Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - T Bancshares, Inc.Financial_Report.xls
EX-21 - EXHIBIT 21 - T Bancshares, Inc.v307661_ex21.htm
EX-23 - EXHIBIT 23 - T Bancshares, Inc.v307661_ex23.htm
EX-31.2 - EXHIBIT 31.2 - T Bancshares, Inc.v307661_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - T Bancshares, Inc.v307661_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - T Bancshares, Inc.v307661_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10−K

 

x  ANNUAL REPORT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2011

 

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

 

For the transition period from ___________to ___________.

 

Commission File Number: 000-51297

 

T Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

Texas   71-0919962
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer  Identification Number)
     
16000 Dallas Parkway, Suite 125, Dallas, Texas 75248   (972) 720-9000
(Address of principal executive offices) (ZIP Code)   Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01

 

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

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 (§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  x   No   ¨

 

Indicate by check mark if no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to Form 10-K.    ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

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

 

As of June 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common stock held by non-affiliates was $5.2 million.

 

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

 

The number of common shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 4,021,932 shares of the Company’s Common Stock ($0.01 par value per share) were outstanding as of March 30, 2012

 

Specified portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2012 Annual Meeting of Shareholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the registrant’s fiscal year ended December 31, 2011, are incorporated by reference in Part III of this Annual Report on Form 10-K.

 

 
 

 

TABLE OF CONTENTS

 

PART I     3
    Item 1. Business 3
    Item 1A. Risk Factors 18
    Item 2. Properties 24
    Item 3. Legal Proceedings 24
    Item 4. Mine Safety Disclosures 24
       
PART II     24
    Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities 24
    Item 6. Select Financial Data 25
    Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 25
    Item 7A. Quantitative and Qualitative Disclosures about Market Risk 39
    Item 8. Financial Statements and Supplementary Data 40
    Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 64
    Item 9A. Controls and Procedures 64
    Item 9B. Other Information 64
       
PART III     65
    Item 10. Directors, Executive Officers, and Corporate Governance 65
    Item 11. Executive Compensation 65
    Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters 65
    Item 13. Certain Relationships and Related Transactions and Director Independence 65
    Item 14. Principal Accountant Fees and Services 65
       
PART IV     66
    Item 15. Exhibits and Financial Statement Schedules 66

 

2
 

 

PART I

 

FORWARD-LOOKING STATEMENTS

 

This annual report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause the results of T Bancshares, Inc. to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any projections of financing needs, revenue, expenses, earnings or losses from operations, or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. In addition, forward looking statements may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” will continue,” “will result,” “seek,” “could,” “may,” “might,” or any variations of such words or other words with similar meanings.

 

The risks, uncertainties and assumptions referred to above include risks that are described in “Business—Risk Factors” and elsewhere in this annual report and that are otherwise described from time to time in our Securities and Exchange Commission reports filed after this report.

 

The forward-looking statements included in this annual report represent our estimates as of the date of this annual report. We specifically disclaim any obligation to update these forward-looking statements in the future. These forward-looking statements should not be relied upon as representing our estimates or views as of any date subsequent to the date of this annual report.

 

Item 1.Business.

 

General

 

T Bancshares, Inc. (the “Company,” “we,” “us,” or “our,” hereafter) was incorporated under the laws of the State of Texas on December 23, 2002 to serve as the bank holding company for T Bank, N.A., a national bank (the “Bank”), which opened on November 2, 2004. The Bank operates through a main office located at 16000 Dallas Parkway, Dallas, Texas, and another full-service banking office at 8100 North Dallas Parkway, Plano, Texas. We also have a loan production office located at 850 E. State Highway 114, Suite 200, Southlake, Texas.  Other than its ownership of the Bank, the Company conducts no material business.

 

The Bank is a full-service commercial bank offering a broad range of commercial and consumer banking services to small- to medium-sized businesses, independent single-family residential and commercial contractors and consumers. Lending services include consumer loans and commercial loans to small to medium-sized businesses and professional concerns. The Bank offers a wide range of deposit services including demand deposits, regular savings accounts, money market accounts, individual retirement accounts, and certificates of deposit with fixed rates and a range of maturity options. These services are provided through a variety of delivery systems including automated teller machines, private banking, telephone banking and Internet banking.

 

As of December 31, 2011, the Bank had approximately $123 million in assets, $82 million in total loans and $111 million in deposits.

 

Market Area

 

Our primary service areas include North Dallas, Addison, Plano, Frisco, Southlake, Grapevine and the neighboring Texas communities. We serve these markets from three locations, one of which is a loan production office. Our main office is located at 16000 Dallas Parkway, Dallas, Texas, and we also have a full-service branch office at 8100 North Dallas Parkway, Plano, Texas. The branch office enables us to more effectively serve the Plano/Frisco sector of our primary banking market. We have a loan production office located at 850 E State Highway 114, Southlake, Texas. Our primary service area represents a diverse market with a growing population and economy. This population growth has attracted many businesses to the area and led to growth in the local service economy, and, while they cannot be certain, we expect this trend to continue.

 

The market for financial services is rapidly changing and intensely competitive and is likely to become more competitive as the number and types of market entrants increases. The Bank competes in both lending and attracting funds with other commercial banks, savings and loan associations, credit unions, consumer finance companies, pension trusts, mutual funds, insurance companies, mortgage bankers and brokers, brokerage and investment banking firms, asset-based nonbank lenders, government agencies and certain other non-financial institutions, including retail stores, which may offer more favorable financing alternatives than the Bank.

 

3
 

 

Most of the deposits held in financial institutions in our primary banking market are attributable to branch offices of out-of-state banks. We believe that banks headquartered outside of our primary service area often lack the consistency of local leadership necessary to provide efficient service to individuals and small- to medium-sized business customers. Through our local ownership and management, we believe we are uniquely situated to efficiently provide these customers with loan, deposit and other financial products tailored to fit their specific needs. We believe that the Bank can compete effectively with larger and more established banks through an active business development plan and by offering local access, competitive products and services and more responsive customer service.

 

Lending Services

 

Lending Policy

 

We offer a full range of lending products, including commercial loans to small- to medium-sized businesses and professional concerns and consumer loans to individuals. We compete for these loans with competitors who are well established in our primary market area and have greater resources and lending limits. As a result, we currently have to offer more flexible pricing and terms to attract borrowers.

 

The Bank’s delegations of authority, which is approved by the Board of Directors, provide for various levels of officer lending authority. The Bank has an independent review that evaluates the quality of loans on a quarterly basis and determines if loans are originated in accordance with the guidelines established by the Board of Directors. Additionally, our Board of Directors has formed a Directors’ Loan Committee with members determined by board resolution to provide the following oversight:

 

·ensure compliance with loan policy, procedures and guidelines as well as appropriate regulatory requirements;
·approve secured loans above an aggregate amount of $750,000 and unsecured loans above an aggregate amount of $250,000 to any entity and/or related interest;
·monitor delinquent and non-accrual loans;
·monitor overall loan quality through review of information relative to all new loans;
·monitor our loan review systems; and
·review the adequacy of the loan loss reserve.

 

We follow a conservative lending policy, but one which we believe permits prudent risks to assist businesses and consumers in our lending market. Interest rates vary depending on our cost of funds, the loan maturity, the degree of risk and other loan terms. The Bank does not make any loans to any of its directors, executive officers or their affiliates.

 

Lending Limits

 

The Bank’s lending activities are subject to a variety of lending limits. Differing limits apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the Bank. In general, however, the Bank is able to loan any one borrower a maximum amount equal to either:

 

·15% of the Bank’s capital and surplus and allowance for loan losses; or
·25% of its capital and surplus and allowance for loan losses if the amount that exceeds 15% is secured by cash or readily marketable collateral, as determined by reliable and continuously available price quotations; or
·any amount when the loan is fully secured by a segregated deposit at the Bank and the Bank has perfected its security interest in the deposit.

 

These legal limits will increase or decrease as the Bank’s capital increases or decreases as a result of its earnings or losses, among other reasons. 

 

Credit Risks

 

The principal economic risk associated with each category of loans that the Bank makes is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the relevant business market segment. General economic factors affecting a borrower’s ability to repay include interest, inflation and employment rates, as well as other factors affecting a borrower’s customers, suppliers and employees. The well-established financial institutions in our primary service area currently make proportionately more loans to medium- to large-sized businesses than the Bank. Many of the Bank’s anticipated commercial loans will likely be made to small- to medium-sized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers.

 

4
 

 

Commercial and Industrial Loans

 

Loans for commercial purposes in various lines of businesses are a major component of the Bank’s loan portfolio. The targets in the commercial loan markets are retail establishments, professional service providers, in particular dentists, and small-to medium-sized businesses. The terms of these loans vary by purpose and by type of underlying collateral, if any. The commercial loans primarily are underwritten on the basis of the borrower’s ability to service the loan from income and their creditworthiness. The Bank will typically make equipment loans for a term of ten years or less at fixed or variable rates, with the loan fully amortized over the term. Loans to support working capital will typically have terms not exceeding one year and will usually be secured by accounts receivable, inventory or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and for loans secured with other types of collateral, principal will typically be repaid over the term of the loan or due at maturity.

 

Commercial lending generally involves greater credit risk than residential mortgage or consumer lending, and involves risks that are different from those associated with commercial real estate lending. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default may represent an insufficient source of repayment because equipment and other business assets may, among other things, be obsolete or of limited use. Accordingly, the repayment of a commercial loan depends primarily on the creditworthiness and projected cash flow of the borrower (and any guarantors), while liquidation of collateral is considered a secondary source of repayment. 

 

Real Estate Loans

 

The Bank makes commercial real estate loans, construction and development loans, owner occupied commercial real estate loans to small businesses, and residential real estate loans. On some of these loans, the Bank takes a security interest in real estate as a prudent practice and measure and not as the principal collateral for the loan.

 

·Commercial real estate. Commercial real estate loan terms generally are limited to ten years or less, although payments may be structured on a longer amortization basis. Interest rates may be fixed or adjustable, although rates typically are not fixed for a period exceeding 60 months. The Bank generally charges an origination fee for its services. The Bank generally requires personal guarantees from the principal owners of the property supported by a review by the Bank’s management of the principal owners’ personal financial statements. The Bank also makes commercial real estate loans to owner occupants of the real estate held as collateral. Risks associated with commercial real estate loans include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and the quality of the borrower’s management. The Bank limits its risk by analyzing borrowers’ cash flow and collateral value on an ongoing basis. In addition, at least two of our directors are experienced in the acquisition, development and management of commercial real estate and use their experience to assist in the evaluation of potential commercial real estate loans.

 

·Construction and development loans. We make construction and development loans on a pre-sold and speculative basis. If the borrower has entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a pre-sold basis. If the borrower has not entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a speculative basis. Construction and development loans are generally made with a term of six to 12 months and interest is paid monthly. The ratio of the loan principal to the value of the collateral as established by independent appraisal typically will not exceed industry standards and applicable regulations. Speculative loans are based on the borrower’s financial strength and cash flow position. Loan proceeds will be disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or third-party inspector. Risks associated with construction loans include, without limitation, fluctuations in the value of real estate, the financial condition of the buyer on a presold basis and of the builder on a speculative basis, and new job creation trends.

 

·Residential real estate. The Bank’s residential real estate loans consist of loans to acquire and renovate existing homes for subsequent re-sale, residential new construction loans and, on a very limited basis, second mortgage loans and traditional mortgage lending for one-to-four family residences. The Bank offers primarily adjustable rate mortgages. All loans are made in accordance with the Bank’s appraisal and loan policy with the ratio of the loan principal to the value of collateral as established by independent appraisal generally not exceeding 80%. We believe these loan-to-value ratios are sufficient to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market.

 

5
 

 

Consumer Installment Loans

 

The Bank makes loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. These loans are typically to the principals and employees of our business customers. Repayment of consumer loans depends upon the borrower’s financial stability and is more likely to be adversely affected by divorce, job loss, illness and personal hardships than repayment of other loans. Because many consumer loans are secured by depreciable assets such as boats, cars and trailers, the loan should be amortized over the useful life of the asset. The loan officer will review the borrower’s past credit history, past income level, debt history and, when applicable, cash flow and determine the impact of all these factors on the ability of the borrower to make future payments as agreed. The principal competitors for consumer loans are the established banks and finance companies in our market.

 

Portfolio Composition

 

The following table sets forth the composition of the Bank’s loan portfolio at December 31, 2011. Loan balances do not include undisbursed loan proceeds, unearned income, and allowance for loan losses.

 

   Portfolio Percentage 
   at 
   December 31, 2011 
Commercial and industrial   69%
Real Estate – mortgage   24%
Real Estate – construction   6%
Consumer installment   1%
      
    100%

 

Investments

 

The Bank invests a portion of its assets in U.S. Treasuries, U.S. government agencies, mortgage-backed securities, direct obligations of quasi government agencies including Fannie Mae, Freddie Mac, and the Federal Home Loan Bank, and federal funds sold. No investment in any of those instruments exceeds any applicable limitation imposed by law or regulation. The Bank’s investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at minimal risks while providing liquidity to fund increases in loan demand or to offset deposit fluctuations. The Bank’s Asset-Liability Committee reviews the investment portfolio on an ongoing basis in order to ensure that the investments conform to the Bank’s policy as set by the Board of Directors.

 

Deposit Services

 

Deposits are the major source of the Bank’s funds for lending and other investment activities. Additionally, we also generate funds from loan principal repayments and prepayments. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. The Bank considers the majority of its regular savings, demand, NOW, and money market deposit accounts to be core deposits. These accounts comprised approximately 68% of the Bank’s total deposits at December 31, 2011. The Bank’s remaining deposits were composed of time deposits less than $100,000, which comprised 6% of total deposits, and time deposits of  $100,000 and greater, which comprised approximately 26% of total deposits at December 31, 2011. The Bank believes it is very competitive in the types of accounts and interest rates we offer on deposit accounts, in particular money market accounts and time deposits. We actively solicit these deposits through personal solicitation by its officers and directors, advertisements published in the local media, and through our Internet banking strategy.

 

As a result of not being considered well capitalized (as discussed below), we cannot price our deposit products in excess of 0.75% over the national average of similar deposit types and terms as published weekly by the FDIC. Because of the 85% loan to deposit requirement, we intend to spread future asset growth across various asset categories in addition to loan assets. Other areas of asset growth are anticipated to be high quality, short term, investment grade securities. These asset classes currently provide a lower return to the Bank, commensurate with their lower risk, as compared to loan assets. We do not believe the restrictions on deposit pricing will factor into the Bank’s future growth because of the availability of the trust money market deposits. In addition, we have been able to replace maturing time deposits at managed volumes and rates that were well below the maximum rate allowable.

 

Trust Services

 

Since August 2006, the Bank has offered traditional fiduciary services, such as serving as executor, trustee, agent, administrator or custodian for individuals, nonprofit organizations, employee benefit plans and organizations. The Bank’s trust department works with our customers and their financial advisors to define objectives, goals and strategies for their investment portfolios and tailor their investment portfolios accordingly. As of December 31, 2011, the Bank had approximately $872 million in trust assets under management.

 

6
 

 

Other Banking Services

 

Other banking services currently offered or anticipated include cashier’s checks, travelers’ checks, direct deposit of payroll and Social Security payments, bank-by-mail, remote check deposits, automated teller machine cards and debit cards. The Bank offers full service personal and business internet banking which includes remote deposit for both consumers and businesses, bill payment, electronic transfer of funds between financial institutions as well as traditional internet services such as balance inquiries and internal funds transfers. The Bank offers its customers free usage of any automated teller machine in the world through its debit card.

 

Employees

 

The success of the Bank depends, in significant part, on its ability to attract, retain and motivate highly qualified management and other personnel, for whom competition is intense. The Bank currently has 25 full-time equivalent employees. None of the Bank’s employees are represented by a collective bargaining agreement. The Bank believes that its relations with its employees are good.

 

Employees are covered by a comprehensive employee benefit program which provides for, among other benefits, hospitalization and major medical insurance, disability insurance, and life insurance. Such employee benefits are considered by management to be generally competitive with employee benefits provided by other similar employers in the Bank's geographic market area.

 

Other Available Information

 

We file or furnish with the Securities and Exchange Commission (the “SEC”) annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other reports required by Section 13(a) or 15(d) of the Securities Exchange Act of 1934. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at www.sec.gov that contains our reports, proxy statements, and other information that we file electronically with the SEC.

 

In addition, our annual reports on Form 10-K and quarterly reports on Form 10-Q are available through our Internet website, www.tbank.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

 

SUPERVISION AND REGULATION

 

Banking is a complex, highly regulated industry. Consequently, our growth and earnings performance and those of the Bank can be affected not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the SEC, the Federal Deposit Insurance Corporation (the “FDIC”), the Office of the Comptroller of the Currency (“Comptroller”), the Internal Revenue Service, and state taxing authorities. The effect of these statutes, regulations, and policies and any changes to any of them can be significant and cannot be predicted.

 

The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies, and the banking industry. The system of supervision and regulation applicable to us and our banking subsidiary establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the Bank’s depositors, and the public, rather than our shareholders and creditors. The following is an attempt to summarize some of the relevant laws, rules, and regulations governing banks and bank holding companies, but does not purport to be a complete summary of all applicable laws, rules, and regulations governing banks and bank holding companies. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

 

T Bancshares, Inc.

 

We are a bank holding company registered with, and subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended. The Bank Holding Company Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

 

In accordance with Federal Reserve policy, we are expected to act as a source of financial strength to the Bank and commit resources to support the Bank. This support may be required under circumstances when we might not be inclined to do so absent this Federal Reserve policy. As discussed below, we could be required to guarantee the capital plan of the Bank if it becomes undercapitalized for purposes of banking regulations.

 

7
 

 

Certain acquisitions

 

The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) acquiring more than 5% of the voting stock of any bank or other bank holding company, (2) acquiring all or substantially all of the assets of any bank or bank holding company, or (3) merging or consolidating with any other bank holding company.

 

Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below. As a result of the USA PATRIOT Act, which is discussed below, the Federal Reserve is also required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions.

 

Under the Bank Holding Company Act, any bank holding company located in Texas, if adequately capitalized and adequately managed, may purchase a bank located outside of Texas. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Texas may purchase a bank located inside Texas. In each case, however, restrictions currently exist on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.

 

Change in bank control

 

Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. With respect to our Company, control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities.

 

Permitted activities

 

Generally, bank holding companies are prohibited under the Bank Holding Company Act from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in any activity other than (1) banking or managing or controlling banks or (2) an activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

 

·factoring accounts receivable;
·making, acquiring, brokering, or servicing loans and usual related activities;
·leasing personal or real property;
·operating a non-bank depository institution, such as a savings association;
·trust company functions;
·financial and investment advisory activities;
·conducting discount securities brokerage activities;
·underwriting and dealing in government obligations and money market instruments;
·providing specified management consulting and counseling activities;
·performing selected data processing services and support services;
·acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
·performing selected insurance underwriting activities.

 

8
 

 

Despite prior approval, the Federal Reserve has the authority to require a bank holding company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness, or stability of any of its banking subsidiaries. A bank holding company that qualifies and elects to become a financial holding company is permitted to engage in additional activities that are financial in nature or incidental or complementary to financial activity. The Bank Holding Company Act expressly lists the following activities as financial in nature:

 

·lending, exchanging, transferring, investing for others, or safeguarding money or securities;
·insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state;
·providing financial, investment, or advisory services;
·issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;
·underwriting, dealing in, or making a market in securities;
·other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;
·foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;
·merchant banking through securities or insurance affiliates; and
·insurance company portfolio investments.

 

To qualify to become a financial holding company, the Bank and any other depository institution subsidiary that we may own at the time must be “well capitalized” and “well managed” and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, we would need to file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days’ written notice prior to engaging in a permitted financial activity. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities. The Federal Reserve serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators, and insurance activities by insurance regulators. We have not elected to become a financial holding company.

 

Source of Strength

 

Under the Federal Reserve Board’s “source of strength” doctrine, a bank holding company is required to act as a source of financial and managerial strength to any subsidiary bank. A bank holding company is expected to commit resources to support a subsidiary bank, including at times when the holding company may not be in a financial position to provide such support. A bank holding company’s failure to meet its source-of-strength obligations may constitute an unsafe and unsound practice or a violation of the Federal Reserve’s regulations, or both. The source-of-strength doctrine most directly affects bank holding companies in situations where the bank holding company’s subsidiary bank fails to maintain adequate capital levels. This doctrine was codified by the Dodd-Frank Act, but the Federal Reserve has not yet adopted regulations to implement this requirement.

 

The Federal Reserve also has the power to order a bank holding company to terminate any activity or investment, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or investment or such ownership or control constitutes a serious risk to the financial safety, soundness, or stability of any subsidiary bank of the bank holding company.

 

Sound banking practice

 

Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.

 

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 expanded the Federal Reserve’s authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. The Financial Institutions Reform, Recovery and Enforcement Act increased the amount of civil money penalties which the Federal Reserve can assess for activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues. The Financial Institutions Reform, Recovery and Enforcement Act also expanded the scope of individuals and entities against which such penalties may be assessed.

 

Further, the Federal Reserve issued Supervisory Letter SR 09-4 on February 24, 2009 and revised March 27, 2009, which provides guidance on the declaration and payment of dividends, capital redemptions, and capital repurchases by bank holding company.  Supervisory Letter SR 09-4 provides that, as a general matter, a bank holding company should eliminate, defer, or significantly reduce its dividends if:  (1) the bank holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends, (2) the bank holding company’s prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition, or (3) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.  Failure to do so could result in a supervisory finding that the bank holding company is operating in an unsafe and unsound manner.

 

9
 

 

Anti-tying restrictions

 

Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by a holding company or its affiliates.

 

Dividends

 

Consistent with its policy that bank holding companies should serve as a source of financial strength for their subsidiary banks, the Federal Reserve has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of distributions to shareholders unless its available net income has been sufficient to fully fund the distributions, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality, and overall financial condition. In addition, we are subject to certain restrictions on the making of distributions as a result of the requirement that the Bank maintain an adequate level of capital as described below. As a Texas corporation, we are restricted under the Texas Business Organizations Code from paying dividends under certain conditions. Under Texas law, we cannot pay dividends to shareholders if the dividends exceed our surplus or if after giving effect to the dividends, we would be insolvent.

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act of 2002 (the “SOX Act”) represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. Among other requirements, the SOX Act established: (i) new requirements for audit committees of public companies, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the chief executive officers and chief financial officers of reporting companies; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for reporting companies regarding various matters relating to corporate governance; and (v) new and increased civil and criminal penalties for violation of the securities laws. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, smaller companies like us are permanently exempt from having an independent auditor test and report on the effectiveness of their internal controls over financial reporting.

 

The Dodd-Frank Act

 

On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act will have a broad impact on the financial services industry, imposing significant regulatory and compliance changes, including the designation of certain financial companies as systemically significant, the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework of authority to conduct systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, or Council, the Federal Reserve, the Comptroller, and the FDIC.

 

The following items provide a brief description of certain provisions of the Dodd-Frank Act that may have an effect on us.

 

·The Dodd-Frank Act significantly reduces the ability of national banks to rely upon federal preemption of state consumer financial laws. Although the Comptroller, as the primary regulator of national banks, will have the ability to make preemption determinations where certain conditions are met, the broad rollback of federal preemption has the potential to create a patchwork of federal and state compliance obligations. This could, in turn, result in significant new regulatory requirements applicable to us and certain of our lending activities, with potentially significant changes in our operations and increases in our compliance costs. It could also result in uncertainty concerning compliance, with attendant regulatory and litigation risks.

 

·The Dodd-Frank Act makes permanent the general $250,000 deposit insurance limit for insured deposits. The Dodd-Frank Act also extends until January 1, 2013, federal deposit coverage for the full net amount held by depositors in non-interest bearing transaction accounts. Amendments to the FDIC Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to DIF will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity. Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. Several of these provisions could increase the FDIC deposit insurance premiums paid by us.

 

10
 

 

·The Dodd-Frank Act generally enhances the restrictions on transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered credit transactions must be satisfied. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivatives transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

 

·The Dodd-Frank Act strengthens the existing limits on a depository institution’s credit exposure to one borrower. Federal banking law currently limits a federal thrift’s ability to extend credit to one person (or group of related persons) in an amount exceeding certain thresholds. The Dodd-Frank Act expands the scope of these restrictions to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions.

 

·The Dodd-Frank Act authorizes the establishment of the Consumer Financial Protection Bureau (“the CFPB”), which has the power to issue rules governing all financial institutions that offer financial services and products to consumers. The CFPB has the authority to monitor markets for consumer financial products to ensure that consumers are protected from abusive practices. Financial institutions will be subject to increased compliance and enforcement costs associated with regulations established by the CFPB.

 

·The Dodd-Frank Act may create risks of “secondary actor liability” for lenders that provide financing to entities offering financial products to consumers. We may incur compliance and other costs in connection with administration of credit extended to entities engaged in activities covered by Dodd-Frank.

 

·The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including ours. The Dodd-Frank Act (1) grants stockholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers; (4) provides the SEC with authority to adopt proxy access rules that would allow stockholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials; (5) prohibits uninstructed broker votes on election of directors, executive compensation matters (including say on pay advisory votes), and other significant matters, and (6) requires disclosure on board leadership structure

 

Many of the requirements of the Dodd-Frank Act will be implemented over time and most will be subject to regulations implemented over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.

 

The Bank

 

The Bank is subject to the supervision, examination and reporting requirements of the National Bank Act and the regulations of the Comptroller. The Comptroller will regularly examine the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The Comptroller also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. The Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations. Collectively, these regulations add to the cost of operations to ensure the Bank is operating in a compliant fashion.

 

The Bank’s deposits are insured by the FDIC to the maximum extent provided by law.

 

11
 

 

Interstate Banking and Branching

 

Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 amended the Federal Deposit Insurance Act (the “FDIA”) and certain other statutes to permit state and national banks with different home states to merge across state lines, with approval of the appropriate federal banking agency, unless the home state of a participating bank had passed legislation prior to May 31, 1997 expressly prohibiting interstate mergers. Under the Riegle-Neal Act amendments, once a state or national bank has established branches in a state, that bank may establish and acquire additional branches at any location in the state at which any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the state which has opted out, whether through an acquisition or de novo.

 

However, under the Dodd-Frank Act, the national branching requirements have been relaxed and national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.

 

Both the Comptroller and the Texas Banking Department accept applications for interstate merger and branching transactions, subject to certain limitations on ages of the banks to be acquired and the total amount of deposits within the state a bank or financial holding company may control. Since our primary service area is Texas, we do not expect that the ability to operate in other states will have any material impact on our growth strategy. We may, however, face increased competition from out-of-state banks that branch or make acquisitions in our primary markets in Texas.

 

Deposit insurance assessments

 

Substantially all of the deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (the “DIF”), as administered by the FDIC, and are subject to deposit insurance assessments to maintain the DIF.  Until October 2008, the insurance protection generally did not exceed $100,000 per depositor. Beginning in October 2008, the amount of protection was increased to $250,000, under the Temporary Liquidity Guarantee Program (TLGP) of the Emergency Economic Stabilization Act of 2008. This increased protection to $250,000 was initially available only through December 31, 2009 but in 2010, the FDIC made this $250,000 protection permanent. The new regulations were also expanded whereby the protection for non-interest bearing deposits was unlimited at institutions participating in the TLGP. This unlimited coverage for these non-interest bearing accounts was also initially only available through December 31, 2009 but was extended until December 31, 2012. Non-interest bearing deposits initially also included, by definition, certain Interest on Lawyers Trust Accounts (IOLTA) and Negotiable Order of Withdrawal accounts (NOW Accounts) with a maximum capped interest rate. Effective January 1, 2011 through December 31, 2012, the definition of non-interest bearing was changed to no longer include NOW accounts. The FDIC uses a risk-based assessment system that imposes insurance premiums based upon a risk matrix.  Each insured depository institution is assigned to one of four risk categories that are based on both capital and supervisory evaluations.  

 

The FDIC announced in 2009 the requirement of member banks to prepay on December 30, 2009, their estimated quarterly assessments for 2010, 2011 and 2012, including a three basis point increase in premium rates for 2011 and 2012. The Company’s prepayment amount totaled $921,000 in the aggregate and is being expensed over a three year period based on future quarterly assessment calculations. As of December 31, 2011, $544,000 in pre-paid deposit insurance assessments is included in other assets in the accompanying consolidated balance sheet.

 

In October 2010, the FDIC adopted a new Restoration Plan for the DIF to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. Under the Restoration Plan, the FDIC did not institute the uniform three-basis point increase in assessment rates scheduled to take place on January 1, 2011 and maintained the current schedule of assessment rates for all depository institutions. At least semi-annually, the FDIC will update its loss and income projections for the DIF and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking, if required. 

 

As required by the Dodd-Frank Act, the FDIC also revised the deposit insurance assessment system, effective April 1, 2011, to base assessments on the average total consolidated assets of insured depository institutions during the assessment period, less the average tangible equity of the institution during the assessment period. Previously, only deposits were included in determining the premium paid by an institution. This base assessment change necessitated that the FDIC adjust the assessment rates to ensure that the revenue collected under the new assessment system, will approximately equal that under the existing assessment system. Pursuant to this new rule, the assessment base will be larger than the current assessment base, but the new rates are lower than current rates, ranging from approximately 2.5 basis points to 45 basis points (depending on applicable adjustments for unsecured debt and brokered deposits) until such time as the FDIC’s reserve ratio equals 1.15%. Once the FDIC’s reserve ratio equals or exceeds 1.15%, the applicable assessment rates may range from 1.5 basis points to 40 basis points. The Bank’s deposit insurance expense have decreased as a result of the changes to the Bank’s deposit insurance premium assessment base implemented by the FDIC pursuant to the Dodd-Frank Act.

 

Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

 

Expanded financial activities

 

Similar to bank holding companies, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 expanded the types of activities in which a bank may engage. Generally, a bank may engage in activities that are financial in nature through a “financial subsidiary” if the bank and each of its depository institution affiliates are “well capitalized,” “well managed” and have at least a “satisfactory” rating under the Community Reinvestment Act. However, applicable law and regulation provide that the amounts of investment in these activities generally are limited to 45% of the total assets of the Bank, and these investments are deducted when determining compliance with capital adequacy guidelines. Further, the transactions between the Bank and this type of subsidiary are subject to a number of limitations.

 

Expanded financial activities of national banks generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Bank currently has no plans to conduct any activities through financial subsidiaries. 

 

12
 

 

Community Reinvestment Act

 

The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC, or the Comptroller, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Because our aggregate assets are currently less than $250 million, under the Gramm-Leach-Bliley Act, we are subject to a Community Reinvestment Act examination only once every 60 months if we receive an outstanding rating, once every 48 months if we receive a satisfactory rating and as needed if our rating is less than satisfactory. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

 

Dividends

 

The Bank is required by federal law to obtain prior approval of the Comptroller for payments of dividends if the total of all dividends declared by its board of directors in any year will exceed its net profits earned during the current year combined with its retained net profits of the immediately preceding two years, less any required transfers to surplus. In addition, the Bank will be unable to pay dividends unless and until it has positive retained earnings. As of December 31, 2011, the Bank had an accumulated deficit of approximately $8.1 million. Accordingly, we will be unable to pay dividends until the accumulated deficit is eliminated.

 

In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay any dividend if the payment of the dividend would cause the Bank to become undercapitalized or in the event the Bank is “undercapitalized.” The Comptroller may further restrict the payment of dividends by requiring that a financial institution maintain a higher level of capital than would otherwise be required to be “adequately capitalized” for regulatory purposes. Moreover, if, in the opinion of the Comptroller, the Bank is engaged in an unsound practice (which could include the payment of dividends), the Comptroller may require, generally after notice and hearing, that the Bank cease such practice. The Comptroller has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe banking practice. Moreover, the Comptroller has also issued policy statements providing that insured depository institutions generally should pay dividends only out of current operating earnings.

 

Capital adequacy

 

The Federal Reserve monitors the capital adequacy of bank holding companies, such as the Company, and the Comptroller monitors the capital adequacy of the Bank. The federal bank regulators use a combination of risk-based guidelines and leverage ratios to evaluate capital adequacy and consider these capital levels when taking action on various types of applications and when conducting supervisory activities related to the safety and soundness of the Company and the Bank. The risk-based guidelines apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more and, generally, on a bank-only basis for bank holding companies with less than $500 million in consolidated assets. Each insured depository subsidiary of a bank holding company with less than $500 million in consolidated assets is expected to be “well-capitalized.”

 

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

 

An institution is considered "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and it is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.

 

An institution is considered "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of at least 4% and leverage capital ratio of 4% or greater (or a leverage ratio of 3% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate Federal bank regulatory agency guidelines), and the institution does not meet the definition of an undercapitalized institution.

 

An institution is considered "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage ratio that is less than 4% (or a leverage ratio that is less than 3% if the institution is rated composite 1 in its most recent report of examination, subject to appropriate Federal Banking agency guidelines).

 

13
 

 

The Federal Deposit Insurance Corporation Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”), and all institutions are assigned one such category. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is “critically undercapitalized.” The federal banking agencies have specified by regulation the relevant capital level for each category. An institution that is categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an “undercapitalized” subsidiary’s assets at the time it became “undercapitalized” or the amount required to meet regulatory capital requirements. An “undercapitalized” institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

 

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

 

Restrictions on Transactions with Affiliates and Loans to Insiders    

 

The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

 

·a bank’s loans or extensions of credit to affiliates;

 

·a bank’s investment in affiliates;

 

·assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;

 

·the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and

 

·a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

 

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.

 

The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in the transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

 

Privacy

 

Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions’ own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers.

 

14
 

 

Anti-terrorism legislation

 

In the wake of the tragic events of September 11th, on October 26, 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 was enacted. Also known as the “Patriot Act,” the law enhances the powers of the federal government and law enforcement organizations to combat terrorism, organized crime and money laundering. The Patriot Act significantly amends and expands the application of the Bank Secrecy Act, including enhanced measures regarding customer identity, new suspicious activity reporting rules and enhanced anti-money laundering programs.

 

Under the Patriot Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:

 

·to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

 

·to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

 

·to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank and the nature and extent of the ownership interest of each such owner; and

 

·to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

 

Under the Patriot Act, financial institutions must also establish anti-money laundering programs. The Act sets forth minimum standards for these programs, including: (i) the development of internal policies, procedures and controls; (ii) the designation of a compliance officer; (iii) an ongoing employee training program; and (iv) an independent audit function to test the programs.

 

In addition, the Patriot Act requires the bank regulatory agencies to consider the record of a bank or bank holding company in combating money laundering activities in their evaluation of bank and bank holding company merger or acquisition transactions. Regulations proposed by the U.S. Department of the Treasury to effectuate certain provisions of the Patriot Act provide that all transaction or other correspondent accounts held by a U.S. financial institution on behalf of any foreign bank must be closed within 90 days after the final regulations are issued, unless the foreign bank has provided the U.S. financial institution with a means of verification that the institution is not a “shell bank.” Proposed regulations interpreting other provisions of the Patriot Act are continuing to be issued.

 

Under the authority of the Patriot Act, the Secretary of the Treasury adopted rules on September 26, 2002 increasing the cooperation and information sharing between financial institutions, regulators and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Under these rules, a financial institution is required to:

 

·expeditiously search its records to determine whether it maintains or has maintained accounts, or engaged in transactions with individuals or entities, listed in a request submitted by the Financial Crimes Enforcement Network (“FinCEN”);

 

·notify FinCEN if an account or transaction is identified;

 

·designate a contact person to receive information requests;

 

·limit use of information provided by FinCEN to: (1) reporting to FinCEN, (2) determining whether to establish or maintain an account or engage in a transaction and (3) assisting the financial institution in complying with the Bank Secrecy Act; and

 

·maintain adequate procedures to protect the security and confidentiality of FinCEN requests.

 

15
 

 

Under the new rules, a financial institution may also share information regarding individuals, entities, organizations and countries for purposes of identifying and, where appropriate, reporting activities that it suspects may involve possible terrorist activity or money laundering. Such information-sharing is protected under a safe harbor if the financial institution: (1) notifies FinCEN of its intention to share information, even when sharing with an affiliated financial institution; (2) takes reasonable steps to verify that, prior to sharing, the financial institution or association of financial institutions with which it intends to share information has submitted a notice to FinCEN; (3) limits the use of shared information to identifying and reporting on money laundering or terrorist activities, determining whether to establish or maintain an account or engage in a transaction, or assisting it in complying with the Bank Security Act; and (4) maintains adequate procedures to protect the security and confidentiality of the information. Any financial institution complying with these rules will not be deemed to have violated the privacy requirements discussed above.

 

The Secretary of the Treasury also adopted a rule on September 26, 2002 intended to prevent money laundering and terrorist financing through correspondent accounts maintained by U.S. financial institutions on behalf of foreign banks. Under the rule, financial institutions: (1) are prohibited from providing correspondent accounts to foreign shell banks; (2) are required to obtain a certification from foreign banks for which they maintain a correspondent account stating the foreign bank is not a shell bank and that it will not permit a foreign shell bank to have access to the U.S. account; (3) must maintain records identifying the owner of the foreign bank for which they may maintain a correspondent account and its agent in the Unites States designated to accept services of legal process; (4) must terminate correspondent accounts of foreign banks that fail to comply with or fail to contest a lawful request of the Secretary of the Treasury or the Attorney General of the United States, after being notified by the Secretary or Attorney General.

 

Bank Secrecy Act

 

In 2007, the FDIC and the other federal financial regulatory agencies issued an interagency policy on the application of section 8(s) of the FDIA. This provision generally requires each federal banking agency to issue an order to cease and desist when a bank is in violation of the requirement to establish and maintain a Bank Secrecy Act/anti-money laundering (BSA/AML) compliance program, or, in the alternative, the bank fails to correct a deficiency that has been previously cited by the federal banking agency with respect to the bank's BSA/AML compliance program. The policy statement provides that, in addition to the circumstances where the agencies will issue a cease and desist order in compliance with section 8(s), they may take other actions as appropriate for other types of BSA/AML program concerns or for violations of other BSA requirements. The policy statement also does not address the independent authority of the U.S. Department of the Treasury's Financial Crimes Enforcement Network to take enforcement action for violations of the BSA.

 

Fair Lending Laws

 

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to a financial institution’s performance under the fair lending laws and regulations could adversely impact the financial institutions rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact the financial institution’s reputation, business, financial condition and results of operations.

 

Concentrated Commercial Real Estate Lending Regulations

 

The Federal Reserve, the FDIC and the Comptroller promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm residential properties and loans for construction, land development, and other land represent 300% or more of total capital and the Bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and increasing capital requirements. As of December 31, 2011, we did not have a concentration in commercial real estate.

 

Regulation Z

 

On April 5, 2011, the Federal Reserve’s Final Rule on Loan Originator Compensation and Steering (Regulation Z) became final. Regulation Z is more commonly known as regulation that implements the Truth in Lending Act. Regulation Z address two components of mortgage lending, i.e., loans secured by a dwelling, and implements restrictions and guidelines for: (a) prohibited payments to loan originators and (b) prohibitions on steering. Under Regulation Z, a creditor is prohibited from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction's terms or conditions, except the amount of credit extended, which is deemed not to be a transaction term or condition. In addition, Regulation Z prohibits a loan originator from “steering” a consumer to a lender or a loan that offers less favorable terms in order to increase the loan originator’s compensation, unless the loan is in the consumer's interest. Regulation Z also contains a record-retention provision requiring that, for each transaction subject to Regulation Z, the financial institution must maintain records of the compensation it provided to the loan originator for that transaction as well as the compensation agreement in effect on the date the interest rate was set for the transaction. These records must be maintained for two years.

 

UDAP and UDAAP

 

Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act—the primary federal law that prohibits unfair or deceptive acts or practices and unfair methods of competition in or affecting commerce (“UDAP” or “FTC Act”). “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the UDAP law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” (“UDAAP”), which has been delegated to the CFPB for supervision. The CFPB has published its first Supervision and Examination Manual that addresses compliance with and the examination of UDAAP.

 

Other regulations

 

The Bank’s operations are also subject to various federal and state laws such as:

 

·the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
·the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
·the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
·the Fair Credit Reporting Act of 1978 and its amendment, the Fair and Accurate Credit Transactions Act of 2003, governing the use and provision of information to credit reporting agencies;
·the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
·the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
·the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
·the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

 

Regulatory Reform and Legislation

 

The U. S. and global economies have experienced and are experiencing significant stress and disruptions in the financial sector. Dramatic slowdowns in the housing industry with falling home prices and increasing foreclosures and unemployment have created strains on financial institutions, including government-sponsored entities and investment banks. As a result, many financial institutions sought and continue to seek additional capital, merge or seek mergers with larger and stronger institutions and, in some cases, failed.

 

16
 

 

On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee, announced agreement on the calibration and phase — in arrangements for a strengthened set of capital requirements, known as Basel III. Basel III increases the minimum Tier 1 common equity ratio to 4.5%, net of regulatory deductions, and introduces a capital conservation buffer of an additional 2.5% of common equity to risk — weighted assets, raising the target minimum common equity ratio to 7%. This capital conservation buffer also increases the minimum Tier 1 capital ratio from 6% to 8.5% and the minimum total capital ratio from 8% to 10.5%. In addition, Basel III introduces a countercyclical capital buffer of up to 2.5% of common equity or other fully loss absorbing capital for periods of excess credit growth. Basel III also introduces a non-risk adjusted Tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards. The Basel III capital and liquidity standards will be phased in over a multi-year period. The final package of Basel III reforms was submitted to the Seoul G20 Leaders Summit in November 2010 for endorsement by G20 leaders, and then will be subject to individual adoption by member nations, including the United States. The Federal Reserve will likely implement changes to the capital adequacy standards applicable to the Company and our subsidiary bank in light of Basel III.

 

Effect of governmental monetary policies

 

The commercial banking business is affected not only by general economic conditions but also by the fiscal and monetary policies of the Federal Reserve Board. Some of the instruments of fiscal and monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against member banks’ deposits and assets of foreign branches, the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates, and the placing of limits on interest rates that member banks may pay on time and savings deposits. Such policies influence to a significant extent the overall growth of bank loans, investments, and deposits and the interest rates charged on loans or paid on time and savings deposits. We cannot predict the nature of future fiscal and monetary policies and the effect of such policies on the future business and our earnings.

 

All of the above laws and regulations add significantly to the cost of operating the Bank and thus have a negative impact on our profitability. It should also be noted that there has been a tremendous expansion experienced in recent years by certain financial service providers that are not subject to the same rules and regulations as the Company or the Bank. These institutions, because they are not so highly regulated, have a competitive advantage over us and may continue to draw large amounts of funds away from traditional banking institutions, with a continuing adverse effect on the banking industry in general.

 

17
 

 

Item 1A.Risk Factors.

 

An investment in our common stock involves certain risks.  Our business, financial condition, operating results and cash flows can be impacted by a number of factors. These important factors could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed in the risk factors, described below. You should carefully consider the following risk factors and all other information contained in this Report. The risks and uncertainties described below may not be the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial also may impair our business. If any of the events described in the following risk factors occur, our business, results of operations and financial condition could be materially adversely affected. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment.

 

We are operating under a formal Agreement with the Comptroller.

 

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

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of tier 1 capital (as defined) to average assets (as defined). To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, tier 1 risk-based, and tier 1 leverage ratios as set forth in the table.

 

In 2010, the Bank was informed by the Office of the Comptroller of the Currency (the “Comptroller”) that the Comptroller intended to institute an enforcement action for alleged violations of the Federal Trade Commission Act in connection with certain merchants and a payment processor that were Bank customers between September 1, 2006 and August 27, 2007.   The Comptroller proposed that the Bank enter into a formal agreement with the Comptroller (the “Agreement”). To avoid the expense, delay, and uncertainty related to potential litigation with its primary regulator, the Bank negotiated a settlement with the Comptroller.  Accordingly, on April 15, 2010, the Bank executed the Agreement, neither admitting nor denying the Comptroller’s findings, which among other provisions required the Bank to reimburse eligible consumers for charges made  by the merchants to the eligible consumers. On October 28, 2011, the Comptroller concurred that the Bank had fulfilled this obligation. The Agreement also contains the general terms outlined as follows:

 

·require the Bank to establish a capital plan which, among other provisions, details the Bank’s plan to achieve tier 1 capital ratio of 9% and total risk based capital ratio of 11.5%;

 

·require the Bank to develop a written program designed to reduce the level of criticized assets;

 

·require the Bank to develop and implement an asset liquidity enhancement plan designed to increase the amount of asset liquidity maintained by the Bank, including a loan to deposit ratio of 85%; and

 

·require the Bank to develop a written profit plan to improve and sustain the earnings of the Bank.

 

The Bank submitted the required capital, liquidity enhancement, and profit plans, as well as a written program to reduce criticized assets to the Comptroller in accordance with the requirements of the formal agreement. The Comptroller did not object to the plans and program as submitted.

 

The capital ratios required by the Agreement are 11.5% total capital to risk weighted assets and 9.00% tier 1 capital to average assets. As of December 31, 2011, the Bank’s total capital to risk weighted assets ratio was 13.23%. The Bank’s tier 1 capital to average assets ratio was 10.24%. Both ratios exceed the requirements set forth in the Agreement. There is no assurance the Bank will continue to meet the minimum capital requirements set forth in the Agreement. If the Bank fails to meet the minimum capital requirements set forth in the Agreement, the Comptroller may provide written notice that the Bank’s capital is materially deficient. Should that occur, the Bank would have 60 days to submit a capital contingency plan to the Comptroller for review.

 

18
 

 

If as a result of its review or examination of the Bank, the Comptroller should determine that the financial condition, capital resources, asset quality, liquidity, earnings ability, or other aspects of its operations have worsened or that it or its management is violating or has violated the formal agreement, or failed to comply with any provision of the formal agreement, or any law or regulation, various additional remedies are available to the Comptroller. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict our growth, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate our deposit insurance, which would result in the seizure of the Bank by its regulators. As of December 31, 2011, the Comptroller has made no such determination relating to any of the aforementioned aspects of the Bank’s operations.

 

The Agreement with the Comptroller prevents us from being well capitalized under the system of prompt corrective action established by the Federal Deposit Insurance Corporation Improvement Act of 1991 which may inhibit our ability to retain and attract deposits.

 

The Bank’s capital ratios as of December 31, 2011 were 10.24% tier 1 leverage ratio and 13.23% total risk based capital ratio. Although the Bank’s capital ratios met the definition of well capitalized under the system of prompt corrective action and exceed the requirements of the formal agreement, the formal agreement prevents us from being considered well capitalized regardless of our capital ratios. Because of FDIC restrictions which took effect on January 1, 2010 for all insured banks which are considered not well capitalized, the Bank is restricted from offering deposit rates in excess of 0.75% over the national average rate for various deposit terms as published weekly by the FDIC.  This may adversely and materially affect the Bank’s ability to attract and retain deposits which could have a negative impact on the Bank’s liquidity and impair its ability to comply with the formal agreement.

 

Since we commenced operations in 2004, we have had a short and intermittent history of experiencing profits.

 

Our profitability will depend on the Bank’s profitability and, while we were profitable in 2006 and 2007, we experienced significant and material losses for the years 2008 through 2011. We may incur continued difficulties or setbacks reaching profitability in the future. We have incurred substantial start-up expenses associated with our organization and our public offering and sustained losses or achieved minimal profitability during our initial years of operations. At December 31, 2011, we had an accumulated deficit account of approximately $8.1 million, principally resulting from the organizational and pre-opening expenses that we incurred in connection with the opening of the Bank, losses on loans, expenses in connection with the Agreement with the Comptroller, and expenses related to the correction of participant account balances as a result of revising unit values on certain collective investment funds sponsored by the Bank. Our success will depend, in large part, on our ability to attract and retain deposits and customers for our services. If we are ultimately unsuccessful, you may lose part or all of the value of your investment.

 

Our results of operation and financial condition would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses.

 

Experience in the banking industry indicates that a portion of our loans in all categories of our lending business will become delinquent, and some may only be partially repaid or may never be repaid at all. Our methodology for establishing the adequacy of the allowance for loan losses depends on subjective application of risk grades as indicators of borrowers’ ability to repay. Deterioration in general economic conditions and unforeseen risks affecting customers may have an adverse effect on borrowers’ capacity to repay timely their obligations before risk grades could reflect those changing conditions. In times of improving credit quality, with growth in our loan portfolio, the allowance for loan losses may decrease as a percent of total loans. Changes in economic and market conditions may increase the risk that the allowance would become inadequate if borrowers experience economic and other conditions adverse to their businesses. Maintaining the adequacy of our allowance for loan losses may require that we make significant and unanticipated increases in our provisions for loan losses, which would materially affect our results of operations and capital adequacy. Recognizing that many of our loans individually represent a significant percentage of our total allowance for loan losses, adverse collection experience in a relatively small number of loans could require an increase in our allowance. Federal regulators, as an integral part of their respective supervisory functions, periodically review our allowance for loan losses. The regulatory agencies may require us to change classifications or grades on loans, increase the allowance for loan losses with large provisions for loan losses and to recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our results of operations and financial condition.

 

19
 

 

Failure to implement our business strategies may adversely affect our financial performance.

 

We have developed a business plan that details the strategies we intend to implement in our efforts to achieve profitable operations. If we cannot implement our business strategies, we will be hampered in our ability to develop business and serve our customers, which, in turn, could have an adverse effect on our financial performance. Even if our business strategies are successfully implemented, we cannot assure you that our strategies will have the favorable impact that we anticipate. Furthermore, while we believe that our business plan is reasonable and that our strategies will enable us to execute our business plan, we have no control over the future occurrence of certain events upon which our business plan and strategies are based, particularly general and local economic conditions that may affect the Bank’s loan-to-deposit ratio, total deposits, the rate of deposit growth, cost of funding, the level of earning assets and interest-related revenues and expenses.

 

We may elect or be compelled to seek additional capital, but that capital may not be available or it may be dilutive.

 

We are required by the Agreement with the Comptroller to achieve and maintain a Tier 1 leverage capital ratio of 9% and a total risk-based capital ratio of 11.5% by a date determined by the Agreement which is the earlier of 90 days after the Comptroller determines the restitution process has been completed or the Comptroller notifies us of such requirement.  As of December 31, 2011, we exceeded these requirements.

 

In connection with our Rights Offering and Limited Public Offering pursuant to the Registration Statement on Form S-1 (Registration Number 333-177766), which was declared effective by the Securities and Exchange Commission on January 13, 2012, we raised $4,161,254 in additional capital.

 

Our ability to raise capital in the future, if needed, will depend on conditions in the capital markets, which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital when needed, on favorable terms or at all. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These outcomes could negatively impact our ability to operate or further expand our operations through acquisitions or the establishment of additional branches and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition and results of operations. In addition, in order to raise additional capital, we may need to issue shares of our common stock that would dilute the book value of our common stock and reduce our shareholders’ percentage ownership interest to the extent they do not participate in future offerings. Also, if we are unable to raise additional capital, we may be required to take alterative actions which may include the sale of income-producing assets to meet our capital requirements, which could have an adverse impact on our operations and ability to generate income.

 

The Company’s use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral.

 

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and an error in fact or judgment could adversely affect the reliability of an appraisal. In addition, events occurring after the initial appraisal may cause the value of the real estate to decrease. As a result of any of these factors, the value of collateral backing a loan may be less than supposed, and if a default occurs, we may not recover the outstanding balance of the loan.

 

20
 

 

The success of our trust services is dependent upon market fluctuations and a non-diversified source for its growth.

 

Since August 2006, we have offered traditional fiduciary services such as serving as executor, trustee, agent, administrator or custodian for individuals, nonprofit organizations, employee benefit plans and organizations. The Bank received regulatory approval from the Comptroller to establish trust powers in February 2006. As of December 31, 2011, the Bank had approximately $872 million in trust assets under management. To date, virtually all of the growth in our assets under management relates to a registered investment advisor who has advised its clients of the existence of our trust services. We have not compensated the registered investment advisor in any way for making its clients aware of our trust services and cannot assure you that the investment advisor will continue to notify its clients of our trust services or that those clients will open trust accounts at the Bank. Furthermore, the level of assets under management is significantly impacted by the market value of the assets which has increased each year after the sharp decline during 2008. In addition, we are subject to regulatory supervision with respect to these trust services that may restrain our growth and profitability.

 

Certain of our investment advisory and wealth management contracts are subject to termination on short notice, and termination of a significant number of investment advisory contracts could have a material adverse impact on our revenue.

 

Certain of our investment advisory and wealth management clients can terminate their relationships with us, reduce their aggregate assets under management, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, inflation, changes in investment preferences of clients, changes in our reputation in the marketplace, change in management or control of clients, loss of key investment management personnel and financial market performance. We cannot be certain that our trust operations will be able to retain all of its clients. If its clients terminate their investment advisory and wealth management contracts, our trust operations, and consequently we, could lose a substantial portion of our revenues and liquidity.

 

We have a loan concentration related to the acquisition and financing of dental practices.

 

Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. There were no losses in the dental portfolio from 2005 through 2008. In 2009 and 2010, losses represented 0.89% and 0.33% of year end dental portfolio assets, respectively. There were no losses during 2011. At December 31, 2011, our loan portfolio included $58.5 million of loans, approximately 69.9% of our total funded loans, to the dental industry, including practice acquisition loans, dental equipment loans, and dental facility loans. We believe that these loans are conservatively underwritten to credit worthy borrowers and are diversified geographically. However, to the extent that there is a decline in the dental industry in general, we may incur significant losses in our loan portfolio as a result of this concentration.

 

Our operations are significantly affected by interest rate levels.

 

Our profitability is dependent to a large extent on our net interest income, which is the difference between interest income we earn as a result of interest paid to us on loans and investments and interest we pay to third parties such as our depositors and those from whom we borrow funds. Like most financial institutions, we are affected by changes in general interest rate levels, which are currently at record low levels, and by other economic factors beyond our control. Prolonged periods of unusually low interest rates may have an adverse effect on earnings by reducing the value of demand deposits, stockholders’ equity and fixed rate liabilities with rates higher than available earning assets. Interest rate risk can result from mismatches between the dollar amount of repricing or maturing assets and liabilities and from mismatches in the timing and rate at which our assets and liabilities reprice.

 

Although we have implemented strategies which we believe reduce the potential effects of changes in interest rates on our results of operations, these strategies will not always be successful. In addition, any substantial and prolonged increase in market interest rates could reduce our customers’ desire to borrow money from us or adversely affect their ability to repay their outstanding loans by increasing their costs since most of our loans have adjustable interest rates that reset periodically. If our borrowers’ ability to repay is affected, our level of non-performing assets would increase and the amount of interest earned on loans will decrease, thereby having an adverse effect on operating results. Any of these events could adversely affect our results of operations or financial condition.

 

We face intense competition from a variety of competitors.

 

We face competition for deposits, loans, and other financial services from other community banks, regional banks, out-of-state and in-state national banks, savings banks, thrifts, credit unions and other financial institutions as well as other entities which provide financial services, including consumer finance companies, securities brokerage firms, insurance companies, mutual funds, and other lending sources and alternative investment providers. Some of these financial institutions and financial services organizations are not subject to the same degree of regulation as we are. We face increased competition due to the Gramm-Leach-Bliley Act, which allows insurance firms, securities firms, and other non-traditional financial companies to provide traditional banking services. The banking business in our target banking market and the surrounding areas has become increasingly competitive over the past several years, and we expect the level of competition to continue to increase. Many of these competitors have been in business for many years, have established customers, are larger, have substantially higher lending limits than we do, and are able to offer certain services that we do not provide. In addition, many of these entities have greater capital resources than we have, which among other things may allow them to price their services at levels more favorable to the customer or to provide larger credit facilities.

 

21
 

 

We believe that the Bank will be a successful competitor in the area’s financial services market. An inability to compete effectively with other financial institutions serving our target banking market could have a material adverse effect on the Bank’s growth and profitability.

 

We compete in an industry that continually experiences technological change, and we may not be able to compete effectively with other banking institutions with greater resources.

 

The banking industry continues to undergo rapid technological changes with frequent introduction of new technology-driven products and services. In addition to providing better service to customers, the effective use of technology increases efficiency and enables us to reduce costs. Our future success depends in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional operating efficiencies. Many of our competitors have substantially greater resources to invest in technological improvements. Such technology may permit competitors to perform certain functions at a lower cost than we can. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these to our customers. Our inability to do so could have a material adverse effect on our ability to compete effectively in our market and also on our business, financial condition, and results of operations.

 

Our legal lending limits may impair our ability to attract borrowers and ability to compete with larger financial institutions.

 

Our per customer lending limit at December 31, 2011 was approximately $1.7 million, subject to further reduction based on regulatory criteria. Accordingly, the size of loans which we can offer to potential customers is less than the size which many of our competitors with larger lending limits are able to offer. This limit has affected and will continue to affect our ability to seek relationships with larger businesses in our market area. We accommodate loans in excess of our lending limit through the sale of portions of such loans to other banks. However, we may not be successful in attracting or maintaining customers seeking larger loans or in selling portions of such larger loans on terms that are favorable to us.

 

An economic downturn, especially one affecting our primary service area, could diminish the quality of our loan portfolio, reduce our deposit base, and negatively affect our financial performance.

 

Adverse economic developments can impact the collectability of loans and the sustainability of our core deposits and may negatively impact our earnings and financial condition. In addition, the banking industry in general is affected by economic conditions such as inflation, recession, unemployment, and other factors beyond our control. A prolonged economic recession or other economic dislocation could cause increases in nonperforming assets and impair the values of real estate collateral, thereby causing operating losses, decreasing liquidity, and eroding capital. Factors that adversely affect the economy in our local banking market could reduce our deposit base and the demand for our products and services, which may decrease our earnings capability.

 

Monetary policy and other economic factors could adversely affect the Bank’s profitability.

 

Our results of operations may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate market values, rapid changes in interest rates, and the monetary and fiscal policies of the federal government. Our profitability is partly a function of the spread between the interest rates earned on investments and loans and those paid on deposits. As with most banking institutions, our net interest spread is affected by general economic conditions and other factors that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities may be affected differently by a given change in interest rates. As a result, an increase or decrease in rates could have a material adverse effect on our net income, capital and liquidity. While we take measures to reduce interest-rate risk, these measures may not adequately minimize exposure to interest-rate risk.

 

We are subject to extensive regulatory oversight, which could constrain our growth and profitability.

 

Banking organizations such as the Company and the Bank are subject to extensive federal and state regulation and supervision. Laws and regulations affecting financial institutions are undergoing continuous change, and we cannot predict the ultimate effect of these changes. We cannot assure you that any change in the regulatory structure or the applicable statutes and regulations will not materially and adversely affect the business, condition or operations of the Company or the Bank or benefit competing entities that are not subject to the same regulations and supervision.

 

Bank regulators have imposed various conditions, among other things, that: (1) the Company would not assume additional debt without prior approval by the Federal Reserve Board; (2) the Company and the Bank will remain well-capitalized at all times; (3) we will make appropriate filings with the regulatory agencies; and (4) the Bank will meet all regulatory requirements as set forth. The regulatory capital requirements imposed on the Bank could have the effect of constraining growth.

 

We are subject to extensive state and federal government supervision and regulations that impose substantial limitations with respect to loans, purchase of securities, payments of dividends, and many other aspects of the banking business. Regulators include the Comptroller, the Federal Reserve, and the FDIC. Applicable laws, regulations, interpretations, assessments and enforcement policies have been subject to significant and sometimes retroactively applied changes and may be subject to significant future changes. 

 

22
 

 

The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Other changes to statues, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to reduced revenues, additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

Regulatory agencies are funded, in part, by assessments imposed upon banks. Additional assessments could occur in the future which could impact our financial condition. Many of these regulations are intended to protect depositors, the public, and the FDIC, not shareholders. Future legislation or government policy could adversely affect the banking industry, our operations, or shareholders. The burden imposed by federal and state regulations may place banks, in general, and us, specifically, at a competitive disadvantage compared to less regulated competitors. Federal economic and monetary policy may affect our ability to attract deposits, make loans, and achieve satisfactory operating results.

 

The new CFPB may reshape the consumer financial laws through rulemaking and enforcement of unfair, deceptive or abusive practices, which may directly impact the business operations of depository institutions offering consumer financial products or services including the Bank.

 

The CFPB has broad rulemaking authority to administer and carry out the purposes and objectives of the “Federal consumer financial laws, and to prevent evasions thereof,” with respect to all financial institutions that offer financial products and services to consumers. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider identifying and prohibiting acts or practices that are “unfair, deceptive, or abusive” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service (“UDAP authority”). The potential reach of the CFPB’s broad new rulemaking powers and UDAP authority on the operations of financial institutions offering consumer financial products or services including the Bank is currently unknown and may significantly raise our compliance costs.

 

The recent repeal of Federal prohibitions on payment of interest on demand deposits could increase our interest expense.

 

All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act beginning on July 21, 2011. As a result, some financial institutions have commenced offering interest on demand deposits to compete for customers. The Company does not yet know what interest rates other institutions may offer as market interest rates begin to increase. The Company’s interest expense will increase and its net interest margin will decrease if it begins offering interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

RISKS RELATED TO OUR COMMON STOCK

 

Our common stock is thinly traded and, therefore, you may have difficulty selling shares.

 

The Company’s common stock is traded on the Over-the-Counter Bulletin Board (“OTCBB”); however, we have no ability to ensure that an active market will exist in the future or that shares can be liquidated without delay. The average daily trading volume in our stock during 2011 was 394 shares.

 

We do not anticipate paying dividends for the foreseeable future.

 

We do not anticipate dividends will be paid on our common stock for the foreseeable future. The Company is largely dependent upon dividends paid by the Bank to provide funds to pay cash dividends if and when the board of directors may declare such dividends. Our future earnings may not be sufficient to satisfy regulatory requirements and permit the legal payment of dividends to shareholders at any time in the future. Even if we could legally declare dividends, the amount and timing of such dividends would be at the discretion of our board of directors. The board may in its sole discretion decide not to declare dividends.

 

The market price of our common stock may be volatile.

 

The market price of our common stock is subject to fluctuations as a result of a variety of factors, including the following:

 

·quarterly variations in our operating results or those of other banking institutions;

 

·changes in national and regional economic conditions, financial markets or the banking industry; and

 

·other developments affecting us or other financial institutions.

 

23
 

 

The trading volume of our common stock is limited, which may increase the volatility of the market price for our stock. In addition, the stock market has experienced significant price and volume fluctuations in recent years. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons not necessarily related to the operating performance of these companies.

 

Item 2.Properties.

 

Our main office is located at 16000 Dallas Parkway, Dallas, Texas 75248. We occupy 4,357 square feet of the main lobby-accessed ground floor of a multi-story office building at that address. The lease for our main office began on January 1, 2004 and is for a term of 125 months.  We subsequently leased an additional 3,493 square feet on the second floor of the same building to house our trust and operations areas. The lease began on June 1, 2006, and was for a term of 64 months. The lease was amended effectively as of February 1, 2011, and is for a term of 40 months. The leases also call for the Bank to pay for a pro rata share of operating, tax and electric costs above a certain base amount. We also operate a branch office located at 8100 North Dallas Parkway, Plano, Texas, which is approximately 10 miles north of the main office. The branch office occupies 1,750 square feet in a two story, commercial building in a developed commercial center. The lease for our branch office began on December 1, 2003 and is for a term of 120 months. The lease rate increased on month 60. The lease also calls for the Bank to pay for a pro rata share of operating and tax costs above a certain base amount. We also operate a loan production office located at 850 E Highway 114, Southlake, Texas, which is approximately 15 miles northwest of the main office. The loan production office occupies 2,245 square feet on the second floor of a two story, commercial building in a developed commercial center. The lease for our office began on February 1, 2007 and is for a term of 120 months. The lease rate is scheduled to increase on February 1, 2012. The lease also calls for the Bank to pay for a pro rata share of operating and tax costs above a certain base amount. Management believes that the principal terms of the leases are consistent with prevailing market terms and conditions and that these facilities are in good condition and adequate to meet our current needs.

 

Item 3.Legal Proceedings.

 

The Bank is involved, from time to time, as plaintiff or defendant in various legal actions arising in the normal course of its business. Based on the information presently available, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business’s financial condition or results of operations of the Company on a consolidated basis.  

 

Item 4.Mine Safety Disclosures.

 

Not applicable.

 

PART II

 

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

 

Market Information

 

Our common stock has been quoted on the OTCBB under the symbol “TBNC.OB” since June 2007 and “FMPX.OB” from November 2004 to June 2007. The table below gives the high and low bid information for the last two fiscal years. The bid information in the table was obtained from the OTCBB and reflects inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. There may have been other transactions in our common stock of which we are not aware.

 

   High   Low 
2011          
Fourth Quarter  $4.30   $1.50 
Third Quarter  $2.00   $1.82 
Second Quarter  $4.75   $1.75 
First Quarter  $3.00   $1.45 
           
2010          
Fourth Quarter  $2.50   $1.60 
Third Quarter  $3.50   $1.50 
Second Quarter  $3.75   $0.75 
First Quarter  $5.76   $3.00 

 

On March 15, 2012 we had 373 holders of record of our common stock.

 

24
 

 

Dividends

 

It is the policy of our Board of Directors to reinvest earnings for such period of time as is necessary to ensure our successful operations. There are no current plans to initiate payment of cash dividends, and future dividends will depend on our earnings, capital and regulatory requirements, financial condition, and other factors considered relevant by our Board of Directors. In addition, we are subject to regulatory restrictions on our payment of dividends. For more information regarding the Company’s ability to pay dividends, please refer to the “Supervision and Regulation” section under Item 1.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

Equity Compensation Plan Information

 

Plan Category  Number of securities
to be issued upon
exercise of
outstanding options,
warrants, and rights
(a)
   Weighted average
exercise price of
outstanding options,
warrants, and rights
(b)
   Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in (a))
 
                
Equity compensation plans approved by security holders   210,000   $9.12    39,000 

 

Item 6.Selected Financial Data.

 

Because the registrant is a smaller reporting company, disclosure under this item is not required.

 

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

 

This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. Please see “Item 1—Business—Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion in conjunction with our audited consolidated financial statements and the notes to our audited consolidated financial statements included elsewhere in this report. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under “Item 1A—Risk Factors” and included in other portions of this report.

 

Introduction

 

We are a bank holding company headquartered in Dallas, Texas, offering a broad array of banking services through our wholly owned banking subsidiary, T Bank, N.A.

 

We were incorporated under the laws of the State of Texas on December 23, 2002 to organize and serve as the holding company for the Bank. The Bank opened for business on November 2, 2004.

 

Business Strategy

 

We believe we can effectively compete as a community bank in our market area and the niche markets we serve. We offer a broad range of commercial and consumer banking services primarily to small to medium-sized businesses and independent single-family residential and commercial contractors. We believe that meeting the needs of our customers and making their banking experience more efficient leads to increased customer loyalty. In addition to our traditional community banking services, we offer trust services to individuals and benefit plans. We also have a nationwide niche practice in servicing the banking needs of dental professionals.

  

We are able to utilize relatively low cost deposits provided by our trust activities to fund additional loan growth. The amount of deposits available to us while maintaining full FDIC insurance protection for our trust customers has consistently exceeded $30 million for the last three years. With the maturity of significant volumes of five-year CDs, which were above current market rates and funded the Bank’s growth in 2006, lower cost funds along with the low cost trust deposits have contributed to a significant improvement in the Bank’s net interest margin. We anticipate the trust custodial deposits to be relatively low cost and comparable to the rate we pay non-trust customers on money market account balances.

 

The Bank’s goals are as follows:

·achieve and sustain profitability;
·maintain controlled growth by focusing on increasing our loan and deposit market share by providing personalized customer service;
·closely manage yields on earning assets and rates on interest-bearing liabilities;
·continue focusing on noninterest income opportunities including our trust business;
·control noninterest expenses; and,
·maintain strong asset quality.

  

25
 

 

2011 Executive Overview

 

Financial Highlights

 

The following were significant factors related to 2011 results as compared to 2010.

 

Total assets at December 31, 2011 increased by $8.2 million to $123.3 million, compared to $115.1 million at December 31, 2010. This increase was due to an increase in interest-bearing deposits by $24.2 million, primarily from trust custodial deposits, offset by a decline in net loans by $11.9 million.

 

Net interest income decreased $337,000 for the year ending 2011 to $4.8 million compared to $5.2 million for the year ending 2010, even though the net interest margin increased from 4.3% for 2010 to 4.7% for 2011. The decrease primarily resulted from the reduction in the amount of earning assets.

 

Trust management fees were up $859,000 and were partially offset by an increase in trust investment management expenses, resulting in a net increase of $282,000 in net trust fees for 2011 compared to 2010. This increase is primarily due to the financial equities markets averaging higher in 2011 compared to the prior year, and both trust income and expenses correlate closely to the market value of assets in custody which are largely invested in the markets. The Company recorded $2.4 million in non-recurring expenses related to the correction of participant account balances as a result of revised unit values on certain collective investment funds sponsored by the Bank.

 

The Company recorded a provision for loan losses of approximately $213,000 for the year ended December 31, 2011, after recording a provision of $851,000 in 2010. The provision for loan losses was a result of the decrease in loan volume, reductions in classified and non-performing assets, overall improvement of economic conditions from the prior year and a significant decrease in net charge-offs. Net charge-offs were $189,000 for the year ended December 31, 2011, compared to net charge-offs of $810,000 for the year ended December 31, 2010.  

 

Nonperforming assets decreased 56%, from $4.1 million as of December 31, 2010 to $1.8 million as of December 31, 2011. Ratios of nonperforming assets as a percentage of total assets also decreased from 3.58% at December 31, 2010 to 1.47% at December 31, 2011.

 

Net loss for 2011 was $651,000, compared to net loss of $470,000 in 2010. The net loss in 2011 was a result of the $2.4 million in expenses related to the correction of participant account balances as a result of revised unit values on certain collective investment funds sponsored by the Bank, which was offset by $1.7 million in operating income for the year.

 

Recent Developments

 

The Company completed a Rights Offering and Limited Public Offering pursuant to the Registration Statement on Form S-1 (Registration Number 333-177766), which was declared effective by the Securities and Exchange Commission on January 13, 2012. As result of the rights offering, the Company issued 1,331,027 shares of common stock at a price of $2.00 per share, resulting in total proceeds to the company of approximately $2.7 million. The Company raised an additional $1.5 million through the issuance of 749,600 shares of common stock pursuant to a limited public offering completed on March 9, 2012. On March 29, 2012, the Company contributed $3.0 million to the Bank as additional paid in capital. A portion of the remaining proceeds are available to be contributed to the Bank as additional capital in the future to support the Bank’s growth.

 

26
 

 

Critical Accounting Policies

 

The Company’s financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, the Company must use its best judgment to arrive at that carrying value of certain assets. The following accounting policies are identified by management as being critical to the results of operations:

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required by considering the collectability of loans based on historical experience and the borrower’s ability to repay, the nature and volume of the portfolio, information about specific borrower situations and the estimated value of any underlying collateral, economic conditions and other factors. The allowance consists of general and specific reserves. The specific component relates to loans that are individually evaluated and determined to be impaired. This evaluation is often based on significant estimates and assumptions due to the level of subjectivity and judgment necessary to account for highly uncertain matters of the susceptibility of such matters to change. The general component relates to the entire group of loans that are evaluated in the aggregate based primarily on industry historical loss experience adjusted for current economic factors. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of the provision for loan loss, and related allowance can, and will, fluctuate. As of December 31, 2011, the allowance for loan loss was $1.4 million which represented approximately 1.61% of total loans.

 

Securities available for sale

 

Securities available for sale are evaluated periodically to determine whether a decline in their value is other than temporary. The term "other than temporary" is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security.

 

The initial indication of other than temporary impairment (“OTTI”) for both debt and equity securities is a decline in the market value below the amount recorded for an investment, and the severity and duration of the decline. In determining whether an impairment is other than temporary, we consider the length of time and the extent to which the market value has been below cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions of its industry, our intent to sell the investment, and if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. For marketable equity securities, we also consider the issuer's financial condition, capital strength, and near−term prospects. For debt securities and for perpetual preferred securities that are treated as debt securities for the purpose of OTTI analysis, we also consider the cause of the price decline (general level of interest rates and industry− and issuer−specific factors), the issuer's financial condition, near−term prospects and current ability to make future payments in a timely manner, the issuer's ability to service debt, and any change in agencies' ratings at evaluation date from acquisition date and any likely imminent action. Once a decline in value is determined to be other than temporary, the security is segmented into credit− and noncredit−related components. Any impairment adjustment due to identified credit−related components is recorded as an adjustment to current period earnings, while noncredit−related fair value adjustments are recorded through other comprehensive income. In situations where we intend to sell or it is more likely than not that we will be required to sell the security, the entire OTTI loss must be recognized in earnings.

 

Income Taxes

 

Deferred tax assets and liabilities are the expected future tax amounts for the temporary difference between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Positions taken by the Company in preparing the consolidated federal tax return are subject to the review of the Internal Revenue Service or to reinterpretation based on management’s ongoing assessment of facts and evolving case law, and as such positions taken by management could result in a material adjustment to the financial statements.

 

Periodically and in the ordinary course of business, we are involved in inquiries and reviews by tax authorities that normally require management to provide supplemental information to support certain tax positions we take in our tax returns. Uncertain tax positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. Management believes it has taken appropriate positions on its tax returns, although the ultimate outcome of any tax review cannot be predicted with certainty. Still, the final outcome of these matters may be different than what is reflected in the current and historical financial statements.

 

27
 

 

Loan income recognition

 

Interest income on loans is accrued at the contractual rate based on the principal outstanding. Loan origination fees and certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual loan terms. Accrual of interest is discontinued when its receipt is in doubt, which typically occurs when a loan becomes impaired. Any interest accrued to income in the year when interest accruals are discontinued is generally reversed. Management may elect to continue the accrual of interest when a loan is in the process of collection and the estimated fair value of the collateral is sufficient to satisfy the principal balance and accrued interest. Loans are returned to accrual status once the doubt concerning collectability has been removed and the borrower has demonstrated the ability to pay and remain current. Payments on nonaccrual loans are generally applied to principal.

 

Real estate acquired through foreclosure

 

We record foreclosed real estate assets at the lower of cost or estimated fair value on the acquisition date and at the lower of such initial amount or estimated fair value less estimated selling costs thereafter. Estimated fair value is based upon many subjective factors, including location and condition of the property and current economic conditions, among other things. Because the calculation of fair value relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

 

Write−downs at time of transfer are made through the allowance for loan losses. Write−downs subsequent to transfer are included in our noninterest expenses, along with operating income, net of related expenses of such properties and gains or losses realized upon disposition.

 

Stock Based Compensation

 

We adopted FASB ASC Topic 718 using the modified-prospective-transition method. Accordingly, no compensation expense was recognized in our financial statements for years ended prior to January 1, 2006. For the years ended December 31, 2011 and 2010, we recorded expense of $36,000 and $43,000, respectively, for option grants.

 

We calculated the compensation expense of the options using the Modified Black-Scholes-Merton option pricing model to determine the fair value of the options granted. In calculating the fair value of the options, management makes assumptions regarding the risk-free rate of return, the expected volatility of our common stock and the expected life of the options.

 

Recent Accounting Pronouncements

 

Please refer to Note 1 of the accompanying Consolidated Financial Statements for information related to the adoption of new accounting standards and the effect of newly issued but not yet effective accounting standards.

 

Financial Condition

 

Investment Securities

 

Securities held to maturity represent those securities which the Bank has the positive intent and ability to hold to maturity. The primary purpose of the Bank’s investment portfolio is to provide a source of earnings for liquidity management purposes, to provide collateral to pledge against borrowings, and to control interest rate risk. In managing the portfolio, the Bank seeks to attain the objectives of safety of principal, liquidity, diversification, and maximized return on investment.

 

At December 31, 2011, securities available for sale consisted of U.S. government agencies and mortgage-backed securities guaranteed by U.S. government agencies. The Company has no securities held to maturity. Restricted securities consisted of Federal Reserve Bank of Dallas stock, having an amortized cost and fair value of $420,000, Federal Home Loan Bank of Dallas stock, having an amortized cost and fair value of $590,900. The weighted average yield for the securities was 2.85% at December 31, 2011.

 

At December 31, 2010, securities available for sale consisted of mortgage-backed securities guaranteed by U.S. government agencies. Securities held to maturity consisted of a GNMA mortgage backed security having an amortized cost of $641,000 and a fair value of $682,000. Restricted securities consisted of Federal Reserve Bank of Dallas stock, having an amortized cost and fair value of $420,000, Federal Home Loan Bank of Dallas stock, having an amortized cost and fair value of $760,600. The weighted average yield for the securities was 2.73% at December 31, 2010.

 

28
 

 

The following presents the amortized cost and fair values of the securities portfolio at December 31, 2011 and 2010:

 

   As of December 31, 
   2011   2010 
(000's)  Amortized
Cost
   Estimated
Fair Value
   Amortized
Cost
   Estimated
Fair Value
 
Securities available for sale:                    
U.S. government agencies  $3,580   $3,639   $-   $- 
Mortgage-backed securities   2,796    2,855    4,077    4,067 
Securities held to maturity:                    
Mortgage-backed securities   -    -    641    682 
Securities, restricted:                    
Other   1,011    1,011    1,181    1,181 
Total  $7,387   $7,505   $5,899   $5,930 

 

The following tables summarize the maturity distribution schedule with corresponding weighted-average yields of securities held to maturity and securities available for sale as of December 31, 2011. Yields are calculated based on amortized cost. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Other securities classified as restricted include stock in the Federal Reserve Bank of Dallas and the Federal Home Loan Bank of Dallas, which have no maturity date. These securities have been included in the total column only.

 

   Maturing 
       After One Year   After Five Years         
   One Year   Through   Through   After     
   or Less   Five Years   Ten Years   Ten Years   Total 
(000's), except percentages  Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield 
Securities available for sale:                                                  
U.S. government agencies  $-    -%  $-    -%  $2,000    3.00%  $1,580    2.96%  $3,580    2.98%
Mortgage-backed securities             301    2.21    2,495    2.56              2,796    2.52 
Securities held to maturity:                                                  
Mortgage-backed securities   -    -    -    -    -    -    -    -    -    - 
Securities, restricted:                                                  
Other   -    -    -    -    -    -    -    -    1,011    - 
Total  $-    -%  $301    2.21%  $4,495    2.75%  $1,580    2.96%  $7,387    2.78%

 

Loan Portfolio Composition

 

Commercial and industrial loans comprise the largest group of loans in our portfolio amounting to $57.8 million, or 69.1% of the total loan portfolio, at December 31, 2011, which is down from $64.4 million, or 67.0% of the total loan portfolio, at December 31, 2010. Commercial real estate loans comprise the second largest group of loans in the portfolio.  At December 31, 2011, commercial real estate loans totaled $25.6 million, or 30.6% of the total loan portfolio, compared to $30.7 million, or 32.0%, at year end in prior year. The following table sets forth the composition of our loan portfolio:

 

   As of December 31, 
(000's)  2011   2010 
Commercial and industrial  $57,813    69.1%  $64,381    67.0%
Consumer installment   221    0.3%   1,002    1.0%
Real estate — mortgage   20,148    24.1%   22,377    23.3%
Real estate — construction and land   5,495    6.5%   8,309    8.7%
Other   35    0.0%   6    0.0%
   $83,712    100.0%  $96,075    100.0%
                     
Less allowance for loan losses   1,352         1,754      
Less deferred loan fees   82         136      
                     
   $82,278        $94,185      

 

29
 

 

Loan concentrations are considered to exist when there are amounts loaned to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2011, our loan portfolio included $58.5 million of loans, approximately 69.9% of our total funded loans, to the dental industry, as compared to $66.4 million, or 69.1% of total funded loans, at December 31, 2010. We believe that these loans are to credit worthy borrowers and are diversified geographically. As new loans are generated to replace loans which have paid off or reduced balances as a result of payments, the percentage of the total loan portfolio creating the foregoing concentration may remain constant thereby continuing the risk associated with industry concentration.

 

As of December 31, 2011, 22.0% of the loan portfolio consisting of commercial, consumer and real estate loans, or $18.4 million, matures or re-prices within one year or less. The following table presents the contractual maturity ranges for commercial, consumer and real estate loans outstanding at December 31, 2011 and 2010, and also presents for each maturity range the portion of loans that have fixed interest rates or variable interest rates over the life of the loan in accordance with changes in the interest rate environment as represented by the base rate:

 

   As of December 31, 2011 
       Over 1 Year through 5 Years   Over 5 Years     
(000's)  One Year or
Less
   Fixed Rate   Floating or
Adjustable
Rate
   Fixed Rate   Floating or
Adjustable
Rate
   Total 
                         
Commercial and industrial  $7,907   $10,095   $25,631   $13,703   $477   $57,813 
Consumer installment   110    111    -    -    -    221 
Real estate — mortgage   4,963    8,092    3,759    553    2,781    20,148 
Real estate — construction and land   5,422    73    -    -    -    5,495 
Other   35    -    -    -    -    35 
                               
Total  $18,437   $18,371   $29,390   $14,256   $3,258   $83,712 

 

   As of December 31, 2010 
       Over 1 Year through 5 Years   Over 5 Years     
(000's)  One Year or
Less
   Fixed Rate   Floating or
Adjustable
Rate
   Fixed Rate   Floating or
Adjustable
Rate
   Total 
                         
Commercial and industrial  $6,708   $6,558   $28,038   $22,422   $655   $64,381 
Consumer installment   567    435    -    -    -    1,002 
Real estate — mortgage   6,998    6,292    3,977    1,889    3,221    22,377 
Real estate — construction and land   5,604    2,060    -    -    645    8,309 
Other   6    -    -    -    -    6 
                               
Total  $19,883   $15,345   $32,015   $24,311   $4,521   $96,075 

 

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is less than their average contractual terms due to prepayments.

 

30
 

 

Nonperforming Assets

 

Our primary business is making commercial, real estate, and consumer loans. That activity entails potential loan losses, the magnitude of which depends on a variety of economic factors affecting borrowers which are beyond our control. While we have instituted underwriting guidelines and policies and credit review procedures to protect us from avoidable credit losses, some losses will inevitably occur.

 

Non-performing assets include non-accrual loans and other repossessed assets. Non-performing assets decreased $2.3 million to $1.8 million at December 31, 2011, as compared to $4.1 million at December 31, 2010. Nonperforming loans decreased $1.7 million to $79,000 at December 31, 2011, as compared to $1.8 million at December 31, 2010. The decrease was primarily due to one loan changing from nonaccrual status as of December 31, 2010 to accrual status at December 31, 2011. Other real estate owned at December 31, 2011, decreased $562,000 to $1.7 million, as compared to $2.3 million at December 31, 2010. The decrease was the result of sales of properties with carrying balance of $225,000, and write-down of properties of $337,000.

 

Loans are placed on nonaccrual status when management has concerns relating to the ability to collect the loan principal and interest and generally when such loans are 90 days or more past due. A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract.

 

Foreclosed assets represent property acquired as the result of borrower defaults on loans. Foreclosed assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for possible loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations. Write-downs are provided for subsequent declines in value and are included in other non-interest expense along with other expenses related to maintaining the properties.

 

The following table sets forth certain information regarding nonaccrual loans by type, including ratio of such loans to total assets as of the dates indicated:

 

   As of December 31, 
(000's)  2011   2010 
Allocated:  Amount   Loan
Category to
Total Assets
   Amount   Loan
Category to
Total Assets
 
                 
Commercial and industrial  $79    0.06%  $367    0.32%
Real estate — mortgage   -    -    1,462    1.27 
Real estate — construction   -    -    -    - 
Consumer and other   -    -    -    - 
Total nonaccrual loans   79    0.06    1,829    1.59 
Other real estate owned   1,729    1.40    2,291    1.99%
Total non-performing assets  $1,808    1.47%  $4,120    3.58%
Restructured loans  $1,759    1.43%  $2,395    2.08%
Loans past due 90 days and accruing  $-    -%  $-    -%

 

We record interest payments received on impaired loans as interest income unless collections of the remaining recorded investment are placed on nonaccrual, at which time we record payments received as reductions of principal. We recognized interest income on impaired loans of approximately $150,000 and $215,000 during the years ended December 31, 2011 and 2010, respectively. If interest on impaired loans had been recognized on a full accrual basis during the years ended December 31, 2011 and 2010, income would have increased by approximately $23,000 and $81,000, respectively.

 

Restructured loans are considered “trouble debt restructuring” if due to the borrower’s financial difficulties, we have granted a concession that we would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modifications of terms that could potentially qualify as a trouble debt restructuring include reduction of contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, or a reduction of the face amount of debt, either forgiveness of principal or accrued interest. As of December 31, 2011, we have $1.8 million in loans considered as trouble debt restructuring that are not already on nonaccrual. Of the nonaccrual loans at December 31, 2011, none met the criteria for trouble debt restructuring. A loan continues to qualify as trouble debt restructuring until a consistent payment history has been evidenced, generally no less than twelve months.

 

We had no loans past due 90 days and still accruing interest at December 31, 2011 and 2010.

 

31
 

 

Potential problem loans consist of loans that are performing in accordance with contractual terms, but for which we have concerns about the borrower’s ability to comply with repayment terms because of the borrower’s potential financial difficulties. We monitor these loans closely and review their performance on a regular basis. At December 31, 2011, we had $24,000 in loans of this type, which were not included in non-accrual or restructured loans.

 

Credit Risk Management

 

Credit risk is the risk of loss arising from the inability of a borrower to meet its obligations. We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.

 

We provide for loan losses through the establishment of an allowance for loan losses by provisions charged against earnings. Our allowance represents an estimated reserve for existing losses in the loan portfolio. We deploy a systematic methodology for determining our allowance that includes a quarterly review process, risk rating, and adjustment to our allowance. We classify our portfolios as either consumer or commercial and monitor credit risk separately as discussed below. We evaluate the adequacy of our allowance continually based on a review of all significant loans, with a particular emphasis on nonaccruing, past due, and other loans that we believe require special attention.

 

The allowance consists of two elements: (1) specific reserves and valuation allowances for individual credits; (2) general reserves for types or portfolios of loans based on historical loan loss experience, judgmentally adjusted for current conditions and credit risk concentrations. All outstanding loans are considered in evaluating the adequacy of the allowance.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for credit losses in the loan portfolio. Management has adopted a methodology to properly analyze and determine an adequate loan loss allowance. The analysis is based on sound, reliable and well documented information and is designed to support an allowance that is adequate to absorb all estimated incurred losses in our loan portfolio.

 

In estimating the specific and general exposure to loss on impaired loans, we have considered a number of factors, including the borrower’s character, overall financial condition, resources and payment record, the prospects for support from any financially responsible guarantors, and the realizable value of any collateral.

 

We also consider other internal and external factors when determining the allowance for loan losses, which include, but are not limited to, changes in national and local economic conditions, loan portfolio concentrations, and trends in the loan portfolio.

 

Senior management and the Directors Loan Committee review this calculation and the underlying assumptions on a routine basis not less frequently than quarterly.

 

The allowance for loan losses amounted to $1.4 million at December 31, 2011 and $1.8 million at December 31, 2010. During the year ended December 31, 2011, the Bank had charge-offs of $262,000 compared to $1.4 million for the year ended December 31, 2010. The total reserve percentage decreased to 1.61% at year-end 2011 from 1.83% of loans at December 31, 2010 as a result of the improving economic conditions of borrowers and values of assets pledged as collateral. Based on an analysis performed by management at December 31, 2011, the allowance for loan losses is considered to be adequate to cover estimated loan losses in the portfolio as of that date. However, management’s judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, charge-offs in future periods may exceed the allowance for loan losses or that significant additional increases in the allowance for loan losses may be required.

 

32
 

 

The table below presents a summary of our loan loss experience for the past five years:

 

(000's), except percentages  2011   2010   2009   2008   2007 
Balance at January 1,  $1,754   $1,713   $1,638   $1,600   $1,000 
                          
Charge-offs:                         
Commercial and industrial   262    1,224    933    451    - 
Consumer installment   -    4    88    -    - 
Real estate – construction and land   -    129    282    -    - 
Total charge-offs   262    1,357    1,303    451    - 
                          
Recoveries:                         
Commercial and industrial   13    547    9    72    - 
Consumer installment   3    -    -    -    - 
Real estate – construction and land   57    -    -    -    - 
Total recoveries   73    547    9    72    - 
                          
Net charge-offs   189    810    1,294    379    - 
                          
Provision for loan losses   (213)   851    1,369    417    600 
Balance at December 31,  $1,352   $1,754   $1,713   $1,638   $1,600 
                          
Loans at year-end  $83,712   $96,075   $123,283   $125,177   $121,726 
Average loans   89,725    111,556    122,814    132,524    104,943 
                          
Net charge-offs/average loans   0.21%   0.73%   1.05%   0.29%   -%
Allowance for loan losses/year-end loans   1.61    1.83    1.39    1.31    1.31 
Total provision for loan losses/average loans   -0.24%   0.76%   1.11%   0.31%   0.06%

 

The following table sets forth the specific allocation of the allowance for years ended December 31, 2011 and 2010 and the percentage of allocated possible loan losses in each category to total gross loans:

 

   As of December 31, 
(000's), except percentages  2010   2010 
Allocated:  Amount   Loan
Category to
Gross Loans
   Amount   Loan
Category to
Gross Loans
 
                 
Commercial and industrial  $1,175    67.0%  $1,175    67.0%
Consumer installment   18    1.0    18    1.0 
Real estate — mortgage   409    23.3    409    23.3 
Real estate — construction and land   152    8.6    152    8.6 
Total allowance for loan losses  $1,754    100.0%  $1,754    100.0%

Note: An allocation for a loan classification is only for internal analysis of the adequacy of the allowance and is not an indication of expected or anticipated losses.

 

Sources of Funds

 

General

 

Deposits, loan and investment security repayments and prepayments, proceeds from the sale of securities, and cash flows generated from operations are the primary sources of our funds for lending, investing, and other general purposes. Loan repayments are generally a relatively stable source of funds, while deposit inflows and outflows tend to fluctuate with prevailing interests rates, markets and economic conditions, and competition.

 

33
 

 

Deposits

 

Deposits are attracted principally from our primary geographic market area with the exception of time deposits, which, due to the Bank’s attractive rates, are attracted from across the nation. The Bank offers a broad selection of deposit products, including demand deposit accounts, NOW accounts, money market accounts, regular savings accounts, term certificates of deposit and retirement savings plans (such as IRAs). Deposit account terms vary, with the primary differences being the minimum balance required, the time period the funds must remain on deposit, and the associated interest rates. Management sets the deposit interest rates weekly based on a review of deposit flows for the previous week, and a survey of rates among competitors and other financial institutions. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank’s ability to attract and retain deposits. The Bank cannot be considered well capitalized, regardless of its capital ratios. Because of FDIC restrictions which took affect on January 1, 2010 for all insured banks which are not well capitalized, the Bank is restricted from offering rates in excess of .75% over the national average rate for various deposit terms as published weekly by the FDIC.  This further affects the Bank’s ability to attract and retain deposits. (See Item 1A “Risk Factors” for additional discussion regarding our ability to attract and retain deposits).

 

The following table sets forth our average deposit account balances, the percentage of each type of deposit to total deposits, and average cost of funds for each category of deposits:

 

   As of December 31, 
(000's), except percentages  2011   2010 
   Average
Balance
   Percent of
Deposits
   Average
Rate
   Average
Balance
   Percent of
Deposits
   Average
Rate
 
Noninterest bearing deposits  $12,890    14.3%   0.00%  $10,499    10.0%   0.00%
NOW accounts   2,818    3.1    0.53    1,983    1.9    0.68 
Money market accounts   24,594    27.3    0.76    35,869    34.2    0.88 
Savings accounts   294    0.3    0.60    183    0.2    0.89 
Certificates of deposit less than $100,000   10,138    11.2    3.30    13,794    13.1    3.75 
Certificates of deposit $100,000 or more   39,564    43.8    3.51    42,642    40.6    4.05 
                               
Total average deposits  $90,298    100.0%   2.49%  $104,970    100.0%   2.72%

 

The following table presents maturity of our domestic certificates of deposits and other time deposits of $100,000 or more at December 31, 2011 and 2010:

 

   As of December 31, 
(000's)  2011   2010 
         
Three months or less  $4,458   $1,467 
Over three months through six months   11,295    9,184 
Over six months through twelve months   8,155    18,420 
Over twelve months   5,272    13,368 
           
Total  $29,180   $42,439 

 

Liquidity

 

Our liquidity relates to our ability to maintain a steady flow of funds to support our ongoing operating, investing and financing activities. Our Board establishes policies and analyzes and manages liquidity to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of a large, stable supply of core deposits and funds. Ultimately, public confidence is generated through profitable operations, sound credit quality and a strong capital position. Liquidity management is viewed from a long-term and a short-term perspective as well as from an asset and liability perspective. We monitor liquidity through a regular review of loan and deposit maturities and forecasts, incorporating this information into a detailed projected cash flow model.

 

34
 

 

The Bank’s primary sources of funds will be retail and commercial deposits, loan repayments, maturity of investment securities, other short-term borrowings, and other funds provided by operations. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Bank will maintain investments in liquid assets based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset/liability management program.

 

The Bank had cash and cash equivalents of $29.5 million, or 23.9% of total assets, at December 31, 2011. In addition to the on balance sheet liquidity available, the Bank has lines of credit with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank of Dallas (“FRB”), which provides the Bank with a source of off-balance sheet liquidity. As of December 31, 2011, the Bank’s established credit line with the FHLB was $16.5 million, or 13.3% of assets, of which none was utilized or outstanding. The established credit line with the FRB was $17.3 million, or 14.0% of assets, of which none was utilized or outstanding at December 31, 2011. The Bank’s trust operations serve in a fiduciary capacity for approximately $872 million in total market value of assets as of December 31, 2011. Some of these custody assets are invested in cash. This cash is maintained either in a third party money market mutual fund (invested predominately in U.S. Treasury securities and other high grade investments) or in a Bank money market account. Only cash which is fully insured by the FDIC is maintained at the Bank. This cash can be moved readily between the Bank and the third party money market mutual fund.  As of December 31, 2011, there was $35.8 million of cash at the third party money market mutual fund available to transfer to the Bank which would be fully FDIC insured for the trust customers of the Bank.

 

Net Interest Income

 

The following table presents the changes in net interest income and identifies the changes due to differences in the average volume of earning assets and interest–bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities.  The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.

 

   2011 vs 2010   2010 vs 2009 
(000's)  Increase (Decrease) Due to
Change in
       Increase (Decrease) Due
to Change in
     
   Rate   Volume   Total   Rate   Volume   Total 
                         
Federal funds sold  $-   $-   $-   $(79)  $(33)  $(112)
Securities and interest bearing deposits   9    39    48    (11)   19    8 
Loans, net of reserve   397    (1,449)   (1,052)   149    (790)   (641)
Total earning assets   406    (1,410)   (1,004)   59    (804)   (745)
                               
NOW   (3)   4    1    (1)   1    - 
Money market   (40)   (86)   (126)   (251)   (108)   (359)
Savings   (1)   1    -    (1)   -    (1)
Certificates of deposit $100,000 or less   (63)   (120)   (183)   (109)   (181)   (290)
Certificates of deposit $100,000 or more   (231)   (108)   (339)   (203)   135    (68)
Other borrowings   (15)   (5)   (20)   22    (44)   (22)
Total Interest-bearing liabilities   (353)   (314)   (667)   (543)   (197)   (740)
                               
Changes in net interest income  $759   $(1,096)  $(337)  $602   $(607)  $(5)

 

Net interest income for 2011 decreased $337,000, or 6.5%, compared to 2010.  The decrease was the result of a decrease in the average volume of loans, offset by a decrease in the average interest yield and volume for interest-bearing liabilities, along with an increase in the average yield for loans. The average volume in earning assets decreased $17.6 million to $102.4 million for 2011, compared to $119.9 million for 2010. The average yield on interest-bearing assets increased to 6.59% for 2011, compared to 6.46% for 2010. The average yield on interest-bearing liabilities decreased to 2.37% for 2011, compared to 2.56% for 2010.

 

35
 

 

Net interest income for 2010 decreased $5,000, or 0.1%, compared to 2009.  The moderate decrease was the result of a decrease in the average volume of loans, offset primarily by a decrease in the average interest yield for interest-bearing liabilities. The average volume in earning assets decreased $27.3 million to $119.9 million for 2010, compared to $147.2 million for 2009. The average yield on interest-bearing liabilities decreased to 2.56% for 2010, compared to 2.64% for 2009.

 

Capital Resources and Regulatory Capital Requirements

 

Shareholders’ equity decreased $487,000 during 2011 to $10.6 million at December 31, 2011 from $11.1 million at December 31, 2010. The decrease was primarily due to a net loss for 2011 of $651,000. The net loss for 2011 was primarily the result $2.4 million in expenses related to the correction of participant account balances as a result of revised unit values on certain collective investment funds sponsored by the Bank which was offset by operating income of $1.7 million.

 

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

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).

 

To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table.

 

(000's)  Actual   For Capital
Adequacy Purposes
   To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
As of December 31, 2011                              
Total Capital (to Risk Weighted Assets)  $11,480    13.23%  $6,941>   8.00%  $8,677>   10.00%
                               
Tier 1 Capital (to Risk Weighted Assets)   10,391    11.98%   3,471>   4.00%   5,206>   6.00%
                               
Tier 1 Capital (to Average Assets)   10,391    10.24%   4,058>   4.00%   5,073>   5.00%
                               
As of December 31, 2010                              
Total Capital (to Risk Weighted Assets)  $12,156    12.20%  $7,973>   8.00%  $9,966>   10.00%
                               
Tier 1 Capital (to Risk Weighted Assets)   10,904    10.94%   3,986>   4.00%   5,979>   6.00%
                               
Tier 1 Capital (to Average Assets)   10,904    9.41%   4,635>   4.00%   5,793>   5.00%

 

On April 15, 2010 the Bank entered into a formal agreement with the Comptroller in which the Bank has agreed to maintain specific capital ratios, among other provisions. (See “Item 1A Risk Factors”). Regardless of the Bank’s capital position, the requirement in the Agreement to meet and maintain a specific capital level means that the Bank may not be deemed to be well capitalized under regulatory requirements, irrespective of the Bank’s actual capital ratios. The capital ratios required by the Order are 11.5% total capital to risk weighted assets and 9.00% tier 1 capital to average assets. As of December 31, 2011, the Company’s capital ratios exceeded these requirements.

 

36
 

 

Off-Balance Sheet Arrangements and Contractual Obligations

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying balance sheets. Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of credit extended is based on management’s credit evaluation of the customer and, if deemed necessary, may require collateral.

 

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. At December 31, 2011, we had commitments to extend credit and standby letters of credit of approximately $3.2 million and $10,000, respectively.

 

The following is a summary of our contractual obligations, including certain on-balance-sheet obligations, at December 31, 2011:

 

   As of December 31, 2011 
(000's)  Less than
One Year
   One to
Three Years
   Over Three to
Five Years
   Over Five
Years
 
Unused lines of credit  $2,681   $8   $9   $552 
Standby letters of credit   10    -    -    - 
Operating Leases   279    423    139    6 
Certificates of Deposit   29,071    5,916    974    - 
Total  $32,041   $6,347   $1,122   $558 

 

Results of Operations

 

Our operating results depend primarily on our net interest income. Net interest income is the difference between interest income, principally from loan, lease and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume and spread and are reflected in the net interest margin. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

 

While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

 

Net interest income was $4.8 million and $5.2 million for the years ended December 31, 2011 and 2010, respectively. Net interest margin was 4.7% and 4.3% for the years ended December 31, 2011 and 2010, respectively. The increase in net interest margin was offset by reduction of average earning assets to $102.4 million in 2011, compared to $119.9 million in 2010, resulting in a decrease of $337,000, or 6.5% in the net interest income.

 

Total interest income was $6.7 million and $7.8 million for the years ended December 31, 2011 and 2010, respectively. The decrease in interest income was primarily a result of lower average loan balances of $19.9 million, offset by increase of loan average yield. Total average loans and average yield for the year ended December 31, 2011 was $89.7 million and 7.3%, respectively, compared with $109.6 million and 6.9% for the year ended December 31, 2010.

 

Total interest expense was $1.9 million and $2.6 million for the years ended December 31, 2011 and 2010, respectively. The decrease in interest expense was a result of lower average deposit balances and lower interest rates on interest bearing deposits. Total average interest-bearing liabilities and average interest rate for interest-bearing liabilities for the year ended December 31, 2011 was $81.4 million and 2.4%, respectively, compared with $101.4 million and 2.6% for the year ended December 31, 2010.

 

37
 

 

The following table sets forth our average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and our net interest margin for the years ended December 31, 2011 and 2010.

 

   Twelve Months Ended December 31, 
(000'S)  2011   2010 
   Average
Balance
   Interest   Average
Yield
   Average
Balance
   Interest   Average
Yield
 
Interest-earning assets                              
                               
Loans, net of reserve(1)  $89,725   $6,546    7.30%  $109,588   $7,598    6.93%
Federal funds sold   807    2    0.23    799    2    0.19 
Securities and other   11,832    201    1.69    9,532    153    1.60 
Total earning assets   102,364    6,749    6.59    119,919    7,753    6.46 
Cash and other assets   3,763              6,509           
Total assets  $106,127             $126,428           
                               
Interest-bearing liabilities                              
NOW accounts  $2,818    15    0.53   $1,983    13    0.68 
Money market accounts   24,594    188    0.76    35,869    314    0.88 
Savings accounts   293    2    0.60    183    2    0.89 
Certificates of deposit less than $100,000   10,138    334    3.30    13,794    517    3.75 
Certificates of deposit $100,000 or greater   39,564    1,387    3.51    42,642    1,727    4.05 
Total interest bearing deposits   77,407    1,926    2.49    94,471    2,573    2.72 
Borrowed funds   3,990    7    0.17    6,933    27    0.39 
Total interest bearing liabilities   81,397    1,933    2.37    101,404    2,600    2.56 
Noninterest bearing deposits   12,890              10,499           
Other liabilities   1,565              3,965           
Stockholders’ equity   10,275              10,560           
Total liabilities and stockholders' equity  $106,127             $126,428           
                               
Net interest income       $4,816             $5,153      
Net interest spread             4.22%             3.90%
Net interest margin             4.70%             4.30%

(1) Includes nonaccrual loans 

 

Provision for Loan Losses

 

We established a provision for loan losses, which are charged to operations, at a level we believe to be appropriate to absorb probable es in the loan portfolio. For additional information concerning this determination, see the section of this discussion and analysis captioned “Allowance for Loan Losses.”

 

The provision for loan losses for the years ended December 31, 2011 and 2010 were $(213,000) and $851,000 respectively. The negative provision in the current period was due to the decrease in average loans to $89.7 million in 2011from $109.6 million in 2010, and also to the reduction of past due loans and nonaccrual loans in 2011.

 

38
 

 

Noninterest Income

 

The components of non-interest income for the years ended December 31, 2011 and 2010 were as follows:

 

   Year ended December 31, 
   2011   2010 
Service charges and fees  $242   $159 
Trust services   8,594    7,735 
           
   $8,836   $7,894 

 

Non-interest income for the year-ended December 31, 2011 increased $942,000 or 11.9%, as compared to 2010. The increase is due primarily to trust income attributable to the general improvement in the market values of assets in trust accounts on which the fees are based.

 

Noninterest Expenses

 

For the year ended December 31, 2011, our noninterest expenses increased $1.8 million to $14.5 million, compared to $12.7 million for the year ended December 31, 2010. The increase was primarily due to the increase in other expenses explained below.

 

Salaries and employee benefits decreased $316,000 to $2.4 million for the year ended December 31, 2011, as compared to $2.7 million for 2010.  The decrease was primarily due to the reduction of middle and upper level management at midyear of 2010. We had 24 full-time equivalent employees as of December 31, 2011, and 25 full-time employees as of December 31, 2010.

 

Occupancy and equipment expenses totaled $926,000 for the year ended December 31, 2011, as compared to $1.0 million for 2010. Expense in both periods is attributable primarily to lease expense and depreciation and amortization of leasehold improvements and furniture, fixtures and equipment.

 

Expenses related to trust consulting services were $7.2 million for the year ended December 31, 2011, compared to $6.6 million for 2010. Advisory fees are based on total assets held in custody and are paid to a fund advisor to manage the assets in the trust. Similar to trust income, the increase in trust expense is directly attributable to the general improvement in the market values in trust accounts.

 

Professional fees were $716,000 for the year ended December 31, 2011, compared to $694,000 for 2010.

 

Data processing fees were $260,000 for the year ended December 31, 2011, compared to $256,000 for 2010.

 

Other expenses increased $1.6 million to $3.0 million for the year ended December 31, 2011, as compared to $1.4 million for the year ended December 31, 2010.  In 2011, the Company recorded $2.4 million in non-recurring expenses related to the correction of participant account balances as a result of revised unit values on certain collective investment funds sponsored by the Bank. In 2010 the Company recorded $560,000 in non-recurring losses related to the consumer restitution in connection with the Agreement with the Comptroller.

 

Income Taxes

 

No federal tax expense has been recorded for the years ended December 31, 2011 and 2010 based upon prior net operating losses and the Company’s carry-forward of those losses. The Company has fully reserved the federal tax benefit of these losses. Cumulative net operating loss available to carry forward for tax purposes amounted to approximately $5.6 million as of December 31, 2011. This is lower than the losses per the financial statements as all organizational costs are capitalized for income tax purposes.

 

Item 7A.Quantitative and Qualitative Disclosures about Market Risk.

 

Because the registrant is a smaller reporting company, disclosure under this item is not required.

 

39
 

 

Item 8.Financial Statements and Supplementary Data

 

INDEX TO FINANCIAL STATEMENTS

 

    Page
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   41
     
FINANCIAL STATEMENTS    
     
Consolidated Balance Sheets   42
     
Consolidated Statements of Operations   43
     
Consolidated Statements of Changes in Stockholders’ Equity   44
     
Consolidated Statements of Cash Flows   45
     
Notes to Consolidated Financial Statements   46

 

40
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and

Shareholders

 

We have audited the accompanying consolidated balance sheets of T Bancshares, Inc. (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of T Bancshares, Inc. as of December 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

 

/s/ WEAVER AND TIDWELL, L.L.P.

Dallas, Texas

March 30, 2012

 

41
 

 

T BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2011 and 2010

 

(000's), except share amounts  2011   2010 
         
ASSETS          
           
Cash and due from banks  $1,422   $2,142 
Interest-bearing deposits   27,878    4,695 
Federal funds sold   183    3,352 
Total cash and cash equivalents   29,483    10,189 
           
Securities available for sale at estimated fair value   6,494    4,067 
Securities held to maturity at amortized cost   -    641 
Securities, restricted at cost   1,011    1,181 
Loans, net of allowance for loan losses of $1,352 and $1,754, respectively   82,278    94,185 
Bank premises and equipment, net   317    539 
Other real estate owned   1,729    2,291 
Other assets   2,004    2,055 
Total assets  $123,316   $115,148 
           
LIABILITIES          
           
Demand deposits:          
Noninterest-bearing  $13,980   $11,919 
Interest-bearing   61,284    28,975 
Time deposits $100,000 and over   29,180    42,439 
Other time deposits   6,781    12,437 
Total deposits   111,225    95,770 
           
Borrowed funds   -    6,000 
Other liabilities   1,441    2,241 
Total liabilities   112,666    104,011 
           
SHAREHOLDERS’ EQUITY          
           
Common Stock, $ .01 par value; 10,000,000 shares authorized; 1,941,305 shares issued and outstanding   19    19 
Additional paid-in capital   18,616    18,580 
Retained deficit   (8,103)   (7,452)
Accumulated other comprehensive income   118    (10)
Total shareholders' equity   10,650    11,137 
Total liabilities and shareholders' equity  $123,316   $115,148 

 

See accompanying notes to consolidated financial statements

 

42
 

 

T BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2011 and 2010

   

(000's), except per share amounts  2011   2010 
         
Interest Income          
           
Loan, including fees  $6,546   $7,598 
Securities   188    138 
Federal funds sold   2    2 
Interest-bearing deposits   13    15 
Total interest income   6,749    7,753 
           
Interest Expense          
           
Deposits   1,926    2,573 
Borrowed funds   7    27 
Total interest expense   1,933    2,600 
           
Net interest income   4,816    5,153 
Provision for loan losses   (213)   851 
Net interest income after provision for loan losses   5,029    4,302 
           
Noninterest Income          
           
Trust income   8,594    7,735 
Service fees   242    159 
Total noninterest income   8,836    7,894 
           
Noninterest Expense          
           
Salaries and employee benefits   2,411    2,727 
Occupancy and equipment   926    1,016 
Trust expenses   7,174    6,597 
Professional fees   716    694 
Data processing   260    256 
Fiduciary expense   1,978    - 
Other   1,051    1,376 
Total noninterest expense   14,516    12,666 
           
Net Loss  $(651)  $(470)
           
Loss per common share:          
           
Basic   (0.34)   (0.24)
Diluted   (0.34)   (0.24)
           
Weighted average common shares outstanding   1,941,305    1,941,305 
Weighted average diluted shares outstanding   1,941,305    1,941,305 

 

See accompanying notes to consolidated financial statements

 

43
 

 

T BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 2011 and 2010

 

(000's)  Common
Stock
   Additional
Paid-in
Capital
   Retained
Deficit
   Accumulated
Other
Comprehensive
Income
   Total 
                     
BALANCE, December 31, 2009  $19   $18,537   $(6,982)  $17   $11,591 
                          
Comprehensive loss:                         
Net loss             (470)        (470)
Change in accumulated gain on securities available for sale                  (27)   (27)
Total comprehensive loss                       (497)
Stock based compensation        43              43 
BALANCE, December 31, 2010  $19   $18,580   $(7,452)  $(10)  $11,137 
                          
Comprehensive loss:                         
Net loss             (651)        (651)
Change in accumulated gain on securities available for sale                  128    128 
Total comprehensive loss                       (523)
Stock based compensation        36              36 
BALANCE, December 31, 2011  $19   $18,616   $(8,103)  $118   $10,650 

 

See accompanying notes to consolidated financial statements

 

44
 

 

T BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2011 and 2010

 

(000's)  2011   2010 
           
Cash Flows from Operating Activities          
Net loss  $(651)  $(470)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:          
           
Provision for loan losses   (213)   851 
Depreciation and amortization   240    285 
Securities premium amortization (discount accretion), net   51    53 
Impairment of other real estate owned   337    - 
(Gain)Loss on sale of securities   (70)   1 
(Gain)loss on sale of real estate   -    12 
Stock based compensation   36    43 
Change in operating assets and liabilities:          
Other assets   96    149 
Other liabilities   (800)   (1,454)
Net cash used in operating activities   (974)   (530)
           
Cash Flows from Investing Activities          
Principal payments and maturities of securities held to maturity   65    161 
Proceeds from sale of securities held to maturity   628    - 
Purchase of securities available for sale   (55,603)   (54,056)
Principal payments, calls and maturities of securities available for sale   2,870    3,913 
Proceeds from sale of securities available for sale   50,401    49,999 
Purchase of securities, restricted   (859)   (629)
Proceeds from sale of securities, restricted   1,029    729 
Net change in loans   12,120    24,988 
Proceeds from sale of other real estate   225    708 
Purchases of premises and equipment   (18)   (31)
Net cash provided by investing activities   10,858    25,782 
           
Cash Flows from Financing Activities          
Net change in demand deposits   34,370    (4,691)
Net change in time deposits   (18,915)   (7,664)
Proceeds from borrowed funds   188,600    83,400 
Repayment of borrowed funds   (194,600)   (93,400)
Net proceeds from rights offering   (45)   - 
Net cash provided by (used in) financing activities   9,410    (22,355)
           
Net change in cash and cash equivalents   19,294    2,897 
Cash and cash equivalents at beginning of period   10,189    7,292 
           
Cash and cash equivalents at end of period  $29,483   $10,189 
           
Supplemental disclosures of cash flow information          
Cash paid during the period for          
Interest  $1,966   $2,624 
Income taxes  $-   $- 
Non-cash transactions:          
Transfers from loans to other real estate owned  $-   $1,395 

 

See accompanying notes to consolidated financial statements

 

45
 

 

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Organization and Nature of Operations

 

T Bancshares, Inc. (the “Company”) is a bank holding company headquartered in Dallas, Texas. The consolidated financial statements include the accounts of T Bancshares, Inc. and its wholly owned subsidiary, T Bank, N.A. (the “Bank”). The Company’s financial condition and operating results principally reflect those of the Bank. All intercompany transactions and balances are eliminated in consolidation.

 

The Bank provides a full range of banking services to individuals and corporate customers with two banking facilities serving North Dallas, Addison, Plano, Frisco and surrounding area communities. Additionally, the Bank maintains a loan production office in Southlake. The Bank’s primary business segment is community banking and consists of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, and a variety of consumer loans. At December 31, 2011, the Bank’s loan portfolio consisted of approximately $58.5 million, or 69.9% of the loan portfolio, in loans to dentists and dental practices. Substantially all loans are secured by specific collateral, including business assets, consumer assets, and commercial real estate.

 

The Bank also offers traditional fiduciary services primarily to clients of Cain Watters & Associates P.C. The Bank, Cain Watters & Associates P.C., and III:I Financial Management Research, L.P. have entered into an advisory services agreement related to the trust operations.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period, as well as the disclosures provided. Changes in assumptions or in market conditions could significantly affect the estimates. The determination of the allowance for loan losses, the fair value of stock options, the fair values of financial instruments and other real estate owned, and the status of contingencies are particularly susceptible to significant change in recorded amounts.

 

Cash and Cash Equivalents

 

The Company maintains its cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe it is exposed to significant credit risk on cash and cash equivalents.

 

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, deposits with other financial institutions, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions.

 

Trust Assets

 

Property held for customers in a fiduciary capacity, other than trust cash on deposit at the Bank, is not included in the accompanying consolidated financial statements since such items are not assets of the Company.

 

Securities

 

Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them until maturity. Securities to be held for indefinite periods of time are classified as available for sale and carried at fair value, with the unrealized holding gains and losses reported as a component of other comprehensive income, net of tax. Securities held for resale in anticipation of short-term market movements are classified as trading and are carried at fair value, with changes in unrealized holding gains and losses included in income. Management determines the appropriate classification of securities at the time of purchase. Securities with limited marketability, such as stock in the Federal Reserve Bank of Dallas and the Federal Home Loan Bank of Dallas, are carried at cost. The Company has investments in stock of the Federal Reserve Bank of Dallas and the Federal Home Loan Bank of Dallas as is required for participation in the services offered. These investments are classified as restricted and are recorded at cost.

 

Interest income includes amortization of purchase premiums and accretion of purchase discounts. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments. Gains and losses are recorded on the trade date and determined using the specific identification method. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. 

 

46
 

 

Loans

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees, and allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

 

Interest income on commercial business and commercial real estate loans is discontinued when the loan becomes 90 days delinquent unless the credit is well secured and in process of collection. Unsecured consumer loans are generally charged off when the loan becomes 90 days past due. Consumer loans secured by collateral other than real estate are charged off after a review of all factors affecting the ability to collect on the loan, including the borrower’s history, overall financial condition, resources, guarantor support, and the realizable value of any collateral. However, any consumer loan past 180 days is charged off. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

 

All interest accrued but not received for loans placed on nonaccrual are reversed against interest income. Interest received on such loans is accounted for on a cash-basis or cost-recovery method, until qualifying for return to accrual basis. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required by considering the collectability of loans based on historical experience and the borrower’s ability to repay, the nature and volume of the portfolio, information about specific borrower situations and the estimated value of any underlying collateral, economic conditions and other factors.

 

The allowance consists of general and specific reserves. The specific component relates to loans that are individually evaluated and determined to be impaired. This evaluation is often based on significant estimates and assumptions due to the level of subjectivity and judgment necessary to account for highly uncertain matters of the susceptibility of such matters to change. The general component relates to the entire group of loans that are evaluated in the aggregate based primarily on industry historical loss experience adjusted for current economic factors. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of the provision for loan loss, and related allowance can, and will, fluctuate.

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include, among others, payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.

 

Bank Premises and Equipment

 

Bank premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years. Leasehold improvements are depreciated over the lease term or estimated life, whichever is shorter. Repair and maintenance costs are expensed as incurred.

 

Foreclosed Assets

 

Assets acquired through or instead of loan foreclosure are held for sale and are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through expense.  The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions. Foreclosed assets are included in the accompanying balance sheets and totaled $1.7 million and $2.3 million at December 31, 2011 and 2010.

 

Stock Based Compensation

 

The Company adopted Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) Topic 718 using the modified-prospective-transition method. Under this method, prior periods are not restated. Also, under this transition method, stock compensation cost recognized beginning January 1, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date estimated fair value, and (b) compensation cost for all share-based payments granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of FASB ASC Topic 718.

  

47
 

 

Fiduciary Expense

 

In 2011, the Company recorded $2.0 million in non-recurring expense related to the correction of participant account balances as a result of revised unit values on certain collective investment funds sponsored by the Bank. Additional non-recurring professional fees of $400,000 were recorded related to revising the unit values and quantifying the participant account balance corrections.

 

Income Taxes

 

The Company accounts for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

The Company has provided a 100% valuation allowance for its net deferred tax asset due to the Company’s net operating loss carry-forward of approximately $5.6 million as of December 31, 2011. 

 

The Company accounts for uncertainties in income taxes in accordance with current accounting guidance which prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of cumulative benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. No uncertain tax positions have been recognized.

 

The Company files income tax returns in the U.S. federal jurisdiction and the Texas state jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2008.

 

Loss Per Share

 

Basic loss per share is computed by dividing net loss applicable to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share are computed by dividing net loss by the weighted average number of common shares and common share equivalents. Common stock equivalents consist of stock options and warrants and are computed using the treasury stock method.

 

The Company reported a net loss for the year ended December 31, 2011. The effect of 210,000 outstanding options and 96,750 outstanding warrants for the year ended December 31, 2011, is not considered in the per share calculations for these periods as the impact would have been anti-dilutive.

 

Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes net unrealized gains and losses on available for sale securities, which are recognized as a separate component of equity.  Accumulated comprehensive income (loss), net for the year ended December 31, 2011 and 2010 is reported in the accompanying consolidated statements of changes in stockholders’ equity.

 

Transfer of Financial Assets

 

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Company, (ii) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

 

Loss Contingencies

 

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

 

Fair Value of Financial Instruments

 

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

 

48
 

 

Recent Accounting Pronouncements

 

Accounting Standards Update (“ASU”) No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures About Fair Value Measurements.”  In 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance expanding disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized, and (iv) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. The new guidance further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) disclosures should be provided about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy became effective for the Company on January 1, 2011. The remaining disclosure requirements and clarifications made by the new guidance became effective on January 1, 2010.

 

Accounting Standards Update (ASU) No.2010-20, “Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll forward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Company’s financial statements beginning on January 1, 2011. ASU 2011-01, “Receivables (Topic 310) - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which is further discussed below.

 

Accounting Standards Update (ASU) No. 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.”  ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 became effective for the Company on July 1, 2011, and required retrospective application to all restructurings occurring on or after January 1, 2011 along with disclosure of certain additional information. Adoption of ASU 2011-02 is not expected have a significant impact on the Company’s financial statements.

 

Accounting Standards Update (ASU) No. 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.”ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 is effective for annual periods beginning after December 15, 2011, and is not expected to have a significant impact on the Company’s financial statements.

 

Accounting Standards Update (ASU) No. 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.”ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 is effective for annual and interim periods beginning after December 15, 2011; however, certain provisions related to the presentation of reclassification adjustments have been deferred by ASU 2011-12 “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” as further discussed below. ASU 2011-05 is not expected to have a significant impact on the Company’s financial statements.

 

49
 

 

Accounting Standards Update (ASU) No.2011-11, “Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.”ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and is not expected to have a significant impact on the Company’s financial statements.

 

Accounting Standards Update (ASU) No.2011-12, “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.”ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to redeliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 is effective for annual and interim periods beginning after December 15, 2011 and is not expected to have a significant impact on the Company’s financial statements.

 

NOTE 2. SECURITIES

 

Year-end securities consisted of the following:

   December 31, 2011 
(000's)  Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
Securities available for sale:                    
U.S. government agencies  $3,580   $66   $7   $3,639 
Mortgage-backed securities   2,796    59    -    2,855 
Total securities available for sale  $6,376   $125   $7   $6,494 
                     
Securities, restricted:                    
Other  $1,011   $-   $-   $1,011 

  

   December 31, 2010 
(000's)  Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
Securities available for sale:                    
Mortgage-backed securities  $4,077   $40   $50   $4,067 
                     
Securities Held to Maturity:                    
Mortgage-backed securities  $641   $41   $-   $682 
                     
Securities, restricted:                    
Other  $1,181   $-   $-   $1,181 

 

All mortgage-backed securities included in the above table were issued by U.S. government agencies, or by U.S. government-sponsored agencies. Securities, restricted consists of Federal Reserve Bank of Dallas stock and Federal Home Loan Bank of Dallas stock which are carried at cost.

 

At December 31, 2011, there were no securities classified as held to maturity. During 2011, the Company sold the only held-to-maturity security with amortized cost of $585,000 for a realized gain of $51,000. This security was sold to record income and help the Company comply with capital requirements. As of December 31, 2011, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. Management does not believe any of the securities are impaired due to reasons of credit quality.

 

Securities with a carrying value of $318,000 and $641,000 at December 31, 2011 and 2010 were pledged to the Company’s trust department. Securities with a carrying value of $1.1 million at December 31, 2011 were pledged to the Federal Reserve Bank of Dallas. There were no securities pledged to the Federal Reserve Bank of Dallas at December 31, 2010.  Securities with a carrying value of $5.1 million and $4.1 million at December 31, 2011 and 2010, respectively, were pledged to secure borrowings at the Federal Home Loan Bank of Dallas. 

 

50
 

 

The amortized cost and estimated fair value of securities, excluding trading securities, at December 31, 2011 and 2010 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage backed securities are shown separately since they are not due at a single maturity date.

 

   December 31, 2011 
   Held to Maturity   Available for Sale 
(000's)  Amortized
Cost
   Estimated
Fair Value
   Amortized
Cost
   Estimated
Fair Value
 
                 
Due in one year or less  $-   $-   $-   $- 
Due after one year through five years:   -    -    -    - 
Due after five years through ten years   -    -    2,000    1,993 
Due after ten years   -    -    1,580    1,646 
Mortgage-backed securities   -    -    2,796    2,855 
                     
Total  $-   $-   $6,376   $6,494 

 

   December 31, 2010 
   Held to Maturity   Available for Sale 
(000's)  Amortized
Cost
   Estimated
Fair Value
   Amortized
Cost
   Estimated
Fair Value
 
                 
Due in one year or less  $-   $-   $-   $- 
Due after one year through five years:   -    -    -    - 
Due after five years through ten years   -    -    -    - 
Due after ten years   -    -    -    - 
Mortgage-backed securities   641    682    4,077    4,067 
                     
Total  $641   $682   $4,077   $4,067 

 

NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Major classifications of loans are as follows:

(000's)  December 31,
2011
   December 31,
2010
 
           
Commercial and industrial  $57,813   $64,381 
Consumer installment   221    1,002 
Real estate — mortgage   20,148    22,377 
Real estate — construction and land   5,495    8,309 
Other   35    6 
           
    83,712    96,075 
           
Less allowance for loan losses   1,352    1,754 
Less deferred loan fees   82    136 
           
Net loans  $82,278   $94,185 

 

At December 31, 2011, our loan portfolio included $58.5 million of loans, approximately 69.9% of our total funded loans, to the dental industry, as compared to $66.4 million, or 69.1% of total funded loans, at December 31, 2010. We believe that these loans are to credit worthy borrowers and are diversified geographically. 

  

Loan Origination/Risk Management.

 

The Bank maintains written loan origination policy, procedures, and processes which address credit quality at several levels including individual loan level, loan type, and loan portfolio levels.

 

Commercial and Industrial loans, which are predominantly loans to dentists, are underwritten based on historical and projected income of the business and individual borrowers and guarantors. The Bank utilizes a comprehensive global debt service coverage analysis to determine debt service coverage ratios. This analysis compares global cash flow of the borrowers and guarantors on an individual credit to existing and proposed debt after consideration of personal and business related other expenses. Collateral is generally a lien on all available assets of the business borrower including intangible assets. Credit worthiness of individual borrowers and guarantors is established through the use of credit reports and credit scores.

 

Consumer loans are evaluated on the basis of credit worthiness as established through the use credit reports and credit scores. Additional credit quality indicators include borrower debt to income ratios based on verifiable income sources.

 

Real estate mortgage loans are evaluated based on collateral value as well as global debt service coverage ratios based on historical and projected income from all related sources including the collateral property, the borrower, and all guarantors where applicable.

 

Construction and land development loans are evaluated based on the borrower’s and guarantor’s credit worthiness, past experience in the industry, track record and experience with the type of project being considered, and other factors. Collateral value is determined generally by independent appraisal utilizing multiple approaches to determine value based on property type.

 

For all loan types, the Bank establishes guidelines for its underwriting criteria including collateral coverage ratios, global debt service coverage ratios, and maximum amortization or loan maturity terms.

 

At the portfolio level, the Bank monitors concentrations of loans based on several criteria including loan type, collateral type, industry, geography, and other factors. The Bank also performs periodic market research and economic analysis at a local geographic and national level. Based on this research, the Bank may from time to time change the minimum or benchmark underwriting criteria applied to the above loan types.

 

51
 

 

The activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2011 and 2010, and the change for the years then ended is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio.

  

(000's)  Commercial
and
Industrial
   Consumer
Installment 
   Real Estate
- Mortgage
   Real Estate -
Other
   Total 
2011                    
Beginning balance  $1,259   $16   $343   $136   $1,754 
Provision for loan losses   (59)   (15)   (31)   (108)   (213)
Charge-offs   (262)   -    -    -    (262)
Recoveries   13    3    -    57    73 
Net (charge-offs) recoveries   (249)   3    -    57    (189)
Ending balance  $951    4    312    85    1,352 
                          
Period-end amount allocated to:                         
  Loans individually evaluated for impairment  $854   $4   $312   $85   $1,255 
  Loans collectively evaluated for impairment   97    -    -    -    97 
  Ending balance  $951   $4   $312   $85   $1,352 
                          
2010                         
Beginning balance  $1,226   $21   $384   $82   $1,713 
Provision for loan losses   710    (2)   (41)   184    851 
Charge-offs   (1,224)   (3)   -    (130)   (1,357)
Recoveries   547    -    -    -    547 
Net charge-offs   (677)   (3)   -    (130)   (810)
Ending balance  $1,259   $16   $343   $136   $1,754 
                          
Period-end amount allocated to:                         
  Loans individually evaluated for impairment  $255   $-   $-   $-   $255 
  Loans collectively evaluated for impairment   1,004    16    343    136    1,499 
  Ending balance  $1,259   $16   $343   $136   $1,754 

  

(000's)  December 31,
2011
   December 31,
2010
 
           
Impaired loans were as follows:          
Year end loans with allowance allocated  $1,169   $1,517 
Year end loans with no allowance allocated   1,193    2,600 
Impaired loans  $2,362   $4,117 
           
Amount of allowance allocated  $97   $255 
           
Average of impaired loans during the year  $2,723   $4,824 
           
Interest income recognized during impairment  $150   $215 
           
Loans past due 90 days still on accrual  $-   $- 
           
Non-accrual  loans:          
Commercial and industrial  $79   $367 
Real estate – mortgage   -    1,462 
Total  $79   $1,829 
           
Restructured  loans:          
Commercial and industrial  $1,759   $2,395 

 

The restructuring of a loan is considered “trouble debt restructuring” when the borrower is experiencing financial difficulty and we have granted a concession that we would not otherwise consider. There were no loans which were restructured during 2011.

 

52
 

 

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

The Company’s impaired loans and related allowance is summarized in the following table:

 

(000's)  Unpaid
Contractual
Principal
Balance
   Recorded
Investment
With No
Allowance
   Recorded
Investment
With
Allowance
   Total
Recorded
Investment
   Related
Allowance
   Average
Recorded
Investment
 
2011                              
Commercial and industrial  $2,397   $1,193   $1,169   $2,362   $97   $2,482 
Consumer installment   -    -    -    -    -    - 
Real estate – mortgage   -    -    -    -    -    241 
Real estate – construction and land   -    -    -    -    -    - 
Other   -    -    -    -    -    - 
Total  $2,397   $1,193   $1,169   $2,362   $97   $2,723 
                               
2010                              
Commercial and industrial  $2,672   $1,139   $1,517   $2,656   $255   $2,529 
Consumer installment   -    -    -    -    -    - 
Real estate – mortgage   1,534    1,461    -    1,461    -    1,521 
Real estate – construction and land   -    -    -    -    -    774 
Other   -    -    -    -    -    - 
Total  $4,206   $2,600   $1,517   $4,117   $255   $4,824 

 

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including internal credit risk based on past experiences as well as external statistics and factors.   Loans are classified in one of four categories: (i) pass, (ii) special mention, (iii) substandard, (iv) doubtful, or (v) loss. Loans classified as loss are charged-off.

 

The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on credits quarterly. Ratings are adjusted to reflect the degree of risk and loss that is felt to be inherent in each credit. The Company’s methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

 

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

 

Credit rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

 

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss.

 

At December 31, 2011, the following summarizes the Company’s internal ratings of its loans:

 

(000's)  Pass   Special
Mention
   Substandard   Doubtful   Total 
                          
Commercial and industrial  $55,071   $1,226   $1,516   $-   $57,813 
Consumer installment   221    -    -    -    221 
Real estate - mortgage   16,785    2,733    630    -    20,148 
Real estate – construction and land   3,000    2,495    -    -    5,495 
Other   35    -    -    -    35 
Total  $75,112   $6,454   $2,146   $-   $83,712 

 

53
 

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. At December 31, 2011, the Company’s past due loans are as follows:

 

(000's)  30-89 Days
Past Due
   Greater Than
90 Days
   Total
Past Due
   Total
Current
   Total
Loans
   Total 90
Days Past Due
Still Accruing
 
                          
Commercial and industrial  $-   $-   $-   $57,813   $57,813   $- 
Consumer installment   -    -    -    221    221    - 
Real estate – mortgage   -    -    -    20,148    20,148    - 
Real estate – construction and  land   -    -    -    5,495    5,495    - 
Other   -    -    -    35    35    - 
Total  $-   $-   $-   $83,712   $83,712   $- 

 

NOTE 4.BANK PREMISES AND EQUIPMENT

 

Year-end premises and equipment were as follows:

 

(000's)  December 31,
2011
   December 31,
2010
 
           
Leasehold improvements  $929   $929 
Furniture and equipment   1,925    1,907 
    2,854    2,836 
           
Less: accumulated depreciation   2,537    2,297 
Balance at end of period  $317   $539 

 

Depreciation expense, including amortization of leasehold improvements, was $240,000 and $285,000 for the years ended December 31, 2011 and 2010, respectively.

 

NOTE 5.OTHER REAL ESTATE AND OTHER ASSETS

 

Other assets as of December 31, 2011 and 2010 were as follows:

 

(000's)  December 31,
2011
   December 31,
2010
 
           
Prepaid assets   874    1,015 
Accounts receivable – trust fees   815    680 
Accrued interest receivable   283    330 
Other   32    30 
Total  $2,004   $2,055 

 

Other Real Estate Owned (“OREO”) totaled $1.7 million and $2.3 million at December 31, 2011 and December 31, 2010, respectively, which are initially recorded at lower of loan balance or fair value less costs to sell the asset. There were no properties added to OREO for the year ended December 31, 2011. The OREO assets are actively being marketed, and disposal of the assets is anticipated to occur in the next 12 months. Included in other noninterest expense for the year ended December 31, 2011 was approximately $337,000 for impairment of OREO (see Note 15).

 

54
 

 

NOTE 6.DEPOSITS

 

Deposits at December 31, 2011 and 2010 are summarized as follows:

 

(000's)  December 31, 2011   December 31, 2010  
                     
Noninterest bearing demand  $13,980    13%  $11,919    13%
Interest bearing demand (NOW)   3,236    3    2,130    2 
Money market accounts   57,660    52    26,671    28 
Savings accounts   388    0    174    0 
Certificates of deposit, less than $100,000   6,781    6    12,437    13 
Certificates of deposit, greater than $100,000   29,180    26    42,439    44 
Total  $111,225    100%  $95,770    100%

 

Money market accounts included trust custodial cash of $32.7 million and $7.2 million at December 31, 2011 and 2010, respectively.

 

At December 31, 2011, the scheduled maturities of certificates of deposit were as follows:

 

2012    29,071 
2013    5,323 
2014    593 
2015    342 
2016    632 
Total   $35,961 

 

NOTE 7. BORROWED FUNDS

 

Borrowed funds as of December 31, 2011 and December 31, 2010, were as follows:

 

(000's)  December 31,
2011
   December 31,
2010
 
           
Federal Home Loan Bank  $-   $6,000 

 

At December 31, 2011, the Company had no borrowings outstanding. The Company has a $17.3 million credit line with the Federal Reserve Bank of Dallas, secured by $27.0 million in pledged commercial and industrial loans, and an $16.5 million credit line with the Federal Home Loan Bank of Dallas, secured by $11.4 million in pledged real estate loans and $5.1 million in pledged securities.

 

At December 31, 2010, borrowed funds consisted of two $3.0 million advances from the Federal Home Loan Bank of Dallas. The loans have a term of 1 year and 3 months and mature on April 13, 2011 and January 28, 2011, respectively. The interest rates for the loans are fixed at 0.54% and 0.10%. The Company has a $25.3 million credit line with the Federal Reserve Bank of Dallas, secured by $40.4 million in pledged commercial and industrial loans, and an $17.9 million credit line with the Federal Home Loan Bank of Dallas, secured by $13.9 million in pledged real estate loans and $4.0 million in pledged securities.

 

NOTE 8. OTHER LIABILITIES

 

Other liabilities as of December 31, 2011 and December 31, 2010, were as follows:

 

(000's)  December 31,
2011
   December 31,
2010
 
           
Reserve for consumer restitution  $-   $963 
Trust Advisor Fees Payable   1,018    576 
Audit Fees   131    121 
Incentive Compensation   21    107 
Franchise & Property Taxes   68    100 
Interest Payable   43    77 
Legal   14    10 
Other Accruals   146    287 
   $1,441   $2,241 

 

55
 

 

NOTE 9.BENEFIT PLANS

 

The Company funds certain costs for medical benefits in amounts determined at the discretion of management. The Company offers a 401K plan, which provides for contributions by employees. As of December 31, 2011, the Company had no plans to match employee contributions.

 

NOTE 10.INCOME TAXES

 

The provision (benefit) for income taxes consists of the following:

 

(000s)  2011   2010 
           
Income tax expense (benefit) was as follows:          
Current federal taxable income  $-   $- 
NOL utilized   -    - 
Total current taxes due   -    - 
           
Deferred federal tax provision (benefit)   204    160 
Valuation allowance   (204)   (142)
Other   -    (18)
   $-   $- 

 

The effective tax rate differs from the U. S. statutory tax rate due to the following for 2011 and 2010:

 

U.S. statutory rate   34.0%
Valuation Allowance   -30.0%
Other   -4.0%
Effective tax rate   0.0%

 

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31 are as follows:

 

(000s)  2011   2010 
           
Deferred tax assets:          
Stock-based compensation   142    129 
Allowance for loan losses   460    597 
ASC 310 fees   28    46 
Accrued liabilities   -    327 
Net operating loss carryforward   1,900    1,276 
Total deferred tax asset   2,530    2,375 
Deferred tax liabilities:          
Depreciation and amortization   6    (43)
    2,536    2,332 
Less valuation allowance for net deferred tax asset   (2,536)   (2,332)
   $-   $- 

 

Management has provided a 100% valuation allowance for its net deferred tax asset. For year ended December 31, 2011, the Company had a taxable loss of $1.9 million, which increased the net tax operating loss carry-forward to $5.6 million.  The net operating loss carry-forward will fully expire in 2031 if not used. For year ended December 31, 2010, the Company produced a taxable loss of $2.0 million.

 

Projections for continued levels of profitability will be reviewed quarterly and any necessary adjustments to the deferred tax assets will be recognized in the provision or benefit for income taxes. In assessing the realization rate of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. At December 31, 2011, management believes it is more likely than not that the Company will not realize the benefits of those deductible differences. 

 

56
 

 

 

NOTE 11.STOCK OPTIONS AND WARRANTS

 

The shareholders of the Company approved the 2005 Stock Incentive Plan (“Plan”) at the annual shareholder meeting held on June 2, 2005. The Plan authorizes the granting of options to purchase up to 260,000 shares of common stock of the Company to employees of the Company and its subsidiaries. The Plan is designed to provide the Company with the flexibility to grant incentive stock options and non-qualified stock options to its executive and other officers. The purpose of the Plan is to provide increased incentive for key employees to render services and to exert maximum effort for the success of the Company.

 

The Plan is administered by the Board of Directors and has a term of 10 years. Any award that expires or is forfeited is returned to the Plan.  Stock options are granted under the Plan with an exercise price equal to or greater than the stock fair market value at the date of grant. All stock options granted have ten-year lives with vesting terms of five years.

 

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model. Expected volatilities are based on historical volatility of the Company’s stock. The risk-free rate for the period within the contractual life of the stock option is based upon the five year Treasury rate at the date of grant.

 

As of December 31, 2011 and December 31, 2010, options to purchase a total of 210,000 and 212,500 common shares, respectively, had been issued with an average exercise price of $9.12 and $9.14, respectively. These options vest through May 2015.

 

The Company recorded $36,000 and $43,000 in compensation expense for the years ended December 31, 2011 and December 31, 2010, respectively, in connection with the Plan. This amount is not reduced by related deferred tax assets since all deferred tax assets are impaired as of December 31, 2011 (see Note 10). As of December 31, 2011 there was $44,000 of total unrecognized compensation cost related to non-vested equity-based compensation awards expected to vest, with an average vesting period of 2.7 years.

 

The following is a summary of activity in the Plan for 2011 and 2010:

 

   2011   2010
   Number of   Weighted   Number of  Weighted 
   Shares   Average   Shares  Average 
   Underlying   Exercise   Underlying  Exercise 
   Options   Prices   Options  Prices 
Outstanding at beginning of the year   212,500   $9.14   195,500  $10.03 
Granted   -    -   27,000   1.79 
Exercised   -    -   -   - 
Expired / forfeited   2,500    10.75   10,000   6.75 
                   
Outstanding at end of period   210,000   $9.12   212,500  $9.14 
Exercisable at end of period   178,600   $9.98   164,800  $10.21 
Available for grant at end of period   39,000        36,500     

 

   2011   2010 
       Weighted       Weighted 
       Average       Average 
       Grant Date       Grant Date 
   Shares   Fair Value   Shares   Fair Value 
                 
Nonvested at January 1   47,700   $2.10   39,600   $3.24 
Granted   -    -   27,000    0.98 
Vested   16,300    2.70   10,900    3.55 
Forfeited   -    -   8,000    2.01 
                    
Nonvested at December 31   31,400   $1.78   47,700   $2.10 

  

57
 

 

The fair value of options granted was determined using the following weighted-average assumptions as of grant date:

 

   2011   2010  
       
Risk-free interest rate   n/a   2 %
Dividend yield   n/a   0 %
Expected stock price volatility   n/a   42 %
Expected term   n/a   10.0 years  
Forfeiture rate   n/a   0 %

 

All options carry exercise prices ranging from $1.01 to $13.00. At December 31, 2011, there were 178,600 exercisable options, of which all but 2,000 shares had no intrinsic value as the exercise price exceeded the stock price.

 

The Company’s organizers advanced funds for organizational and other preopening expenses. As consideration for the advances the organizers received warrants to purchase one share of common stock for every $20 advanced up to a limit of $100,000. A total of 96,750 warrants were issued and remain outstanding at December 31, 2011. These warrants are exercisable at a price of $10.00 per share at any time until November 2, 2014.

 

NOTE 12.LOAN COMMITMENTS AND OTHER CONTINGENCIES

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At December 31, 2011, the Company had commitments to extend credit and standby letters of credit of approximately $3.2 million and $10,000, respectively. At December 31, 2010, the Company had commitments to extend credit and standby letters of credit of approximately $3.4 million and $15,000, respectively.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

The Company has four lease agreements, which expire on or before 2017. In addition to the leases for office space, the Company also leases various pieces of office equipment under short-term agreements. The following table summarizes loan commitments and minimum rental commitments for office space leases as of December 31, 2011:

 

   As of December 31, 2011 
   Less than   One to  Over Three to   Over Five 
(000's)  One Year   Three Years  Five Years   Years 
Unused lines of credit  $2,681 $ 8  $9   $552 
Standby letters of credit   10   -   -    - 
Operating leases   279   423   139    6 
Total  $2,970 $ 431  $148   $558 

 

Lease expense for the years ended December 31, 2011 and 2010 was $271,000 and $292,000, respectively.

 

The Company is involved in various regulatory inspections, inquiries, investigations and proceedings, and litigation matters that arise from time to time in the ordinary course of business. The process of resolving matters through litigation or other means is inherently uncertain, and it is possible that an unfavorable resolution of these matters, will adversely affect the Company, its results of operations, financial condition and cash flows. The Company’s regular practice is to expense legal fees as services are rendered in connection with legal matters, and to accrue for liabilities when payment is probable.

 

58
 

 

Employment Agreements

 

The Company has entered into employment agreements with two officers of the Bank, Steve Jones and Patrick Howard. The agreements are for an initial one-year term and are automatically renewable for an additional one-year term unless either party elects not to renew.

 

NOTE 13.RELATED PARTIES

 

The Company purchased corporate insurance through an insurance agency in which one of its principals is also a director and organizer of the Company. Premiums paid totaled $183,000 and $188,000 for the years ended December 31, 2011 and 2010, respectively.

 

The Company purchased employee benefit insurance through an insurance agency in which one of its principals is also a director and organizer of the Company. During the years ended December 31, 2011 and 2010 those premiums totaled $224,000 and $250,000 respectively.

 

Certain Directors and Officers of the Bank have depository accounts with the Bank. None of those deposit accounts have terms more favorable than those available to any other depositor.

 

NOTE 14.REGULATORY MATTERS

 

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

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of tier 1 capital (as defined) to average assets (as defined). To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, tier 1 risk-based, and tier 1 leverage ratios as set forth in the table.

 

On April 15, 2010, the Bank and the Comptroller of the Currency of the United States of America, (the “Comptroller”) entered into a formal written agreement, as such term is used in the Comptroller’s regulations (the “formal agreement”). In addition, the Bank entered into a consent order requiring the payment by the Bank of a civil money penalty in the amount of $100,000 (the “2010 Consent Order”).

 

The formal agreement replaced the consent order that the Bank entered into with the Comptroller in July 2008 (the “2008 Consent Order”), and, consequently, the 2008 Consent Order was terminated. In the formal agreement and the 2010 Consent Order, the Comptroller made findings that the Bank violated the Federal Trade Commission Act and engaged in unfair banking practices as a result of the Bank’s account relationships maintained with a third party payment processor and certain telemarketers and internet merchants between September 1, 2006 and August 27, 2007. The Comptroller also made findings that the Bank engaged in unsafe and unsound banking practices relating to asset quality, liquidity management and earnings. As a result of those findings, the Comptroller proposed the 2010 Consent Order and the formal agreement to the Bank requiring the Bank to provide restitution to consumers of the telemarketers and internet merchants, as well as continuing certain requirements from the 2008 Consent Order resulting from the Comptroller’s findings of unsafe and unsound banking practices relating to asset quality, liquidity management and earnings. The Bank neither admitted nor denied the Comptroller’s findings, but agreed to enter into the formal agreement and the 2010 Consent Order.

 

To resolve the matter, on April 15, 2010, the Bank entered into the 2010 Consent Order requiring a civil money penalty in the amount of $100,000 and executed the formal agreement with the Comptroller, which contained, among other provisions, requirements to establish a segregated deposit account for consumer restitution and to maintain a loan to deposit ratio no greater than 85% (see “Risks Related to the Company” under “Risk Factors”). The formal agreement also requires the Bank to achieve a Tier 1 capital ratio of 9.0% and a total risk based capital ratio of 11.5%, which are the same capital ratios that the Bank was required to achieve under the 2008 Consent Order. The requirement to maintain certain capital levels means the Bank cannot be considered well capitalized even if the Bank’s capital ratios exceed the requirements set forth in the formal agreement. In addition, the formal agreement required the Bank to submit a written program to reduce its level of criticized assets and a written profit plan to improve and sustain its earnings.

 

The Bank paid the civil money penalty in April 2010. In addition, the Bank submitted the required capital, liquidity enhancement, and profit plans, as well as a written program to reduce criticized assets to the Comptroller in accordance with the requirements of the formal agreement. The Comptroller did not object to the plans and program as submitted. Although the Bank was previously unable to comply with the capital ratio requirements of the 2008 Consent Order and formal agreement, as of December 31, 2011, the Bank’s capital ratios and loan to deposit ratios exceeded the requirements set forth in the formal agreement.

 

59
 

 

           To Be Well Capitalized 
           Under Prompt 
       For Capital   Corrective Action 
(000's)  Actual   Adequacy Purposes   Provisions 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
As of December 31, 2011                              
Total Capital (to Risk Weighted Assets)  $11,480    13.23%  $6,941>   8.00%  $8,677>   10.00%
                               
Tier 1 Capital (to Risk Weighted Assets)   10,391    11.98%   3,471>   4.00%   5,206>   6.00%
                               
Tier 1 Capital (to Average Assets)   10,391    10.24%   4,058>   4.00%   5,073>   5.00%
                               
As of December 31, 2010                              
Total Capital (to Risk Weighted Assets)  $12,156    12.20%  $7,973>   8.00%  $9,966>   10.00%
                               
Tier 1 Capital (to Risk Weighted Assets)   10,904    10.94%   3,986>   4.00%   5,979>   6.00%
                               
Tier 1 Capital (to Average Assets)   10,904    9.41%   4,635>   4.00%   5,793>   5.00%

  

NOTE 15.FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. FASB ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

·Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

·Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.

 

60
 

  

Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

 

The following table summarizes financial and nonfinancial assets measured at fair value as of December 31, 2011 and 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

   Level 1  Level 2   Level 3  Total 
(000's)  Inputs  Inputs   Inputs  Fair Value 
As of December 31, 2011                
Securities available for sale:                
U.S. government agencies$   $3,639 $   $3,639 
Mortgage-backed securities     2,855      2,855 
Impaired loans          1,072   1,072 
Other Assets:                
OREO     1,729      1,729 
                 
As of December 31, 2010                
Securities available for sale:                
Mortgage-backed securities$   $4,067 $   $4,067 
Impaired loans          1,217   1,217 
Other Assets:                
OREO     2,291      2,291 

 

Impaired loans are remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon net present value discounted at note rate.

 

Non-financial assets measured at fair value on a non-recurring basis are comprised of OREO. Certain OREO assets, upon initial recognition, are remeasured and reported at fair value through a charge-off to the allowance for possible loan losses based upon the fair value of the OREO asset. There were no properties added to OREO in the current period, and so there was no impact on the Company’s provision for loan loss. The fair value of an OREO asset, upon initial recognition, is estimated using Level 2 inputs based on a market approach using observable market data, such as comparable sales in the area.  In connection with the remeasurement of the OREO assets, the Company recognized writedowns totaling $337,000 in the current period, which have been recorded on the consolidated statement of income in other non-interest expense.

 

Carrying amount and estimated fair values of financial instruments were as follows at year end:

 

   2011   2010 
   Carrying   Estimated   Carrying   Estimated 
   Amount   Fair Value   Amount   Fair Value 
Financial assets                    
Cash and cash equivalents  $29,483   $29,483   $10,189   $10,189 
Securities available for sale   6,494    6,494    4,067    4,067 
Loans, net   82,278    84,596    94,185    94,305 
Accrued interest receivable   283    283    330    330 
                     
Financial liabilities                    
Deposits   111,225    112,038    95,770    97,717 
Accrued interest payable   43    43    77    77 

 

The methods and assumptions used to estimate fair value are described as follows:

 

Carrying amount is the estimated fair value for cash and cash equivalents, restricted securities, accrued interest receivable and payable, and demand and savings deposits and variable rate loans or deposits that re-price frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. The estimated fair value of other financial instruments and off-balance-sheet loan commitments approximate cost and are not considered significant to this presentation. 

  

61
 

 

 

NOTE 16.PARENT COMPANY CONDENSED FINANCIAL STATEMENTS

 

T BANCSHARES, INC.

CONDENSED BALANCE SHEETS

 

   December 31,   December 31, 
(000's)  2011   2010 
         
ASSETS          
           
Cash and due from banks  $97   $256 
Investment in subsidiary   10,509    10,894 
Other assets   44    - 
           
Total assets  $10,650   $11,150 
           
LIABILITIES AND CAPITAL          
           
Accounts payable   -    13 
Capital   10,650    11,137 
           
Total liabilities and capital  $10,650   $11,150 

 

T BANCSHARES, INC.

CONDENSED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31,

 

(000's)   2011     2010  
             
Equity in loss from subsidiary   $ (513 )   $ (338
                 
Noninterest expense:                
Professional and administrative     102       89  
Stock options     36       43  
Total noninterest expenses     138       132  
                 
Net loss   $ (651 )   $ (470 )

 

62
 

 

NOTE 16.PARENT COMPANY CONDENSED FINANCIAL STATEMENTS cont’d

 

T BANCSHARES, INC.

CONDENSED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31,

 

(000's)   2011     2010  
             
Cash Flows from Operating Activities            
             
Net Loss   $ (651 )   $ (470 )
Adjustments to reconcile net income to net cash provided by(used in) operating activities:                
                 
Equity in loss of Subsidiary     513       338  
Stock based compensation     36       43  
Net change in other assets     (44     -  
Net change in other liabilities     (13     (22
Net cash used in operating activities     (159     (111
                 
Cash Flows from Investing Activities            
                 
Cash Flows from Financing Activities            
                 
Net change in cash and cash equivalents     (159     (111
Cash and cash equivalents at beginning of period     256       367  
                 
Cash and cash equivalents at end of period   $ 97     $ 256  
                 
Supplemental disclosures of cash flow information                
Cash paid during the period for                
Interest   $ -     $ -  
Income taxes   $ -     $ -  

 

NOTE 17.SUBSEQUENT EVENT.

 

In connection with our Rights Offering and Limited Public Offering pursuant to the Registration Statement on Form S-1 (Registration Number 333-177766), which was declared effective by the Securities and Exchange Commission on January 13, 2012, we raised $4,161,254 in additional capital and issued 2,080,627 additional common shares.

 

63
 

 

Item 9.          Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.       Controls and Procedures.

 

As of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”).  Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.  

 

Our management, including the principal executive officer and principal financial officer, does not expect that our Disclosure Controls will prevent all error and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based upon their controls evaluation, our chief executive officer and principal financial officer have concluded that our Disclosure Controls are effective at a reasonable assurance level.

 

Management’s Report on Internal Control over Financial Reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Securities and Exchange Act of 1934. The Company’s internal control over financial reporting system is designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of the Company’s financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the financial statement preparation’s and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management assessed the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2011, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management believes that as of December 31, 2011, the Company’s internal controls over financial reporting are effective.

 

Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisitions, use, or disposition of the Company’s assets that could have a material affect on the Company’s financial statements are prevented or timely detected.

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal controls over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

There have been no changes in our internal controls over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

Item 9B.       Other Information.

 

None.

 

64
 

 

PART III

 

Item 10.        Directors, Executive Officers, and Corporate Governance

 

Information concerning the Company’s directors and executive officers will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the caption “Election of Directors” and “Executive Officers.” Such information is incorporated herein by reference.

 

Information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the caption “Section 16(a) Beneficial Ownership Reporting Compliance.” Such information is incorporated herein by reference.

 

We have adopted a Code of Conduct and Ethics, which is applicable to all directors, officers and employees of the Company and the Bank. The Code of Conduct and Ethics will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the caption “Code of Ethics.” Such information is incorporated herein by reference.

 

Item 11.        Executive Compensation.

 

Information in response to this item will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the captions “Executive Compensation,” “Director Compensation,” and “Compensation Committee.” Such information is incorporated herein by reference.

 

Item 12.        Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.

 

Information concerning security ownership of certain beneficial owners and management will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the caption “Security Ownership of Certain Beneficial Owners and Management.” Such information is incorporated herein by reference.

 

Item 13.        Certain Relationships and Related Transactions and Director Independence.

 

Information concerning certain relationships and related transactions will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the caption “Certain Relationships and Related Transactions.” Such information is incorporated herein by reference.

 

Item 14.        Principal Accountant Fees and Services.

 

Information concerning principal accounting fees and services will appear in the Company’s Proxy Statement for the 2012 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2012, under the caption “Independent Public Accountants.” Such information is incorporated herein by reference.

 

65
 

 

 

PART IV

 

Item 15.        Exhibits and Financial Statement Schedules.

 

Exhibit
No.
  Description of Exhibit
     
3.1   Articles of Incorporation (1)
3.2   Bylaws of Registrant (2)
10.1   T Bancshares, Inc. (f/k/a First Metroplex Capital, Inc.) 2005 Incentive Plan (3)(4)
10.2   Form of Incentive Stock Option Agreement (3)(4)
10.3   Form of Non-Qualified Stock Option Agreement (3)(4)
10.4   T Bancshares, Inc. (f/k/a First Metroplex Capital, Inc.) Organizers' Warrant Agreement dated November 2, 2004  (5)
10.5   T Bancshares, Inc. (f/k/a First Metroplex Capital, Inc.) Shareholders' Warrant Agreement dated November 2, 2004  (5)
10.6   Extension of term of initial Shareholder Warrants (5)
10.7   Form of Employment Agreement by and between T Bancshares, Inc. and Patrick Howard (4)(6)
10.8   Form of Employment Agreement by and between T Bancshares, Inc. and Steve Jones (4)(7)
10.9   Agreement between T Bank, N.A. and the Office of the Comptroller of the Currency, dated April 15, 2010(8)
10.10   Consent Order for Civil Money Penalty of T Bank, N.A., dated April 15, 2010(8)
21   Subsidiaries of T Bancshares, Inc.  *
23   Consent of Weaver and Tidwell L.L.P.*
31.1   Rule 13a-14(a) Certification of Chief Executive Officer*
31.2   Rule 13a-14(a) Certification of Chief Financial Officer*
32   Certification Pursuant to Rule 14d-14(b) of the Securities Exchange Act*

 

(1)   Incorporated by reference from the Quarterly Report on Form 10-QSB filed by Registrant with the SEC on August 14, 2007.
(2)   Incorporated by reference from the Current Report on Form 8-K filed by Registrant with the SEC on April 30, 2008.
(3)   Incorporated by reference from the Registration Statement on Form S-8 filed by the Registrant with the SEC on September 20, 2005 (file no. 333-128456).
(4)   Indicates a compensatory plan or contract.
(5)   Incorporated by reference from the Registration Statement on Form SB-2 filed by the Registrant with the SEC on December 15, 2003 and as amended on June 11, 2007 (file no. 333-111153)..
(6)   Incorporated by reference from the Current Report on Form 8-K filed by Registrant with the SEC on September 5, 2007.
(7)   Incorporated by reference from the Annual Report on Form 10-KSB filed by Registrant with the SEC on March 5, 2005 and, as amended on April 20, 2005.
(8)   Incorporated by reference from the Annual Report on Form 10-K filed by Registrant with the SEC on April 15, 2010.
*   Filed Herewith

 

66
 

  

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    T BANCSHARES, INC.
     
Dated:  March 30, 2012 By: /s/ Patrick Howard
    Patrick Howard
     
    President & Chief Executive Officer
    (Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

SIGNATURE   TITLE   DATE
         
/s/ Patrick Howard    Director and Principal Executive   March 30, 2012
Patrick Howard    Officer    
         
/s/ Ken Bramlage    Principal Financial Officer and   March 30, 2012
Ken Bramlage   Principal Accounting Officer    
         
/s/ Stanley E. Allred   Director   March 30, 2012
Stanley E. Allred        
         
/s/ Dan Basso    Director   March 30, 2012
Dan Basso        
         
/s/ Frankie Basso    Director   March 30, 2012
Frankie Basso        
         
/s/ David Carstens    Director   March 30, 2012
David Carstens        
         
/s/ Ron Denheyer    Director   March 30, 2012
Ron Denheyer        
         
/s/ Eric Langford    Director   March 30, 2012
Eric Langford        

 

67
 

  

SIGNATURE   TITLE   DATE
         
/s/ Charles M. Mapes, III    Director   March 30, 2012
Charles M. Mapes, III        
         
/s/ Thomas McDougal   Director   March 30, 2012
Thomas McDougal, DDS        
         
/s/ Gordon R. Youngblood   Director   March 30, 2012
Gordon R. Youngblood        
         
/s/ Cyvia Noble    Director   March 30, 2012
Cyvia Noble        
         
/s/ Steven Jones    Director   March 30, 2012
Steven Jones        

 

68