future conditions in the credit and equity markets, (b) continued or unexpected increases in credit losses in our loan portfolio, (c) continued adverse conditions in the economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (d) the financial success or changing strategies of our customers, (e) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect our business, (f) changes in the interest rate environment and the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, (g) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively against other financial institutions in our banking markets; (h) weather and similar conditions, particularly the effect of hurricanes on our banking and operations facilities and on our customers and the communities in which we do business; and (i) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements in this Report are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and we do not intend, to update these forward-looking statements.

Executive Summary

ECB Bancorp, Inc. is a bank holding company headquartered in Engelhard, North Carolina. Our wholly owned subsidiary, The East Carolina Bank (the “Bank”), is a state-chartered community bank that was founded in 1919. For the purpose of this discussion, “we,” “us” and “our” refers to the Bank and the bank holding company as a single, consolidated entity unless the context otherwise indicates.

As of June 30, 2010, we had consolidated assets of approximately $921.8 million, total loans of approximately $570.2 million, total deposits of approximately $792.5 million and shareholders’ equity of approximately $86.9 million. For the three months ended June 30, 2010, we had income available to common shareholders of $692 thousand or $0.24 basic and diluted earnings per share, compared to income available to common shareholders of $532 thousand, or $0.19 basic and diluted earnings per share for the three months ended June 30, 2009. For the six

 

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months ended June 30, 2010, we had income available to common shareholders of $914 thousand or $0.32 basic and diluted earnings per share, compared to income available to common shareholders of $1.6 million or $0.55 basic and diluted earnings per share for the six months ended June 30, 2009.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K Annual Report for the fiscal year ended December 31, 2009. Of these significant accounting policies, the Company considers its policy regarding the allowance for loan losses to be its most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Company has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company’s assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Asset Quality”.

We also consider our determination of retirement plans and other postretirement benefit cost to be a critical accounting estimate as it requires the use of estimates and judgments related to the amount and timing of expected future cash out-flows for benefit payments and cash in-flows for maturities and return on plan assets. Our retirement plans and other post-retirement benefit costs are actuarially determined based on assumptions on the discount rate, estimated future return on plan assets and the health care cost trend rate. Changes in estimates and assumptions related to mortality rates and future health care costs could have a material impact to our financial condition or results of operations. The discount rate is used to determine the present value of future benefit obligations and the net periodic benefit cost. The discount rate used to value the future benefit obligation as of each year-end is the rate used to determine the periodic benefit cost in the following year. For additional discussion concerning our retirement plans and other postretirement benefits refer to Note 8 to the Consolidated Financial Statements contained in our Form 10-K Annual Report for the fiscal year ended December 31, 2009.

 

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Comparison of the Results of Operations for the Three- and Six-Month Periods Ended June 30, 2010 and 2009

The following table summarizes components of income and expense and the changes in those components for the three- and six-month periods ended June 30, 2010 as compared to the same periods in 2009.

Condensed Consolidated Statements of Income

(Dollars in thousands)

 

     For the Three
Months Ended
June 30, 2010
   Changes from the
Prior Year
    For the Six
Months Ended
June 30, 2010
   Changes from the
Prior Year
 
      Amount     %        Amount     %  

Total interest income

   $ 9,965    $ (340   (3.3   $ 19,985    $ (549   (2.7

Total interest expense

     2,932      (731   (20.0     5,957      (1,923   (24.4
                                          

Net interest income

     7,033      391      5.8        14,028      1,374      10.9   

Provision for loan losses

     1,780      (220   (11.0     4,780      2,030      73.8   
                                          

Net interest income after Provision for loan losses

     5,253      611      13.2        9,248      (656   (6.6

Noninterest income

     1,866      103      5.8        4,534      835      22.6   

Noninterest expense

     5,916      461      8.5        12,154      1,254      11.5   
                                          

Income before income taxes

     1,203      253      26.6        1,628      (1,075   (39.8

Income tax provision

     246      96      64.0        184      (466   (71.7
                                          
              
                                          

Net income

     957      157      19.6        1,444      (609   (29.7

Preferred stock dividend and accretion of discount

     265      (3   (1.1     530      55      11.6   
                                          

Net income available to common shareholders

   $ 692    $ 160      30.1      $ 914    $ (664   (42.1
                                          

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. Net interest income for the three months ended June 30, 2010 was $7.0 million, an increase of $0.4 million or 5.8% when compared to net interest income of $6.6 million for the three months ended June 30, 2009. For the six months ended June 30, 2010, net interest income was $14.0 million, an increase of $1.3 million or 10.9% when compared to net interest income of $12.7 million for the period in 2009

The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and interest-bearing liabilities and the various rate spreads between our interest-earning assets and our interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.

Interest income decreased $340 thousand or 3.3% for the three months ended June 30, 2010 compared to the same three months of 2009. Interest income decreased $549 thousand or 2.7% for the six months ended June 30, 2010 compared to the same six months in 2009. The decreases for the three and six months ended June 30, 2010 are due to the decrease in the rates paid on our average earning assets which was partially offset by increase in the volume of these earning assets. The tax equivalent yield on average earning assets decreased 23 basis points for the

 

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quarter ended June 30, 2010 to 4.94% from 5.17% for the same period in 2009. For the first six months of 2010, the yield on average earning assets, on a tax-equivalent basis, decreased 22 basis points to 4.99% compared to 5.21% at June 30, 2009. Management attributes the decrease in the yield on our earning assets to the continued low level of short-term market interest rates. Approximately $353.2 million or 61.9% of our loan portfolio consists of variable rate loans that adjust with the movement of the prime rate. As a result of low rates for an extended period of time, these loans’ yields have remained relatively flat while other loans have repriced at lower rates; therefore the composite yield on our loans decreased approximately 6 basis points for the first six months of 2010 compared to the same period in 2009. Also, yields on our taxable securities decreased approximately 80 basis points for the first six months of 2010 as compared to the same period last year as securities sold, called or matured have been replaced with lower yielding securities.

Our average cost of funds during the second quarter of 2010 was 1.66%, a decrease of 46 basis points when compared to 2.12% for the second quarter of 2009. Average rates paid on bank certificates of deposit decreased 54 basis points from 2.63% for the quarter ended June 30, 2009 to 2.09% for the quarter ended June 30, 2010, while our average cost of borrowed funds increased 121 basis points during the second quarter of 2010 compared to the same period in 2009. Total interest expense decreased $731 thousand or 20.0% during the second quarter of 2010 compared to the same period in 2009, primarily the result of decreased market rates paid on these liabilities. For the six months ended June 30, 2010, our cost of funds was 1.70% a decrease of 62 basis points when compared to 2.32% for the same period in 2009. Average rates paid on bank certificates of deposit decreased 80 basis points from 2.89% to 2.09% for the first six months of 2010, while our cost of borrowed funds increased 78 basis points compared to the same period a year ago. The increase in the average cost of borrowed funds for both the three- and six- month periods is the result of a decrease in the volume of lower cost short term borrowings. Total interest expense decreased $1.9 million or 24.4% during the six months of 2010 compared to the same period in 2009, primarily the result of decreased market rates paid on these liabilities. The volume of average interest-bearing liabilities increased approximately $22.5 million for the six months of 2010 compared with the same period in 2009.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest bearing deposits in earning assets.

Our annualized net interest margin, on a tax-equivalent basis, for the three months ended June 30, 2010 was 3.52% compared to 3.37% in the second quarter of 2009 while our net interest spread increased 23 basis points during the same period. For the six months ended June 30, 2010, our net interest margin, on a tax-equivalent basis, was 3.54% compared to 3.24% in the six months of 2009 while our net interest spread increased 40 basis points.

Average interest-bearing liabilities, as a percentage of interest-earning assets for the quarters ended June 30, 2010 and 2009 were 85.2% and 85.4%, respectively. For the six months ended June 30, 2010, average interest-bearing liabilities as a percentage of interest-earning assets were 85.5% compared to 84.9% for the six months ended June 30, 2009.

 

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Average Consolidated Balance Sheets and Net Interest Analysis Fully on Tax Equivalent Basis

For the three months ended June 30, 2010 and 2009

 

     Average
Balance
   2010
Yield/
Rate(5)
    Income/
Expense
   Average
Balance
   2009
Yield/
Rate(5)
    Income/
Expense
     (Dollars in thousands)

Assets

               

Loans – net (1)

   $ 569,042    5.49   $ 7790    $ 557,169    5.52   $ 7,666

Taxable securities

     192,000    3.51     1,680      211,735    4.37     2,307

Non-taxable securities (2)

     49,038    6.07     742      34,733    5.81     503

Other investments

     19,659    0.10     5      8,395    —       —  
                                       

Total interest- earning assets

     829,739    4.94   $ 10,217      812,032    5.17   $ 10,476

Cash and due from banks

     11,910           10,856     

Bank premises and equipment, net

     25,082           25,407     

Other assets

     26,763           24,179     
                       

Total assets

   $ 893,494         $ 872,474     
                       

Liabilities and Shareholders’ Equity

               

Interest-bearing deposits

   $ 678,439    1.63   $ 2,749    $ 611,259    2.22   $ 3,383

Short-term borrowings

     13,933    1.76     61      60,947    0.74     112

Long-term obligations

     14,500    3.37     122      21,000    3.21     168
                                       

Total interest- bearing liabilities

     706,872    1.66     2,932      693,206    2.12     3,663

Non-interest-bearing deposits

     101,194           86,849     

Other liabilities

     32           4,579     

Shareholders’ equity

     85,396           87,840     
                       

Total liabilities and Shareholders’ equity

   $ 893,494         $ 872,474     
                       

Net interest income and net interest margin (FTE) (3)

      3.52   $ 7,285       3.37   $ 6,813
                               

Interest rate spread (FTE) (4)

      3.28         3.05  
                       

 

(1) Average loans include non-accruing loans, net of allowance for loan losses and loans held for sale.
(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $252 thousand and $171 thousand for periods ended June 30, 2010 and 2009, respectively.
(3) Net interest margin is computed by dividing net interest income by total earning assets.
(4) Interest rate spread equals the earning asset yield minus the interest-bearing liability rate.
(5) Annualized

 

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For the six months ended June 30, 2010 and 2009

 

     Average
Balance
   2010
Yield/
Rate(5)
    Income/
Expense
   Average
Balance
   2009
Yield/
Rate(5)
    Income/
Expense
     (Dollars in thousands)

Assets

               

Loans – net (1)

   $ 567,999    5.48   $ 15,422    $ 546,654    5.54   $ 15,013

Taxable securities

     196,348    3.70     3,604      217,921    4.50     4,867

Non-taxable securities (2)

     47,583    6.11     1,442      34,395    5.78     986

Other investments

     16,208    0.09     7      8,495    0.07     3
                                       

Total interest- earning assets

     828,138    4.99   $ 20,475      807,465    5.21   $ 20,869

Cash and due from banks

     11,107           10,063     

Bank premises and equipment, net

     25,169           25,547     

Other assets

     26,829           23,370     
                       

Total assets

   $ 891,243         $ 866,445     
                       

Liabilities and Shareholders’ Equity

               

Interest-bearing deposits

   $ 674,457    1.66   $ 5,567    $ 594,642    2.43   $ 7,175

Short-term borrowings

     16,455    1.43     117      67,485    0.92     308

Long-term obligations

     17,193    3.20     273      23,459    3.41     397
                                       

Total interest- bearing liabilities

     708,105    1.70     5,957      685,586    2.32     7,880

Non-interest-bearing deposits

     97,634           84,756     

Other liabilities

     161           10,289     

Shareholders’ equity

     85,343           85,814     
                       

Total liabilities and Shareholders’ equity

   $ 891,243         $ 866,445     
                       

Net interest income and net interest margin (FTE) (3)

      3.54   $ 14,518       3.24   $ 12,989
                               

Interest rate spread (FTE) (4)

      3.29         2.89  
                       

 

(1) Average loans include non-accruing loans, net of allowance for loan losses and loans held for sale.
(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $490 thousand and $335 thousand for periods ended June 30, 2010 and 2009, respectively.
(3) Net interest margin is computed by dividing net interest income by total earning assets.
(4) Interest rate spread equals the earning asset yield minus the interest-bearing liability rate.
(5) Annualized

The following table presents the relative impact on net interest income of average outstanding balances (volume) of earning assets and interest-bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

 

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Change in Interest Income and Expense on Tax Equivalent Basis

For the three months ended June 30, 2010 and 2009

Increase (Decrease) in interest income and expense due to changes in:

 

     2010 compared to 2009  
     Volume (1)     Rate (1)     Net  
     (Dollars in thousands)  

Loans

   $ 163      $ (39   $ 124   

Taxable securities

     (194     (433     (627

Non-taxable securities (2)

     211        28        239   

Other investments

     1        4        5   
                        

Interest income

     181        (440     (259

Interest-bearing deposits

     322        (956     (634

Short-term borrowings

     (146     95        (51

Long-term obligations

     (53     7        (46
                        

Interest expense

     123        (854     (731
                        

Net interest income

   $ 58      $ 414      $ 472   
                        

 

(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances.
(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $252 thousand and $171 thousand for periods ended June 30, 2010 and 2009, respectively.

For the six months ended June 30, 2010 and 2009

Increase (Decrease) in interest income and expense due to changes in:

 

     2010 compared to 2009  
     Volume (1)     Rate (1)     Net  
     (Dollars in thousands)  

Loans

   $ 583      $ (174   $ 409   

Taxable securities

     (439     (824     (1,263

Non-taxable securities (2)

     389        67        456   

Other investments

     3        1        4   
                        

Interest income

     536        (930     (394

Interest-bearing deposits

     811        (2,419     (1,608

Short-term borrowings

     (298     107        (191

Long-term obligations

     (103     (21     (124
                        

Interest expense

     410        (2,333     (1,923
                        

Net interest income

   $ 126      $ 1,403      $ 1,529   
                        

 

(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances.
(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $490 thousand and $335 thousand for periods ended June 30, 2010 and 2009, respectively.

 

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Provision for Loan Losses

The provision for loan losses charged to operations during the three and six months ended June 30, 2010 was $1.8 million and $4.8 million, respectively. The provision for loan losses charged to operations during the three and six months ended June 30, 2009 was $2.0 million and $2.8 million, respectively. The decrease in the three-month period ending June 30, 2010 as compared to the same period ending June 30, 2009 is the result of a modification to our assumptions for FAS-5 loss allocations which is described in more detail under the caption “Asset Quality.” The increase for the six-month period reflects higher historical loss rates, additional impaired loans and management’s response to the current economic environment. The Bank had net charge-offs of $2.6 million for the quarter ended June 30, 2010 compared to net charge-offs of $1.0 million during the second quarter of 2009. For the six-month periods ended June 30, 2010 and 2009, the Bank had net charge-offs of $4.0 million and $2.9 million, respectively. We use the results of our allowance for loan loss model to estimate the dollar amount of provision expense needed to maintain the adequacy of our allowance for loan losses. Our management analyzes the adequacy of the allowance on a monthly basis and adjustments to the provision expense are made as necessary. Additional information regarding our allowance for loan losses is contained in this discussion under the caption “Asset Quality.”

Noninterest Income

Noninterest income, principally charges and fees assessed for the use of our services, is a significant contributor to net income. The following table presents the components of noninterest income for the three- and six-month periods ended June 30, 2010 and 2009.

 

     For the Three
Months Ended
June 30, 2010
   Changes from the
Prior Year
    For the Six
Months Ended
June 30, 2010
   Changes from the
Prior Year
 
      Amount     %        Amount     %  
     (Dollars in thousands)  

Service charges on deposit accounts

   $ 893    $ (23   (2.5   $ 1,716    $ (76   (4.2

Other service charges and fees

     433      83      23.7        698      81      13.1   

Mortgage origination brokerage fees

     293      57      24.2        505      (22   (4.2

Net gain on sale of securities

     152      (31   (16.9     1,441      853      145.1   

Income from bank owned life insurance

     74      (8   (9.6     148      (16   (8.5

Other operating income

     21      25      NM        26      15      136.4   
                                          

Total noninterest income

   $ 1,866    $ 103      5.8      $ 4,534    $ 835      22.6   
                                          

Noninterest income increased $103 thousand or 3.8% to $1.9 million for the second quarter of this year compared to $1.8 million for the same period in 2009. For the six months ended June 30, 2010 noninterest income increased $835 thousand or 22.6% to $4.5 million compared to $3.7 million for the same period in 2009. The increase in noninterest income in the second quarter of 2010 is primarily due to an increase in other service charges and fees. The year to date increase in noninterest income is primarily the result of an increase in gains on the sale of securities of $853 thousand. Service charges on deposit accounts decreased $23 thousand and $76 thousand, respectively, for the three and six months ended June 30, 2010 as compared to the same periods in 2009 mainly due to a decrease in overdraft protection fees. Other service charges and fees increased $83 thousand and $81 thousand, respectively, for the three and six months ended June 30, 2010 as compared to the same periods in 2009. The primary reason for the increase is that brokerage investment service fees were up during both periods. Year to date mortgage loan origination brokerage fees decreased $22 thousand compared to the previous year six-month period.

 

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Noninterest Expense

Noninterest expense increased 8.5% and 11.5%, respectively, for the three and six months ended June 30, 2010, as compared to the same periods in 2009. The following table presents the components of noninterest expense for the three and six months ended June 30, 2010 and dollar and percentage changes from the prior year.

 

     For the
Three Months
Ended
June 30, 2010
   Changes from the
Prior Year
    For the
Six Months
Ended
June 30, 2010
   Changes from the
Prior Year
 
      Amount     %        Amount     %  
     (Dollars in thousands)  

Salaries

   $ 2,326    $ 321      16.0      $ 4,645    $ 571      14.0   

Retirement and other employee benefits

     712      10      1.4        1,442      (11   (0.8

Occupancy

     447      (2   (0.5     904      (25   (2.7

Equipment

     486      55      12.8        953      134      16.4   

Professional fees

     211      109      106.9        499      100      25.1   

Supplies

     68      13      23.6        120      9      8.1   

Telephone

     157      19      13.8        340      50      17.2   

FDIC deposit insurance

     345      (310   (47.3     678      (232   (25.5

Other outside services

     110      13      13.4        228      (12   (5.0

Net cost of real estate and repossessions acquired in settlement of loans

     47      34      261.5        381      275      259.4   

Other operating expenses

     1,007      199      24.6        1,964      395      25.2   
                                          

Total noninterest expenses

   $ 5,916    $ 461      8.5      $ 12,154    $ 1,254      11.5   
                                          

Salary expense for the three and six months ended June 30, 2010 increased $321 thousand and $571 thousand, respectively, compared to the same prior year periods. The increase is primarily the result of additions made to senior management during the past twelve months.

Employee related benefits expense for the three and six months ended June 30, 2010 remained relatively flat increasing $10 thousand and decreasing $11 thousand, respectively, over the same prior year periods. As of June 30, 2010, we had 230 full time equivalent employees and operated 24 full service banking offices and one mortgage loan origination office.

Equipment expense for the three and six months ended June 30, 2010 increased $55 thousand and $134 thousand, respectively, compared to the same prior year periods. The second quarter increase is primarily the result of an increase in equipment maintenance expense while the year to date increase was due to an increase in equipment rental expense.

Professional fees, which include consulting, audit and legal fees, increased $109 thousand for the three months ended June 30, 2010 compared to the same period of 2009 and increased $100 thousand when compared on a year to date basis to the prior year period. Consulting expense during the second quarter increased $19 thousand and, on a year to date basis, consulting expense increased $12 thousand in 2010 when compared to the same period in 2009. Audit and accounting fees in the second quarter of 2010 remained the same as audit fees incurred during the second quarter of 2009 and for the six-month period ended June 30, 2010 audit fees decreased $15 thousand over the prior year six-month period. Legal expense during the second quarter increased $89 thousand and, on a year to date basis, legal expense increased $104 thousand in 2010 when compared to the same period in 2009.

FDIC deposit insurance expenses decreased $310 thousand for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. For the six-month period ended June 30, 2010, FDIC deposit insurance expense decreased $232 thousand over the six-month period ended June 30, 2009. Of the decrease for both the three-month and six-month periods, $400 thousand is related to the accrual during the second quarter of 2009 for the special assessment that was levied on all banks by the FDIC.

 

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Income Taxes

Income tax expense for the three months ended June 30, 2010 and 2009 was $246 thousand and $150 thousand, respectively, resulting in effective tax rates of 20.4% and 15.8%, respectively. For the six-month period ending June 30, 2010, tax expense was $184 thousand compared to $650 thousand for the same period of 2009, which resulted in effective tax rates of 11.3% and 24.0%, respectively. The decreased effective tax rate in 2010 is principally due to a larger percentage of tax exempt income to taxable income during the 2010 period. The effective tax rates in both years differ from the federal statutory rate of 34.0% primarily due to tax-exempt interest income.

Balance Sheet

Our total assets were $921.8 million at June 30, 2010, $888.7 million at December 31, 2009 and $877.5 million at June 30, 2009. Deposit growth funded our year-over-year asset growth. For the twelve months ended June 30, 2010, we grew our loans $3.6 million or 0.6% while our deposits grew by approximately $89.0 million or 12.7%. Year-over-year, our earning assets grew by $46.6 million primarily through additions to our available-for-sale investment securities portfolio. For the six months ended June 30, 2010, our loans outstanding decreased $7.7 million and deposits increased by $37.7 million.

Loans

As of June 30, 2010, total loans had decreased to $570.2 million, down 1.3% from total loans of $577.8 million at December 31, 2009 and up 0.6% from total loans of $566.6 million at June 30, 2009. The decline in loans for the six months ending June 30, 2010 can be attributed to continued weak economic conditions.

Asset Quality

At June 30, 2010, our allowance for loan losses as a percentage of loans was 1.83%, down from 1.96% at March 31, 2010 and up from 1.68% at December 31, 2009. The decrease from March 31, 2010 is the result of a modification to our assumptions for general reserve loss allocations. Beginning in the second quarter of 2010 we began using the actual historical loss data for our loan portfolio for developing the general reserve portion of the loan loss model assumptions. Previously we had used a more industry wide assumption application in determining this portion of the reserve calculation. Due to our actual loan loss history the model modified the required reserve for this portion of the portfolio reserve, which resulted in a slight reduction in total reserves to outstanding loans for the quarter. The increase from December 31, 2009 in part reflects the increase in our historical loss rate as our charge-offs have increased during the past year. Also, the increase reflects the recognition of additional loans identified as being impaired. In evaluating the allowance for loan losses, we prepare an analysis of our current loan portfolio in total through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

Historical loss calculations for each homogeneous risk group are based on a three-year average loss ratio calculation with the most recent quarter’s loss history included in the model. The impact is to more quickly recognize and increase the loss history in a respective grouping. For those groups with little or no loss history, management increases the historical factor through a positive adjustment to more accurately represent current economic conditions and their potential impact on that particular loan group.

Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and on their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. All loans risk rated “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

 

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A portion of the Bank’s allowance for loan losses is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the portion of the allowance considered unallocated may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. The Bank has identified an acceptable range for this unallocated portion to be 5%—15% of the total reserve. While we believe that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Loans are charged-off against the Bank’s allowance for loan losses as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal. Included in the write-down is the estimated expense to liquidate the property and typically an additional allowance for the foreclosure discount. Generally, if the loan is unsecured the loan must be charged-off in full while if it is secured the loan is charged down to the net liquidation value of the collateral.

Net charge-offs for the first six months of 2010 totaled $4.0 million compared to net charge-offs of $2.9 million during the first six months of 2009. The provision for loan losses charged to operations for the six months ended June 30, 2010 and 2009 was $4.8 million and $2.8 million, respectively. The following table presents an analysis of the changes in the allowance for loan losses for the six months ended June 30, 2010 and 2009.

Analysis of Changes in Allowance for Loan Losses

 

    

For the six months

Ended June 30,

 
     2010     2009  
     (Dollars in thousands)  

Total loans outstanding at end of period-gross

   $ 570,174      $ 566,601   

Average loans outstanding-gross

   $ 578,071      $ 551,874   
                

Allowance for loan losses at beginning of period

   $ 9,725      $ 5,931   
                

Loans charged off:

    

Real estate

     (3,093     (2,842

Installment loans

     (26     (13

Credit cards and related plans

     —          —     

Demand deposit overdraft program

     (97     (113

Commercial and all other loans

     (900     (65
                

Total charge-offs

     (4,116     (3,033
                

Recoveries of loans previously charged off:

    

Real estate

     16        —     

Installment loans

     2        5   

Credit cards and related plans

     1        —     

Demand deposit overdraft program

     53        66   

Commercial and all other loans

     1        68   
                

Total recoveries

     73        139   
                

Net charge offs

     (4,043     (2,894
                

Provision for loan losses

     4,780        2,750   
                

Allowance for loan losses at end of period

   $ 10,462      $ 5,787   
                

 

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For the six months

Ended June 30,

 
     2010     2009  

Ratios

    

Annualized net charge offs to average loans during the period

   1.40   1.05

Allowance for loan losses to loans at period end

   1.83   1.02

Allowance for loan losses to nonperforming loans at period end

   54   56

Allowance for loan losses to impaired loans at period end

   36.1   28.3

The ratio of annualized net charge-offs to average loans increased to 1.40% at June 30, 2010 from 1.05% at June 30, 2009 mainly due to an increase in commercial related charge-offs. Declining economic conditions, particularly in our southern coastal markets, resulted in an increased number of impaired collateral dependant loans which resulted in a portion of these loans being charged-off. The increase in the allowance for loan losses to loans to 1.83% at June 30, 2010 from 1.02% at June 30, 2009 reflects the increase in our historical loss rate as our charge-offs have increased during the past year. Also, the increase reflects the recognition of additional loans identified as being impaired. The ratio of our allowance for loan losses to nonperforming loans decreased slightly to 54% as of June 30, 2010 compared to 56% as of June 30, 2009.

Construction, land and development (“CLD”) loans make up 17.3% of the Bank’s loan portfolio. This sector of the economy has been particularly impacted by declines in housing activity, and has had a disproportionate impact on the credit quality of the Bank. The table below shows trends of CLD loans, along with ratios relating to their relative credit quality.

 

     CLD Loans     All Other Loans     Total
Loans
 
     Balance     % of Total     Balance     % of Total    
     (Dollars in thousands)  

Balances at June 30, 2010

   $ 98,610      17.3   $ 471,564      82.7   $ 570,174   

Impaired loans

     14,311      49.4     14,656      50.6     28,967   

Allocated Reserves

     4,794      51.7     4,485      48.3     9,279   

YTD Net Charge-offs

     1,697      42.0     2,346      58.0     4,043   

Nonperforming loans (NPL)

     13,283      69.1     5,940      30.9     19,223   

NPL as % of loans

     13.5       1.3       3.4

While balances of CLD loans make up 17.3% of the Bank’s loan portfolio at June 30, 2010, they represent 49.4% and 42.0% of the Bank’s impaired loans and YTD net charge-offs, respectively. CLD loans represent 69.1% of the Bank’s nonperforming loans and 51.7% of the Bank’s allocated reserves are allocated to CLD loans.

Nonperforming Assets

The following table summarizes our nonperforming assets and past due loans at the dates indicated.

 

     June 30,
2010
   December 31,
2009
     (Dollars in thousands)

Non-accrual loans

   $ 16,119    $ 13,343

Restructured loans

     3,104      1,353

Other real estate owned & repossessions

     4,644      5,443
             

Total

   $ 23,867    $ 20,139
             

 

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Nonperforming assets consist of loans not accruing interest, loans past due ninety days and still accruing interest, restructured debt and real estate acquired in settlement of loans and other repossessed collateral. It is our policy to place loans on non-accrual status when any portion of principal or interest becomes 90 days past due, or earlier if full collection of principal and interest becomes doubtful. When loans are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments received thereafter are applied as a reduction to the remaining principal balance so long as doubt exists as to the ultimate collection of the principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when the collectability of principal or interest is no longer doubtful. Nonperforming assets were $23.9 million and $20.1 million, or 4.19% and 3.49% of loans outstanding at June 30, 2010 and December 31, 2009, respectively. On June 30, 2010, our nonperforming loans (consisting of nonaccruing, and restructured loans) amounted to approximately $19.2 million compared to $14.7 million as of December 31, 2009. We had $4.6 million in other real estate owned and repossessions at June 30, 2010 compared to $5.4 million at December 31, 2009.

Loans Considered Impaired

We review our nonperforming loans and other groups of loans based on loan size or other factors for impairment. At June 30, 2010, we had loans totaling $29.0 million (which includes $19.2 million in nonperforming loans) which were considered to be impaired compared to $23.9 million at December 31, 2009. As discussed in Asset Quality, loans are considered impaired if, based on current information, circumstances or events, it is probable that the Bank will not collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. However, treating a loan as impaired does not necessarily mean that we expect to incur a loss on that loan, and our impaired loans include loans that currently are performing in accordance with their terms. For example, if we believe it is probable that a loan will be collected, but not according to its original agreed upon payment schedule, we may treat that loan as impaired even though we expect that the loan will be repaid or collected in full. As indicated in the table below, when we believe a loss is probable on a non-collateral dependent impaired loan, a portion of our reserve is allocated to that probable loss. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal.

The following table sets forth the number and volume of loans considered impaired and their associated reserve allocation, if any, at June 30, 2010.

 

     Number
of Loans
   Loan
Balances
Outstanding
   Allocated
Reserves
     (Dollars in millions)

Non-accrual loans

   40    $ 16.1    $ 1.4

Restructured loans

   5      3.1      0.8
                  

Total nonperforming loans

   45    $ 19.2    $ 2.2
                  

Other impaired loans with allocated reserves

   11      3.6      0.9

Impaired loans without allocated reserves

   16      6.2      —  
                  

Total impaired loans

   72    $ 29.0    $ 3.1
                  

Investment Securities and Other Assets

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. We use two categories to classify our securities: “held-to-maturity” and “available-for-sale.” Currently, none of our investments are classified as held-to-maturity. While we have no plans to liquidate a significant amount of our securities, the securities classified as available-for-sale may be sold to meet liquidity needs should management deem it to be in our best interest.

 

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Our investment securities totaled $268.1 million at June 30, 2010, $239.3 million at December 31, 2009 and $232.5 million at June 30, 2009. Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are not otherwise needed to satisfy loan demand. Investable funds not otherwise utilized are temporarily invested as federal funds sold or as interest-bearing balances at other banks, the level of which is affected by such considerations as near-term loan demand and liquidity needs.

At June 30, 2010, the securities portfolio had unrealized net gains of approximately $3.0 million, net of tax, which are reported in accumulated other comprehensive income on the consolidated statement of shareholders’ equity. Our securities portfolio at June 30, 2010 consisted of U.S. government sponsored agencies, collateralized mortgage obligations (CMOs), mortgage-backed securities (MBS), corporate bonds and tax-exempt municipal securities.

We currently have the ability to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. As of June 30, 2010, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our common shareholders’ equity. As of June 30, 2010 the amortized cost and market value of the securities from such issuers were as follows:

 

     Amortized Cost    Market Value
     (Dollars in thousands)

Federal National Mortgage Corporation

   $ 77,785    $ 79,163

Federal Home Loan Mortgage Corporation

     34,003      34,450

Federal Home Loan Banks

     17,307      17,891

Government National Mortgage Association

     27,221      27,620

Federal Farm Credit Banks

     7,768      8,122

Small Business Administration

     44,399      44,739

At June 30, 2010, we held $8.8 million in bank owned life insurance, compared to $8.7 million and $8.5 million at December 31, 2009 and June 30, 2009, respectively.

Deposits and Other Borrowings

Deposits

Deposits totaled $792.5 million as of June 30, 2010 compared to deposits of $754.7 million at December 31, 2009 and up 12.7% compared to deposits of $703.5 million at June 30, 2009. We attribute our deposit growth during the twelve months ended June 30, 2010 to an increase in public funds in money market accounts and an increase in noninterest bearing demand accounts. We believe that we can improve our core deposit funding by improving our branching network and providing more convenient opportunities for customers to bank with us.

Other Borrowings

Short-term borrowings include sweep accounts, advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) having maturities of one year or less, Federal Funds purchased and repurchase agreements. Our short-term borrowings totaled $22.4 million at June 30, 2010, compared to $22.9 million on December 31, 2009, a net decrease of $0.5 million.

The following table details the maturities and rates of our borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”), as of June 30, 2010.

 

Borrow Date

 

Type

 

Principal

 

Term

 

Rate

 

Maturity

(Dollars in thousands)

June 17 2010

  Fixed rate   10,000   1 month   0.19   July 16, 2010

March 12, 2008

  Fixed rate   6,500   3 years   2.89   March 14, 2011

February 29, 2008

  Fixed rate   5,000   4 years   3.18   February 29, 2012

March 12, 2008

  Fixed rate   2,000   4 years   3.25   March 12, 2012

March 12, 2008

  Fixed rate   7,500   5 years   3.54   March 12, 2013
 

Total Borrowings:

  $ 31,000   Composite rate:   2.25%  
             

 

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Long-Term Obligations

Long-term obligations consist of advances from FHLB with maturities greater than one year. Our long-term borrowing from the FHLB totaled $14.5 million on June 30, 2010, compared to $21.0 million FHLB advances on both December 31, 2009 and June 30, 2009. The decrease of $6.5 million in long-term FHLB advances as of June 30, 2010, is the result of an FHLB advance being reclassified to short-term borrowing because the current time to maturity is less than a year.

Liquidity

Liquidity refers to our continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) lines for the purchase of federal funds from other banks; (d) lines of credit established at the FHLB, less existing advances; and (e) our investment securities portfolio. All our debt securities are of investment grade quality and, if the need arises, can be promptly liquidated on the open market or pledged as collateral for short-term borrowing.

Consistent with our general approach to liquidity management, loans and other assets of the Bank are funded primarily using local core deposits, retail repurchase agreements and the Bank’s capital position. To date, these core funds, supplemented by FHLB advances, institutional deposits obtained through the internet and brokered deposits, have been adequate to fund loan demand in our market areas, while maintaining the desired level of immediate liquidity and an investment securities portfolio available for both immediate and secondary liquidity purposes. It is anticipated that funding sources in the future will include continued use of brokered deposits and institutional deposits obtained through the Internet.

We are a member of the FHLB. Membership, along with a blanket collateral commitment of our one-to-four family residential mortgage loan portfolio, as well as our commercial real estate loan portfolio, provided us the ability to draw up to $184.4 million, $177.7 million and $175.5 million of advances from the FHLB at June 30, 2010, December 31, 2009 and June 30, 2009, respectively. At June 30, 2010, we had outstanding FHLB advances totaling $31.0 million compared to $41.0 million and $70.0 million at December 31, 2009 and June 30, 2009, respectively.

As a requirement for membership, we invest in stock of the FHLB in the amount of 1% of our outstanding residential loans or 5% of our outstanding advances from the FHLB, whichever is greater. That stock is pledged as collateral for any FHLB advances drawn by us. At June 30, 2010, December 31, 2009 and June 30, 2009 we owned 51,160 shares of the FHLB’s $100 par value capital stock. No ready market exists for such stock, which is carried at cost.

We also had unsecured federal funds lines in the aggregate amount of $41.0 million available to us at June 30, 2010 under which we can borrow funds to meet short-term liquidity needs. At June 30, 2010, we had no borrowings outstanding under these federal funds lines. Another source of funding is loan participations sold to other commercial banks (in which we retain the servicing rights). We believe that our liquidity sources are adequate to meet our operating needs.

Net cash provided by operations during the six months ended June 30, 2010 totaled $3.9 million, compared to net cash provided by operations of $3.2 million for the same period in 2009. Net cash used in investing activities decreased to $21.8 million for the six months ended June 30, 2010, as compared to $83.1 million for the same period in 2009. Net cash provided by financing activities was $29.5 million for the first half of 2010, compared to net cash provided of $88.3 million for the same period in 2009. Cash and cash equivalents at June 30, 2010 were $29.5 million compared to $25.2 million at June 30, 2009.

 

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Capital Resources

Shareholders’ Equity

As of June 30, 2010, our total shareholders’ equity was $86.9 million (consisting of common shareholders’ equity of $69.7 million and preferred stock of $17.2 million) compared with total shareholders’ equity of $84.4 million as of December 31, 2009 (consisting of common shareholders’ equity of $67.3 million and preferred stock of $17.1 million). Common shareholders’ equity increased by approximately $2.4 million to $69.7 million at June 30, 2010 from $67.3 million at December 31, 2009. We generated net income of $1.4 million, experienced an increase in net unrealized gains on available-for-sale securities of $1.9 million and recognized stock based compensation of $20 thousand on incentive stock awards. We declared cash dividends of $399 thousand on our common shares or $0.14 per share during the first half of 2010 and dividends and accretion of discount of $530 thousand on preferred shares.

We are subject to various regulatory capital requirements administered by our federal banking regulators. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by these regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines involving quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by the FDIC to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (each as defined in the regulations). As a bank holding company, we also are subject, on a consolidated basis, to the capital adequacy guidelines of the Federal Reserve Board. The capital requirements of the Federal Reserve Board are similar to those of the FDIC governing the Bank. As of June 30, 2010, we and the Bank met all capital adequacy requirements to which we are subject.

As of June 30, 2010, we experienced a decrease in our capital ratios when compared to the period ending June 30, 2009. This decrease is primarily due to an increase in risk weighted assets. Ratios were relatively flat when compared to December 31, 2009.

Based on the most recent notification from the FDIC, the Bank is well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.

 

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Our and the Bank’s actual capital ratios are presented in the following table:

 

     To be well capitalized
under prompt
corrective action
provisions

Ratio
    Minimum required
for capital
adequacy purposes
Ratio
    Our
Ratio
    Bank’s
Ratio
 

As of June 30, 2010:

        

Tier 1 Capital (to Average Assets)

   ³ 5.00   ³ 3.00   9.26   7.25

Tier 1 Capital (to Risk Weighted Assets)

   ³ 6.00   ³  4.00   12.78      10.01   

Total Capital (to Risk Weighted Assets)

   ³ 10.00   ³  8.00   14.03      11.26   

As of December 31, 2009:

        

Tier 1 Capital (to Average Assets)

   ³ 5.00   ³  3.00   9.59   7.53

Tier 1 Capital (to Risk Weighted Assets)

   ³ 6.00   ³  4.00   12.77      10.03   

Total Capital (to Risk Weighted Assets)

   ³ 10.00   ³  8.00   14.02      11.28   

As of June 30, 2009:

        

Tier 1 Capital (to Average Assets)

   ³ 5.00   ³  3.00   9.76   7.71

Tier 1 Capital (to Risk Weighted Assets)

   ³ 6.00   ³  4.00   13.20      10.43   

Total Capital (to Risk Weighted Assets)

   ³  10.00   ³  8.00   14.09      11.33   

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of the Company’s loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. The Company does not maintain a trading account nor is the Company subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the Company’s asset/liability management function.

Management does not believe there has been any significant change in the overall analysis of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis prepared and presented in conjunction with the Form 10-K Annual Report for the fiscal year ended December 31, 2009.

 

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that we are able to record, process, summarize and report in a timely manner the information required to be disclosed in reports we file under the Exchange Act.

 

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We review our disclosure controls and procedures, including our internal control over financial reporting, on an ongoing basis and may from time to time make changes aimed at enhancing their effectiveness. In connection with the above evaluation of our disclosure controls and procedures, no change in our internal control over financial reporting was identified that occurred during the quarterly period ended June 30, 2010, and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

None.

 

Item 1A. Risk Factors

The Dodd-Frank Act and related regulations may adversely affect our business, financial condition, liquidity or results of operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted on July 21, 2010. The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with power to promulgate and enforce consumer protection laws. Smaller depository institutions (those with $10 billion or less in assets) will be subject to the Consumer Financial Protection Bureau’s rule-writing authority, and existing depository institution regulatory agencies will retain examination and enforcement authority for such institutions. The Dodd-Frank Act also establishes a Financial Stability Oversight Council chaired by the Secretary of the Treasury with authority to identify institutions and practices that might pose a systemic risk and, among other things, includes provisions affecting (1) corporate governance and executive compensation of all companies whose securities are registered with the SEC, (2) FDIC insurance assessments, (3) interchange fees for debit cards, which would be set by the Federal Reserve under a restrictive “reasonable and proportional cost” per transaction standard, (4) minimum capital levels for bank holding companies, subject to a grandfather clause for financial institutions with less than $15 billion in assets, (5) derivative and proprietary trading by financial institutions, and (6) the resolution of large financial institutions.

At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may adversely impact us. However, compliance with these new laws and regulations may increase our costs, limit our ability to pursue attractive business opportunities, cause us to modify our strategies and business operations and increase our capital requirements and constraints, any of which may have a material adverse impact on our business, financial condition, liquidity or results of operations.

In addition to the risk factor mentioned above and other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3. Defaults upon Senior Securities

None.

 

Item 4. Removed and Reserved

 

Item 5. Other Information

None.

 

Item 6. Exhibits

 

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An Exhibit Index listing exhibits that are being filed or furnished with, or incorporated by reference into, this Report appears immediately following the signature page and is incorporated herein by reference.

 

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    ECB BANCORP, INC.
   

(Registrant)

Date: August 12, 2010      
    By:  

        /s/ A. Dwight Utz

              A. Dwight Utz
     

  (President & CEO)

Date: August 12, 2010     By:  

/s/ Thomas M. Crowder

     

Thomas M. Crowder

      (Executive Vice President & CFO)

 

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EXHIBIT INDEX

 

Exhibit
Number
   Description
31.01    Certification of Chief Executive Officer required by Rule 13a-14(a) (furnished herewith)
31.02    Certification of Chief Financial Officer required by Rule 13a-14(a) (furnished herewith)
32.01    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)
32.02    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)

 

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