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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended March 31, 2011

or

 

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

For the transition period from              to             

Commission File No. 0-24753

 

 

ECB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina   56-2090738
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

Post Office Box 337, Engelhard, North Carolina 27824

(Address of principal executive offices) (Zip Code)

(252) 925-5501

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

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

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

On May 11, 2011, there were 2,849,841 outstanding shares of Registrant’s common stock.

This Form 10-Q has 51 pages.

 

 

 


Table of Contents

Table of Contents

 

Index    Begins
on Page
 

Part 1 – Financial Information

  

Item 1.

  Financial Statements:   

Consolidated Balance Sheets at March 31, 2011 and December 31, 2010

     3   

Consolidated Results of Operations for Three Months Ended March 31, 2011 and 2010

     4   

Consolidated Statements of Changes in Shareholders’ Equity for Three Months Ended March 31, 2011 and 2010

     5   

Consolidated Statements of Cash Flows for Three Months Ended March 31, 2011 and 2010

     6   

Notes to Consolidated Financial Statements

     7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      31   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      44   

Item 4.

  Controls and Procedures      44   

Part II – Other Information

  

Item 1.

  Legal Proceedings      45   

Item 1A.

  Risk Factors      45   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      45   

Item 3.

  Defaults upon Senior Securities      45   

Item 4.

  Removed and Reserved      45   

Item 5.

  Other Information      45   

Item 6.

  Exhibits      45   

Signatures

     46   

Exhibit Index

     47   

Certifications

     48   

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

March 31, 2011 and December 31, 2010

(Dollars in thousands, except per share data)

 

     March 31,
2011
    December 31,
2010*
 

Assets

    

Non-interest bearing deposits and cash

   $ 10,176      $ 11,731   

Interest bearing deposits

     30        20   

Overnight investments

     —          8,415   
                

Total cash and cash equivalents

     10,206        20,166   
                

Investment securities

    

Available-for-sale, at market value (cost of $307,812 and $275,883 at March 31, 2011 and December 31, 2010, respectively)

     304,975        273,229   

Loans held for sale

     623        4,136   

Loans

     546,641        567,631   

Allowance for loan losses

     (15,219     (13,247
                

Loans, net

     531,422        554,384   
                

Real estate and repossessions acquired in settlement of loans, net

     7,258        4,536   

Federal Home Loan Bank common stock, at cost

     4,571        4,571   

Bank premises and equipment, net

     26,716        26,636   

Accrued interest receivable

     4,808        5,243   

Bank owned life insurance

     9,028        8,954   

Other assets

     16,964        18,014   
                

Total

   $ 916,571      $ 919,869   
                

Liabilities and Shareholders’ Equity

    

Deposits

    

Demand, noninterest bearing

   $ 106,898      $ 104,932   

Demand, interest bearing

     251,474        262,977   

Savings

     36,314        29,938   

Time

     392,068        388,094   
                

Total deposits

     786,754        785,941   
                

Accrued interest payable

     639        631   

Short-term borrowings

     17,421        11,509   

Long-term obligations

     27,500        34,500   

Other liabilities

     5,044        6,394   
                

Total liabilities

     837,358        838,975   
                

Shareholders’ equity

    

Preferred stock, Series A

     17,329        17,288   

Common stock, par value $3.50 per share

     9,974        9,974   

Capital surplus

     25,858        25,852   

Warrants

     878        878   

Retained earnings

     27,006        28,554   

Accumulated other comprehensive loss

     (1,832     (1,652
                

Total shareholders’ equity

     79,213        80,894   
                

Total

   $ 916,571      $ 919,869   
                

Common shares outstanding

     2,849,841        2,849,841   

Common shares authorized

     10,000,000        10,000,000   

Preferred shares outstanding

     17,949        17,949   

Preferred shares authorized

     2,000,000        2,000,000   

 

* Derived from audited consolidated financial statements.

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Results of Operations

For the three months ended March 31, 2011 and 2010

(Dollars in thousands, except per share data)

 

    

Three months ended

March 31,

 
     2011     2010  

Interest income:

    

Interest and fees on loans

   $ 7,357      $ 7,632   

Interest on investment securities:

    

Interest exempt from federal income taxes

     128        462   

Taxable interest income

     1,937        1,897   

Dividend income

     9        27   

Other interest income

     7        2   
                

Total interest income

     9,438        10,020   
                

Interest expense:

    

Deposits:

    

Demand accounts

     557        317   

Savings

     53        12   

Time

     1,811        2,489   

Short-term borrowings

     69        56   

Long-term obligations

     180        151   
                

Total interest expense

     2,670        3,025   
                

Net interest income

     6,768        6,995   

Provision for loan losses

     3,930        3,000   
                

Net interest income after provision for loan losses

     2,838        3,995   
                

Noninterest income:

    

Service charges on deposit accounts

     765        823   

Other service charges and fees

     244        265   

Mortgage origination fees

     326        212   

Net gain on sale of securities

     26        1,289   

Income from bank owned life insurance

     74        74   

Other operating income (expense)

     (4     5   
                

Total noninterest income

     1,431        2,668   
                

Noninterest expenses:

    

Salaries

     2,564        2,319   

Retirement and other employee benefits

     676        730   

Occupancy

     483        457   

Equipment

     559        467   

Professional fees

     271        288   

Supplies

     51        52   

Telephone/data communications

     169        183   

FDIC insurance

     326        333   

Other outside services

     181        118   

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

     18        334   

Other operating expenses

     946        957   
                

Total noninterest expenses

     6,244        6,238   
                

Income (loss) before income taxes

     (1,975     425   

Income tax benefit

     (891     (62
                

Net income (loss)

     (1,084     487   
                

Preferred stock dividends

     224        224   

Accretion of discount

     41        41   
                

Income (loss) available to common shareholders

   ($ 1,349   $ 222   
                

Net income (loss) per share - basic

   ($ 0.47   $ 0.08   
                

Net income (loss) per share - diluted

   ($ 0.47   $ 0.08   
                

Weighted average shares outstanding - basic

     2,849,841        2,848,839   
                

Weighted average shares outstanding - diluted

     2,849,841        2,848,969   
                

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity

Three months ended March 31, 2011 and 2010

(Dollars in thousands, except per share data)

 

    Preferred
stock,
    Common Stock     Common
stock
    Capital     Retained     Accumulated
other
comprehensive
    Comprehensive        
    Series A     Number     Amount     warrants     surplus     earnings     income     income     Total  

Balance January 1, 2010

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

Unrealized loss, net of income tax benefit of $ 110

                (176   $ (176     (176

Net income

              487          487        487   
                       

Total comprehensive income

                $ 311     
                       

Stock based compensation

        —            11              11   

Stock options exercised

      1,960        6          13              19   

Preferred stock accretion

    41                (41         —     

Cash dividends on preferred stock

              (224         (224

Cash dividends ($0.07 per share)

              (200         (200
                                                                 

Balance March 31, 2010

  $ 17,163        2,849,841      $ 9,974      $ 878      $ 25,827      $ 29,577      $ 873        $ 84,292   
                                                                 
    Preferred
stock,
    Common Stock     Common
stock
    Capital     Retained     Accumulated
other
comprehensive
    Comprehensive        
    Series A     Number     Amount     warrants     surplus     earnings     loss     loss     Total  

Balance January 1, 2011

  $ 17,288        2,849,841      $ 9,974      $ 878      $ 25,852      $ 28,554      $ (1,652     $ 80,894   

Unrealized loss, net of income tax benefit of $ 70

                (113   $ (113     (113

Post retirement health insurance benefit adjustment, net of income tax benefit of $ 42

                (67     (67     (67

Net loss

              (1,084       (1,084     (1,084
                       

Total comprehensive income

                $ (1,264  
                       

Stock based compensation

            6              6   

Preferred stock accretion

    41                (41         —     

Cash dividends on preferred stock

              (224         (224

Cash dividends ($0.07 per share)

              (199         (199
                                                                 

Balance March 31, 2011

  $ 17,329        2,849,841      $ 9,974      $ 878      $ 25,858      $ 27,006      $ (1,832     $ 79,213   
                                                                 

 

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ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Three months ended March 31, 2011 and 2010

(Dollar amounts in thousands)

 

     Three months ended
March 31,
 
     2011     2010  

Cash flows from operating activities:

    

Net income (loss)

   $ (1,084   $ 487   

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

    

Depreciation

     374        317   

Amortization of premium on investment securities, net

     749        337   

Provision for loan losses

     3,930        3,000   

Gain on sale of securities

     (26     (1,289

Stock based compensation

     6        11   

Decrease in accrued interest receivable

     435        261   

(Gain) loss on sale of real estate and repossessions acquired in settlement of loans

     (13     405   

Income from Bank owned life insurance

     (74     (74

Originations of mortgage loans held for sale

     (15,910     (627

Proceeds from sale of loans held for sale

     19,423        —     

Decrease in other assets

     1,162        168   

(Decrease) increase in accrued interest payable

     8        (79

Decrease in other liabilities, net

     (1,459     (38
                

Net cash provided by operating activities

     7,521        2,879   
                

Cash flows from investing activities:

    

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

     4,902        47,243   

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

     10,991        14,599   

Purchases of investment securities classified as available-for-sale

     (48,545     (19,614

Purchases of premises and equipment

     (454     (102

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

     802        561   

Net loan originations (repayments)

     15,521        (2,066
                

Net cash provided (used) by investing activities

     (16,783     40,621   
                

Cash flows from financing activities:

    

Net increase in deposits

     813        18,197   

Net decrease in borrowings

     (1,088     (8,533

Dividends paid to common shareholders

     (199     (520

Dividends paid on preferred stock

     (224     (224

Net proceeds from issuance of common stock

     —          19   
                

Net cash provided (used) by financing activities

     (698     8,939   
                

Increase (decrease) in cash and cash equivalents

     (9,960     52,439   

Cash and cash equivalents at beginning of period

     20,166        17,811   
                

Cash and cash equivalents at end of period

   $ 10,206      $ 70,250   
                

Cash paid during the period:

    

Interest

   $ 2,662      $ 3,104   

Taxes

     —          —     

Supplemental disclosures of noncash financing and investing activities:

    

Cash dividends declared but not paid

   $ 199      $ 199   

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

     (113     (176

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

     3,511        497   

Transfer from long-term to short-term borrowings

     7,000        6,500   

Transfer from investments to other assets

     —          250   

See accompanying notes to consolidated financial statements.

 

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Table of Contents

ECB BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(1) Basis of Presentation

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

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

All adjustments considered necessary for a fair presentation of the results for the interim periods presented have been included (such adjustments are normal and recurring in nature). The notes to consolidated financial statements in Bancorp’s annual report on Form 10-K should be referenced when reading these unaudited interim financial statements. Operating results for the period ended March 31, 2011, are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Loans

Loans are generally stated at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs. Loan origination fees net of certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual life of the related loans using the level-yield method.

Impaired loans are defined as those which management believes it is probable we will not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms have been modified in a troubled debt restructuring.

Interest on loans is recorded based on the principal amount outstanding. The Company ceases accruing interest on loans (including impaired loans) when, in management’s judgment, the collection of interest appears doubtful or the loan is past due 90 days or more. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Management may return a loan classified as nonaccrual to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms over an extended period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Allowance for Loan Losses

The allowance for loan losses (AFLL) is established through provisions for losses charged against income. Loan amounts deemed to be uncollectible are charged against the AFLL, and subsequent recoveries, if any, are credited to the allowance. The AFLL represents management’s estimate of the amount necessary to absorb estimated probable losses in the loan portfolio. Management’s periodic evaluation of the adequacy of the allowance is based on individual loan reviews, past loan loss experience, economic conditions in the Company’s market areas, the fair value and adequacy of underlying collateral, and the growth and loss attributes of the loan portfolio. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows

 

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Table of Contents

expected to be received on impaired loans that may be susceptible to significant change. Thus, future changes to the AFLL may be necessary based on the impact of changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s AFLL. Such agencies may require the Company to recognize adjustments to the AFLL based on their judgments about information available to them at the time of their examination.

In evaluating the allowance for loan losses, the Company prepares an analysis of its current loan portfolio through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

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

Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and on their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. Most loans risk rated “substandard”, “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Some smaller loans risk rated “substandard”, “doubtful” and “loss” with balances less than $100 thousand are not removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

A portion of the Bank’s allowance for loan losses is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the portion determined through general qualitative and quantitative internal and external factors, the general portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. While the Company believes that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

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

 

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Subsequent Events

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

(2) Net Income Per Share

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

Diluted net income per share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Restricted stock is considered outstanding for purposes of diluted net income per share. The amount of compensation cost attributed to future services and not yet recognized is considered “proceeds” using the treasury stock method. Restricted stock had no dilutive effect on earnings per share for the three months ended March 31, 2011 and March 31, 2010.

In computing diluted net income per share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate diluted net income per share for the Company. Diluted weighted average shares outstanding did not increase for the three month ended March 31, 2011 as there was no dilutive impact of options for the period. For the three months ended March 31, 2010, diluted weighted average shares outstanding increased by 130 due to the dilutive impact of options. As of March 31, 2011, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department and 28,513 options were not included in the computation of diluted earnings per share as the effect would have been anti-dilutive. There were 55,375 options outstanding for the three months ended March 31, 2010, with an exercise price above the average market value of the Company’s stock for that period. As of March 31, 2010, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department was not included in the computation of net income per share because its exercise price exceeded the average market price of the company’s stock for the periods.

 

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The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income per share.

 

     Three months ended March 31, 2011
(Dollars in thousands, except share and per share data)
 
     Income
(Numerator)
    Shares
(Denominator)
     Per Share
Amount
 

Basic net loss per share

   $ (1,349     2,849,841       $ (0.47
             

Effect of dilutive securities

     —          —        
                   

Diluted net loss per share

   $ (1,349     2,849,841       $ (0.47
                         
     Three months ended March 31, 2010
(Dollars in thousands, except share and per share data)
 
     Income
(Numerator)
    Shares
(Denominator)
     Per Share
Amount
 

Basic net income per share

   $ 222        2,848,839       $ 0.08   
             

Effect of dilutive securities

     —          130      
                   

Diluted net income per share

   $ 222        2,848,969       $ 0.08   
                         

(3) Postretirement Benefits

The Company has a postretirement benefit plan whereby the Company pays postretirement health care benefits for certain of its retirees that have met minimum age and service requirements. Net periodic postretirement benefit cost for the three months ended March 31, 2011 and 2010 includes the following components.

 

     Three months ended
March  31,
 
Components of Net Periodic Benefit Cost    2011      2010  
     (Dollars in thousands)  

Service cost

   $ 2       $ 1   

Interest cost

     9         10   

Prior service cost

     —           (2
                 

Net periodic postretirement benefit cost

   $ 11       $ 9   
                 

The Company expects to contribute $43 thousand to its postretirement benefit plan in 2011. No contributions were made in the first quarter of 2011.

 

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Table of Contents

(4) Investment Securities

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

 

     March 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Securities available-for-sale:

  

Government-sponsored enterprises and FFCB bonds

   $ 23,266       $ 69       $ (829   $ 22,506   

Obligations of states and political subdivisions

     12,407         279         (19     12,667   

Mortgage-backed securities

     164,499         730         (1,431     163,798   

SBA-backed securities

     78,328         250         (858     77,720   

Corporate bonds

     29,312         173         (1,201     28,284   
                                  
   $ 307,812       $ 1,501       $ (4,338   $ 304,975   
     December 31, 2010  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Securities available-for-sale:

  

Government-sponsored enterprises and FFCB bonds

   $ 25,466       $ 183       $ (868   $ 24,781   

Obligations of states and political subdivisions

     12,818         240         (80     12,978   

Mortgage-backed securities

     150,850         837         (1,597     150,090   

SBA-backed securities

     57,362         258         (767     56,853   

Corporate bonds

     29,387         77         (937     28,527   
                                  
   $ 275,883       $ 1,595       $ (4,249   $ 273,229   

Gross realized gains and losses on sales of securities for the three months ended March 31, 2011 and March 31, 2010 were as follows (dollars in thousands):

 

    

Three months ended

March 31,

(Dollars in thousands)

 
     2011      2010  

Gross realized gains

   $ 26       $ 1,289   

Gross realized losses

     —           —     
                 

Net realized (losses) gains

   $ 26       $ 1,289   
                 

 

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Table of Contents

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

The following tables set forth the amount of unrealized losses at March 31, 2011 and December 31, 2010 (that is, the amount by which cost or amortized cost exceeds fair value), and the related fair value of investments with unrealized losses, none of which are considered to be other-than-temporarily impaired. The tables are segregated into investments that have been in a continuous unrealized-loss position for less than 12 months from those that have been in a continuous unrealized-loss position for 12 months or longer.

March 31, 2011

 

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

Government-sponsored enterprises and FFCB bonds

   $ 17,433       $ 829       $ —         $ —         $ 17,433       $ 829   

Obligations of states and political subdivisions

     1,729         19         —           —           1,729         19   

Mortgage-backed securities

     93,738         1,431         —           —           93,738         1,431   

SBA-backed securities

     36,213         858         —           —           36,213         858   

Corporate bonds

     23,411         525         1,324         676         24,735         1,201   
                                                     

Total

   $ 172,524       $ 3,662       $ 1,324       $ 676       $ 173,848       $ 4,338   
                                                     

December 31, 2010

 

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

Government-sponsored enterprises and FFCB bonds

   $ 17,410       $ 868       $ —         $ —         $ 17,410       $ 868   

Obligations of states and political subdivisions

     3,548         80         —           —           3,548         80   

Mortgage-backed securities

     99,549         1,597         —           —           99,549         1,597   

SBA-backed securities

     31,963         767         —           —           31,963         767   

Corporate bonds

     20,815         654         1,717         283         22,532         937   
                                                     

Total

   $ 173,285       $ 3,966       $ 1,717       $ 283       $ 175,002       $ 4,249   
                                                     

 

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As of March 31, 2011 and December 31, 2010, management concluded that the unrealized losses presented above are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for a time necessary to recover their cost. The losses above are on debt securities that have contractual maturity dates and are primarily related to market interest rates. Municipal losses are also related to lack of liquidity and demand in the general investment market. All unrealized losses on investment securities are not considered to be other-than-temporary, because they are related to changes in interest rates, lack of liquidity and demand in the general investment market and do not affect the expected cash flows of the underlying collateral or the issuer. The Bank’s mortgage-backed securities are all backed by government sponsored enterprises or agencies. The Bank does not own any private label mortgage-backed securities.

At March 31, 2011 and December 31, 2010, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company was $4.6 million for both periods. On March 31, 2011, FHLB paid a dividend for the fourth quarter of 2010 with an annualized rate of 0.79%. The dividend rate was equal to average three-month LIBOR for the period of October 1, 2010 to December 31, 2010 plus 0.50%, and was applicable to capital stock held during that period. Management believes that its investment in FHLB stock was not other-than-temporarily impaired as of March 31, 2011 or December 31, 2010. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a decrease in the value of the FHLB stock held by the Company.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at March 31, 2011 by remaining contractual maturity are as follows:

 

     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Government-sponsored enterprises and FFCB bonds:

  

Due in one through five years

   $ 2,000       $ 1,980   

Due in five through ten years

     21,266         20,526   

Obligations of states and political subdivisions:

     

Due in one year or less

     370         371   

Due in one through five years

     151         152   

Due in five through ten years

     5,149         5,302   

Due after ten years

     6,737         6,841   

Mortgage-backed securities:

     

Due in five through ten years

     8,920         9,105   

Due after ten years

     155,579         154,694   

SBA-backed securities:

     

Due in five through ten years

     5,444         5,537   

Due after ten years

     72,884         72,183   

Corporate bonds:

     

Due in one through five years

     8,754         8,746   

Due in five through ten years

     20,558         19,538   
                 

Total securities

   $ 307,812       $ 304,975   
                 

 

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Securities with an amortized cost of $200.7 million at March 31, 2011 are pledged as collateral. Of this total, securities with an amortized cost of $49.7 million and fair value of $49.0 million are pledged as collateral for FHLB advances.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at December 31, 2010 by remaining contractual maturity are as follows:

 

     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Government-sponsored enterprises and FFCB bonds:

  

Due in one through five years

   $ 2,000       $ 1,972   

Due in five through ten years

     16,108         15,982   

Due after ten years

     7,358         6,827   

Obligations of states and political subdivisions:

     

Due in one year or less

     370         373   

Due in one through five years

     252         253   

Due in five through ten years

     5,203         5,354   

Due after ten years

     6,993         6,998   

Mortgage-backed securities:

     

Due in five through ten years

     4,307         4,551   

Due after ten years

     146,543         145,539   

SBA-backed securities:

     

Due in five through ten years

     5,889         5,973   

Due after ten years

     51,473         50,880   

Corporate bonds:

     

Due in one year through five years

     8,779         8,712   

Due in five through ten years

     17,421         16,767   

Due after ten years

     3,187         3,048   
                 

Total securities

   $ 275,883       $ 273,229   
                 

Securities with an amortized cost of $212.2 million at December 31, 2010 were pledged as collateral. Of this total, securities with an amortized cost of $52.9 million and fair value of $52.2 million were pledged as collateral for FHLB advances.

(5) Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity during a period for non-owner transactions and is divided into net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. The components of comprehensive income (loss) for the periods presented are as follows:

 

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Table of Contents
    

Three months ended

March 31

 
     2011     2010  
     (Dollars in thousands)  

Net income (loss)

   $ (1,084   $ 487   

Other comprehensive income (loss):

    

Unrealized gains (losses) arising during the period

     (158     1,003   

Tax (expense) benefit

     61        (386

Reclassification to realized (gains) losses

     (26     (1,289

Tax expense

     10        496   

Defined benefit pension adjustment, net of taxes

     (67     —     
                

Total other comprehensive income (loss)

     (180     (176
                

Total comprehensive income (loss)

   $ (1,264   $ 311   
                

(6) Recent Accounting Pronouncements

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

In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company is required to include these disclosures in its interim and annual consolidated financial statements. See Note 9.

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011, FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present.

Disclosures related to TDRs under ASU 2010-20 will be effective for reporting periods beginning after June 15, 2011.

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

(7) Fair Value Of Financial Instruments

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

 

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Table of Contents

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at March 31, 2011 and December 31, 2010:

 

     March 31, 2011      December 31, 2010  
     Carrying
Value
     Estimated  Fair
Value
     Carrying
Value
     Estimated  Fair
Value
 
     (Dollars in thousands)  

Financial assets:

  

Cash and cash equivalents

   $ 10,206       $ 10,206       $ 20,166       $ 20,166   

Investment securities

     304,975         304,975         273,229         273,229   

FHLB stock

     4,571         4,571         4,571         4,571   

Accrued interest receivable

     4,808         4,808         5,243         5,243   

Net loans

     531,422         527,808         554,384         550,614   

Loans held for sale

     623         623         4,136         4,136   

Financial liabilities:

           

Deposits

   $ 786,754       $ 793,374       $ 785,941       $ 790,105   

Short-term borrowings

     17,421         17,421         11,509         11,509   

Accrued interest payable

     639         639         631         631   

Long-term obligations

     27,500         27,814         34,500         34,954   

The fair value of net loans is based on estimated cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. This does not include consideration of liquidity that market participants would use to value such loans. The estimated fair values of deposits and long-term obligations at March 31, 2011 and December 31, 2010 are based on estimated cash flows discounted at market interest rates. The carrying values of other financial instruments, including various receivables and payables, approximate fair value. The fair value of off-balance sheet financial instruments is considered immaterial. These off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

Fair Value Hierarchy

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

 

Level 1   Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2   Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3   Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

 

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Table of Contents

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

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

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

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, 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 Banking Activity

The Company enters into interest rate lock commitments and commitments to sell mortgages. At March 31, 2011, the amount of fair value associated with these interest rate lock commitments was $95 thousand, which is included in other assets. At December 31, 2010, the amount of fair value associated with these interest rate lock commitments was $101 thousand, which was included in other assets. Forward loan sale commitments have been deemed insignificant for both periods.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2011, the majority of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Real Estate and Repossessions Acquired in Settlement of Loans

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

 

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Table of Contents

Assets recorded at fair value on a recurring basis

 

March 31, 2011    Total      Level 1      Level 2      Level 3  
     (Dollars in thousands)  

Investment Securities Available-for-Sale

  

Government-sponsored enterprises and FFCB bonds

   $ 22,506       $ —         $ 22,506       $ —     

Obligations of states and political subdivisions

     12,667         —           12,667         —     

Mortgage-backed securities

     163,798         18,711        145,087         —     

SBA-backed securities

     77,720         77,720         —           —     

Corporate bonds

     28,284         —           26,960         1,324   

Total Securities

   $ 304,975       $ 96,431       $ 207,220       $ 1,324   

Interest rate lock commitments

   $ 95       $ —         $ —         $ 95   

Total assets at fair value

   $ 305,070       $ 96,431       $ 207,220       $ 1,419   

Assets recorded at fair value on a recurring basis, continued

 

December 31, 2010    Total      Level 1      Level 2      Level 3  
     (Dollars in thousands)  

Investment Securities Available-for-Sale

  

Government-sponsored enterprises and FFCB bonds

   $ 24,781       $ —         $ 24,781       $ —     

Obligations of states and political subdivisions

     12,978         —           12,978         —     

Mortgage-backed securities

     150,090         4,200        145,890         —     

SBA-backed securities

     56,853         55,422         1,431         —     

Corporate bonds

     28,527         —           26,811         1,716   

Total Securities

   $ 273,229       $ 59,622       $ 211,891       $ 1,716   

Interest rate lock commitments

   $ 101       $ —         $ —         $ 101   

Total assets at fair value

   $ 273,330       $ 59,622       $ 211,891       $ 1,817   

 

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Table of Contents

Assets recorded at fair value on a nonrecurring basis

 

March 31, 2011    Total      Level 1      Level 2      Level 3  
     (Dollars in thousands)  

Impaired Loans

  

Real estate—construction and land development

   $ 12,155       $ —         $ 2,548       $ 9,607   

Real estate—secured by residential properties

     3,788         —           2,509         1,279   

Real estate—secured by nonfarm nonresidential properties

     2,460         —           1,064         1,396   

Commercial and industrial

     237         —           36         201   

Credit cards and related plans

     30         —           —           30   

Total impaired loans

   $ 18,670       $ —         $ 6,157       $ 12,513   

Real estate and repossessions acquired in settlement of loans

           

Total real estate and repossessions acquired in settlement of loans

   $ 7,258       $ —         $ 5,080       $ 2,178   

Total assets at fair value

   $ 25,928       $ —         $ 11,237       $ 14,691   
December 31, 2010    Total      Level 1      Level 2      Level 3  
     (Dollars in thousands)  

Impaired Loans

  

Real estate—construction and land development

   $ 11,077       $ —         $ 3,027       $ 8,050   

Real estate—secured by residential properties

     3,834         —           3,666         168   

Real estate—secured by nonfarm nonresidential properties

     2,550         —           2,467         83   

Commercial and industrial

     77         —           —           77   

Total impaired loans

   $ 17,538       $ —         $ 9,160       $ 8,378   

Real estate and repossessions acquired in settlement of loans

           

Real estate and repossessions acquired in settlement of loans

   $ 4,536       $ —         $ 2,277       $ 2,259   

Total assets at fair value

   $ 22,074       $ —         $ 11,437       $ 10,637   

 

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Table of Contents

As of March 31, 2011 there were $4.2 million of Level 2 investment securities available for sale that were reported as Level 1 as of December 31, 2010. The bonds were transferred from Level 1 to Level 2 during the year of 2011 because the December 31, 2010 pricing was based on the Company’s actual trades for the securities at initial purchase while the March 31, 2011 pricing was through a pricing system.

During the first quarter of 2011 there were no investment securities transferred in or out of Level 3. During the first quarter of 2010, there was one Level 3 investment security that was transferred to Level 2 given that the March 31, 2010 valuation was based on a third party market valuation that was based on quoted prices for similar instruments in active markets versus the December 31, 2009 valuation which was based on book value. The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the first quarter of 2011 and the first quarter of 2010.

 

     Corporate
Bonds
    Interest Rate
Lock
Commitments
    Total  
     (Dollars in thousands)  

Balance, December 31, 2010

   $ 1,716      $ 101      $ 1,817   

Total gains or losses (realized/unrealized):

      

Included in earnings

     —          (6 )     (6 )

Included in other comprehensive income

     (392     —          (392

Purchases, issuances, and settlements

     —          —          —     

Transfers in to/out of Level 3

     —          —          —     

Balance, March 31, 2011

   $ 1,324      $ 95      $ 1,419   
     Government-
sponsored
enterprises and

FFCB bonds
    Corporate
Bonds
    Total  
     (Dollars in thousands)  

Balance, December 31, 2009

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

Total gains or losses (realized/unrealized):

      

Included in earnings

     —          —          —     

Included in other comprehensive income

     —          (5     (5

Purchases, issuances, and settlements

         —     

Transfers in to/out of Level 3

     (2,480       (2,480

Balance, March 31, 2010

   $ —        $ 1,866      $ 1,866   

 

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Table of Contents

(8) LOANS

Loans at March 31, 2011 and December 31, 2010 classified by type are as follows (dollars in thousands):

 

     March 31,
2011
     December 31,
2010
 

Real estate loans:

     

Construction and land development

   $ 84,170       $ 90,267   

Secured by farmland

     27,857         26,694   

Secured by residential properties

     119,089         120,183   

Secured by nonfarm, nonresidential properties

     216,285         218,028   

Consumer installment

     4,090         4,096   

Credit cards and related plans

     2,366         2,261   

Commercial and all other loans:

     

Commercial and industrial

     55,147         60,242   

Loans to finance agricultural production

     22,097         28,217   

All other loans

     15,761         17,863   
                 
     546,862         567,851   

Less deferred fees and costs, net

     221         220   
                 
   $ 546,641       $ 567,631   
                 

Included in the above:

     

Nonaccrual loans

   $ 16,801       $ 15,896   

Restructured loans 1

     5,296         6,193   

 

1. Restructured loans include loans restructured and still accruing. The Company is not committed to advance additional funds on restructured loans.

 

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Table of Contents

(8) LOANS, continued

 

At March 31, 2011 $8.4 million of the recorded investment in impaired loans were loans that were written down through partial charge-offs of $5.5 million. At December 31, 2010 $11.8 million of the recorded investment in impaired loans were loans that were written down through partial charge-offs of $7.3 million.

The Company, through its normal lending activity, originates and maintains loans receivable that are substantially concentrated in the Eastern region of North Carolina, where its offices are located. The Company’s policy calls for collateral or other forms of repayment assurance to be received from the borrower at the time of loan origination. Such collateral or other form of repayment assurance is subject to changes in economic value due to various factors beyond the control of the Company, and such changes could be significant.

At March 31, 2011 and December 31, 2010, included in mortgage, commercial, and residential loans were loans collateralized by owner-occupied residential real estate of approximately $52.0 million and $55.5 million, respectively.

Loans with a book value of approximately $24.5 million at March 31, 2011 are pledged as eligible collateral for FHLB advances. Loans with a book value of approximately $30.1 million at December 31, 2010 were pledged as eligible collateral for FHLB advances.

(9) CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES

An analysis of the allowance for loan losses for the quarters ended March 31, 2011, and March 31, 2010 follows (dollars in thousands):

 

     March 31,
2011
    March 31,
2010
 

Beginning balance

   $ 13,247      $ 9,725   

Provision for loan losses

     3,930        3,000   

Recoveries

     102        47   

Loans charged off

     (2,060     (1,443
                

Ending balance

   $ 15,219      $ 11,329   
                

 

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(9) CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES, continued

 

The following tables summarizes the balances by loan category of the allowance for loan losses with changes arising from charge-offs, recoveries and provision expense for the quarter ending March 31, 2011 and for the year ending December 31, 2010 (dollars in thousands):

Allowance for Loan Losses

As of March 31, 2011

 

Allowance for
Credit Losses
  Real Estate
Construction
and Land
Development
    Real Estate
Secured by
Farmland
    Real Estate
Secured by
Residential
Properties
    Real Estate
Secured by
Nonfarm
Nonresidential
    Consumer
Installment
    Credit
Cards and
Related
Plans
    Commercial
and
Industrial
    Loans to
Finance
Agricultural
Production
    All
Other
Loans
    General
Qualitative
&
Quantitative
Portion
    Total  

Beginning balance

  $ 6,168      $ 28      $ 3,450      $ 1,007      $ 12      $ 21      $ 882      $ 18      $ 139      $ 1,522      $ 13,247   

Charge-offs

    (1,273     (—       (449     (—       (9     (9     (254     (—       (66     (—       (2,060

Recoveries

    —          —          1        —          2        —          63        —          36        —          102   

Provisions

    2,692        1        1,000        111        11        177        441        (3     21        (521     3,930   
                                                                                       

Ending Balance

  $ 7,587      $ 29      $ 4,002      $ 1,118      $ 16      $ 189      $ 1,132      $ 15      $ 130      $ 1,001      $ 15,219   
                                                                                       

Ending Balance: individually evaluated for impairment

  $ 2,113      $ —        $ 751      $ 594      $ —        $ 169     $ 362      $ —        $ —        $ —        $ 3,989   
                                                                                       

Ending Balance: collectively evaluated for impairment

  $ 5,474      $ 29      $ 3,251      $ 524      $ 16      $ 20      $ 770      $ 15      $ 130      $ 1,001      $ 11,230   
                                                                                       

Loans

                     

Ending Balance

  $ 84,045      $ 27,812      $ 119,202      $ 215,979      $ 4,192      $ 2,366      $ 55,150      $ 22,086      $ 15,809      $ —        $ 546,641   
                                                                                       

Ending Balance: individually evaluated for impairment

  $ 15,642      $ —        $ 7,285      $ 4,573      $ —        $ 200     $ 843      $ —        $ —        $ —        $ 28,543   
                                                                                       

Ending Balance: collectively evaluated for impairment

  $ 68,403      $ 27,812      $ 111,917      $ 211,406      $ 4,192      $ 2,166      $ 54,307      $ 22,086      $ 15,809      $ —        $ 518,098   
                                                                                       

 

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Table of Contents

Allowance for Loan Losses

As of December 31, 2010

 

Allowance for
Credit Losses
  Real Estate
Construction
and Land
Development
    Real Estate
Secured by
Farmland
    Real Estate
Secured by
Residential
Properties
    Real Estate
Secured by
Nonfarm
Nonresidential
    Consumer
Installment
    Credit
Cards and
Related
Plans
    Commercial
and
Industrial
    Loans to
Finance
Agricultural
Production
    All
Other
Loans
    General
Qualitative
&
Quantitative
Portion
    Total  

Beginning balance

  $ 4,623      $ 25     $ 2,383      $ 541      $ 23      $ 13      $ 523      $ 16      $ 169      $ 1,409      $ 9,725   

Charge-offs

    (5,977     (—       (2,022     (213     (54     (11     (1,191     (—       (277     (—       (9,745

Recoveries

    111        —          19        —          7        1        19        —          130        —          287   

Provisions

    7,411        3        3,070        679        36        18        1,531        2        117        113        12,980   
                                                                                       

Ending Balance

  $ 6,168      $ 28      $ 3,450      $ 1,007      $ 12      $ 21      $ 882      $ 18      $ 139      $ 1,522      $ 13,247   
                                                                                       

Ending Balance: individually evaluated for impairment

  $ 803      $ —        $ 916      $ 546      $ —        $ —        $ 102      $ —        $ —        $ —        $ 2,367   
                                                                                       

Ending Balance: collectively evaluated for impairment

  $ 5,365      $ 28      $ 2,534      $ 461      $ 12      $ 21      $ 780      $ 18      $ 139      $ 1,522      $ 10,880   
                                                                                       

Loans

                     

Ending Balance

  $ 90,145      $ 26,661      $ 120,278      $ 217,709      $ 4,209      $ 2,261      $ 60,238      $ 28,215      $ 17,915      $ —        $ 567,631   
                                                                                       

Ending Balance: individually evaluated for impairment

  $ 15,940      $ —        $ 6,103      $ 3,812      $ —        $ —        $ 397      $ —        $ —        $ —        $ 26,252   
                                                                                       

Ending Balance: collectively evaluated for impairment

  $ 74,205      $ 26,661      $ 114,175      $ 213,897      $ 4,209      $ 2,261      $ 59,841      $ 28,215      $ 17,915      $ —        $ 541,379   
                                                                                       

 

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Table of Contents

(9) CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES, continued

 

Loans are closely monitored by management for changes in quality. This monitoring includes assessing the appropriateness of the credit quality indicator in relation to the risk of the loan. Management uses the following indicators to grade the risk of each loan based on a system of eight possible ratings.

Pass: Include loans that are risk rated one through three. The primary source of repayment for pass loans is very likely to be sufficient, with secondary sources readily available; strong financial position; minimal risk; profitability, liquidity and capitalization are better than industry norms.

Weak Pass: Include loans that are risk rated four. The asset quality for weak pass assets is generally acceptable. Primary source of loan repayment is acceptable and secondary sources are likely to be realized, if needed; acceptable business credit, but borrowers operations, cash flow, or financial condition evidence more than average risk; requires above average levels of supervision and attention from Loan Officer. The source of increased risk has been identified, can be effectively managed/corrected, and the increased risk is not significant to warrant a more severe rating.

Special Mention: Include loans that are risk rated five. A special mention asset is considered to be high risk due to potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard: Include loans that are risk rated six through eight. Loans rated as substandard are considered to be very high risk. A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

The following tables present loans as of March 31, 2011 and December 31, 2010 classified by risk type (dollars in thousands):

Credit Quality Indicators

As of March 31, 2011

 

     Pass      Weak Pass      Special
Mention
     Substandard      Total  

Real Estate – Construction and Land Development Loans

   $ 34,371       $ 26,042       $ 5,809       $ 17,823       $ 84,045   

Real Estate – Secured by Farmland

     19,873         3,661         4,276         2         27,812   

Real Estate – Secured by Residential Properties

     63,051         35,435         10,206         10,510         119,202   

Real Estate – Secured by Nonfarm Nonresidential

     92,863         81,780         29,844         11,492         215,979   

Consumer Installment

     2,534         1,310         243         105         4,192   

Credit Cards and Related Plans

     1,266         684         125         291         2,366   

Commercial and Industrial

     31,736         20,202         2,185         1,027         55,150   

Loans to Finance Agriculture Production

     14,857         4,121         3,108         —           22,086   

All Other Loans

     6,631         9,064         105         9         15,809   
                                            

Total

   $ 267,182       $ 182,299       $ 55,901      $ 41,259       $ 546,641   
                                            

 

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Table of Contents

Credit Quality Indicators

As of December 31, 2010

 

     Pass      Weak Pass      Special
Mention
     Substandard      Total  

Real Estate – Construction and Land Development Loans

   $ 35,356       $ 27,978       $ 9,466       $ 17,345       $ 90,145   

Real Estate – Secured by Farmland

     17,869         6,294         2,495         3         26,661   

Real Estate – Secured by Residential Properties

     64,457         43,364         3,469         8,988         120,278   

Real Estate – Secured by Nonfarm Nonresidential

     94,208         96,287         20,107         7,107         217,709   

Consumer Installment

     2,466         1,460         265         18         4,209   

Credit Cards and Related Plans

     1,211         869         89         92         2,261   

Commercial and Industrial

     33,416         22,805         3,292         725         60,238   

Loans to Finance Agriculture Production

     18,346         7,230         2,639         —           28,215   

All Other Loans

     8,442         9,341         119         13         17,915   
                                            

Total

   $ 275,771       $ 215,628       $ 41,941      $ 34,291       $ 567,631   
                                            

The following tables summarize the past due loans by category as of March 31, 2011 and December 31, 2010 (dollars in thousands):

Past Due Loans

As of March 31, 2011

 

     30 -59 Days
Past Due
     60 -89 Days
Past Due
     Greater than
90 Days
     Total Past
Due
     Current      Total  

Real Estate Construction and Land Development

   $ 748       $ 519       $ 6,447       $ 7,714       $ 76,331       $ 84,045   

Real Estate Secured by Farmland

     —           —           —           —           27,812         27,812   

Real Estate Secured by Residential Properties

     501         6         2,872         3,379         115,823         119,202   

Real Estate Secured by Nonfarm Nonresidential

     1,162         940         914         3,016         212,963         215,979   

Consumer Installment

     12         —           5         17         4,175         4,192   

Credit Cards and Related Plans

     —           —           —           —           2,366         2,366   

Commercial and Industrial

     50         —           314         364         54,786         55,150   

Loans to Finance Agricultural Production

     —           —           —           —           22,086         22,086   

All Other Loans

     1         —           —           1         15,808         15,809   
                                                     

Total

   $ 2,474       $ 1,465       $ 10,552       $ 14,491       $ 532,150       $ 546,641   
                                                     

 

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Table of Contents

Past Due Loans

As of December 31, 2010

 

     30 -59 Days
Past Due
     60 -89 Days
Past Due
     Greater than
90 Days
     Total Past
Due
     Current      Total  

Real Estate Construction and Land Development

   $ 2,997       $ 929       $ 9,627       $ 13,553       $ 76,592       $ 90,145   

Real Estate Secured by Farmland

     —           —           —           —           26,661         26,661   

Real Estate Secured by Residential Properties

     251         389         2,526         3,166         117,112         120,278   

Real Estate Secured by Nonfarm Nonresidential

     545         —           919         1,464         216,245         217,709   

Consumer Installment

     35         6         5         46         4,163         4,209   

Credit Cards and Related Plans

     3         —           —           3         2,258         2,261   

Commercial and Industrial

     111         19         553         683         59,555         60,238   

Loans to Finance Agricultural Production

     —           —           —           —           28,215         28,215   

All Other Loans

     22         4         —           26         17,889         17,915   
                                                     

Total

   $ 3,964       $ 1,347       $ 13,630       $ 18,941       $ 548,690       $ 567,631   
                                                     

 

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(9) CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES, continued

 

The following tables summarize impaired loans as of March 31, 2011 and December 31, 2010 (dollars in thousands). The recorded investment balance includes the loan balance, deferred fees that have yet to be recognized and accrued interest. The deferred fees that have yet to be recognized are not material amounts.

Impaired Loans

As of March 31, 2011

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Real Estate Construction and Land Development

   $ 6,858       $ 10,859       $ —         $ 8,534       $ 45   

Real Estate Secured by Farmland

     —           —           —           —           —     

Real Estate Secured by Residential Properties

     4,406         4,694         —           3,837         15   

Real Estate Secured by Nonfarm Nonresidential

     1,548         1,546         —           851         6   

Consumer Installment

     —           —           —              —     

Credit Cards and Related Plans

     —           —           —           —           —     

Commercial and Industrial

     393         518         —           434         5   

Loans to Finance Agricultural Production

     —           —           —           —           —     

All Other Loans

     —           —           —           —           —     
                                            

Total impaired loans with no related allowance

   $ 13,205       $ 17,617       $ —         $ 13,656       $ 71   

With an allowance recorded:

              

Real Estate Construction and Land Development

   $ 8,792       $ 9,796       $ 2,112       $ 7,622       $ 40   

Real Estate Secured by Farmland

     —           —           —           —           —     

Real Estate Secured by Residential Properties

     2,885         2,880         751         2,921         11   

Real Estate Secured by Nonfarm Nonresidential

     3,030         3,095         594         3,402         22   

Consumer Installment

     —           —           —           —           —     

Credit Cards and Related Plans

     201         200         170         200         3   

Commercial and Industrial

     452         451         362         449         6   

Loans to Finance Agricultural Production

     —           —           —           —           —     

All Other Loans

     —           —           —           —           —     
                                            

Total impaired loans with related allowance recorded

   $ 15,360       $ 16,422       $ 3,989       $ 14,594       $ 82   

Total

              

Construction and Land Development

   $ 15,650       $ 20,655       $ 2,112       $ 16,156       $ 85   

Residential

     7,291         7,574         751         6,758         26   

Commercial

     5,423         5,610         956         5,136         39   

Consumer

     201         200         170         200         3   
                                            

Total impaired loans

   $ 28,565       $ 34,039       $ 3,989       $ 28,250       $ 153   

 

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(9) CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES, continued

 

Impaired Loans

As of December 31, 2010

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

        

Real Estate Construction and Land Development

   $ 9,212       $ 13,354       $ —     

Real Estate Secured by Farmland

     —           —           —     

Real Estate Secured by Residential Properties

     2,700         2,972         —     

Real Estate Secured by Nonfarm Nonresidential

     1,029         1,097         —     

Consumer Installment

     —           —           —     

Credit Cards and Related Plans

     —           —           —     

Commercial and Industrial

     218         217         —     

Loans to Finance Agricultural Production

     —           —           —     

All Other Loans

     —           —           —     
                          

Total impaired loans with no related allowance

   $ 13,159       $ 17,640       $ —     

With an allowance recorded:

        

Real Estate Construction and Land Development

   $ 6,771       $ 9,497       $ 803   

Real Estate Secured by Farmland

     —           —           —     

Real Estate Secured by Residential Properties

     3,411         3,405         915   

Real Estate Secured by Nonfarm Nonresidential

     2,794         2,784         546   

Consumer Installment

     —           —           —     

Credit Cards and Related Plans

     —           —           —     

Commercial and Industrial

     179         199         102   

Loans to Finance Agricultural Production

     —           —           —     

All Other Loans

     —           —           —     
                          

Total impaired loans with related allowance recorded

   $ 13,155       $ 15,885       $ 2,366   

Total

        

Construction and Land Development

   $ 15,983       $ 22,851       $ 803   

Residential

     6,111         6,377         915   

Commercial

     4,220         4,297         648   

Consumer

     —           —           —     
                          

Total impaired loans

   $ 26,314       $ 33,525       $ 2,366   

The following table presents nonaccrual loans as of March 31, 2011 and December 31, 2010 by loan category (dollars in thousands):

 

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Nonaccrual Loans

 

     March 31,
2011
     December 31,
2010
 

Real Estate Construction and Land Development

   $ 9,932       $ 10,839   

Real Estate Secured by Farmland

     —           —     

Real Estate Secured by Residential Properties

     4,952         3,268   

Real Estate Secured by Nonfarm Nonresidential

     1,374         1,231   

Consumer Installment

     5         5   

Credit Cards and Related Plans

     —           —     

Commercial and Industrial

     538         553   

Loans to Finance Agricultural Production

     —           —     

All Other Loans

     —           —     
                 

Total

   $ 16,801       $ 15,896   
                 

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

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

(11) Regulatory Matters

Bancorp’s and the Bank’s actual capital ratios for purposes of bank regulatory capital guidelines are presented in the following table:

 

     Ratio required to be
well capitalized
under prompt
corrective action
provisions
    Minimum ratio
required for
capital adequacy
purposes
    Bancorp’s
Ratio
    Bank’s
Ratio
 

As of March 31, 2011:

        

Tier 1 Capital (to Average Assets)

     ³   5.00     ³ 3.00     8.42     8.42

Tier 1 Capital (to Risk Weighted Assets)

     ³   6.00     ³ 4.00     11.97        11.97   

Total Capital (to Risk Weighted Assets)

     ³ 10.00     ³ 8.00     13.24        13.24   

As of December 31, 2010:

        

Tier 1 Capital (to Average Assets)

     ³   5.00     ³ 3.00     8.66     8.66

Tier 1 Capital (to Risk Weighted Assets)

     ³   6.00     ³ 4.00     12.08        12.08   

Total Capital (to Risk Weighted Assets)

     ³ 10.00     ³ 8.00     13.34        13.34   

As of March 31, 2010:

        

Tier 1 Capital (to Average Assets)

     ³   5.00     ³ 3.00     9.26     7.25

Tier 1 Capital (to Risk Weighted Assets)

     ³   6.00     ³ 4.00     12.69        9.91   

Total Capital (to Risk Weighted Assets)

     ³ 10.00     ³ 8.00     13.95        11.17   

During April 2011, the Bank’s Board of Directors adopted a resolution at the request of the Federal Deposit Insurance Corporation to the effect that the Bank, through its management, will take various actions designed to address issues related to the Bank’s operations. The Resolution provides that, among other things, the Bank will (1) establish and continue to maintain an adequate reserve for loan losses, and review the adequacy of the reserve with the Board prior to each quarter-end and make appropriate provisions to the reserve; (2) in order to maintain sufficient capital levels, establish and document a prudent policy regarding cash dividends the Bank pays to Bancorp, document an analysis of amounts to be paid by each quarter-end prior to payment, and not pay any cash dividend to Bancorp without seeking the prior approval of the FDIC and N.C. Commissioner of Banks; (3) implement various recommendations regarding risk management policies and practices for the Bank’s funds management and investment functions; (4) provide for the internal audit program to include a review and coverage of activities sufficient to determine compliance with the Bank’s policies, applicable laws and regulations and sound banking principles, and identification of audit personnel who periodically report directly to the Board; (5) correct or eliminate various credit administration weaknesses and establish an effective credit administration function, and ascertain that all necessary supporting documentation is obtained and evaluated before loans are extended; and (6) correct violations of and ensure further compliance with applicable laws, rules and regulations.

 

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

Forward-Looking Statements

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

Executive Summary

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

As of March 31, 2011, we had consolidated assets of approximately $916.6 million, total loans of approximately $546.6 million, total deposits of approximately $786.8 million and shareholders’ equity of approximately $79.2 million. For the three months ended March 31, 2011, we had a net loss attributable to common shareholders of $1.3 million or $0.47 basic and diluted loss per share, compared to income available to common shareholders of $0.2 million, or $0.08 basic and diluted earnings per share for the three months ended March 31, 2010.

Recent Developments

During April 2011, the Bank’s Board of Directors adopted a resolution at the request of the Federal Deposit Insurance Corporation to the effect that the Bank, through its management, will take various actions designed to address issues related to the Bank’s operations. More detailed information is described in Note 11 of the unaudited consolidated financial statements included in Item 1 of this Report.

 

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Critical Accounting Policies

Our significant accounting policies are set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K Annual Report for the fiscal year ended December 31, 2010. Of these significant accounting policies, we consider our policy regarding the allowance for loan losses to be our most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. We have developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning our allowance for loan losses and related matters, see “Asset Quality”.

Comparison of the Results of Operations for the Three Month Periods Ended March 31, 2011 and 2010

Results of Operations

The following table summarizes components of income and expense and the changes in those components for the three-month period ended March 31, 2011 as compared to the same period in 2010.

Condensed Consolidated Results of Operations

 

     For the
Three months ended
    For the
Three months ended
    Changes from the
Prior Year
 
     March 31, 2011     March 31, 2010     Amount     %  
     (Dollars in thousands)  

Gross interest income

   $ 9,438      $ 10,020      $ (582     (5.8

Gross interest expense

     2,670        3,025        (355     (11.7
                                

Net interest income

     6,768        6,995        (227     (3.2

Provision for loan losses

     3,930        3,000        930        31.0   
                                

Net interest income after provision for loan losses

     2,838        3,995        (1,157     (29.0

Noninterest income

     1,431        2,668        (1,237     (46.4

Noninterest expense

     6,244        6,238        6        0.1   
                                

Income (loss) before income taxes

     (1,975     425        (2,400     (564.7

Income tax benefit

     (891     (62     (829     (1,337.1
                                

Net income (loss)

   $ (1,084   $ 487        (1,571     (322.6

Preferred stock dividend and accretion of discount

     265        265        —          —     
                                

Net income (loss) available to common shareholders

   $ (1,349   $ 222      $ (1,571     (707.7
                                

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. Net interest income for the three months ended March 31, 2011 was $6.8 million compared to $7.0 million for the three months ended March 31, 2010.

The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and interest-bearing liabilities and the various rate spreads between our interest-earning assets and our interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in

 

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the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as non-interest-bearing deposits.

Interest income decreased $582 thousand or 5.8% for the three months ended March 31, 2011 compared to the same three months of 2010. The decrease for the three months ended March 31, 2011 is due to the decrease in the rates earned on our average earning assets which was partially offset by an increase in the volume of these earning assets. Average earning assets increased $12.1 million as compared to the same period in 2010. We funded the increases in interest-earning assets primarily with interest-bearing deposits and long-term obligations. The tax equivalent yield on average earning assets decreased 43 basis points for the quarter ended March 31, 2011 to 4.60% from 5.03% for the same period in 2010. Management attributes the decrease in the yield on our earning assets to the continued low level of short-term market interest rates. Yields on our taxable securities decreased approximately 94 basis points for the first quarter of 2011 as compared to the same period last year as securities sold, called or matured have been replaced with lower yielding securities. Also, approximately $333.2 million or 61.0% of our loan portfolio consists of variable rate loans that adjust with the movement of the prime rate. As a result of low rates for an extended period of time, these loans’ yields have remained relatively flat.

Our average cost of funds during the first quarter of 2011 was 1.49%, a decrease of 24 basis points when compared to 1.73% for the first quarter of 2010. Average rates paid on bank certificates of deposit decreased 20 basis points from 2.09% for the quarter ended March 31, 2010 to 1.89% for the quarter ended March 31, 2011, while our average cost of borrowed funds increased 3 basis points during the first quarter of 2011 compared to the same period in 2010. The increase in the average cost of borrowed funds occurred because there was a larger percentage of long-term obligations to total borrowing during the first quarter of 2011 as compared to the same period in 2010. Total interest expense decreased $355 thousand or 11.7% during the first quarter of 2011 compared to the same period in 2010, primarily the result of decreased market rates paid on certificates of deposit.

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

Our annualized net interest margin, on a tax-equivalent basis, for the three months ended March 31, 2011 was 3.30% compared to 3.55% in the first quarter of 2010 while our net interest spread decreased 19 basis points to 3.11% for the three months ended March 31, 2011 compared to 3.30% during that same period in 2010. The decrease in our net interest margin is mainly the result of decreased average yield of 94 basis points earned on our taxable securities. Average interest-bearing liabilities, as a percentage of interest-earning assets for the quarters ended March 31, 2011 and 2010 was 86.4% and 85.8%, respectively.

 

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

For the three months ended

 

     March 31, 2011      March 31, 2010  
    

Average

Balance

     Yield/
Rate(5)
   

Income/

Expense

     Average
Balance
     Yield/
Rate(5)
   

Income/

Expense

 
     (Dollars in thousands)  

Assets

               

Loans – net (1)

   $ 547,223         5.45   $ 7,357       $ 566,921         5.46   $ 7,632   

Taxable securities

     267,627         2.95     1,946         200,750         3.89     1,924   

Non-taxable securities (2)

     12,646         6.22     194         46,107         6.16     700   

Other investments

     11,162         0.25     7         12,785         0.06     2   
                                                   

Total interest- earning assets

     838,658         4.60   $ 9,504         826,563         5.03   $ 10,258   

Cash and due from banks

     13,327              10,295        

Bank premises and equipment, net

     26,773              25,257        

Other assets

     34,446              26,896        
                           

Total assets