SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Quarterly Period Ended March 31, 2012
For the Transition Period from to
Commission file number 333-152331
COASTAL CAROLINA BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
2305 Oak Street
Myrtle Beach , South Carolina 29577
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x YES ¨ NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ YES x NO
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date: 2,188,000 shares of common stock par value $0.01 per share, were outstanding as of May 4, 2012.
COASTAL CAROLINA BANCSHARES, INC.
See notes to the consolidated financial statements.
COASTAL CAROLINA BANCSHARES, INC.
See notes to the consolidated financial statements.
COASTAL CAROLINA BANCSHARES, INC.
See notes to the consolidated financial statements
COASTAL CAROLINA BANCSHARES, INC.
See notes to the consolidated financial statements
COASTAL CAROLINA BANCSHARES, INC.
March 31, 2012
Note 1Business and Basis of Presentation
OrganizationOn February 28, 2008, Coastal Carolina Bancshares, Inc. (the Company) was incorporated to act as the holding company for Coastal Carolina National Bank (the Bank). The Bank began banking operations on June 8, 2009. The principal business activity of the Bank is to provide banking services to domestic markets, principally in Myrtle Beach, South Carolina. The Bank is a nationally-chartered commercial bank and its deposits are insured by the Federal Deposit Insurance Corporation.
Basis of PresentationThe accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. For further information, refer to the financial statements and footnotes thereto included in our Annual Report on Form 10-K for 2011 as filed with the Securities and Exchange Commission (the SEC).
Note 2Summary of Significant Accounting Policies
A summary of these policies is included in our Form 10-K filed with the SEC for the year ended December 31, 2011. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for 2011 as filed with the SEC. It is uncertain whether Accounting standards that have been issued or proposed by the Financial Accounting Standards Board (the FASB) that do not require adoption until a future date will have a material impact on the Companys consolidated financial statements upon adoption.
Statement of Cash FlowFor purposes of reporting cash flows, the Company considered certain highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents include amounts due from banks, federal funds sold, and interest-bearing bank deposits. Generally, federal funds are sold for one-day periods.
Loss Per ShareBasic loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding. Diluted loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding and dilutive common share equivalents using the treasury stock method. Dilutive common share equivalents include common shares issuable upon exercise of outstanding stock warrants and stock options. There were no dilutive common share equivalents outstanding during the three months ended March 31, 2012 and 2011 due to the net loss; therefore, basic loss per share and diluted earnings per share were the same.
Comprehensive IncomeAccounting principles generally require that recognized income, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component and such items, along with net income, are components of comprehensive income.
Note 3Recently Issued or Proposed Accounting Pronouncements
The following is a summary of recent authoritative pronouncements:
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Companys financial position, results of operations or cash flows.
Note 4Cash and Cash Equivalents
As of March 31, 2012, cash and cash equivalents totaled $16.1 million and were represented by $1.1 million in cash on hand and noninterest-bearing deposits with other banks, $13.9 million in interest-bearing deposits with other banks, and $1.1 million in federal funds sold. Interest-bearing deposits with other banks included $3.7 million in CDs invested at other banks that carry a weighted average rate of .68% with maturities between 4 and 18 months, $6.9 million at the Federal Reserve, and $3.3 million in money market deposit accounts. These balances allow the Company to meet liquidity requirements and provide temporary holdings until the funds can be otherwise deployed or invested.
At March 31, 2012 and December 31, 2011, the Banks securities available for sale consisted of a U.S. Government Agency Bond issued by the Federal National Mortgage Association (FNMA), city and county issued municipal bonds, mortgage-backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), collateralized mortgage obligations issued by the Government National Mortgage Association (GNMA), and a Small Business Administration (SBA) bond, summarized as follows:
The following table summarizes the unrealized losses and fair value of securities, aggregated by category and length of time that securities have been in a continuous unrealized loss position at March 31, 2012 and December 31, 2011.
The contractual maturity distribution and yields of the Bank's securities portfolio at March 31, 2012 are summarized below. Actual maturities may differ from contractual maturities shown below since borrowers may have the right to pre-pay these obligations without pre-payment penalties.
The Bank also owned Federal Reserve Bank (FRB) stock with a cost of $394,050 at March 31, 2012 and at December 31, 2011. The yield at both periods was 6%. The amount of FRB stock held is based on our shareholders equity. As shareholders equity decreases due to losses, the amount of FRB stock may also decrease quarterly.
The Bank owned $230,400 in Federal Home Loan Bank (FHLB) stock at March 31, 2012 and $183,800 at December 31, 2011. The amount of FHLB stock held is based on our total assets and the amount of outstanding advances with the FHLB. Therefore, stock ownership levels with the FHLB are subject to change. The yield on FHLB stock is variable at the discretion of the FHLB. The dividend paid for March 31, 2012 was 1.87% and 1.23% for December 31, 2011.
Securities with an amortized cost of $9.1 million at March 31, 2012 and $6.3 million at December 31, 2011, were pledged to secure public deposits. During the three months ended March 31, 2012, the Bank sold three mortgage backed securities with amortized costs of $4.3 million and purchased 2 securities with an amortized cost of $2.9 million.
There were no write-downs for other-than-temporary declines in the fair value of debt securities for the three month period ended March 31, 2012. At March 31, 2012, there were no investment securities considered to be other than temporarily impaired. The Banks mortgage-backed securities are investment grade securities backed by a pool of mortgages. Principal and interest payments on the underlying mortgages are used to pay monthly interest and principal on the securities.
Note 6Credit Quality
Provision and Allowance for Loan Losses
An allowance for loan losses has been established through a provision for loan losses charged to expense on the consolidated statement of operations. The allowance for loan losses represents an amount management has determined is adequate to absorb probable losses on existing loans that may become uncollectible. Growth in the loan portfolio is the primary reason for additions to the allowance for loan losses. Additionally, provisions may be made for non-performing loans.
The first step in the process is to assign a credit risk grade to each loan in the portfolio based on one common set of parameters that include items such as cash flow coverage ratios, debt-to-worth ratio, liquidity of the borrower, net worth, experience of the borrower, and other factors. The general pool of performing loans is then segmented into categories based on FFIEC call codes, which represent different loan types such as commercial loans, construction loans, consumer loans, and so on. The loss history of each loan type is measured and includes actual history experienced by the bank and the loss experiences of peer banks. The loss history results in a factor that is applied to each loan pool. Additionally, other factors are applied to represent known or expected changes to the loan portfolio resulting from economic and industry developments, the depth and knowledge of management, changes in policies and practices, and more. These environmental factors require judgment and estimates, and the eventual outcomes may differ from the estimates. The combined factors are applied to each loan category and result in the necessary allowance for the general performing loan pool.
The bank evaluates non-performing loans, loans with credit risk grades of Special Mention, Substandard, Doubtful, or worse, past due loans, loans on non-accrual, and any restructured loans separately to determine if the loan is impaired. Impaired loans and non-performing loans can require higher loan loss reserves. If a loan is individually evaluated and identified as impaired, it is measured by using either the fair value of the collateral less costs to sell, present value of expected future cash flows discounted at the loans effective interest rate, or observable market price of the loan. Management chooses a method on a loan-by-loan basis depending on which information is available. Measuring impaired loans requires judgment and estimates and the eventual outcomes may differ from the estimates.
The following table sets forth certain information with respect to our allowance for loan losses and the composition of charge offs and recoveries at March 31, 2012 and December 31, 2011.
Loans are categorized differently in the allowance tables compared to the loan composition table below. The loan composition table reflects categories determined by the loan purpose, whereas the allowance table below reflects categories that are based on the collateral that secures the loan as defined by the FFIEC call codes. For example, a loan made for commercial purposes but secured by 1-4 family real estate will be reported as a Commercial Loan in the composition table, but is considered a Real Estate 1-4 Family loan in the allowance tables.
The adequacy of the allowance for loan losses is reviewed on an ongoing basis. The amount of the allowance is adjusted to reflect changing circumstances. Recognized losses are charged to the allowance and recoveries are added back to the allowance. As of March 31, 2012, management considered the allowance for loan losses to be adequate to meet presently known and inherent losses in the loan portfolio. The underlying assumptions used in the analysis may be impacted in future periods by changes in economic conditions, the impact of changing regulations, and the discovery of new information with respect to borrowers not previously known to management. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required.
Credit Quality and Non-Performing Loans
Generally, the first indication of the non-performance of a loan is a missed payment. Thus, one of the adverse indicators used in monitoring the credit quality of a loan is the past due status of the loan payments. As of March 31, 2012, loans past due totaled $431,633, all of which was past due greater than 90 days. As of December 31, 2011, loans past due totaled $427,559, of which $37,277 was past due greater than 90 days.
Below are tables that present the past due status of loans receivable as of March 31, 2012 and December 31, 2011.
Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrowers financial condition is such that collection of the loan is doubtful. When a loan is placed on non-accrual, all previously accrued interest that has not been received is reversed against current income. The recognition of interest on a non-accrual loan is placed on a cash basis and can be recognized when and if a payment is received. Generally, payments received on non-accrual loans are applied directly to principal.
At March 31, 2012, the Bank had four loans totaling $531,822 in non-accrual status. At December 31, 2011, the Bank had five loans in non-accrual status totaling $698,570. The Bank did not have any loans past due 90 days and still accruing as of March 31, 2012 or December 31, 2011.
Loans are assigned a credit risk grade upon their origination. Loans are monitored for non-performance and may be downgraded to reflect adverse conditions that might affect collectability. Heightened risk characteristics include a history of poor payment performance, poor financial performance, as well as the potential for adverse earnings impact from deteriorating collateral values. The Bank had $3,200,781 and $3,337,162 in loans classified as Substandard or worse as of March 31, 2012 and December 31, 2011, respectively.
General definitions for each credit risk level are as follows:
Credit risk grades within the loan portfolio as of March 31, 2012 and December 31, 2011 are presented in the following three tables, separately for commercial loans, residential real estate loans, and consumer loans, with breakdowns provided for loan types within those categories.
Impaired loans totaled $531,822 and $245,200 as of March 31, 2012 and 2011, respectively, and were represented by loans on non-accrual. The following table sets forth certain information regarding the type of impaired loans, their related allowances, and any interest income recognized on impaired loans during the first quarter of 2012 and 2011, ended March 31st.
If a loan is modified as a result of a customers inability to meet the original terms, and if the modification gives the customer more favorable terms that would not otherwise be granted, the loan is considered to be a troubled debt restructuring. As of March 31, 2012, the Bank has three loans that qualify as trouble debt restructuring. The following table presents information regarding the Banks loans that qualify as a troubled debt restructuring as of March 31, 2012 and 2011.
As of March 31, 2012, management was not aware of any additional loans that were not already considered for impairment or categorized as impaired or on non-accrual.
Note 7Fair Value Measurements
The current accounting literature requires the disclosure of fair value information for financial instruments, whether or not they are recognized in the consolidated balance sheets, when it is practical to estimate the fair value. The guidance defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations, which require the exchange of cash, or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Companys common stock, premises and equipment, accrued interest receivable and payable, and other assets and liabilities.
The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.
The Company has used managements best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented.
Assets and liabilities carried at fair value are classified in one of the following three categories based on a hierarchy for ranking the quality and reliability of the information used to determine fair value:
For financial instruments whose fair values are estimated for disclosure purposes only, the following methods were used:
Cash and Cash Equivalents, Federal Funds Sold and InterestBearing Bank DepositsThe carrying amount is a reasonable estimate of fair value due to the short term nature of such items. These amounts generally relate to currency or highly liquid assets, thus these are considered a Level 1 valuation.
Securities Available for SaleInvestment securities available-for-sale are recorded at fair value on a recurring basis. These securities trade in highly liquid markets with observable quoted prices for identical assets, thus these assets are considered a Level 1 valuation.
Federal Reserve Bank and Federal Home Loan Bank StockThe carrying value of nonmarketable equity securities approximates the fair value since no ready market exists for the stock. These assets are considered a Level 3 valuation.
Loans Held for SaleLoans held for sale are carried at the lower of cost or market value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. Since the secondary market creates some liquidity and observable market inputs for similar assets, these assets are considered a Level 2.
Loans ReceivableFor certain categories of loans, such as variable rate loans, which are repriced frequently and have no significant change in credit risk, fair values are based on the carrying amounts. The fair values of loans, excluding leases, are estimated based on groupings of similar loans by type, interest rate, and borrower creditworthiness. Discounted future cash flow analyses are performed for the groupings, incorporating assumptions of current and projected prepayment speeds and expected loss. Discount rates are determined using the Companys current origination rates on similar loans, adjusted for changes in current liquidity and credit spreads, if necessary. Because the current liquidity spreads are generally not observable in the market and the expected loss assumptions are based on the Companys experience, these are Level 3 valuations. However, the fair value of impaired loans is estimated based on discounted cash flows or underlying collateral values, where applicable. Thus, impaired loans are reported at Level 2 and Level 3 depending on the specifics of each impaired loan.
DepositsThe fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date. The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities. These liabilities are reported as a Level 2.
Off-Balance-Sheet Financial InstrumentsThe carrying amount for loan commitments are reported with zero fair value, since these amounts have not been issued.
The carrying values and estimated fair values of the Companys financial instruments as of March 31, 2012 and December 31, 2011 were as follows:
There were no transfers between valuation levels for any assets during the quarter ended March 31, 2012.
Assets Measured at Fair Value on a Recurring Basis
Following is a description of the valuation methodologies used for assets and liabilities measured at fair value on a recurring basis at March 31, 2012, as well as the general classification of such instruments pursuant to the valuation hierarchy:
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions.
Securities traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds are considered highly liquid and are classified as Level 1. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
The following table presents the fair value of assets evaluated on a recurring basis as of March 31, 2012 and December 31, 2011 by level within the hierarchy.
There were no other assets and no liabilities measured at fair value on a recurring basis at March 31, 2012 and December 31, 2011.
Assets Measured at Fair Value on a Non-Recurring Basis
Loans Held for Sale
Loans held for sale are carried at the lower of cost or market value. The fair value of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans for sale is nonrecurring Level 2.
A loan is considered impaired when the full payment under the loan terms is not expected. Impaired loans are carried at the present value of estimated future cash flows or the fair value of collateral. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available and there is no observable market price, the Company records the loan as nonrecurring Level 3. The following table presents the fair value of assets evaluated on a nonrecurring basis as of March 31, 2012 and December 31, 2011.
There were no other assets and no liabilities measured at fair value as of March 31, 2012 and December 31, 2011 on a nonrecurring basis. During the quarter ended March 31, 2012, one Level 3 impaired loan paid off. Loans held for sale at December 31, 2011 were sold during the quarter ending March 31, 2012, and the values reported for loans held for sale as of March 31, 2012 represent new assets in that category. There were no other transfers between valuation levels for assets measured for fair value on a non-recurring basis.
The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at March 31, 2012.
The impaired loan representing construction and land development is collateralized with a 25% interest in real estate. The impaired loan was valued by applying a 50% discount to the appraised value of the full property, which used a sales comparison approach, followed by applying the pro-rata 25% ownership in the property. The resulting valuation resulted in a full impairment of the loan balance. There is no observable market for selling the 25% interest in the property, therefore this impaired loan is considered a Level 3 valuation.
The impaired loan representing Real Estate-Other is collateralized with property that has a deed restriction for residential use only. However, the property has been converted to and used for commercial purposes for an extended period of time. The deed restriction for residential use and the commercial use of the property calls into question the marketability of the property and there are no observable market inputs for similar properties. Therefore, the fair valuation is considered to be Level 3. The valuation technique used was based on an appraisal of the property, based on sales comparisons for similar commercial properties, with a 10% discount applied. The valuation resulted in an impairment of $100,020, which is fully reserved.
The loan representing consumer loans is unsecured and, therefore, has no collateral for which to observe market inputs. Therefore, it is considered a Level 3 valuation. The valuation was performed using a discounted cash flows model and resulted in a full impairment of the loan balance.
Note 8Subsequent Events
In preparing these consolidated financial statements, subsequent events were evaluated through the time the consolidated financial statements were issued. Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users, or filed with the SEC. In conjunction with applicable accounting standards, all material subsequent events have been either recognized in the consolidated financial statements or disclosed in the notes to the consolidated financial statements.
The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements. The commentary should be read in conjunction with the discussion of forward-looking statements, the consolidated financial statements, and the related notes and the other statistical information included in this report.
DISCUSSION OF FORWARD-LOOKING STATEMENTS
This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words may, would, could, should, will, expect, anticipate, predict, project, potential, believe, continue, assume, intend, plan, and estimate, as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in our forward-looking statements include, but are not limited to, those described in our Annual Report on Form 10-K for the year ended December 31, 2011 under Item 1ARisk Factors and the following:
These risks are exacerbated by the volatility and disruption experienced in national and international financial, capital, and credit markets during the last three years. Beginning in 2008 and continuing through 2011, the capital and credit markets experienced unprecedented levels of extended volatility and disruption. During the first quarter of 2012, economic conditions, while slow by historical standards, have shown signs of stabilization. However, as a result of U.S. government fiscal challenges, continued volatility in European sovereign and bank debt, slow improvement in domestic employment conditions, and the economic and monetary policy statements by the Board of Governors of the Federal Reserve System (the Federal Reserve), it is difficult to predict if this stabilization is indicative of a lasting trend. Current economic reports are mixed and the outlook for the remainder of 2012 is unclear and does not yet indicate expectations of a sustained recovery. There can be no assurance that the current level of economic activity will not continue to materially and adversely impact the U.S. economy in general, the banking industry, and our business, financial condition and results of operations, as well as our ability to maintain sufficient capital or other funding for liquidity and business purposes.
Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Coastal Carolina Bancshares, Inc. is a bank holding company headquartered in Myrtle Beach, South Carolina. We were incorporated in February 2008 and our national bank subsidiary, Coastal Carolina National Bank, opened for business on June 8, 2009. The principal business activity of our bank is to provide retail and commercial banking services in Myrtle Beach and our surrounding market areas. Our deposits are insured by the Federal Deposit Insurance Corporation.
We completed our stock offering in June 2009, upon the issuance of 2,180,000 shares for gross proceeds of $21.8 million, pursuant to a closing in June 2009. We capitalized the bank with $19.9 million of the proceeds from the stock offering.
Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on the majority of which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our earnings. In the following section we have included a detailed discussion of this process.
The following discussion describes our results of operations for the three months ended March 31, 2012 and 2011 and also analyzes our financial condition as of March 31, 2012 and December 31, 2011.
Critical Accounting Policies
We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2011, as filed in our Annual Report on Form 10-K.
Certain accounting policies involve significant judgments and assumptions by us that may have a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe are reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan Losses
We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, assumptions about cash flow, determination of loss factors for estimating credit losses, and the impact of current events, conditions, and other factors impacting the level of probable inherent losses. Under different conditions, the actual amount of credit losses incurred by us may be different from managements estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.
We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our consolidated financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined to be possible that all or some portion of the potential deferred tax asset will not be realized. We believe our loss position may adversely impact our ability to recognize the full benefit of our deferred tax asset. Therefore, we currently have placed a valuation allowance for our full deferred tax asset. No assurance can be given that either
the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.
Results of Operations
Our primary source of revenue is net interest income. Net interest income is the difference between income earned on interest-bearing assets and interest paid on deposits and borrowings used to support such assets. The level of net interest income is determined by the balances of interest-earning assets and interest-bearing liabilities and corresponding interest rates earned and paid on those assets and liabilities, respectively. In addition to the volume of and corresponding interest rates associated with these interest-earning assets and interest-bearing liabilities, net interest income is affected by the timing of the repricing of these interest-earning assets and interest-bearing liabilities.
Three months ended March 31, 2012 and 2011
We incurred a net loss of $142,101, or .06 cents per share, for the three months ended March 31, 2012, compared to a net loss of $791,370, or .36 cents per share, for the three months ended March 31, 2011. Interest income was $921,629 and $646,941 for the three months ended March 31, 2012 and 2011, respectively. The increase in interest income is attributed to the larger loan portfolio maintained by the bank in 2012, offset by less interest income received on investments and interest bearing bank deposits. Interest income for the three months ended March 31, 2012 was comprised of $770,452 earned on loans, $139,333 earned on investment securities, and $11,844 earned on fed funds sold and interest bearing bank deposits.
Interest expense was $190,612 for the three months ended March 31, 2012, compared to $212,751 for the three months ended March 31, 2011. The decrease in interest expense is attributed to a reduction in deposit rates. Our net interest spread and net interest margin were 2.90% and 3.08%, respectively, for the three months ended March 31, 2012, compared to 2.23% and 2.53%, respectively, for the three months ended March 31, 2011. We are achieving higher yields on earning assets due to loan growth, as lower yielding liquidity has been redeployed into higher yielding loans. We are also achieving lower costs associated with deposit liabilities.
The loan loss provision, which is driven primarily by loan growth, non-performing loans, and a historical loss and environmental analysis, was $14,094 for the three months ended March 31, 2012, compared to $318,431 for the three months ended March 31, 2011. The decrease in loan loss provision is attributed primarily to higher specific reserves needed in 2011 for non-performing loans.
Non-interest income was $68,844 for the three months ended March 31, 2012, of which $19,272 came from service charges on deposits, $19,850 came from gains on the sale of mortgage loans, and $7,930 came from gains on sale of investments. For the three months ended March 31, 2011, non-interest income was $17,107, of which $5,120 came from service charges on deposits and $6,605 came from gains on the sale of mortgage loans. There were no gains on sale of investment securities during the first quarter 2011. Service charge fee income has increased due to consumer NSF activity. Additionally, the Bank received $15,891 on a fully depreciated bank vehicle that was disposed during the three months ended March 31, 2012. Non-interest expense was $927,868 and $924,236 for the three months ended March 31, 2012 and 2011, respectively. Employee benefit expenses, occupancy and equipment expense, and marketing expenses all decreased while data processing and consulting services, including an executive search firm, increased during the three months ended March 31, 2012 compared to the same time period in 2011.
Assets and Liabilities
Total assets as of March 31, 2012 were $99.0 million, representing an increase of $4.6 million, or 4.9%, compared to $94.4 million as of December 31, 2011. The increase in assets is due primarily to net loan growth of $3.0 million, which was funded primarily by deposit growth of $4.6 million. At March 31, 2012, total assets consisted principally of $16.1 million in cash and cash equivalents, $26.8 million in available-for-sale investment securities and $54.4 million in net loans. Net loans at December 31, 2011 were $51.4 million. The primary source of funding is deposits that are acquired locally. Liabilities at March 31, 2012 totaled $85.0 million, represented almost entirely by retail customer deposits totaling $84.4 million. Liabilities as of December 31, 2011 totaled $80.3 million, including $79.8 million in deposits. At March 31, 2012, shareholders equity was $14.0 million, compared to $14.1 million as of December 31, 2011. The reason for the decrease in shareholders equity is net losses. Book value per share was $6.41 at March 31, 2012, compared to $6.43 as of December 31, 2011.
Loans typically provide higher interest yields than other types of interest-earning assets. Net loans have increased $3.0 million, or 5.8%, to $54.4 million, during the three months ended March 31, 2012, primarily in the category of Real Estate Other, compared to $51.4 million as of December 31, 2011. The following table summarizes the composition of our loan portfolio as of March 31, 2012 and December 31, 2011.
Classified loans are performing loans with elevated levels of credit risk. These loans are assigned credit risk grades of substandard or worse. The Banks classified loans decreased during the first three months of 2012 from $3,337,162 as of December 31, 2011 to $3,200,781 as of March 31, 2012, primarily due to the payoff of one loan relationship.
At March 31, 2012, nonaccrual loans totaled $531,822, related to four lending relationships, compared to $698,570 in nonaccrual loans as of December 31, 2011. There were no accruing loans which were contractually past due 90 days or more as to principal or interest payments at March 31, 2012 and December 31, 2011. Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of the loan is doubtful. The nonaccrual loan relationship is considered impaired.
As of March 31, 2012, we were not aware of any other loans that were not already considered for impairment or categorized as impaired or on nonaccrual.
Provision and Allowance for Loan Losses
The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Additions to the allowance are often the result of growth in the loan portfolio. Additionally, our judgment as to the adequacy of the allowance for loan losses is based on an ongoing review of the quality, mix, and size of our overall loan portfolio. We make a number of assumptions regarding current portfolio and economic conditions. We consider our historical loan loss experience, the loan loss experience of our peers, and any specific problem loans and commitments that may affect the borrowers ability to pay. We believe the assumptions we have made to be reasonable, but which may or may not prove to be accurate.
Periodically, we will adjust the amount of the allowance based on changing circumstances. We will charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.
We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. The allowance for loan losses was $1,105,971 as of March 31, 2012, or 1.99% of gross loans outstanding, compared to $1,091,877 as of December 31, 2011, or 2.07% of gross loans outstanding. Total provision expense for the three months ended March 31, 2012 was $14,094, compared to $318,431 for the three months ended March 31, 2011. The decrease in provision expense in 2012 compared to 2011 was primarily due to less growth in the loan portfolio and additional provision in 2011 needed for classified and nonperforming loan relationships.
There were no charge offs or recoveries during the first three months of 2012 and 2011. As of March 31, 2012, management considered the allowance for loan losses to be adequate and sufficient to meet presently known and inherent losses in the loan portfolio.
Our primary source of funds for loans and investments is the funds obtained through our customer deposits. At March 31, 2012, we had $84.4 million in deposits, representing an increase of $4.6 million from December 31, 2011. Our deposits as of March 31, 2012 consisted primarily of $8.9 million in demand deposit accounts, $36.4 million in certificates of deposit, and $39.1 million of savings and money market accounts. The primary source of funding for our loan portfolio is deposits that are acquired locally. As of March 31, 2012, we have no brokered or wholesale deposits and no borrowings.
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. For an operating bank, liquidity represents the ability to provide steady sources of funds for loan commitments and investment activities, as well as to maintain sufficient funds to cover deposit withdrawals and payment of debt and operating obligations. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
Our primary sources of liquidity are deposits, scheduled repayments on our loans, and interest/principal payments received on and maturities of our investments. We plan to meet our future cash needs through the generation of deposits. Occasionally, we might sell investment securities in connection with the management of our interest sensitivity gap or to manage cash availability. We may also utilize our cash and due from banks and federal funds sold to meet liquidity requirements as needed. In addition, we have the ability, on a short-term basis, to purchase federal funds from other financial institutions or borrow advances from the Federal Home Loan Bank Atlanta. As of March 31, 2012, our primary sources of liquidity included cash, non-interest and interest-bearing deposits and federal funds sold with financial institutions totaling $16.1 million. In addition, the fair value of our available for sale investment portfolio was $26.8 million as of March 31, 2012. Our lines of credit available with correspondent banks total $8.0 million with no outstanding principal or interest on these lines at March 31, 2012 and are unsecured. These lines may be withdrawn at the discretion of the correspondent financial institutions. Our credit availability at the Federal Home Loan Bank is $9.35 million as of March 31, 2012 and requires collateralization by eligible investment securities or loans. We believe our liquidity levels are adequate to meet our operating needs.
Off-Balance Sheet Risk
Through the operations of our bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At March 31, 2012, we had issued commitments to extend credit of $9.8 million through various types of lending arrangements, compared to $10.1 million as of December 31, 2011. We evaluate each customers credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.
Total shareholders equity was $14.0 million at March 31, 2012 compared to $14.1 million at December 31, 2011. The decrease is primarily a result of net losses of $142,101 for the three months ended March 31, 2012.
Our bank and the Company are subject to various regulatory capital requirements administered by the federal banking agencies. However, the Federal Reserve guidelines contain an exemption from the capital requirements for small bank holding companies
which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC. Since our assets are less than $500 million and our stock is not registered under Section 12 of the Securities Exchange Act of 1934, we believe our Company qualifies as a small bank holding company and is exempt from the capital requirements. Nevertheless, our bank remains subject to these capital requirements. 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 banks 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 banks assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The banks capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Regardless, our bank is well capitalized under these minimum capital requirements as set per bank regulatory agencies.
Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. A third capital ratio that is closely monitored, known as the Tier 1 Leverage Ratio, measures Tier 1 capital as a percentage of average assets during the quarter.
At the bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. To be considered adequately capitalized under these capital guidelines, we must maintain a minimum total risk-based capital of 8%, with at least 4% being Tier 1 capital. In addition, we must maintain a minimum Tier 1 leverage ratio of at least 4%. To be considered well-capitalized, we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.
In approving the banks application for deposit insurance, the FDIC required that the bank maintain a leverage ratio of at least 8% during the banks de novo period. In addition, the business plan submitted as part of our application with the OCC to obtain a national bank charter calls for the Bank to maintain a Tier 1 risked-based capital ratio of at least 8% and a total risk-based capital ratio of 12% during the Banks de novo period.
The bank exceeded its minimum regulatory capital ratios as of March 31, 2012 and December 31, 2011, as well as the ratios to be considered well capitalized.
The following table sets forth the banks various capital ratios at March 31, 2012 and December 31, 2011:
We believe our capital is sufficient to fund the activities of the bank as we grow. As of March 31, 2012, there were no significant firm commitments outstanding for capital expenditures.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 15d-15(e). Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our current disclosure controls and procedures are effective as of March 31, 2012. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
There are no material pending legal proceedings to which we are a party or of which any of our property is the subject.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.