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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended September 30, 2010

 

OR

 

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

 

For the Transition Period from              to             

 

Commission File Number 000-26995

 

HCSB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

South Carolina

 

57-1079444

(State or other jurisdiction
of incorporation)

 

(I.R.S. Employer
Identification No.)

 

5201 Broad Street

Loris, South Carolina 29569

(Address of principal executive
offices, including zip code)

 

(843) 756-6333

(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 Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated o

 

Smaller reporting company x

(do not check if smaller reporting company)

 

 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  3,787,170 shares of common stock, $.01 par value, were issued and outstanding as of November 13, 2010.

 

 

 



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Index

 

 

 

Page No.

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets - September 30, 2010 and December 31, 2009

 

3

 

 

 

Condensed Consolidated Statements of Income - Nine months ended September 30, 2010 and 2009 and Three months ended September 30, 2010 and 2009

 

4

 

 

 

Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income - Nine months ended September 30, 2010 and 2009

 

5

 

 

 

Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2010 and 2009

 

6

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7-29

 

 

 

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

 

29-45

 

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

45

 

 

 

Item 4. Controls and Procedures

 

46

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

Item 1. Legal Proceedings

 

46

 

 

 

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

 

46

 

 

 

Item 3. Defaults Upon Senior Securities

 

46

 

 

 

Item 4. Submission of Matters to a Vote of Security Holders

 

46

 

 

 

Item 5. Other Information

 

46

 

 

 

Item 6. Exhibits

 

46

 

 

 

(a) Exhibits

 

46

 

2



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Balance Sheets

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

 

 

(Unaudited)

 

(Audited)

 

Assets:

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Cash and due from banks

 

$

9,863

 

$

44,902

 

Federal funds sold

 

17,791

 

1,407

 

Total cash and cash equivalents

 

27,654

 

46,309

 

Investment securities:

 

 

 

 

 

Securities available-for-sale

 

245,852

 

169,463

 

Nonmarketable equity securities

 

6,283

 

6,715

 

Total investment securities

 

252,135

 

176,178

 

Loans held for sale

 

14,876

 

1,669

 

Loans receivable

 

457,267

 

491,652

 

Less allowance for loan losses

 

(13,466

)

(7,525

)

Loans, net

 

443,801

 

484,127

 

Premises, furniture, and equipment, net

 

23,572

 

24,152

 

Accrued interest receivable

 

3,783

 

4,120

 

Cash value of life insurance

 

9,795

 

9,492

 

Other real estate owned

 

17,092

 

6,432

 

Other assets

 

11,757

 

7,170

 

Total assets

 

$

804,465

 

$

759,649

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing transaction accounts

 

$

35,560

 

$

31,661

 

Interest-bearing transaction accounts

 

41,817

 

41,354

 

Money market savings accounts

 

211,079

 

152,553

 

Other savings accounts

 

7,003

 

6,623

 

Time deposits $100,000 and over

 

139,937

 

130,634

 

Other time deposits

 

192,895

 

215,467

 

Total deposits

 

628,291

 

578,292

 

Repurchase agreements

 

6,811

 

8,031

 

Advances from the Federal Home Loan Bank

 

109,200

 

118,800

 

Subordinated debentures

 

12,062

 

 

Junior subordinated debentures

 

6,186

 

6,186

 

Accrued interest payable

 

1,618

 

1,444

 

Other liabilities

 

3,194

 

1,824

 

Total liabilities

 

767,362

 

714,577

 

Shareholders’ Equity:

 

 

 

 

 

Preferred stock, $1,000 par value. Authorized 5,000,000 shares; issued and outstanding 12,895 shares at September 30, 2010 and December 31, 2009, respectively

 

12,104

 

11,962

 

Common stock, $0.01 par value, 10,000,000 shares authorized; 3,787,170 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively

 

38

 

38

 

Capital surplus

 

30,868

 

30,856

 

Common stock warrants

 

1,012

 

1,012

 

Nonvested restricted stock

 

(645

)

(645

)

Retained earnings (deficit)

 

(8,033

)

1,291

 

Accumulated other comprehensive income

 

1,759

 

558

 

Total shareholders’ equity

 

37,103

 

45,072

 

Total liabilities and shareholders’ equity

 

$

804,465

 

$

759,649

 

 

See Notes to the Consolidated Financial Statements

 

3



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

Nine Months Ended Sept 30,

 

Three Months Ended Sept 30,

 

(Dollars in thousands)

 

2010

 

2009

 

2010

 

2009

 

Interest income

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

19,989

 

$

19,088

 

$

6,501

 

$

6,554

 

Investment securities:

 

 

 

 

 

 

 

 

 

Taxable

 

4,223

 

6,019

 

1,337

 

1,897

 

Tax-exempt

 

158

 

184

 

62

 

60

 

Nonmarketable equity securities

 

16

 

26

 

8

 

22

 

Other interest income

 

61

 

17

 

33

 

4

 

Total

 

24,447

 

25,334

 

7,941

 

8,537

 

Interest expense

 

 

 

 

 

 

 

 

 

Certificates of deposit $100,000 & over

 

2,116

 

2,267

 

686

 

706

 

Other deposits

 

5,503

 

6,701

 

1,920

 

2,198

 

Advances from the Federal Home Loan Bank

 

2,616

 

2,503

 

830

 

934

 

Other interest expense

 

765

 

382

 

377

 

108

 

Total

 

11,000

 

11,853

 

3,813

 

3,946

 

Net interest income

 

13,447

 

13,481

 

4,128

 

4,591

 

Provision for loan losses

 

15,511

 

5,782

 

4,099

 

1,510

 

Net interest income (loss) after provision for loan losses

 

(2,064

)

7,699

 

29

 

3,081

 

Other income

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

1,096

 

1,201

 

372

 

414

 

Credit life insurance commission

 

56

 

38

 

7

 

10

 

Gain on sale of mortgage loans

 

679

 

451

 

251

 

130

 

Other fees and commissions

 

276

 

249

 

85

 

77

 

Brokerage commissions

 

194

 

187

 

73

 

51

 

Gain on sale of securities

 

192

 

3,047

 

70

 

891

 

Income from cash value life insurance

 

364

 

261

 

122

 

89

 

Other operating income

 

189

 

93

 

29

 

39

 

Total

 

3,046

 

5,527

 

1,009

 

1,701

 

Other expense

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

7,069

 

7,260

 

2,301

 

2,456

 

Occupancy expense

 

948

 

844

 

322

 

275

 

Advertising and marketing expense

 

285

 

429

 

88

 

121

 

Furniture and equipment expense

 

1,017

 

971

 

350

 

356

 

Loss on other than temporary impairment

 

 

122

 

 

 

Loss/writedowns on sale of assets

 

1,382

 

505

 

1,253

 

209

 

Loss on other assets

 

21

 

8

 

7

 

9

 

FDIC insurance premiums

 

793

 

765

 

267

 

195

 

Other operating expenses

 

2,820

 

2,318

 

1,091

 

772

 

Total

 

14,335

 

13,222

 

5,679

 

4,393

 

Income (Loss) before income taxes

 

(13,353

)

4

 

(4,641

)

389

 

Income tax expense (benefit)

 

(4,654

)

(41

)

(1,624

)

99

 

Net income (loss)

 

(8,699

)

45

 

(3,017

)

290

 

Accretion of preferred stock to redemption value

 

142

 

102

 

48

 

45

 

Preferred dividends accrued

 

163

 

163

 

83

 

82

 

Net income (loss) available to common shareholders

 

$

(9,004

)

$

(220

)

$

(3,148

)

$

163

 

Basic net income (loss) per common share

 

$

(2.38

)

$

(0.06

)

$

(0.83

)

$

0.04

 

Diluted net income (loss) per common share

 

$

(2.38

)

$

(0.06

)

$

(0.83

)

$

0.04

 

 

See Notes on the Consolidated Financial Statements

 

4



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Income

For the Nine Months ended September 30, 2010 and 2009

(Unaudited)

 

(Dollars in thousands except

 

Common Stock

 

Common
Stock

 

Preferred Stock

 

Nonvested
Restricted

 

Capital

 

Retained
Earnings

 

Accumulated
other
comprehensive

 

 

 

share data)

 

Shares

 

Amount

 

Warrants

 

Shares

 

Amount

 

Stock

 

Surplus

 

(deficit)

 

income

 

Total

 

Balance, December 31, 2008

 

3,788,293

 

38

 

$

 

 

$

 

(645

)

30,728

 

3,231

 

1,098

 

34,450

 

Net loss for the period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

45

 

 

 

45

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

992

 

992

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,037

 

Issuance of preferred stock

 

 

 

 

 

 

 

12,895

 

11,815

 

 

 

 

 

 

 

 

 

11,815

 

Issuance of common stock warrants

 

 

 

 

 

1,012

 

 

 

 

 

 

 

 

 

 

 

 

 

1,012

 

Accretion of preferred stock to redemption value

 

 

 

 

 

 

 

 

 

102

 

 

 

 

 

(102

)

 

 

 

Adjustment due to 3% stock dividend

 

(1,123

)

 

 

 

 

 

 

 

 

 

 

(19

)

19

 

 

 

 

Payment of dividend on preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(284

)

 

 

(284

)

Payment of fractional shares

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(19

)

 

 

(19

)

Stock compensation expense

 

 

 

 

 

 

 

 

 

 

 

 

 

110

 

 

 

 

 

110

 

Balance, Sept 30, 2009

 

3,787,170

 

$

38

 

$

1,012

 

12,895

 

$

11,917

 

$

(645

)

$

30,819

 

$

2,890

 

$

2,090

 

$

48,121

 

Balance, December 31, 2009

 

3,787,170

 

$

38

 

$

1,012

 

12,895

 

$

11,962

 

$

(645

)

$

30,856

 

$

1,291

 

$

558

 

$

45,072

 

Net loss for the period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(8,699

)

 

 

(8,699

)

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,201

 

1,201

 

Comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(7,498

)

Accretion of preferred stock to redemption value T

 

 

 

 

 

 

 

 

 

142

 

 

 

 

 

(142

)

 

 

 

Stock compensation expense

 

 

 

 

 

 

 

 

 

 

 

 

 

12

 

 

 

 

 

12

 

Payment of dividend on preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(483

)

 

 

(483

)

Balance, Sept 30, 2010

 

3,787,170

 

$

38

 

$

1,012

 

12,895

 

$

12,104

 

$

(645

)

$

30,868

 

$

(8,033

)

$

1,759

 

$

37,103

 

 

See Notes on the Consolidated Financial Statements

 

5



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Nine Months Ended September 30,

 

(Dollars in thousands)

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(8,699

)

$

45

 

Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:

 

 

 

 

 

Depreciation

 

795

 

689

 

Provision for loan losses

 

15,511

 

5,782

 

Amortization less accretion on investments

 

763

 

542

 

Amortization of deferred loan costs

 

21

 

7

 

Originations from sales of loans held for sale

 

(34,628

)

(27,129

)

Sale or paydowns of loans held for sale

 

21,420

 

26,143

 

Gain on sale of securities available-for-sale

 

(192

)

(3,047

)

Gain on sale of fixed assets

 

(4

)

 

Loss on sale or writedown of other real estate

 

1,382

 

505

 

(Increase) in interest receivable

 

337

 

(170

)

Increase (decrease) in interest payable

 

174

 

(664

)

Increase in other assets

 

(4,587

)

(361

)

Income (net mortality costs) on cash value of life insurance

 

(303

)

(222

)

Stock compensation expense

 

12

 

110

 

Other than temporary impairment of investment security

 

 

122

 

Increase (decrease) in other liabilities

 

663

 

(1,146

)

Net cash provided (used) by operating activities

 

(7,335

)

1,206

 

Cash flows from investing activities:

 

 

 

 

 

Net (increase) decrease in loans to customers

 

9,989

 

(63,698

)

Purchases of securities available-for-sale

 

(164,368

)

(162,945

)

Maturities of securities available-for-sale

 

70,639

 

64,207

 

Proceeds from sales of securities available-for-sale

 

18,677

 

72,975

 

Sales (purchases) of nonmarketable equity securities

 

432

 

(1,441

)

Purchases of premises and equipment

 

(227

)

(4,827

)

Proceeds from disposals of premises and equipment

 

16

 

 

Proceeds from sale of other real estate

 

2,764

 

2,408

 

Purchase of life insurance contracts

 

 

(600

)

Net cash used by investing activities

 

(62,078

)

(93,921

)

Cash flows from financing activities:

 

 

 

 

 

Net increase in deposits

 

49,999

 

107,488

 

Decrease in federal funds purchased

 

 

(7,653

)

Increase in subordinated debentures

 

12,062

 

 

Increase (decrease) in FHLB borrowings

 

(9,600

)

23,800

 

Net increase in preferred stock

 

 

12,827

 

Increase (decrease) in repurchase agreements

 

(1,220

)

1,170

 

Decrease in notes payable

 

 

(4,500

)

Dividends paid on preferred stock

 

(483

)

(284

)

Cash paid in lieu of fractional shares

 

 

(19

)

Net cash provided by financing activities

 

50,758

 

132,829

 

Net increase (decrease) in cash and cash equivalents

 

(18,655

)

40,114

 

Cash and cash equivalents, beginning of period

 

46,309

 

10,423

 

Cash and cash equivalents, end of period

 

$

27,654

 

$

50,537

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

 

$

803

 

Interest

 

$

8,662

 

$

12,516

 

 

See Notes on the Consolidated Financial Statements

 

6



Table of Contents

 

HCSB FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

 

HCSB Financial Corporation (the “Company,” which may be referred to as “we,” “us,” or “our”) was incorporated on June 10, 1999 to become a holding company for Horry County State Bank (the “Bank”).  The Bank is a state chartered bank which commenced operations on January 4, 1988.  From our 14 branch locations, we offer a full range of deposit services, including checking accounts, savings accounts, certificates of deposit, money market accounts, and IRAs, as well as a broad range of non-deposit investment services.

 

The accompanying consolidated financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they are condensed and omit disclosures, which would substantially duplicate those contained in the most recent annual report to shareholders.  The financial statements as of September 30, 2010 and for the interim periods ended September 30, 2010 and 2009 are unaudited and, in our opinion, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation.  Operating results for the nine-month period ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.  The financial information as of December 31, 2009 has been derived from the audited financial statements as of that date.  For further information, refer to the financial statements and the notes included in the Company’s 2009 Annual Report on Form 10-K.

 

On March 6, 2009, as part of the Troubled Asset Relief Program (the “TARP”) Capital Purchase Program (the “CPP”) established by the U.S. Treasury under the Emergency Economic Stabilization Act of 2009 (“EESA”), the Company issued and sold to the U.S. Treasury (i) 12,895 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series T, having a liquidation preference of $1,000 per share (the “Series T Preferred Stock”), and (ii) a ten-year warrant to purchase up to 91,714 shares of its common stock at an initial exercise price of $21.09 per share (the “CPP Warrant”), for an aggregate purchase price of $12,895,000 in cash.  Refer to the accompanying Management’s Discussion and Analysis of Financial Condition and results of Operations for additional information.

 

There was no stock dividend declared in January 2010 because the Company is prohibited from declaring any dividends on its common stock until March 6, 2012 without the U.S. Treasury’s approval unless the 12,985 shares of the Series T Preferred Stock have been repurchased from the U.S. Treasury.  In January 2009, the Board of Directors declared a stock dividend payable on February 20, 2009 to shareholders of record on February 6, 2009.  As a result of the 3% stock dividend, 110,338 shares were issued.  The Company recorded this dividend in shareholders’ equity for the year ended December 31, 2008.  All share and per share amounts have been adjusted to reflect these dividends.

 

Note 2 — Summary of Significant Accounting Policies

 

Organization - HCSB Financial Corporation was incorporated on June 10, 1999 to serve as a bank holding company for its wholly owned subsidiary, Horry County State Bank.  The Company was incorporated on June 10, 1999. The Bank was incorporated on December 18, 1987, and opened for operations on January 4, 1988.  The principal business activity of the Company is to provide commercial banking services in Horry County, South Carolina, and in Columbus and Brunswick Counties, North Carolina.  The Bank is a state-chartered bank, and its deposits are insured by the Federal Deposit Insurance Corporation.  HCSB Financial Trust I (The Trust) is a special purpose subsidiary organized for the sole purpose of issuing trust preferred securities.  The operations of the Trust have not been consolidated in these financial statements.

 

Management’s Estimates - In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and income and expenses for the period.  Actual results could differ significantly from those estimates.

 

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, and the carrying amount of real estate acquired in

 

7



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

connection with foreclosures or in satisfaction of loans.  Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.

 

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in local economic conditions.  In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for losses on loans and foreclosed real estate.  Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.  Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change materially in the near term.

 

Investment Securities - Investment securities available-for-sale by the Company are carried at amortized cost and adjusted to their estimated fair value for reporting purposes.  The unrealized gain or loss is recorded in shareholders’ equity net of the deferred tax effects.  Management does not actively trade securities classified as available-for-sale, but intends to hold these securities for an indefinite period of time and may sell them prior to maturity to achieve certain objectives.  Reductions in fair value considered by management to be other than temporary are reported as a realized loss and a reduction in the cost basis in the security.  The adjusted cost basis of securities available-for-sale is determined by specific identification and is used in computing the realized gain or loss from a sales transaction.

 

Nonmarketable Equity Securities - Nonmarketable equity securities include the Company’s investments in the stock of the Federal Home Loan Bank.  The stocks are carried at cost because they have no quoted market value and no ready market exists.  Investment in Federal Home Loan Bank stock is a condition of borrowing from the Federal Home Loan Bank, and the stock is pledged to collateralize the borrowings.  Dividends received on Federal Home Loan Bank stock is included as a separate component in interest income.

 

Loans held for Sale - Loans held for sale consist of residential mortgage loans the Company originates for sale to secondary market investors.  They are carried at the lower of aggregate cost or market value.  Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.  Fees collected in conjunction with origination activities are deferred as part of the cost basis of the loan and recognized when the loan is sold.  Gains or losses on sales are recognized when the loans are sold and are determined as the difference between the sales price and the carrying value of the loans.

 

The Company issues rate lock commitments to borrowers based on prices quoted by secondary market investors.  When rates are locked with borrowers, a sales commitment is immediately entered (on a best efforts basis) at a specified price with a secondary market investor.  Accordingly, any potential liabilities associated with rate lock commitments are offset by sales commitments to investors.

 

Loans Receivable - Loans receivable are stated at their unpaid principal balance.  Interest income on loans is computed based upon the unpaid principal balance.  Interest income is recorded in the period earned.

 

The accrual of interest income is generally discontinued when a loan becomes contractually 90 days past due as to principal or interest.  Management may elect to continue the accrual of interest when the estimated net realizable value of collateral exceeds the principal balance and accrued interest.

 

Loan origination and commitment fees and certain direct loan origination costs (principally salaries and employee benefits) are deferred and amortized to income over the contractual life of the related loans or commitments, adjusted for prepayments, using the straight-line method.

 

Loans are defined as impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All loans are subject to this criteria except for smaller balance homogeneous loans that are collectively evaluated for impairment and loans measured at fair value or at the lower of

 

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HCSB FINANCIAL CORPORATION

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

cost or fair value.  The Company considers its consumer installment portfolio, credit card loans, and home equity lines as such exceptions.  Therefore, loans within the real estate and commercial loan portfolios are reviewed individually.

 

Impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.  When management determines that a loan is impaired, the difference between the Company’s investment in the related loan and the present value of the expected future cash flows, or the fair value of the collateral, is charged off with a corresponding entry to the allowance for loan losses.  The accrual of interest is discontinued on an impaired loan when management determines the borrower may be unable to meet payments as they become due.

 

Concentrations of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks.

 

The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily throughout Horry County in South Carolina and Columbus and Brunswick counties of North Carolina.  The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions except for loans secured by residential and commercial real estate and commercial and industrial non-real estate loans.

 

In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.), and loans with high loan-to-value ratios. Management has determined that there is no concentration of credit risk associated with its lending policies or practices. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life.  For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored to manage the associated risks.  Therefore, management believes that these particular practices do not subject the Company to unusual credit risk.

 

The Company’s investment portfolio consists principally of obligations of the United States, its agencies or its corporations and general obligation municipal securities.  In the opinion of management, there is no concentration of credit risk in its investment portfolio.  The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions.  Management believes credit risk associated with correspondent accounts is not significant.

 

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

 

The allowance is subject to examination by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other

 

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HCSB FINANCIAL CORPORATION

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

adequacy tests.  In addition, such regulatory agencies could require the Company to adjust its allowance based on information available to them at their examination.

 

The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to that used to determine the allowance for loan losses adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.

 

Premises, Furniture and Equipment - Premises, furniture and equipment are stated at cost less accumulated depreciation.  The provision for depreciation is computed by the straight-line method.  Rates of depreciation are generally based on the following estimated useful lives:  buildings - 40 years; furniture and equipment - 3 to 25 years.  The cost of assets sold or otherwise disposed of and the related accumulated depreciation is eliminated from the accounts, and the resulting gains or losses are reflected in the income statement.

 

Maintenance and repairs are charged to current expense as incurred, and the costs of major renewals and improvements are capitalized.

 

Other Real Estate Owned - Other real estate owned includes real estate acquired through foreclosure.  Other real estate owned is initially recorded at the lower of cost (principal balance of the former loan plus costs of improvements) or fair value, less estimated costs to sell.

 

Any write-downs at the dates of acquisition are charged to the allowance for loan losses.  Expenses to maintain such assets, subsequent write-downs, and gains and losses on disposal are included in other expenses.

 

Income and Expense Recognition - The accrual method of accounting is used for all significant categories of income and expense.  Immaterial amounts of insurance commissions and other miscellaneous fees are reported when received.

 

Income Taxes - Amounts provided for income taxes are based on income reported for financial statement purposes. Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow.  Therefore no reserves for uncertain income tax positions have been recorded.

 

Net Income (Loss) Per Common Share - Basic income (loss) per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the year.  Diluted net income per share is computed based on net income divided by the weighted average number of common and potential common shares.  Retroactive recognition has been given for the effects of all stock dividends and splits in computing the weighted-average number of shares.  The only potential common share equivalents are those related to stock options and restricted stock awards.  Stock options which are anti-dilutive are excluded from the calculation of diluted net income per share.

 

Comprehensive Income - Accounting principles generally require recognized income, expenses, gains, and losses to be included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

 

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HCSB FINANCIAL CORPORATION

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

Statements of Cash Flows - For purposes of reporting cash flows, the Company considers certain highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.  Cash equivalents include amounts due from banks, federal funds sold, and time deposits with other banks with maturities of three months or less.

 

Off-Balance-Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance-sheet financial instruments consisting of commitments to extend credit and letters of credit.  These financial instruments are recorded in the financial statements when they become payable by the customer.

 

Recently Issued 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.

 

Stock compensation guidance was updated in April 2010 to address the classification of employee share-based payment awards with exercise prices dominated in the currency of a market in which a substantial portion of the entity’s equity securities trade.  The guidance states that these awards should not be considered to contain a condition that is not a market, performance, or service condition. Share based payments that contain conditions related to market, performance and service must be recorded as liabilities.  These awards should not be classified as liabilities if they otherwise qualify to be classified as equity.  The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The Company does not expect the update to have an impact on the financial statements.

 

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HCSB FINANCIAL CORPORATION

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

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.

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.  Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies.  The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks.  Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments.  Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on our business, financial condition, and results of operations.

 

In August 2010, two updates were issued to amend various SEC rules and schedules pursuant to Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies and based on the issuance of SEC Staff Accounting Bulletin 112.  The amendments related primarily to business combinations and removed references to “minority interest” and added references to “controlling” and “noncontrolling interests(s)”.  The updates were effective upon issuance but had no impact on the Company’s financial statements.

 

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 or cash flows.

 

Risks and Uncertainties - In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory.  There are three main components of economic risk:  interest rate risk, credit risk and market risk.  The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets.  Credit risk is the risk of default on the Company’s loan portfolio that results from borrower’s inability or unwillingness to make contractually required payments.  Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

 

The Company is subject to the regulations of various governmental agencies.  These regulations can and do change significantly from period to period.  The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.

 

Additionally, the Company is subject to certain regulations due to our participation in the Capital Purchase Program.  Pursuant to the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the CPP Purchase Agreement, including the common stock which may be issued pursuant to the CPP Warrant.  These standards generally apply to our named executive officers. The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior

 

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HCSB FINANCIAL CORPORATION

 

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; (4) prohibition on providing tax gross-up provisions; and (5) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.  In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.

 

Legislation that has been adopted after we closed on our sale of Series T Preferred Stock and warrants to the Treasury for $12.9 million pursuant to the Capital Purchase Program on March 6, 2009, or any legislation or regulations that may be implemented in the future, may have a material impact on the terms of our Capital Purchase Program transaction with the Treasury.   If we determine that any such legislation or any regulations, in whole or in part, alter the terms of our Capital Purchase Program transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then it is possible that we may seek to unwind, in whole or in part, the Capital Purchase Program transaction by repurchasing some or all of the preferred stock and warrants that we sold to the Treasury pursuant to the Capital Purchase Program.  If we were to repurchase all or a portion of such preferred stock or warrants, then our capital levels could be materially reduced.

 

Reclassifications - Certain captions and amounts in the 2009 financial statements were reclassified to conform to the 2010 presentation.

 

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HCSB FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

NOTE 3 — EARNINGS PER SHARE

 

A reconciliation of the numerators and denominators used to calculate basic and diluted earnings per share for the nine and three months ended September 30, 2010 and 2009 are as follows:

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Income

 

Shares

 

Per Share

 

(Dollars in thousands)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders

 

$

(9,004

)

3,787,170

 

$

(2.38

)

 

 

 

 

 

 

 

 

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders plus assumed conversions

 

$

(9,004

)

3,787,170

 

$

(2.38

)

 

 

 

Nine Months Ended September 30, 2009

 

 

 

Income

 

Shares

 

Per Share

 

 

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders

 

$

(220

)

3,787,380

 

$

(0.06

)

 

 

 

 

 

 

 

 

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders plus assumed conversions

 

$

(220

)

3,787,380

 

$

(0.06

)

 

 

 

Three Months Ended September 30, 2010

 

 

 

Income

 

Shares

 

Per Share

 

 

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders

 

$

(3,148

)

3,787,170

 

$

(0.83

)

 

 

 

 

 

 

 

 

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders plus assumed conversions

 

$

(3,148

)

3,787,170

 

$

(0.83

)

 

 

 

Three Months Ended September 30, 2009

 

 

 

Income

 

Shares

 

Per Share

 

 

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders

 

$

163

 

3,787,380

 

$

0.04

 

 

 

 

 

 

 

 

 

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

33,954

 

 

 

Diluted earnings per common share

 

 

 

 

 

 

 

Income (loss) available to common shareholders plus assumed conversions

 

$

163

 

3,821,334

 

$

0.04

 

 

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HCSB FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

NOTE 4 - COMPREHENSIVE INCOME

 

The following table sets forth the amounts of other comprehensive income included in equity along with the related tax effect for the nine months ended September 30, 2010 and 2009 and for the three months ended September 30, 2010 and 2009:

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Pre-Tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

1,716

 

$

(636

)

$

1,080

 

Plus: reclassification adjustment for gains (losses) realized in net income

 

192

 

(71

)

121

 

Net unrealized gains (losses) on securities

 

1,908

 

(707

)

1,201

 

Other comprehensive income (loss)

 

$

1,908

 

$

(707

)

$

1,201

 

 

 

 

Nine Months Ended September 30, 2009

 

 

 

Pre-Tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

(1,472

)

$

544

 

$

(928

)

Plus: reclassification adjustment for gains (losses) realized in net income

 

3,047

 

(1,127

)

1,920

 

Net unrealized gains (losses) on securities

 

1,575

 

(583

)

992

 

Other comprehensive income (loss)

 

$

1,575

 

$

(583

)

$

992

 

 

 

 

Three Months Ended September 30, 2010

 

 

 

Pre-Tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

1,857

 

$

(687

)

$

1,170

 

Plus: reclassification adjustment for gains (losses) realized in net income

 

70

 

(26

)

44

 

Net unrealized gains (losses) on securities

 

1,927

 

(713

)

1,214

 

Other comprehensive income (loss)

 

$

1,927

 

$

(713

)

$

1,214

 

 

 

 

Three Months Ended September 30, 2009

 

 

 

Pre-Tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

636

 

$

(235

)

$

401

 

Plus: reclassification adjustment for gains (losses) realized in net income

 

891

 

(330

)

561

 

Net unrealized gains (losses) on securities

 

1,527

 

(565

)

962

 

Other comprehensive income (loss)

 

$

1,527

 

$

(565

)

$

962

 

 

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HCSB FINANCIAL CORPORATION

 

NOTE 5 -  INVESTMENT PORTFOLIO

 

Management classifies investment securities as either held-to-maturity or available-for-sale based on their intentions and the Company’s ability to hold them until maturity.  In determining such classifications, securities that management has the positive intent and the Company has the ability to hold until maturity are classified as held-to-maturity and carried at amortized cost.  All other securities are designated as available-for-sale and carried at estimated fair value with unrealized gains and losses included in shareholders’ equity on an after-tax basis.  As of September 30, 2010, all securities were classified as available-for-sale.

 

Securities available-for-sale consisted of the following:

 

 

 

Amortized

 

Gross Unrealized

 

Estimated

 

(Dollars in thousands)

 

Cost

 

Gains

 

Losses

 

Fair Value

 

September 30, 2010

 

 

 

 

 

 

 

 

 

Government-sponsored enterprises

 

$

46,078

 

$

1,034

 

$

 

$

47,112

 

Mortgage-backed securities

 

188,589

 

3,429

 

2,014

 

190,004

 

Obligations of state and local governments

 

8,392

 

349

 

5

 

8,736

 

Total

 

$

243,059

 

$

4,812

 

$

2,019

 

$

245,852

 

December 31, 2009

 

 

 

 

 

 

 

 

 

Government-sponsored enterprises

 

$

27,730

 

$

98

 

$

317

 

$

27,511

 

Mortgage-backed securities

 

135,386

 

1,928

 

1,059

 

136,255

 

Obligations of state and local governments

 

5,462

 

257

 

22

 

5,697

 

Total

 

$

168,578

 

$

2,283

 

$

1,398

 

$

169,463

 

 

The following is a summary of maturities of securities available-for-sale as of September 30, 2010.  The amortized cost and estimated fair values are based on the contractual maturity dates.  Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty.

 

 

 

Securities

 

 

 

Available-For-Sale

 

 

 

Amortized

 

Estimated

 

(Dollars in thousands)

 

Cost

 

Fair Value

 

Due in less than one year

 

$

 

$

 

Due after one year but within five years

 

3,963

 

4,106

 

Due after five years but within ten years

 

46,308

 

47,215

 

Due after ten years

 

192,788

 

194,531

 

Total

 

$

243,059

 

$

245,852

 

 

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HCSB FINANCIAL CORPORATION

 

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at:

 

 

 

 

 

September 30, 2010

 

 

 

 

 

 

 

Less than

 

Twelve months

 

 

 

 

 

 

 

twelve months

 

or more

 

Total

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

(Dollars in thousands)

 

Fair value

 

losses

 

Fair value

 

losses

 

Fair value

 

losses

 

Government-sponsored enterprises

 

$

2,993

 

$

 

$

 

$

 

$

2,993

 

$

 

Mortgage-backed securities

 

57,854

 

1,663

 

6,730

 

351

 

64,584

 

2,014

 

Obligations of state and local governments

 

503

 

5

 

 

 

503

 

5

 

Total

 

$

61,350

 

$

1,668

 

$

6,730

 

$

351

 

$

68,080

 

$

2,019

 

 

 

 

 

 

December 31, 2009

 

 

 

 

 

Less than

 

Twelve months

 

 

 

 

 

twelve months

 

or more

 

Total

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

(Dollars in thousands)

 

Fair value

 

losses

 

Fair value

 

losses

 

Fair value

 

losses

 

Government-sponsored enterprises

 

$

14,835

 

$

317

 

$

 

$

 

$

14,835

 

$

317

 

Mortgage-backed securities

 

25,493

 

946

 

1,218

 

113

 

26,711

 

1,059

 

Obligations of state and local governments

 

253

 

22

 

 

 

253

 

22

 

Total

 

$

40,581

 

$

1,285

 

$

1,218

 

$

113

 

$

68,362

 

$

1,398

 

 

At September 30, 2010, the Bank had five individual securities, or 2.74% of the security portfolio, that have been in an unrealized loss position for more than twelve months.  The Bank does not intend to sell these securities and it is more likely than not that the Bank will not be required to sell these securities before recovery of their amortized cost.  The Bank believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore these losses are not considered other-than-temporary.

 

At September 30, 2010 and December 31, 2009, investment securities with a book value of $149,706,000 and $142,877,000, respectively, and a market value of $152,213,000 and $143,744,000, respectively, were pledged to secure deposits.

 

Gross realized gains on sales of available-for-sale securities as of September 30, 2010 were $507,000, and there were $315,000 in realized losses.

 

NOTE 6 - LOAN PORTFOLIO

 

As a result of a decline in economic conditions in our marketplace and a decline in the quality of the loan portfolio contributing to more charge-offs of loans within the portfolio, the Company has experienced a decline in its loan portfolio throughout 2010 of $34,385,000 to $457,267,000 as of September 30, 2010.  Management has concentrated on improving the credit quality of the loan portfolio. The loan-to-deposit ratio is used to monitor a financial institution’s potential profitability and efficiency of asset distribution and utilization.  Generally, a higher loan-to-deposit ratio is indicative of higher interest income since loans typically yield a higher return than other interest-earning assets.  The loan-to-deposit ratio was 72.78% and 85.02% at September 30, 2010 and December 31, 2009, respectively.  The Company attempted to improve its liquidity position by investing more in its securities portfolio, which not only provides cash flow but also improves our capital position.  The loans-to-total borrowed funds ratio was 59.97% and 69.12% at September 30, 2010 and December 31, 2009, respectively.  Management intends to deploy available funds to loans to the extent it deems prudent to achieve its targeted ratio of loans to

 

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deposits; however, there can be no assurance that management will be able to execute its strategy or that loan demand will continue to support growth.

 

The following table sets forth the composition of the loan portfolio by category at September 30, 2010 and December 31, 2009 and highlights the Company’s general emphasis on mortgage lending.

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Real estate - construction and land development

 

$

99,250

 

95,788

 

Real estate - other

 

270,196

 

305,561

 

Agricultural

 

14,100

 

10,338

 

Commercial and industrial

 

57,037

 

60,914

 

Consumer

 

13,467

 

15,871

 

Other, net

 

3,217

 

3,180

 

 

 

$

457,267

 

$

491,652

 

 

The primary component of our loan portfolio is loans collateralized by real estate, which made up approximately 80.79% of our loan portfolio at September 30, 2010.  These loans are secured generally by first or second mortgages on residential, agricultural or commercial property.  These loans consist of commercial real estate loans, which as of December 31, 2009 totaled $266,750,000, or 66.46% of our real estate loans.  We anticipate decreasing our amount of commercial real estate loans in 2010.  There are no foreign loans, and agricultural loans, as of September 30, 2010, were $14,100,000.  There are no significant concentrations of loans in any particular individuals or industry or group of related individuals or industries.

 

Transactions in the allowance for loan losses are summarized below:

 

 

 

Nine Months ended Sept 30,

 

(Dollars in thousands)

 

2010

 

2009

 

Balance, beginning of period

 

$

7,525

 

$

4,416

 

Provision charged to operations

 

15,511

 

5,782

 

Recoveries on loans previously charged off

 

599

 

2,488

 

Loans charged off

 

(10,169

)

(6,785

)

Balance, end of period

 

$

13,466

 

$

5,901

 

 

NOTE 7 — OTHER REAL ESTATE OWNED

 

Transactions in other real estate owned for the nine-month period ended September 30, 2010 and the year ended December 31, 2009:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Balance, beginning of year

 

$

6,432

 

2,965

 

Additions

 

14,807

 

6,490

 

Sales proceeds

 

(2,765

)

(2,503

)

Net loss and/or write-downs

 

(1,382

)

(520

)

Balance, end of period

 

$

17,092

 

$

6,432

 

 

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NOTE 8 — DEPOSITS

 

At September 30, 2010, total deposits had increased by $49,999,000, or 8.65%, from December 31, 2009.  Noninterest bearing deposits increased $3,899,000 to $35,560,000 and interest-bearing deposits increased $46,100,000 to $592,731,000.  Expressed in percentages, noninterest-bearing deposits increased 12.31% and interest-bearing deposits increased 8.43%.

 

Balances within the major deposit categories as of September 30, 2010 and December 31, 2009 are as follows:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Noninterest-bearing demand deposits

 

$

35,560

 

$

31,661

 

Interest-bearing demand deposits

 

41,817

 

41,354

 

Savings and money market deposits

 

218,082

 

159,176

 

Certificates of deposits

 

332,832

 

346,101

 

 

 

$

628,291

 

$

578,292

 

 

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NOTE 9 — ADVANCES FROM THE FEDERAL HOME LOAN BANK

 

Advances from the Federal Home Loan Bank consisted of the following at September 30, 2010:

 

(Dollars in thousands)

 

Date of Advance

 

Rate

 

Quarterly
Payment

 

Maturity Date

 

Balance

 

March 19, 2001

 

0.29

%

7

 

March 22, 2011

 

5,000

 

January 17, 2002

 

0.52

%

4

 

January 17, 2012

 

5,000

 

July 23, 2002

 

3.81

%

48

 

July 23,2012

 

5,000

 

December 8, 2004

 

3.24

%

41

 

December 8, 2014

 

5,000

 

September 4, 2007

 

4.42

%

58

 

September 4, 2012

 

5,000

 

September 7, 2007

 

4.05

%

10

 

September 7, 2012

 

1,000

 

October 15, 2007

 

4.59

%

58

 

October 15, 2010

 

5,000

 

January 25, 2008

 

2.73

%

14

 

January 26, 2015

 

2,000

 

March 19, 2008

 

2.66

%

27

 

March 19, 2015

 

4,000

 

August 20, 2008

 

3.44

%

44

 

August 20, 2018

 

5,000

 

September 4, 2008

 

3.60

%

19

 

September 4,2018

 

2,000

 

September 4,2008

 

3.32

%

44

 

September 4,2018

 

5,000

 

September 8, 2008

 

3.25

%

42

 

September 10, 2018

 

5,000

 

September 8, 2008

 

3.45

%

44

 

September 10, 2018

 

5,000

 

September 18, 2008

 

2.95

%

39

 

September 18, 2018

 

5,000

 

October 10, 2008

 

2.63

%

34

 

October 10, 2018

 

5,000

 

December 18, 2008

 

2.63

%

33

 

October 18, 2013

 

5,000

 

January 22,2009

 

2.95

%

2

 

January 22, 2014

 

200

 

January 29, 2009

 

2.87

%

15

 

January 29, 2013

 

2,000

 

February 17,2009

 

1.94

%

2

 

March 16, 2011

 

500

 

February 20, 2009

 

2.93

%

15

 

February 20, 2013

 

2,000

 

March 2, 2009

 

2.90

%

22

 

March 4, 2013

 

3,000

 

March 5, 2009

 

2.56

%

6

 

April 13, 2012

 

1,000

 

March 17, 2009

 

2.56

%

3

 

March 19, 2012

 

500

 

March 20, 2009

 

3.05

%

15

 

March 20, 2014

 

2,000

 

April 8, 2009

 

2.86

%

14

 

April 8, 2013

 

2,000

 

April 14, 2009

 

2.65

%

13

 

April 15, 2013

 

2,000

 

April 20, 2009

 

2.95

%

22

 

April 21, 2014

 

3,000

 

April 21, 2009

 

2.55

%

13

 

April 22, 2013

 

2,000

 

April 27, 2009

 

2.95

%

15

 

April 28, 2014

 

2,000

 

May 1, 2009

 

2.60

%

13

 

May 1, 2013

 

2,000

 

May 8, 2009

 

3.00

%

23

 

May 8, 2014

 

3,000

 

August 20, 2009

 

3.86

%

49

 

August 20, 2019

 

5,000

 

October 1, 2009

 

2.89

%

22

 

October 1, 2014

 

3,000

 

 

 

 

 

$

830

 

 

 

$

109,200

 

 

As of September 30, 2010, the Bank’s portfolio of FHLB advances consisted of $10,000,000 of adjustable rate credits, $40,200,000 of fixed rate credit, and $59,000,000 of fixed rate convertible advances.  Interest on fixed rate advances is generally payable monthly and interest on all other advances is payable quarterly.  Convertible advances are callable by the FHLB on their respective call dates.  The Bank has the option to either repay any advance that has been called or to refinance the advance as an adjustable rate credit.

 

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NOTE 9 — ADVANCES FROM THE FEDERAL HOME LOAN BANK

 

At September 30, 2010 the Bank had pledged as collateral for FHLB advances approximately $20,371,000 of 1-4 family first mortgage loans, $31,176,000 of commercial real estate loans, $15,291,000 in home equity lines of credit and $4,028,000 in multi-family loans. We also have pledged to the FHLB $97,140,000 of agency and private issue mortgage securities.  The Bank had an investment in FHLB stock of $6,072,000.

 

NOTE 10 — SUBORDINATED DEBENTURES

 

On December 21, 2004, HCSB Financial Trust I (the “Trust”), a non-consolidated subsidiary of the Company, issued and sold a total of 6,000 trust preferred securities, with $1,000 liquidation amount per capital security (the “Capital Securities”), to institutional buyers in a pooled trust preferred issue.  The Capital Securities, which are reported on the consolidated balance sheet as junior subordinated debentures, generated proceeds of $6 million.  The Trust loaned these proceeds to the Company to use for general corporate purposes.  The junior subordinated debentures qualify as Tier 1 capital under Federal Reserve Board guidelines, subject to limitations.

 

Debt issuance costs, net of accumulated amortization, from junior subordinated debentures totaled $88,611 and $88,611 at September 30, 2010 and 2009, respectively, and are included in other assets on the consolidated balance sheet.  Amortization of debt issuance costs from junior subordinated debentures totaled $2,750 for the periods ended September 30, 2010 and September 30, 2009.

 

In the third quarter of 2010, we concluded an offering of subordinated promissory notes to enhance and strengthen our capital and liquidity such that we could maintain the resources needed to maintain “well-capitalized” levels of regulatory capital at the Bank.  Through September 30, 2010, we raised $12,062,011.57 in aggregate principal amount through the offering.  The subordinated notes were sold to a limited number of purchasers in a private offering; bear interest at a rate equal to the current Prime Rate in effect, as published by the Wall Street Journal, plus 3.00%, provided, that the rate of interest shall not be less than 8.00% per annum or more than 12.00% per annum; are callable anytime after April 19, 2014; and mature in 2020. The subordinated notes have been structured to fully count as Tier 2 regulatory capital on a consolidated basis.

 

NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments.  Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss, current economic conditions, risk characteristics of various financial instruments, and other factors.

 

The following methods and assumptions were used to estimate the fair value of significant financial instruments:

 

Cash and Due from Banks - The carrying amount is a reasonable estimate of fair value.

 

Federal Funds Sold and Purchased - Federal funds sold and purchased are for a term of one day and the carrying amount approximates the fair value.

 

Time Deposits with Other Banks - Time deposits with other banks have a term less than 90 days and the carrying amount approximates the fair value.

 

Investment Securities Available-for-Sale - For securities available-for-sale, fair value equals the carrying amount, which is the quoted market price.  If quoted market prices are not available, fair values are based on quoted market prices of comparable securities.

 

Nonmarketable Equity Securities - The carrying amount is a reasonable estimate of fair value since no ready market exists for these securities.

 

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Loans Held-for-Sale - Fair values of mortgage loans held for sale are based on commitments on hand from investors or market prices.

 

Loans Receivable - For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk and credit card receivables, fair values are based on the carrying amounts.  The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to the borrowers with similar credit ratings and for the same remaining maturities.

 

Deposits - The fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date.  The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities.

 

Advances from the Federal Home Loan Bank - For the portion of borrowings immediately callable, fair value is based on the carrying amount.  The fair value of the portion maturing at a later date is estimated using a discounted cash flow calculation that applies the interest rate of the immediately callable portion to the portion maturing at the future date.

 

Subordinated Debentures - The carrying value of subordinated debentures is a reasonable estimate of fair value since the debentures were issued at a floating rate.

 

Junior Subordinated Debentures - The carrying value of junior subordinated debentures is a reasonable estimate of fair value since the debentures were issued at a floating rate.

 

Accrued Interest Receivable and Payable - The carrying value of these instruments is a reasonable estimate of fair value.

 

Commitments to Extend Credit and Standby Letters of Credit - The contractual amount is a reasonable estimate of fair value for the instruments because commitments to extend credit and standby letters of credit are issued on a short-term or floating rate basis and include no unusual credit risks.

 

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FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

 

The carrying values and estimated fair values of the Company’s financial instruments were as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

Carrying

 

Estimated

 

Carrying

 

Estimated

 

(Dollars in thousands)

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

9,863

 

$

9,863

 

$

44,902

 

$

44,902

 

Federal funds sold

 

17,791

 

17,791

 

1,407

 

1,407

 

Investment securities available-for-sale

 

245,852

 

245,852

 

169,463

 

169,463

 

Nonmarketable equity securities

 

6,283

 

6,283

 

6,715

 

6,715

 

Loans and loans held-for-sale

 

472,143

 

471,494

 

493,321

 

491,445

 

Accrued interest receivable

 

3,783

 

3,783

 

4,120

 

4,120

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Demand deposit, interest-bearing transaction, and savings accounts

 

$

295,459

 

$

295,459

 

$

232,191

 

$

232,191

 

Certificates of deposit

 

332,832

 

335,700

 

346,101

 

347,721

 

Repurchase agreements

 

6,811

 

6,811

 

8,031

 

8,031

 

Advances from the Federal Home Loan Bank

 

109,200

 

112,036

 

118,800

 

120,822

 

Subordinated debentures

 

12,062

 

12,062

 

 

 

Junior subordinated debentures

 

6,186

 

6,186

 

6,186

 

6,186

 

Accrued interest payable

 

1,618

 

1,618

 

1,444

 

1,444

 

 

 

 

Notional

 

Estimated

 

Notional

 

Estimated

 

 

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

Off-Balance Sheet Financial Instruments:

 

 

 

 

 

 

 

 

 

Commitments to extend credit

 

$

50,203

 

$

N/A

 

$

53,840

 

N/A

 

Standby letters of credit

 

1,083

 

N/A

 

1,137

 

N/A

 

 

The Company has adopted FASB ASC Topic 820, which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. The standard requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).

 

The standard also defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1

 

Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasury securities and money market funds.

 

 

 

Level 2

 

Observable inputs other than Level 1 prices such as quoted prices for similar assets or

 

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liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities, and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts and impaired loans.

 

 

 

Level 3

 

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly-structured or long-term derivative contracts.

 

The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.

 

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.

 

Mortgage Loans Held for Sale

 

Mortgage loans held for sale are carried at market value on a recurring basis.  The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics.

 

Loans

 

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan may be considered impaired and an allowance for loan losses may be established.  Loans for which it is probable that payment of 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 estimated fair value methodologies. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value 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 September 30, 2010, substantially all of the impaired loans were evaluated based on the fair value of the collateral because such loans were considered collateral dependent.  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 considers 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 considers the impaired loan as nonrecurring Level 3.

 

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FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

 

Other Real Estate Owned (“OREO”)

 

Typically non-covered OREO, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2).   At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses.  Gains or losses on sale and generally any subsequent adjustments to the value are recorded as a component of OREO expense.

 

Assets and liabilities measured at fair value on a recurring basis are as follows as of September 30, 2010:

 

(Dollars in thousands)

 

Quoted market price in
active markets
(Level 1)

 

Significant other
oberservable inputs
(Level 2)

 

Significant unobservable
inputs
(Level 3)

 

Available-for-sale investment securities

 

$

30,920

 

$

214,932

 

 

 

 

 

 

 

 

 

 

Mortgage loans held for sale

 

 

$

14,876

 

 

 

 

 

 

 

 

 

 

Total

 

$

30,920

 

$

229,808

 

 

 

Assets and liabilities measured at fair value on a recurring basis are as follows as of December 31, 2009:

 

(Dollars in thousands)

 

Quoted market price in
active markets
(Level 1)

 

Significant other
observable inputs
(Level 2)

 

Significant unobservable
inputs
(Level 3)

 

Available-for-sale investment securities

 

$

12,192

 

$

157,271

 

 

 

 

 

 

 

 

 

 

Mortgage loans held for sale

 

 

$

1,669

 

 

 

 

 

 

 

 

 

 

Total

 

$

12,192

 

$

158,940

 

 

 

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FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

 

Assets and liabilities recorded at fair value on a non-recurring basis are as follows as of September 30, 2010:

 

(Dollars in thousands)

 

Quoted market price in
active markets
(Level 1)

 

Significant other
observable inputs
(Level 2)

 

Significant unobservable
inputs
(Level 3)

 

Impaired loans

 

$

 

$

18,575

 

 

 

 

 

 

 

 

 

 

Other real estate owned

 

 

$

17,092

 

 

 

 

 

 

 

 

 

 

Total

 

$

 

$

35,667

 

 

 

Assets and liabilities recorded at fair value on a non-recurring basis are as follows as of December 31, 2009:

 

(Dollars in thousands)

 

Quoted market price in
active markets
(Level 1)

 

Significant other
observable inputs
(Level 2)

 

Significant unobservable
inputs
(Level 3)

 

Impaired loans

 

$

 

$

30,843

 

 

 

 

 

 

 

 

 

 

Other real estate owned

 

 

$

6,432

 

 

 

 

 

 

 

 

 

 

Total

 

$

 

$

37,275

 

 

 

The Company has no liabilities carried at fair value or measured at fair value on a recurring or nonrecurring basis.

 

The Company had no level 3 inputs.

 

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HCSB FINANCIAL CORPORATION

 

NOTE 12 — REGULATORY MATTERS

 

The Company uses several indicators of capital strength.  The most commonly used measure is average common equity to average assets, which was 5.42% at September 30, 2010 compared to 6.12% at December 31, 2009.  The change in this ratio reflects a decrease in the Company’s equity as a percentage of assets at September 30, 2010 as compared to December 31, 2009.

 

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

 

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%.  Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets.  Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital.  The regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital.

 

The Company and the Bank are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.  Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios 1% to 2% above the minimum.

 

NOTE 13 — SUBSEQUENT EVENTS

 

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued.  Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred requiring accrual or disclosure.

 

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HCSB FINANCIAL CORPORATION

 

CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

 

The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiary, Horry County State Bank (the “Bank”), during the periods included in the accompanying financial statements.  This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.

 

This report contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements relate to the financial condition, results of operations, plans, objectives, future performance, and business of our Company.  Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission (the “SEC”) and the following:

 

· reduced earnings due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior, or other factors;

 

· reduced earnings due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

 

· the rate of delinquencies and amounts of loans charged-off;

 

· the amount of our real estate-based loan portfolio collateralized by real estate, and the weakness in the commercial real estate market;

 

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

 

· the adequacy of the level of our allowance for loan losses;

 

· significant increases in competitive pressure in the banking and financial services industries;

 

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

 

· changes in political conditions or the legislative or regulatory environment;

 

· general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

 

· changes occurring in business conditions and inflation;

 

· changes in technology;

 

· changes in deposit flows;

 

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· the rates of loan growth;

 

· changes in monetary and tax policies;

 

· loss of consumer confidence and economic disruptions resulting from terrorist activities;

 

· changes in the securities markets; and

 

· other risks and uncertainties detailed from time to time in our filings with the SEC.

 

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

 

These risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will have on us.  During 2008, 2009 and 2010, the capital and credit markets have experienced extended volatility and disruption.  There can be no assurance that these unprecedented recent developments will not continue to materially and adversely affect our business, financial condition and results of operations, as well as our ability to raise capital or other funding for liquidity and business purposes.

 

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

 

The following discussion describes our results of operations for the quarter and nine months ended September 30, 2010 as compared to the quarter and nine months ended September 30, 2009 and also analyzes our financial condition as of September 30, 2010 as compared to December 31, 2009.  Like most community banks, we derive most of our income from interest we receive on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits.  Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

 

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.  In the following section, we have included a detailed discussion of this process.

 

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

 

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements.  We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

 

Real estate markets, especially those along the coast, have weakened and property values have been impacted negatively by the current economic operating environment.  Our primary service area, Horry County, is not immune to these pressures.  As a result, the quality of our loan portfolio has been adversely impacted.  For both the three months and nine months ended September 30, 2010, we have experienced an increase in nonperforming loans, loan charge-offs, and provision for loan losses which in turn has led to a net loss of earnings for the periods.  If prevailing

 

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economic conditions locally and nationally continue to decline, our financial condition and results of operations may continue to be adversely affected.

 

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises

 

Markets in the United States and elsewhere have experienced extreme volatility and disruption over the past two years.  These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence.  Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans.  Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions.  Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance.  In response to the challenges facing the financial services sector, several regulatory and governmental actions have been announced including:

 

·                  The Emergency Economic Stabilization Act, approved by Congress and signed by President Bush on October 3, 2008, which, among other provisions, created the Troubled Asset Relief Program (“TARP”) that allowed the U.S. Treasury to purchase troubled assets from banks, authorized the Securities and Exchange Commission to suspend the application of marked-to-market accounting, and raised the basic limit of FDIC deposit insurance from $100,000 to $250,000 through December 31, 2013.

 

·                  On October 7, 2008, the FDIC approved a plan to increase the rates banks pay for deposit insurance.

 

·                  On October 14, 2008, the U.S. Treasury announced the creation of a new program, the Capital Purchase Program, that encourages and allows financial institutions to build capital through the sale of senior preferred shares to the U.S. Treasury on terms that are non-negotiable.

 

·                  On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (“TLGP”), which seeks to strengthen confidence and encourage liquidity in the banking system.  The TLGP has two primary components that are available on a voluntary basis to financial institutions:

 

·                  Guarantee of newly-issued senior unsecured debt; the guarantee would apply to new debt issued on or before October 31, 2009 and would provide protection until December 31, 2012; issuers electing to participate would pay a 75 basis point fee for the guarantee; and

 

·                  Unlimited deposit insurance for non-interest bearing deposit transaction accounts; financial institutions electing to participate will pay a 10 basis point premium in addition to the insurance premiums paid for standard deposit insurance.

 

·                  On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan, which earmarked $350 billion of the TARP funds authorized under EESA. Among other things, the Financial Stability Plan includes:

 

·                  A capital assistance program that will invest in mandatory convertible preferred stock of certain qualifying institutions determined on a basis and through a process similar to the Capital Purchase Program;

 

·                  A consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances;

 

·                  A new public-private investment fund that will leverage public and private capital with public financing to purchase up to $500 billion to $1 trillion of legacy “toxic assets” from financial institutions; and

 

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·                  Assistance for homeowners by providing up to $75 billion to reduce mortgage payments and interest rates and establishing loan modification guidelines for government and private programs.

 

On February 17, 2009, the American Recovery and Reinvestment Act (the “Recovery Act”) was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy.  The

 

·                  Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs.  The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws.  The Recovery Act also imposes certain limitations on compensation paid by TARP participants.

 

·             On March 23, 2009, the U.S. Treasury, in conjunction with the FDIC and the Federal Reserve, announced the Public-Private Partnership Investment Program for Legacy Assets which consists of two separate plans, addressing two distinct asset groups:

 

·                  The first plan is the Legacy Loan Program, which has a primary purpose to facilitate the sale of troubled mortgage loans by eligible institutions, including FDIC-insured federal or state banks and savings associations. Eligible assets are not strictly limited to loans; however, what constitutes an eligible asset will be determined by participating banks, their primary regulators, the FDIC and the Treasury. Under the Legacy Loan Program, the FDIC has sold certain troubled assets out of an FDIC receivership in two separate transactions relating to the failed Illinois bank, Corus Bank, NA, and the failed Texas bank, Franklin Bank, S.S.B. These transactions were completed in September 2009 and October 2009, respectively.

 

·                  The second plan is the Securities Program, which is administered by the Treasury and involves the creation of public-private investment funds (“PPIFs”) to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements. Treasury received over 100 unique applications to participate in the Legacy Securities PPIP and in July 2009 selected nine PPIF managers.  As of September 30, 2010, the PPIFs had completed their fundraising and have closed on approximately $7.4 billion of private sector equity capital, which was matched 100 percent by Treasury, representing $14.7 billion of total equity capital. Treasury has also provided $14.7 billion of debt capital, representing $29.4 billion of total purchasing power. As of September 30, 2010, PPIFs have drawn-down approximately $18.6 billion of total capital which has been invested in eligible assets and cash equivalents pending investment.

 

·                  On May 22, 2009, the FDIC levied a one-time special assessment on all banks due on September 30, 2009.

 

·                  On November 12, 2009, the FDIC issued a final rule to require banks to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 and to increase assessment rates effective on January 1, 2011.

 

·                  On July 21, 2010, the U.S. President signed into law the Dodd Frank Act, a comprehensive regulatory framework that will affect every financial institution in the U.S.  The Dodd-Frank Act includes, among other measures, changes to the deposit insurance and financial regulatory systems, enhanced bank capital requirements, and provisions designed to protect consumers in financial transactions.  The Dodd-Frank Act also alters certain corporate governance matters affecting public companies.  Over the next 6 to 18 months,

 

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·                  regulatory agencies will implement new regulations which will establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation’s effect on banks.

 

Internationally, both the Basel Committee on Banking Supervision (the “Basel Committee”) and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and liquidity buffers within the banking system (“Basel III”).  On September 12, 2010, the Group of Governors and Heads of

 

·                  Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with implementation by January 2019.  The U.S. federal banking agencies support this agreement.  The Basel Committee is expected to finalize the new capital and liquidity standard later this year and to present them for approval of the G-20 Finance Minister and Central Bank Governors in November 2010;

 

·                  On September 27, 2010, the U.S. President signed into law the Small Business Jobs and Credit Act which, among other things, creates a $30 billion fund to provide capital for banks with assets under $10 billion to increase their small-business lending. The U.S. Treasury is currently working to finalize terms of participation for this fund.

 

It is likely that further regulatory actions may arise as the Federal government continues to attempt to address the economic situation.

 

The Bank is participating in the Transaction Account Guaranty Program component of the TLGP.  As a result of the enhancements to deposit insurance protection and the expectation that there will be demands on the FDIC’s deposit insurance fund, our deposit insurance costs have increased and will continue to increase significantly throughout the remainder of 2010.  On March 6, 2009, pursuant to the U.S. Treasury’s CPP, the Company issued and sold to the U.S. Treasury (i) 12,895 shares of its Series T Preferred Stock and (ii) the CPP Warrant to purchase up to 91,714 shares of its common stock at an initial exercise price of $21.09 per share, for an aggregate purchase price of $12,895,000 in cash.

 

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CHANGES IN FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Net Interest Income

 

For the nine months ended September 30, 2010, net interest income was $13,447,000, a decrease of $34,000, or 0.25%, over the same period in 2009.  Interest income from loans, including fees, was $19,989,000, an increase of $901,000, or 4.72%, from the nine months ended September 30, 2009. This increase was attributable to the increase in the average balance in our loan portfolio during 2010, which increased $28,302,000, or 6.12%, to $490,780,000 at September 30, 2010 from $462,478,000 at September 30, 2009.  Interest income on taxable securities totaled $4,223,000 for the nine months ended September 30, 2010, a decrease of $1,796,000 over the same period in 2009.  The decrease resulted from the purchase of securities during 2009 at lower yields.  Interest expense for the nine months ended September 30, 2010 decreased $853,000, or 7.20%, to $11,000,000 as compared to $11,853,000 for the same period in 2009 due to a reduction in the cost of interest-bearing liabilities, which decreased 43 basis points, to 2.08% for the nine months ended September 30, 2010 from 2.51% for the comparable period in 2009.  Interest on deposits decreased $1,349,000, or 15.04%, to $7,619,000 for the period ended September 30, 2010 as compared to $8,968,000 for the comparable period in 2009 due to a reduction in the cost of deposits in the marketplace.  The net interest margin realized on earning assets declined to 2.45% for the nine months ended September 30, 2010 as compared to 2.70% for the nine months ended September 30, 2009.  The interest rate spread was 2.38% for the nine months ended September 30, 2010 compared to 2.56% for the nine months ended September 30, 2009.  The decline in our interest rate spread is attributable to the overall level of interest rates during 2010.

 

Net interest income decreased from $4,591,000 for the quarter ended September 30, 2009 to $4,128,000 for the quarter ended September 30, 2010.  This represents a decrease of $463,000, or 10.08%.  Interest income from loans, including fees, decreased $53,000 to $6,501,000 for the quarter ended September 30, 2010 from $6,554,000 for the quarter ended September 30, 2009.  This decrease is attributable to an increase in charge-offs and non-accruals loans during 2010.  Interest income from taxable securities decreased $560,000, or 29.52%, from $1,897,000 for the quarter ended September 30, 2009 to $1,337,000 for the quarter ended September 30, 2010.  The decrease resulted from the purchase of securities during 2009 at lower yields.  Interest expense decreased $133,000, or 3.37%, to $3,813,000 for the three months ended September 30, 2010, compared to $3,946,000 for the three months ended September 30, 2009.  This decrease is attributable to a decrease in the rates on our funding from 2.51% for the period ended September 30, 2009 to 2.08% for the comparable period in 2010.

 

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The following is a nine month and three month ending average balance sheet:

 

 

 

Nine months ended

 

Three months ended

 

September 30, 2010
(Dollars in thousands)

 

Average
Balance

 

Yield/
Rate

 

Average
Balance

 

Yield/
Rate

 

 

 

 

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

490,780

 

5.45

%

481,737

 

5.55

%

Securities

 

203,571

 

2.88

%

217,791

 

2.69

%

Nonmarketable Equity Securities

 

6,623

 

0.32

%

6,443

 

0.33

%

Fed funds sold and other (incl. FHLB)

 

32,235

 

0.25

%

32,337

 

0.25

%

Total earning assets

 

733,209

 

4.46

%

738,308

 

4.43

%

Cash and due from banks

 

8,229

 

 

 

8,439

 

 

 

Allowance for loan losses

 

(9,508

)

 

 

(12,291

)

 

 

Premises & equipment

 

23,937

 

 

 

23,744

 

 

 

Other assets

 

34,391

 

 

 

41,103

 

 

 

Total assets

 

790,258

 

 

 

799,303

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transaction accounts

 

41,098

 

0.24

%

40,491

 

0.25

%

Savings

 

192,742

 

1.69

%

215,996

 

1.51

%

CDs

 

339,855

 

2.01

%

328,086

 

2.08

%

Other borrowings

 

120,336

 

3.10

%

115,390

 

3.23

%

Subordinate debt

 

6,890

 

9.00

%

11,851

 

5.23

%

Debt due to Trust

 

6,186

 

2.74

%

6,186

 

2.74

%

Total interest-bearing liabilities

 

707,107

 

2.08

%

718,000

 

2.05

%

Non-interest deposits

 

36,553

 

 

 

38,311

 

 

 

Other liabilities

 

3,797

 

 

 

4,202

 

 

 

Stockholders’ equity

 

42,801

 

 

 

38,790

 

 

 

Total liabilities & equity

 

790,258

 

 

 

799,303

 

 

 

 

Provision and Allowance for Loan Losses

 

The Company maintains an allowance for loan losses with the intention of estimating the probable losses in the loan portfolio. The allowance is subject to examination and adequacy testing by regulatory agencies.  In addition, such regulatory agencies could require allowance adjustments based on information available to them at the time of their examination. The allowance for loan losses was $13,466,000 and $7,525,000, or 2.94% and 1.53% of total loans, as of September 30, 2010 and December 31, 2009, respectively.

 

The provision for loan losses is the charge to operating expenses that management believes is necessary to maintain an adequate level of allowance for loan losses. For the nine months ended September 30, 2010, the provision charged to expense was $15,511,000 compared to $5,782,000 for the nine months ended September 30, 2009. For

 

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the quarter ended September 30, 2010, the provision charged to expense was $4,099,000 compared to $1,510,000 during the same quarter in 2009.  During the quarter ended September 30, 2010, the Bank recorded charge-offs of $3,605,000.  Loans that were 30 days to 89 days delinquent increased from $6,982,000 at June 30, 2010 to $8,573,000 at September 30, 2010 and loans that were 90 days and more delinquent increased from $20,566,000 at June 30, 2010 to $21,611,000 at September 30, 2010.  Due to continue high levels of loan charge-offs and the current level of impaired loans, management recorded the additional provision for loan losses during the quarter ended September 30, 2010 in order to maintain the Bank’s loan loss reserves at a level believed to be adequate to absorb all probable future loan losses.

 

Primarily as a result of the current economic downturn, our provision for loan losses increased significantly for both the three months and nine months ended September 30, 2010 over the same period ended September 30, 2009. The Bank has had a history of good credit performance as measured by historical delinquency and charge-off rates. However, these historically satisfactory rates have been under pressure as the economy continues its extended downturn with respect to real estate values.  Many of our borrowers are unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance with the drop in real estate values, making it difficult for us to fully recover the principal and interest owed.  This deterioration manifested itself in our borrowers in the following ways: (i) the cash flows from underlying properties supporting the loans decreased (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties); (ii) cash flows from the borrowers themselves and guarantors were under pressure given illiquid personal balance sheets and drainage by investing additional personal capital in the projects; and (iii) fair values of real estate related assets declined, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers were no longer willing to sell the assets at such deep discounts.

 

Due to the negative credit quality trend in our loan portfolio that developed in 2009 and that has accelerated during 2010, during June and July 2010 we performed an expanded internal loan review and conducted a re-evaluation of our lending policy and credit procedures. To assist in this process we contracted with an independent firm that specializes in bank loan reviews, to perform an independent review of our loan portfolio. During the final week of June 2010, they conducted an on-site detailed review of approximately $150 million in loans which represents approximately 30% of our loan portfolio. Their review focused on larger loans secured by real estate but also included a random sample of our smaller loans.

 

In addition to reviewing the results of this external review, our expanded internal loan review incorporated a comprehensive written analysis of all watch loans prepared by our lending officers and reviewed by our senior management team. We incorporated more objective measurements in our internal loan analysis which more accurately addresses each borrower’s probability of default.  Our expanded internal loan analysis confirmed that many of our borrowers are facing the increasing stress of declines in cash flows from the underlying properties and an increasing pressure of greatly reduced liquidity from having to invest personal funds into ongoing projects.

 

In evaluating the adequacy of the Company’s loan loss reserves, management identifies loans believed to be impaired. Impaired loans are those not likely to be repaid as to principal and interest in accordance with the terms of the loan agreement. Impaired loans are reviewed individually by management and the net present value of the collateral is estimated. Reserves are maintained for each loan in which the principal balance of the loan exceeds the net present value of the collateral. In addition to the specific allowance for individually reviewed loans, a general allowance for potential loan losses is established based on management’s review of the composition of the loan portfolio with the purpose of identifying any concentrations of risk, and an analysis of historical loan charge-offs and recoveries. The final component of the allowance for loan losses incorporates management’s evaluation of current economic conditions and other risk factors which may impact the inherent losses in the loan portfolio. These evaluations are highly subjective and require that a great degree of judgmental assumptions be made by

 

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management. This component of the allowance for loan losses includes additional estimated reserves for internal factors such as changes in lending staff, loan policy and underwriting guidelines, and loan seasoning and quality, and external factors such as national and local economic trends and conditions.

 

The downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these conditions will continue. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue. The real estate collateral in each case provides an alternative source of repayment in the event of default by the borrower, and may deteriorate in value during the time the credit is extended. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.

 

There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

 

Thus, there is a risk that charge-offs in future periods could exceed the allowance for loan losses or that substantial additional increases in the allowance for loan losses could be required. Additions to the allowance for loan losses would result in a decrease of our net income and possibly, our capital.

 

Other Income

 

We earned $3,046,000 in noninterest income during the nine months ended September 30, 2010, a decrease of $2,481,000, or 44.89%, from the comparable period in 2009.  The decrease is primarily a result of realizing fewer gains on sale of securities as of September 30, 2010 of $192,000 as compared to $3,047,000 as of September 30, 2009.  There were also decreases in service charges on deposit accounts of $105,000, or 8.74%, from $1,201,000 for the period ended September 30, 2009 to $1,096,000 for the period ended September 30, 2010 due to a decrease in non-sufficient funds (“NSF”) income, which is a result of our Bank processing fewer checks.  These decreases were partially offset by several increases in other sources of noninterest income.  Gains on sale of residential mortgage loans increased $228,000, or 50.55%, from $451,000 for the period ended September 30, 2009 to $679,000 for the comparable period in 2010.  Income from cash value life insurance increased also from $261,000 for the nine months ended September 30, 2009 to $364,000 for the nine months ended September 30, 2010.  Other income increased $96,000, or 103.23%, to $189,000 for the nine months ended September 30, 2010.  This increase is the result of the sale of the guaranteed portion of SBA loans in the secondary market.

 

For the quarter ended September 30, 2010, noninterest income decreased $692,000, or 40.68%, over the same period in 2009.  The decrease is primarily a result of realizing fewer gains on sale of securities for the three months ended September 30, 2010 of $70,000 as compared to $891,000 for the comparable period in 2009.  The decrease in noninterest income is also a result of service charges on deposit accounts of $42,000, or 10.14%.  These decreases were partially offset by several increases in other sources of noninterest income.  Fee income generated from residential loans sold in the secondary market increased $121,000, or 93.08%, from $130,000 for the three months ended September 30, 2009 to $251,000 for the three months ended September 30, 2010.  The increase was the result of the increase in refinances by our mortgage department as our borrowers take advantage of the attractive rates offered on mortgage loans in the marketplace.

 

As previously reported, on July 21, 2010, the U.S. President signed into law the Dodd-Frank Act.  The Dodd-Frank Act calls for new limits on interchange transaction fees that banks receive from merchants via card networks like Visa, Inc. and MasterCard, Inc. when a customer uses a debit card.  The results of this proposed legislation may impact our noninterest income from debit card transactions in the future.

 

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Other Expense

 

Total noninterest expense for the nine months ended September 30, 2010 was $14,335,000, an increase of $1,113,000, or 8.42%, from the comparable period in 2009, primarily attributable to the increase in the loss of sale of assets and other operating expenses.  Loss on sale of assets increased $877,000, or 173.66%, from $505,000 for the nine months ended September 30, 2009 to $1,382,000 for the comparable period in 2010 due to the losses and write-downs experienced on several foreclosed properties during 2010.  Other operating expenses increased $502,000, or 21.66%, from $2,318,000 for the period ended September 30, 2009 to $2,820,000 for the period ended September 30, 2010 due to increases in legal expenses and real estate taxes on our other real estate owned properties.  These increases were partially offset by several decreases in other noninterest expenses.  Salaries and employee benefits decreased $191,000, or 2.63%, to $7,069,000 for the nine months ended September 30, 2010, compared to $7,260,000 for the comparable period in 2009. This decrease is the result of a reduction in personnel to help reduce expenses.  In addition, marketing expenses decreased $144,000, or 33.57%, from $429,000 for the nine months ended September 30, 2009 to $285,000 for the nine months ended September 30, 2010 due to management’s decision to reduce expenses. There was also a reduction in expenses of $122,000 for the nine months ended September 30, 2010 due to the write-off in 2009 of our stock held with Silverton Bank.

 

For the quarter ended September 30, 2010, we incurred $5,679,000 in noninterest expense, an increase of $1,286,000, or 29.27%, over the same period in 2009.  Loss on sale of assets increased $1,044,000, or 499.52%, from $209,000 for the three months ended September 30, 2009 to $1,253,000 for the comparable period in 2010 due to the losses and write-downs experienced on several foreclosed properties during the third quarter.  Other operating expenses increased $319,000, or 41.32%, from $772,000 for the period ended September 30, 2009 to $1,091,000 for the period ended September 30, 2010 due to increases in legal expenses and real estate taxes on our other real estate owned properties.  These increases were partially offset by several decreases in other noninterest expenses.  Salaries and employee benefits decreased $155,000, or 6.31%, to $2,301,000, largely due to a reduction in personnel to help reduce expenses.  In addition, marketing expenses decreased $33,000, or 27.27%, from $121,000 for the three months ended September 30, 2009 to $88,000 for the three months ended September 30, 2010 due to management’s decision to reduce expenses.

 

Income Taxes

 

The income tax benefit for the nine months ended September 30, 2010 was $4,654,000, as compared to $41,000 for the same period in 2009.  The effective tax rates were 34.85%, and (1,025.00)% for the nine months ended September 30, 2010 and 2009, respectively.  The effective tax rates were 34.99% and 25.45% for the quarters ended September 30, 2010 and 2009, respectively.

 

Earnings Performance

 

As of September 30, 2010, the Bank experienced a slight decline in net interest income of $34,000, or 0.25%, over the comparable period in 2009.  The decline in net interest income was a result of the repricing of our securities portfolio to lower yields.  The low interest rate environment and declining economic conditions has resulted in a decline in net earnings of $8,744,000 to a loss of $8,699,000 for the period ended September 30, 2010 from $45,000 for the period ended September 30, 2009.  The Bank has increased its provision for loan losses $9,729,000, or 168.26%, from the comparable period in 2009, to $15,511,000 due to a weakening of economic conditions that has resulted in the borrowers’ inability to repay loans.  Despite declining interest rate margins, the Bank has experienced improvement in its income generated from our residential mortgage area due to our borrowers taking advantage of the low interest rate environment and refinancing their mortgages.  Management has also taken steps to reduce

 

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noninterest expenses.  Management has reduced salaries and employee benefits $191,000 during the first nine months of 2010 and has also reduced marketing expenses $144,000 to help improve the earnings position of the Bank.  We believe earnings should strengthen as economic conditions improve, which should help strengthen the quality of our loan portfolio.  We also believe that noninterest income should continue to increase as economic conditions strengthen.  The above resulted in a loss per common share of $2.38 for the nine months ended September 30, 2010 compared to loss per common share of $0.06 for the nine months ended September 30, 2009.  During the quarter ended September 30, 2010, losses per common share were $0.83, compared to earnings of $0.04 per common share for comparable period in 2009.

 

Assets and Liabilities

 

During the first nine months of 2010, total assets increased $44,816,000, or 5.90%, compared to December 31, 2009.  The primary reason for the increase in assets was due to an increase in securities available-for-sale of $76,389,000 during the first nine months of 2010.  Net loans decreased $40,326,000, or 8.33%, from December 31, 2009 to September 30, 2010.  Federal funds sold increased $16,384,000 as a result of the investing of our cash balances into fed funds sold.  Total deposits increased $49,999,000, or 8.65%, to $628,291,000 from the December 31, 2009 amount of $578,292,000.  Within the deposit area, interest-bearing deposits increased $46,100,000, or 8.43%, and noninterest-bearing deposits increased $3,899,000, or 12.31%, during the first nine months of 2010.  Money market savings accounts increased $58,526,000, or 38.36%, to $211,079,000 at September 30, 2010 due to the attractive rates offered by the Bank compared to competitors in the marketplace.  The increase in deposits has helped us to partially fund the growth in our securities portfolio.

 

Investment Securities

 

Investment securities available-for-sale increased from $169,463,000 at December 31, 2009 to $245,852,000 at September 30, 2010.  This represents an increase of $76,389,000, or 45.08%, from December 31, 2009 to September 30, 2010.  Securities available-for-sale increased to improve the earnings position of the Bank and to pledge against our repurchase agreements and public funds.

 

The following tables summarize the carrying value of investment securities as of the indicated dates and the weighted-average yields of those securities at September 30, 2010.

 

Investment Securities Portfolio Composition

 

September 30, 2010

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Government-Sponsored Enterprises

 

$

47,112

 

$

27,511

 

Obligations of state and local governments

 

8,737

 

5,697

 

Mortgage-backed securities

 

190,003

 

136,255

 

Nonmarketable equity securities

 

6,283

 

6,715

 

 

 

 

 

 

 

Total securities

 

$

252,135

 

$

176,178

 

 

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Table of Contents

 

Investment Securities Portfolio Maturity Schedule

 

 

 

Available-for-Sale

 

September 30, 2010

 

Carrying

 

 

 

(Dollars in thousands)

 

Amount

 

Yield

 

Government-Sponsored Enterprises due:

 

 

 

 

 

After one year but within five years

 

$

1,011

 

2.51

%

After five years but within ten years

 

27,133

 

3.11

%

After ten years

 

18,968

 

2.70

%

 

 

47,112

 

 

 

 

 

 

 

 

 

Obligations of states and local government due:

 

 

 

 

 

After one year but within five years

 

2,441

 

3.61

%

After five years but within ten years

 

2,784

 

3.75

%

After ten years

 

3,512

 

4.11

%

 

 

8,737

 

3.86

%

 

 

 

 

 

 

Mortgage-backed securities

 

79,396

 

3.05

%

 

 

 

 

 

 

Collateralized Mortgage Obligation (CMOs)

 

110,607

 

3.65

%

 

 

 

 

 

 

Nonmarketable equity securities

 

6,283

 

 

 

 

 

 

 

 

 

 

 

$

252,135

 

3.42

%

 

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Table of Contents

 

Loans

 

Net loans decreased $40,326,000, or 8.33%, to $443,801,000 during the nine-month period ended September 30, 2010.  Loan demand in general continued to decrease in our market areas in the first nine months of 2010.  As expected during this time of year, agricultural loans increased $3,762,000, or 36.39%, from December 31, 2009.  Loans consisted of the following:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Real estate - construction and land development

 

$

99,250

 

$

95,788

 

Real estate - other

 

270,196

 

305,561

 

Agricultural

 

14,100

 

10,338

 

Commercial and industrial

 

57,037

 

60,914

 

Consumer

 

13,467

 

15,871

 

Other, net

 

3,217

 

3,180

 

 

 

$

457,267

 

$

491,652

 

 

The following table presents the Company’s rate sensitivity at each of the time intervals indicated for the period ended September 30, 2010 and December 31, 2009 and may not be indicative of the Company’s rate sensitivity at other points in time:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

One month or less

 

$

209,138

 

$

245,333

 

Over one through three months

 

13,507

 

14,701

 

Over three through twelve months

 

74,888

 

70,697

 

Over twelve months

 

174,610

 

162,590

 

 

 

$

472,143

 

$

493,321

 

 

The rate characteristics of our loan portfolio consist of $178,298,000, or 38.13%, of floating interest rates and $289,307,000, or 61.87%, of fixed interest rates.

 

Risk Elements in the Loan Portfolio

 

The following is a summary of risk elements in the loan portfolio:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Loans:

Nonaccrual loans

 

$

21,611

 

$

23,138

 

 

Loans over 90 days past due and still accruing interest

 

 

 

 

Other real estate owned

 

$

17,092

 

$

6,432

 

 

 

 

 

 

 

Loans identified by the internal review mechanism:

 

 

 

 

 

 

Criticized

 

$

41,340

 

$

35,521

 

 

Classified

 

$

104,436

 

$

49,631

 

 

Impaired loans

 

$

34,937

 

$

37,276

 

Impaired loans without a valuation allowance

 

$

9,974

 

$

18,040

 

Impaired loans with a valuation allowance

 

 

24,963

 

 

19,236

 

Total impaired loans

 

$

34,937

 

$

37,276

 

 

 

 

 

 

 

Average investment in impaired loans

 

$

37,256

 

$

34,401

 

 

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Table of Contents

 

The provision for loan losses is the charge to operating expenses that management believes is necessary to maintain an adequate level of allowance for loan losses.  For the nine months ended September 30, 2010, the provision charged to expense was $15,512,000 for the nine months ended September 30, 2010 compared to $5,782,000 for the comparable period in 2009.  For the quarter ended September 30, 2010, the provision charged to expense was $4,099,000 compared to $1,510,000 during the same quarter in 2009.  There are risks inherent in making all loans, including risks with respect to the period of time over which loans may be repaid, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

 

The Company maintains an allowance for loan losses with the intention of estimating the probable losses in the loan portfolio.  The provision for loan losses is based on management’s periodic evaluation of the composition of the loan portfolio, review of all past due and nonperforming loans, review of historical loan charge-offs and recoveries, evaluation of prevailing economic conditions, and other relevant factors.  In evaluating the loan portfolio, management identifies loans believed to be impaired.  Impaired loans are those not likely to be repaid as to principal and interest in accordance with the term of the loan agreement.  Impaired loans are reviewed individually by management and the net present value of the collateral is estimated.  Reserves are maintained for each loan in which the principal balance of the loan exceeds the net present value of the collateral.  In addition to the specific allowance for individually reviewed loans, a general allowance for potential loan losses is established based on management’s review of pools of loans with similar risk characteristics by application of a historical loss factor for each loan pool.  The final component of the allowance for loan losses incorporates management’s evaluation of current economic conditions and other risk factors which may impact the inherent losses in the loan portfolio.  These evaluations are highly subjective and require that a great degree of judgmental assumptions be made by management.  This component of the allowance for loan losses includes additional estimated reserves for trends in loan delinquencies, impaired loans, charge-offs and recoveries, and economic trends and conditions.

 

Activity in the Allowance for Loan Losses is as follows:

 

 

 

Nine Months Ended September 30,

 

(Dollars in thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Balance, January 1

 

$

7,525

 

$

4,416

 

Provision for loan losses for the period

 

15,511

 

5,782

 

Net loans charged off for the period

 

(9,570

)

(4,297

)

 

 

 

 

 

 

Balance, end of period

 

$

13,466

 

$

5,901

 

Gross loans outstanding, end of period

 

$

457,267

 

$

482,772

 

Allowance for Loan Losses to loans outstanding

 

2.94

%

1.22

%

 

The downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these conditions will continue. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue. Thus, there is a risk that charge-offs in future periods could exceed the allowance for loan losses or that substantial additional increases in the allowance for loan losses could be required. Additions to the allowance for loan losses would result in a decrease of our net income and possibly, our capital.  Further, continuation of these negative trends could lead to an enforcement action by our regulators.

 

Deposits

 

Our primary source of funds for loans and investments is our deposits.  The adverse economic environment has also placed greater pressure on our deposits, and we have taken steps to decrease our reliance on brokered deposits, while at the same time the competition for local deposits among banks in our market has been increasing.  We generally obtain out-of-market time deposits of $100,000 or more through brokers with whom we maintain ongoing relationships.  As of September 30, 2010, we had brokered deposits of $104,377,000, representing 16.61% of our total deposits as compared to $123,312,000, representing 21.32% of our total deposits as of December 31, 2009.

 

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At September 30, 2010, total deposits had increased by $49,999,000, or 8.65%, from December 31, 2009.  Noninterest bearing deposits increased $3,899,000 to $35,560,000 and interest-bearing deposits increased $46,100,000 to $592,731,000.  Expressed in percentages, noninterest-bearing deposits increased 12.31% and interest-bearing deposits increased 8.43%.

 

The following table shows the average balance amounts and the average rates paid on deposits held by us for the nine months ended September 30, 2010 and the year ended December 31, 2009.

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Average

 

 

 

Average

 

 

 

 

 

Balance

 

Rate

 

Balance

 

Rate

 

Noninterest-bearing demand

 

$

36,553

 

0.00

%

$

32,675

 

0.00

%

Interest-bearing transaction accounts

 

41,098

 

0.24

%

41,533

 

0.23

%

Money market and other savings accounts

 

192,742

 

1.69

%

132,338

 

1.94

%

Time deposits

 

339,855

 

2.01

%

346,296

 

2.48

%

Total deposits

 

$

610,248

 

1.67

%

$

552,842

 

2.10

%

 

At September 30, 2010, the scheduled maturities of time deposits were as follows:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

 

 

 

 

 

 

One month or less

 

$

37,241

 

$

46,929

 

Over one through three months

 

31,236

 

67,235

 

Over three through twelve months

 

130,299

 

180,412

 

Over twelve months

 

134,056

 

51,525

 

 

 

$

332,832

 

$

346,101

 

 

Advances from the Federal Home Loan Bank

 

The following table summarizes the Company’s short-term borrowings for the nine-month period ended September 30, 2010 and the year ended December 31, 2009.

 

 

 

Maximum

 

 

 

Weighted

 

 

 

 

 

Outstanding

 

 

 

Average

 

 

 

 

 

at any

 

Average

 

Interest

 

 

 

(Dollars in thousands)

 

Month End

 

Balance

 

Rate

 

Balance

 

 

 

 

 

 

 

 

 

 

 

September 30, 2010

 

 

 

 

 

 

 

 

 

Advances from Federal Home Loan Bank

 

$

109,200

 

$

112,759

 

2.97

%

$

109,200

 

 

 

 

 

 

 

 

 

 

 

December 31, 2009

 

 

 

 

 

 

 

 

 

Advances from Federal Home Loan Bank

 

$

118,800

 

$

106,946

 

3.33

%

$

118,800

 

 

Advances from the Federal Home Loan Bank are collateralized by one-to-four family residential mortgage loans, certain commercial real estate loans, certain securities in the Bank’s investment portfolio and the Company’s investment in Federal Home Loan Bank stock.  Although we expect to continue using Federal Home Loan Bank advances as a secondary funding source, core deposits will continue to be our primary funding source.  Of the $109,200,000 advances from Federal Home Loan Bank outstanding at September 30, 2010, $5,000,000 have scheduled principal reductions in 2010, $5,500,000 in 2011, $17,500,000 in 2012 and the remainder after five years.

 

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Table of Contents

 

Liquidity

 

Liquidity measures our ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to accommodate possible outflows in deposit accounts, meet loan requests and commitments, maintain reserve requirements, pay operating expenses, provide funds for dividends and debt service, manage operations on an ongoing basis, capitalize on new business opportunities, and take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds.

 

We meet liquidity needs through scheduled maturities of loans and investments on the asset side and through pricing policies for interest-bearing deposit accounts on the liability side.  The level of liquidity is measured by the loans-to-total borrowed funds ratio, which was 59.97% at September 30, 2010 and 69.12% at December 31, 2009.

 

Unpledged securities available-for-sale, which totaled $93,639,000 at September 30, 2010, serve as a ready source of liquidity.  We also have lines of credit available with correspondent banks to purchase federal funds for periods from one to seven days.  At September 30, 2010, unused lines of credit totaled $17,000,000.  In addition, we have the ability to borrow additional funds from the Federal Home Loan Bank.  As of September 30, 2010, our unused line of credit with Federal Home Loan Bank was $16,800,000.

 

Comprehensive weekly and quarterly liquidity analyses serve management as vital decision-making tools by providing summaries of anticipated changes in loans, investments, core deposits, and wholesale funds.  These internal funding reports provide management with the details critical to anticipate immediate and long-term cash requirements, such as expected deposit runoff, loan and securities paydowns and maturities.  These liquidity analyses act as a cash forecasting tool and are subject to certain assumptions based on past market and customer trends.  Through consideration of the information provided in these reports, management is better able to maximize our earning opportunities by wisely and purposefully choosing our immediate, and more critically, our long-term funding sources.

 

To better manage our liquidity position, management also stress tests our liquidity position on a semi-annual basis under two scenarios:  short-term crisis and a longer-term crisis.  In the short term crisis, our institution would be cut off from our normal funding along with the market in general.  In this scenario, the bank would replenish our funding through the most likely sources of funding that would exist in the order of price efficiency.  In the longer term crisis, the bank would be cut off from several of our normal sources of funding as our bank’s financial situation deteriorated.  In this crisis, we would not be able to utilize our federal funds borrowing lines and brokered CDs and would be allowed to utilize our unpledged securities to raise funds in the reverse repurchase market or borrow from the Federal Home Loan Bank (FHLB).  On a quarterly basis, management monitors the market value of our securities portfolio to ensure its ability to be pledged if liquidity needs should arise.

 

Capital Resources

 

Total shareholders’ equity decreased from $45,072,000 at December 31, 2009 to $37,103,000 at September 30, 2010.  The decrease of $7,969,000 is primarily attributable to our net loss of $8,699,000 for the nine months ended September 30, 2010.  There were increases in shareholders’ equity due to the unrealized gain related to the change in fair market value on available-for-sale securities of $1,201,000.

 

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Table of Contents

 

The following table shows the annualized return on average assets (net income (loss) divided by average total assets), annualized return on average equity (net income (loss) divided by average equity), and average equity to average assets ratio (average equity divided by average total assets) for the nine months ended September 30, 2010 and the year ended December 31, 2009.

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Return on average assets

 

$

(1.47

)%

(0.19

)%

Return on average equity

 

(27.17

)%

(3.03

)%

Equity to assets ratio

 

5.42

%

6.12

%

 

Bank holding companies and their banking subsidiaries are required by banking regulators to meet certain minimum levels of capital adequacy, which are expressed in the form of certain ratios.  Capital is separated into Tier 1 capital (essentially common shareholders’ equity less intangible assets) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets).  The first two ratios, which are based on the degree of credit risk in a company’s assets, provide the weighting of assets based on assigned risk factors and include off-balance sheet items such as loan commitments and standby letters of credit. The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of Tier 2 capital to risk-weighted assets must be at least 8.0%.  The capital leverage ratio supplements the risk-based capital guidelines. Banks and bank holding companies are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.0%.

 

The following table summarizes our risk-based capital at September 30, 2010:

 

(Dollars in thousands)

 

Company

 

Bank

 

 

 

 

 

 

 

Shareholders’ equity

 

$

37,103

 

51,387

 

Plus: qualifying trust preferred securities

 

6,000

 

 

 

 

 

 

 

 

Less: unrealized gains on available-for-sale securities

 

(1,759

)

(1,759

)

 

 

 

 

 

 

Tier 1 capital

 

41,344

 

49,628

 

 

 

 

 

 

 

Plus: Subordinated debentures

 

12,062

 

 

 

 

 

 

 

 

Plus: allowance for loan losses (1)

 

6,725

 

6,723

 

 

 

 

 

 

 

Total capital

 

$

60,131

 

$

56,351

 

 

 

 

 

 

 

Net risk-weighted assets

 

$

531,231

 

$

531,120

 

Risk based capital ratios:

 

 

 

 

 

Tier 1 capital (to net risk-weighted assets)

 

7.78

%

9.34

%

Total capital (to net risk-weighted assets)

 

11.32

%

10.61

%

Tier 1 capital (to total average assets)

 

5.23

%

6.21

%

 


(1) Limited to 1.25% of gross risk-weighted assets

 

On a quarterly basis, management performs a capital projection in a best, most likely, and worst earnings projections.  Management utilizes these projections to better manage our capital position and help determine when capital injections are necessary to help manage the long term success of the Bank.

 

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Table of Contents

 

Off-Balance Sheet Risk

 

Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities.  These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time.  At September 30, 2010, we had issued commitments to extend credit of $50,203,000 and standby letters of credit of $1,083,000 through various types of commercial lending arrangements.  At December 31, 2009, we had issued commitments to extend credit of $53,840,000 and standby letters of credit of $1,137,000 through various types of commercial lending arrangements.  We evaluate each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower.  Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.

 

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at September 30, 2010:

 

 

 

 

 

After One

 

After Three

 

 

 

 

 

 

 

 

 

Within

 

Through

 

Through

 

 

 

Greater

 

 

 

 

 

One

 

Three

 

Twelve

 

Within

 

Than

 

 

 

(Dollars in thousands)

 

Month

 

Months

 

Months

 

One Year

 

One Year

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unused commitments to extend credit

 

$

2,989

 

$

9,484

 

$

15,581

 

$

28,054

 

$

22,149

 

$

50,203

 

Standby letters of credit

 

259

 

23

 

548

 

830

 

253

 

1,083

 

Total

 

$

3,248

 

$

9,507

 

$

16,129

 

$

28,884

 

$

22,402

 

$

51,286

 

 

Critical Accounting Policies

 

We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements.  Our significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2009 as filed on our Annual Report on Form 10-K.  Certain accounting policies involve significant judgments and assumptions by us which have a material impact on the carrying value of certain assets and liabilities.  We consider these accounting policies to be critical accounting policies.  The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

 

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements.  Refer to the portion of this discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

 

Regulatory Matters

 

From time to time, various bills are introduced in the United States Congress with respect to the regulation of financial institutions. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry.  We cannot predict whether any of these proposals will be adopted or, if adopted, how these proposals would affect us.

 

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

 

Not applicable.

 

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Item 4.   Controls and Procedures

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of September 30, 2010.  There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.  The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events.  There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

PART II - OTHER INFORMATION

 

Item 1.   Legal Proceedings

 

There are no material legal proceedings to which we or any of our subsidiaries is a party or of which any of our property is the subject.

 

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

 

31.1        Rule 13a-14(a) Certification of the Principal Executive Officer.

 

31.2        Rule 13a-14(a) Certification of the Principal Financial Officer.

 

32           Section 1350 Certifications.

 

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SIGNATURE

 

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

 

 

Date: November 15, 2010

By:

/s/ JAMES R. CLARKSON

 

 

James R. Clarkson

 

 

President and Chief Executive Officer

 

 

 

 

 

 

Date: November 15, 2010

By:

/s/ EDWARD L. LOEHR, JR.

 

 

Edward L. Loehr, Jr.

 

 

Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit

 

 

Number

 

Description

 

 

 

31.1

 

Rule 13a-14(a) Certification of Principal Executive Officer.

 

 

 

31.2

 

Rule 13a-14(a) Certification of the Principal Financial Officer.

 

 

 

32

 

Section 1350 Certifications.

 

48