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EX-32 - EXHIBIT 32 - FIRST SOUTH BANCORP INC /VA/v393885_ex32.htm
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EX-31.2 - EXHIBIT 31.2 - FIRST SOUTH BANCORP INC /VA/v393885_ex31-2.htm
EXCEL - IDEA: XBRL DOCUMENT - FIRST SOUTH BANCORP INC /VA/Financial_Report.xls

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

 

For the quarterly period ended September 30, 2014.

 

OR

 

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

For the transition period from______to _______.

 

Commission File Number: 0-22219

 

FIRST SOUTH BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Virginia   56-1999749  
(State or other jurisdiction of   (IRS Employer  
incorporation or organization)   Identification No.)  

 

  1311 Carolina Avenue, Washington, North Carolina 27889  
  (Address of principal executive offices)  
  (Zip Code)  

 

  (252) 946-4178  
  (Registrant's telephone number, including area code)  

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

 

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 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. (Check one)

 

  Large Accelerated Filer ¨

Accelerated Filer ¨

  Non-Accelerated Filer ¨ Smaller Reporting Company x
  (Do not check if a Smaller Reporting Company)  

 

Indicate by check mark whether registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

Number of shares of common stock outstanding as of November 13, 2014: 9,598,007.

 

 
 

 

CONTENTS

 

    PAGE
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements
     
  Consolidated Statements of Financial Condition as of September 30, 2014 (unaudited) and December 31, 2013 1
     
  Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited) 2
     
  Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited) 3
     
  Consolidated Statements of Changes in Stockholders' Equity for the  Nine Months Ended September 30, 2014 and 2013 (unaudited) 4
     
  Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (unaudited) 5
     
  Notes to Consolidated Financial Statements (unaudited) 6
     
Item 2. Management's Discussion and Analysis of Financial Condition and   Results of Operations 27
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
     
Item 4. Controls and Procedures 36
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 37
     
Item 1A. Risk Factors 37
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 37
     
Item 3. Defaults Upon Senior Securities 37
     
Item 4. Mine Safety Disclosures 37
     
Item 5. Other Information 37
     
Item 6. Exhibits 37
     
Signatures   38
     
Exhibits    

 

 
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

 

   September 30,   December 31, 
   2014   2013 
   (unaudited)   (*) 
Assets          
           
Cash and due from banks  $10,550,246   $11,816,071 
Interest-bearing deposits with banks   9,556,326    12,419,244 
Investment securities available for sale, at fair value   187,964,534    150,300,079 
Investment securities held to maturity   507,025    506,176 
Loans held for sale:          
Mortgage loans   5,540,058    2,992,017 
Total loans held for sale   5,540,058    2,992,017 
           
Loans and leases held for investment   473,012,676    450,960,277 
Allowance for loan and lease losses   (7,503,987)   (7,609,467)
Net loans and leases held for investment   465,508,689    443,350,810 
           
Premises and equipment, net   12,494,066    11,759,521 
Other real estate owned   8,102,764    9,353,835 
Federal Home Loan Bank stock, at cost   2,294,000    848,800 
Accrued interest receivable   2,322,559    2,334,944 
Goodwill   4,218,576    4,218,576 
Mortgage servicing rights   1,170,828    1,219,623 
Identifiable intangible assets   -    7,860 
Income tax receivable   2,628,641    2,901,062 
Bank-owned life insurance   14,991,685    11,094,182 
Prepaid expenses and other assets   6,816,223    9,599,143 
           
Total assets  $734,666,220   $674,721,943 
           
Liabilities and Stockholders' Equity          
           
Deposits:          
Non-interest bearing demand  $99,219,406   $96,445,049 
Interest bearing demand   182,473,167    171,548,658 
Savings   90,189,605    69,542,654 
Large denomination certificates of deposit   107,796,042    123,492,907 
Other time   122,370,135    124,674,588 
Total deposits   602,048,355    585,703,856 
           
Borrowed money   37,500,000    - 
Junior subordinated debentures   10,310,000    10,310,000 
Other liabilities   4,445,181    3,849,944 
Total liabilities   654,303,536    599,863,800 
           
Common stock, $.01 par value, 25,000,000 shares authorized; 9,598,007 and 9,653,883 shares outstanding, respectively   95,980    96,539 
Additional paid-in capital   35,854,162    35,809,397 
Retained earnings   41,400,807    38,849,326 
Accumulated other comprehensive income   3,011,735    102,881 
Total stockholders' equity   80,362,684    74,858,143 
           
Total liabilities and stockholders' equity  $734,666,220   $674,721,943 

 

(*) Derived from audited consolidated financial statements

 

The accompanying notes are an integral part of these consolidated financial statements.      

 

1
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Operations

Three and Nine Months Ended September 30, 2014 and 2013

(unaudited)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
                 
Interest income:                    
Interest and fees on loans  $6,068,196   $6,054,886   $17,966,829   $18,715,042 
Interest on investments and deposits   1,248,382    1,165,258    3,642,464    3,834,305 
Total interest income   7,316,578    7,220,144    21,609,293    22,549,347 
                     
Interest expense:                    
Interest on deposits   522,861    611,975    1,608,913    1,908,473 
Interest on borrowings   112,174    -    157,287    7,058 
Interest on junior subordinated notes   81,371    82,391    242,651    258,731 
Total interest expense   716,406    694,366    2,008,851    2,174,262 
                     
Net interest income   6,600,172    6,525,778    19,600,442    20,375,085 
Provision for credit losses   400,000    -    1,100,000    400,000 
Net interest income after provision for credit losses   6,200,172    6,525,778    18,500,442    19,975,085 
                     
Non-interest income:                    
Deposit fees and service charges   1,118,599    1,063,243    3,184,808    3,158,690 
Loan fees and charges   39,057    46,076    117,615    125,694 
Mortgage loan servicing fees   248,399    334,382    724,827    968,120 
Gain on sale and other fees on mortgage loans   428,514    644,674    1,076,583    2,163,891 
Gain on sale of other real estate, net   8,949    68,233    82,369    403,067 
Gain on sale of investment securities   -    267,564    13,509    548,074 
Other income   401,584    281,577    1,133,910    733,754 
Total non-interest income   2,245,102    2,705,749    6,333,621    8,101,290 
                     
Non-interest expense:                    
Compensation and fringe benefits   3,826,855    3,838,796    11,454,632    11,530,092 
Federal deposit insurance premiums   137,253    227,820    420,873    700,120 
Premises and equipment   877,447    759,092    2,534,608    2,244,489 
Advertising   126,892    84,228    295,905    166,290 
Data processing   566,513    558,899    1,720,321    1,754,936 
Amortization of intangible assets   55,796    119,253    164,008    357,573 
Other real estate owned expense   167,164    287,527    395,652    1,004,711 
Other   779,226    1,052,389    2,592,176    2,836,566 
Total non-interest expense   6,537,146    6,928,004    19,578,175    20,594,777 
                     
Income before income tax expense   1,908,128    2,303,523    5,255,888    7,481,598 
Income tax expense   565,368    766,694    1,525,293    2,613,702 
                     
NET INCOME  $1,342,760   $1,536,829   $3,730,595   $4,867,896 
                     
Per share data:                    
Basic earnings per share  $0.14   $0.16   $0.39   $0.50 
Diluted earnings per share  $0.14   $0.16   $0.39   $0.50 
Dividends per share  $0.025   $0.00   $0.075   $0.00 
Average basic shares outstanding   9,598,007    9,751,271    9,626,346    9,751,271 
Average diluted shares outstanding   9,616,004    9,757,881    9,644,834    9,756,480 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income

Three and Nine Months Ended September 30, 2014 and 2013

(unaudited)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
                 
Net income  $1,342,760   $1,536,829   $3,730,595   $4,867,896 
                     
Other comprehensive income (loss):                    
Unrealized holding gains (losses) on securities available for sale Tax effect   104,902    (259,966)   4,923,452    (6,505,475)
Unrealized holding gains (losses) on securities available for sale, net of tax   (39,863)   97,496    (1,870,912)   2,436,375 
    65,039    (162,470)   3,052,540    (4,069,100)
                     
Unrealized gains (losses) on interest rate hedge position Tax effect   46,857    (121,788)   (218,242)   (121,788)
Unrealized gains (losses) on interest rate hedge position, net of tax   (17,806)   46,280    82,932    46,280 
    29,051    (75,508)   (135,310)   (75,508)
                     
Reclassification adjustment for realized gains included in net income Tax effect   -    (267,564)   (13,509)   (548,074)
Reclassification adjustment for realized gains, net of tax   -    102,965    5,133    211,112 
    -    (164,599)   (8,376)   (336,962)
                     
Other comprehensive income (loss), net of tax   94,090    (402,577)   2,908,854    (4,481,570)
                     
Comprehensive income  $1,436,850   $1,134,252   $6,639,449   $386,326 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders' Equity

Nine Months Ended September 30, 2014 and 2013

(unaudited)

 

               Accumulated     
       Additional       other     
   Common   paid-in   Retained   comprehensive     
Nine Months Ended September 30, 2014  stock   capital   earnings   income, net   Total 
                     
Balance at December 31, 2013  $96,539   $35,809,397   $38,849,326   $102,881   $74,858,143 
                          
Net income             3,730,595         3,730,595 
                          
Other comprehensive income, net                  2,908,854    2,908,854 
                          
Retirement of common shares   (559)        (456,515)        (457,074)
                          
Stock based compensation expense        44,765              44,765 
                          
Dividends             (722,599)        (722,599)
                          
Balance at September 30, 2014  $95,980   $35,854,162   $41,400,807   $3,011,735   $80,362,684 

 

                   Accumulated     
       Additional           other     
   Common   paid-in   Retained   Treasury   comprehensive     
Nine Months Ended September 30, 2013  stock   capital   earnings   stock   income, net   Total 
                         
Balance at December 31, 2012  $97,513   $35,811,804   $65,532,960   $(31,967,269)  $5,178,045   $74,653,053 
                               
Net income             4,867,896              4,867,896 
                               
Other comprehensive loss, net                       (4,481,570)   (4,481,570)
                               
Stock based compensation benefit        (11,546)                  (11,546)
                               
Balance at September 30, 2013  $97,513   $35,800,258   $70,400,856   $(31,967,269)  $696,475   $75,027,833 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2014 and 2013

(unaudited)

   Nine Months Ended 
   September 30, 
   2014   2013 
         
Cash flows from operating activities:        
Net income  $3,730,595   $4,867,896 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Provision for credit losses   1,100,000    400,000 
Depreciation   1,503,537    828,139 
Amortization of intangibles   164,008    357,573 
Accretion of discounts and premiums on securities, net   742,035    569,243 
(Gain) loss on disposal of premises and equipment   1,821    (11,050)
Gain on sale of other real estate owned   (82,369)   (403,067)
Gain on sale of loans held for sale   (447,888)   (1,189,688)
Gain on sale of investment securities available for sale   (13,509)   (548,074)
Stock based compensation expense (income)   44,765    (11,546)
Originations of loans held for sale, net   (16,805,469)   (18,813,631)
Proceeds from sale of loans held for sale   14,705,316    55,545,353 
Other operating activities   1,627,806    5,704,904 
Net cash provided by operating activities   6,270,648    47,296,052 
Cash flows from investing activities:          
Proceeds from sale of investment securities available for sale   787,500    43,417,503 
Proceeds from principal repayments of mortgage-backed securities available for sale   10,890,995    18,292,495 
Originations of loans held for investment, net of principal repayments   (24,669,972)   (1,357,391)
Proceeds from disposal of other real estate owned   2,672,248    6,120,440 
Proceeds from disposal of premises and equipment   -    11,050 
Purchases of investment securities available for sale   (45,162,382)   (52,777,388)
Purchases of investment securities held to maturity   -    (505,818)
Purchases of bank-owned life insurance   (3,897,503)   (10,132,954)
Sale (purchase) of FHLB stock   (1,445,200)   1,010,400 
Purchase of premises and equipment   (2,239,903)   (354,149)
Net cash provided by (used in) investing activities   (63,064,217)   3,724,188 
Cash flows from financing activities:          
Net increase (decrease) in deposit accounts   16,344,499    (9,269,786)
Net increase (decrease) in FHLB borrowings   37,500,000    (16,500,000)
Cash paid for dividends   (722,599)   - 
Retirement of common shares   (457,074)   - 
Net cash provided by (used in) financing activities   52,664,826    (25,769,786)
           
Increase (decrease) in cash and cash equivalents   (4,128,743)   25,250,454 
Cash and cash equivalents, beginning of period   24,235,315    12,366,389 
Cash and cash equivalents, end of period  $20,106,572   $37,616,843 
           
Supplemental disclosures:          
Other real estate acquired in settlement of loans  $1,412,093   $2,305,084 
Cash paid for interest  $1,983,267   $2,852,536 

 

The accompanying notes are an integral part of these consolidated financial statements.

  

5
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Note 1. Basis of Presentation. The accompanying unaudited consolidated financial statements are prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for fair presentation of the financial position and results of operations for the periods presented are included, none of which are other than normal recurring accruals. The financial statements of First South Bancorp, Inc. (the “Company”) and First South Bank (the “Bank”) are presented on a consolidated basis. The results of operations for the three and nine months ended September 30, 2014, are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2014. Certain amounts in the unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2013 have been reclassified to conform with the presentation as of and for the respective periods ended September 30, 2014. The reclassifications had no effect on previously reported net income or stockholders’ equity.

 

Note 2. Earnings Per Share. Basic and diluted earnings per share for the three and nine months ended September 30, 2014 and 2013 are based on weighted average shares of common stock outstanding. Diluted earnings per share include the potentially dilutive effects of the Company’s stock option plans. For the three and nine months ended September 30, 2014 and 2013, there were 17,997 and 18,488 stock options and 6,610 and 5,209 stock options, respectively, that were dilutive because their exercise prices were less than the average market price of the Company’s common stock.

 

Note 3. Comprehensive Income. Comprehensive income includes net income and changes in other comprehensive income. The components of other comprehensive income (loss) primarily include net changes in unrealized gains and losses on available for sale securities, and the reclassification of net gains and losses on available for sale securities recognized in income during the respective reporting periods.

 

Note 4. Investment Securities. The following is a summary of the securities portfolio by major category. The amortized cost and fair value of each category, with gross unrealized gains and losses at September 30, 2014 and December 31, 2013 are summarized as follows:

 

   September 30, 2014 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
Securities available for sale:  Cost   Gains   Losses   Value 
   (In thousands) 
Government agencies  $22,073   $186   $7   $22,252 
Mortgage-backed securities   98,580    3,756    72    102,264 
Municipal securities   48,702    1,518    61    50,159 
Corporate bonds   13,498    18    226    13,290 
Total  $182,853   $5,478   $366   $187,965 

 

   December 31, 2013 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
Securities available for sale:  Cost   Gains   Losses   Value 
   (In thousands) 
Government agencies  $4,174   $-   $73   $4,101 
Mortgage-backed securities   93,143    2,464    154    95,453 
Municipal securities   45,781    60    1,949    43,892 
Corporate bonds   7,000    -    146    6,854 
Total  $150,098   $2,524   $2,322   $150,300 

 

   September 30, 2014 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
Securities held to maturity:  Cost   Gains   Losses   Value 
   (In thousands) 
Government agencies  $507   $5   $-   $512 
Total  $507   $5   $-   $512 

 

6
 

 

   December 31, 2013 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
Securities held to maturity:  Cost   Gains   Losses   Value 
   (In thousands) 
Government agencies  $506   $5   $-   $511 
Total  $506   $5   $-   $511 

 

The following table summarizes investment securities gross unrealized losses, fair value and length of time the securities were in a continuous unrealized loss position at September 30, 2014 and December 31, 2013. The Company deems these unrealized losses to be temporary and recoverable prior to or at maturity. The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a market price recovery or until maturity.

 

   September 30, 2014 
   Less Than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (In thousands) 
Government agencies  $3,020   $7   $-   $-   $3,020   $7 
Mortgage-backed securities   2,944    37    4,312    35    7,256    72 
Municipal securities   2,309    35    4,649    26    6,958    61 
Corporate bonds   3,882    117    3,891    109    7,773    226 
Total  $12,155   $196   $12,852   $170   $25,007   $366 

 

   December 31, 2013 
   Less Than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (In thousands) 
Government agencies  $4,101   $73   $-   $-   $4,101   $73 
Mortgage-backed securities   20,387    148    1,136    6    21,523    154 
Municipal securities   34,687    1,949    -    -    34,687    1,949 
Corporate bonds   6,854    146    -    -    6,854    146 
Total  $66,029   $2,316   $1,136   $6   $67,165   $2,322 

 

The following table summarizes the amortized cost and fair values of the investment securities portfolio at September 30, 2014, by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   Less Than
One Year
   One to
Five Years
   Five to
Ten Years
   Over
Ten Years
 
   (In thousands) 
Securities available for sale:                    
Government agencies                    
Amortized cost  $-   $-   $22,073   $- 
Fair value   -    -    22,252    - 
Mortgage-backed securities                    
Amortized cost   715    39,146    33,375    25,344 
Fair value   771    40,315    34,383    26,795 
Municipal securities                    
Amortized cost   -    20,302    26,095    2,305 
Fair value   -    20,794    26,997    2,368 
Corporate bonds                    
Amortized cost   -    2,500    10,998    - 
Fair value   -    2,500    10,790    - 
Total Amortized cost  $715   $61,948   $92,541   $27,649 
Total Fair value  $771   $63,609   $94,422   $29,163 

 

7
 

 

   Less Than
One Year
   One to
Five Years
   Five to
Ten Years
   Over
Ten Years
 
  (In thousands) 
Securities held to maturity:    
Government agencies                    
Amortized cost  $-   $507   $-   $- 
Fair value   -    512    -    - 
Total Amortized cost  $-   $507   $-   $- 
Total Fair value  $-   $512   $-   $- 

 

FHLB Agency Bonds with an amortized cost of $9.5 million were pledged as collateral for public deposits at September 30, 2014. Mortgage-backed securities with an amortized cost of $4.7 million were pledged as collateral for public deposits at December 31, 2013. In addition, a government agency bond with an amortized cost of $507,000 and $506,000 was pledged as collateral on a forward starting interest rate swap transaction at September 30, 2014 and December 31, 2013, respectively.

 

At September 30, 2014, the investment securities portfolio included 51 taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. The following table is a summary, by U.S. state, of the Company’s investment in the obligations of state and political subdivisions:

 

   September 30, 2014 
   Amortized Cost   Fair Value 
  (dollars in thousands) 
Obligations of state and political subdivisions:    
General obligation bonds:          
Texas  $11,318   $11,885 
Pennsylvania   5,757    5,825 
New York   4,022    4,086 
South Carolina   2,317    2,371 
North Carolina   2,241    2,295 
Other (7 states)   9,021    9,250 
Total general obligation bonds   34,676    35,712 
Revenue bonds:          
North Carolina   5,004    5,165 
New York   2,820    2,856 
Texas   2,789    2,852 
Pennsylvania   1,739    1,847 
Florida   1,674    1,727 
Total revenue bonds   14,026    14,447 
Total obligations of state and political subdivisions  $48,702   $50,159 

 

The largest exposure in general obligation bonds was one bond issued by Ambridge Area School District, Pennsylvania, with a total amortized cost basis of $2.4 million and total fair value of $2.4 million at September 30, 2014. Of this total, $2.4 million in amortized cost and $2.4 million in fair value are guaranteed by an insurance policy issued by Assured Guaranty Municipal Corp.

 

8
 

 

The following table is a summary of the revenue sources related to the Company’s investment in revenue bonds:

 

   September 30, 2014 
   Amortized Cost   Fair Value 
  (dollars in thousands) 
Revenue bonds by revenue source:    
Refunding bonds  $4,507   $4,656 
University and college   2,789    2,852 
Public improvements   2,196    2,248 
Pension funding   1,739    1,847 
Other   2,795    2,844 
Total revenue bonds  $14,026   $14,447 

 

The largest single exposure in revenue bonds is an issue from the Philadelphia Authority for Industrial Development in Pennsylvania. The debt is to be repaid by the City of Philadelphia from revenues of pledged assets held and their taxes received. As of September 30, 2014, this issue had an amortized cost of $1.7 million and fair value of $1.8 million.

 

Prior to purchasing any security, the Bank ensures that the security is “investment grade”. For a security to be investment grade it must: (1) have a low risk of default by the obligor, and (2) expect the full and timely repayment of principal and interest over the expected life. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), certain investments are deemed investment grade. These include: U.S. Treasury securities, Federal Agency securities, Revenue Bonds, and Unlimited-Tax General Obligation Municipals. Other securities undergo a pre-purchase analysis to ensure they are investment grade. To determine if a security is investment grade, if available, management utilizes the ratings of the Nationally Recognized Statistical Rating Organizations (NRSRO). However, they are not the sole basis of determining if a security is investment grade. In addition, on a pre-purchase basis, at least one of the following items pertaining to the obligor is acquired and reviewed as part of the Bank’s internal credit analysis:

 

·Data from debt offerings Prospectus / Offering Circular

·Data from regulatory filings (i.e. 10-Q, 10-K, 8-K)

·Data available from the obligor’s website (i.e. Annual Reports, Press Releases)

·Data obtained from a third party (i.e. Bond Broker, Analyst)

·NRSRO report on the initial offering and/or subsequent reviews of the issuer

·Other pertinent available financial information

 

There have been no instances where the NRSRO’s credit rating has significantly differed from that of internal analysis performed.

 

Note 5. Loans Held for Sale. The Bank originates residential mortgage loans for sale in the secondary market. Pursuant to ASC 825, Financial Instruments, at September 30, 2014 and December 31, 2013, the Bank marked these mortgage loans to market. Mortgage loans held for sale at September 30, 2014 and December 31, 2013, had estimated fair market values of $5.5 million and $3.0 million, respectively.

 

The Bank originates certain mortgage loans for sale that are approved by secondary investors. Their terms are set by the secondary investor, and they are transferred within 120 days after the Bank initially funds the loans. The Bank issues rate lock commitments to borrowers, and depending on market conditions, may enter into forward contracts with its secondary market investors to minimize interest rate risk related to mortgage loan forward sales commitments. The Bank uses forward contracts to minimize interest rate risk related to mortgage loan forward sales commitments to economically hedge a percentage of the locked-in pipeline. The Bank receives origination fees from borrowers and servicing release premiums from investors that are recognized in income when the loan is sold. The following table summarizes forward contract positions of the Bank at September 30, 2014 and December 31, 2013:

 

Forward Contracts  September 30, 2014   December 31, 2013 
   Fair   Notional   Fair   Notional 
   Value   Value   Value   Value 
   (In thousands) 
Mortgage Loan Forward Sales Commitments  $130   $5,571   $6   $1,873 

 

9
 

 

Note 6. Loans Held for Investment. The following table summarizes loans held for investment at September 30, 2014 and December 31, 2013:

 

   September 30, 2014   December 31, 2013 
   Amount   Percent of
Total
   Amount   Percent of
Total
 
   (Dollars in thousands) 
Loans Held for Investment                    
Mortgage loans:                    
Residential real estate  $65,959    13.9%  $67,426    14.9%
Residential construction   1,416    0.3    1,201    0.3 
Residential lots and raw land   878    0.2    904    0.2 
Total mortgage loans   68,253    14.4    69,531    15.4 
                     
Commercial loans and leases:                    
Commercial real estate   249,930    52.8    227,280    50.3 
Commercial construction   29,922    6.3    24,597    5.4 
Commercial lots and raw land   27,027    5.7    27,681    6.1 
Commercial and Industrial   24,825    5.2    26,108    5.8 
Lease receivables   12,054    2.5    8,179    1.8 
Total commercial loans and leases   343,758    72.5    313,845    69.4 
                     
Consumer loans:                    
Consumer real estate   19,159    4.1    21,221    4.7 
Consumer construction   1,381    0.3    1,549    0.3 
Consumer lots and raw land   10,446    2.2    14,726    3.3 
Home equity lines of credit   27,435    5.8    27,546    6.1 
Consumer other   3,455    0.7    3,547    0.8 
Total consumer loans   61,876    13.1    68,589    15.2 
                     
Gross loans held for investment   473,887    100.0%   451,965    100.0%
                     
Less deferred loan origination fees, net   874         1,005      
Less allowance for loan and lease losses   7,504         7,609      
                     
Net loans held for investment  $465,509        $443,351      

 

The Bank has pledged certain loans secured by one-to-four family residential properties, multifamily residential properties, and commercial properties as collateral for outstanding advances and potential borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”) in the amount of $179.3 million and $98.3 million at September 30, 2014 and December 31, 2013, respectively.

 

The following tables detail non-accrual loans held for investment, including troubled debt restructured (“TDR”) loans accounted for on a non-accrual status, segregated by class of loans, at September 30, 2014 and December 31, 2013:

 

   September 30, 2014   December 31, 2013 
  (Dollars in thousands) 
Non-accrual loans held for investment:    
Non-TDR loans accounted for on a non-accrual status:          
Residential real estate  $462   $250 
Residential lots and raw land   12    - 
Commercial real estate   180    301 
Commercial lots and raw land   75    1,020 
Commercial and Industrial   -    76 
Lease receivables   75    - 
Consumer real estate   318    232 
Consumer lots and raw land   74    40 
Home equity lines of credit   55    93 
Consumer other   6    2 
Total Non-TDR loans accounted for on a non-accrual status  $1,257   $2,014 

 

10
 

 

TDR loans accounted for on a non-accrual status:  September 30, 2014   December 31, 2013 
Past Due TDRs:  (Dollars in thousands) 
Commercial real estate  $1,209   $1,649 
Commercial construction   -    - 
Commercial lots and raw land   -    121 
Commercial and Industrial   -    - 
Consumer real estate   51    51 
Consumer lots and raw land   -    - 
Total Past Due TDRs on a non-accrual status   1,260    1,821 
           
Performing TDRs:          
Residential real estate   840    859 
Commercial real estate   132    145 
Commercial construction   -    - 
Commercial lots and raw land   1,055    735 
Commercial and Industrial   -    - 
Consumer lots and raw land   -    - 
Total performing TDRs on non-accrual status   2,027    1,739 
Total TDR loans accounted for on a non-accrual status  $3,287   $3,560 
Total non-accrual loans  $4,544   $5,574 
Percentage of total loans held for investment, net   1.0%   1.3%
Loans over 90 days past due and still accruing   476    420 
Other real estate owned  $8,103   $9,354 
Total non-performing assets  $13,123   $15,348 

 

Cumulative interest income not recorded on loans accounted for on a non-accrual status was $103,139 and $149,104 at September 30, 2014 and December 31, 2013, respectively.

 

The following table presents an age analysis of past due loans held for investment, segregated by class of loans as of September 30, 2014 and December 31, 2013:

 

Past due loans held for investment:  30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
Than
90 Days
   Total
Past
Due
   Current   Total
Financing
Receivables
   Over 90
Days and
Accruing
 
September 30, 2014  (In thousands) 
Residential real estate  $-   $499   $864   $1,363   $64,596   $65,959   $475 
Residential construction   -    -    -    -    1,416    1,416    - 
Residential lots and raw land   -    3    9    12    866    878    - 
Commercial real estate   1,034    825    1,208    3,067    246,863    249,930    - 
Commercial construction   -    -    -    -    29,922    29,922    - 
Commercial lots and raw land   19    30    75    124    26,903    27,027    - 
Commercial and Industrial   -    -    -    -    24,825    24,825    - 
Lease receivables   -    -    75    75    11,979    12,054    - 
Consumer real estate   128    131    203    462    18,697    19,159    - 
Consumer construction   -    -    -    -    1,381    1,381    - 
Consumer lots and raw land   85    -    39    124    10,322    10,446    - 
Home equity lines of credit   23    32    39    94    27,341    27,435    - 
Consumer other   15    -    7    22    3,433    3,455    1 
Total  $1,304   $1,520   $2,519   $5,343   $468,544   $473,887   $476 

 

11
 

 

Past due loans held for investment:  30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
Than
90 Days
   Total
Past
Due
   Current   Total
Financing
Receivables
   Over 90
Days and
Accruing
 
December 31, 2013  (In thousands) 
Residential real estate  $1,751   $1,641   $404   $3,796   $63,630   $67,426   $404 
Residential construction   -    -    -    -    1,201    1,201    - 
Residential lots and raw land   -    -    16    16    888    904    16 
Commercial real estate   3,463    1,445    732    5,640    221,640    227,280    - 
Commercial construction   -    -    -    -    24,597    24,597    - 
Commercial lots and raw land   772    -    733    1,505    26,176    27,681    - 
Commercial and Industrial   108    -    76    184    25,924    26,108    - 
Lease receivables   5    -    -    5    8,174    8,179    - 
Consumer real estate   251    130    199    580    20,641    21,221    - 
Consumer construction   -    -    -    -    1,549    1,549    - 
Consumer lots and raw land   265    16    40    321    14,405    14,726    - 
Home equity lines of credit   116    -    65    181    27,365    27,546    - 
Consumer other   1    1    -    2    3,545    3,547    - 
Total  $6,732   $3,233   $2,265   $12,230   $439,735   $451,965   $420 

 

The following table presents information on loans that were considered impaired as of September 30, 2014 and December 31, 2013. Impaired loans include loans modified as a TDR, whether on accrual or non-accrual status. At September 30, 2014, impaired loans included $4.7 million of TDRs, compared to $8.7 million at December 31, 2013.

 

Impaired Loans-September 30, 2014  Recorded
Investment
   Contractual
Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Recorded
Investment
   Interest Income
Recognized on
Impaired Loans
 
With no related allowance recorded:  (In thousands) 
Residential real estate  $1,124   $1,421   $-   $1,209   $40 
Commercial real estate   16,009    16,017    -    14,231    686 
Commercial construction   169    169    -    2,216    4 
Commercial lots and raw land   3,293    3,302    -    3,791    147 
Commercial and Industrial   47    47    -    48    2 
Consumer real estate   367    397    -    275    10 
Consumer lots and raw land   135    135    -    582    6 
Home equity lines of credit   29    29    -    43    1 
Consumer other   47    47    -    83    2 
Subtotal:   21,220    21,564    -    22,478    898 
                          
With an allowance recorded:                         
Commercial real estate   1,422    1,442    168    2,915    42 
Commercial lots and raw land   344    344    224    86    21 
Consumer real estate   132    132    19    141    6 
Consumer lots and raw land   565    565    97    569    21 
Home equity lines of credit   25    25    5    12    - 
Subtotal:   2,488    2,508    513    3,723    90 
                          
Totals:                         
Mortgage   1,124    1,421    -    1,209    40 
Commercial   21,284    21,321    392    23,287    902 
Consumer   1,300    1,330    121    1,705    46 
Grand Total:  $23,708   $24,072   $513   $26,201   $988 

 

12
 

 

Impaired Loans-December 31, 2013  Recorded
Investment
   Contractual
Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Recorded
Investment
   Interest Income
Recognized on
Impaired Loans
 
With no related allowance recorded:  (In thousands) 
Residential real estate  $1,146   $1,444   $-   $1,105   $48 
Commercial real estate   14,039    14,039         18,560    791 
Commercial construction   2,973    2,973    -    1,272    48 
Commercial lots and raw land   4,805    4,812    -    5,388    249 
Commercial and Industrial   49    49    -    87    2 
Consumer real estate   300    300    -    403    17 
Consumer lots and raw land   108    108    -    277    6 
Home equity lines of credit   57    57    -    40    3 
Consumer other   95    95    -    101    4 
Subtotal:   23,572    23,877    -    27,233    1,168 
                          
With an allowance recorded:                         
Commercial real estate   3,150    3,150    510    2,954    153 
Commercial and Industrial   73    73    23    73    - 
Consumer real estate   167    167    25    139    2 
Consumer lots and raw land   573    573    105    676    29 
Subtotal:   3,963    3,963    663    3,842    184 
                          
Totals:                         
Mortgage   1,146    1,444    -    1,105    48 
Commercial   25,089    25,096    533    28,334    1,243 
Consumer   1,300    1,300    130    1,636    61 
Grand Total:  $27,535   $27,840   $663   $31,075   $1,352 

 

Credit Quality Indicators. The Bank assigns a risk grade to each loan in the portfolio as part of the on-going monitoring of the credit quality of the loan portfolio.

 

Commercial loans are graded on a scale of 1 to 9 as follows:

 

Risk Grade 1 (Excellent) - Loans in this category are considered to be of the highest quality. The borrower(s) has significant financial strength, stability, and liquidity. Proven cash flow is significantly more than required to service current and proposed debt with consistently strong earnings. Collateral position is very strong and a secondary source of repayment is self-evident. Guarantors may not be necessary to support the debt.

 

Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability. Cash flow is more than sufficient to meet current demands. Earnings are strong and reliable, but may differ from year to year. Collateral is highly liquid and sufficient to repay the debt in full. Guarantors may qualify for the loan on a direct basis.

 

Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability. Liquidity levels fluctuate and need for short-term credit is demonstrated. Cash flow is steady and adequate to meet demands but can fluctuate. Earnings should be consistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value, but the credit can support some level of unsecured exposure. Guarantors with demonstrable financial strength are typically required on loans to business entities, but may not be on loans to individual borrowers.

 

Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability. Liquidity levels fluctuate but are acceptable and need for short term credit is demonstrated. Cash flow is adequate to meet demands but can fluctuate. Earnings may be inconsistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value. Guarantors with demonstrable financial strength are required on loans to business entities, but may not be on loans to individual borrowers.

 

Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status. These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset. There may be unsecured loans that are included in this category. These are loans that management feels need to be watched more closely than those rated as acceptable and if left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets.

 

Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.

 

13
 

 

Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected.

 

Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable.

 

Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

Consumer loans are graded on a scale of 1 to 9 as follows:

 

 • Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss.  Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, adequate cash flow, collateral with acceptable loan to value, additional repayment sources, and reliable earnings.

 

 • Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s position at some future date.

 

 • Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected.

 

 • Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable.

 

•  Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

Mortgage loans are graded on a scale of 1 to 9 as follows:

 

Risk Grades 1 - 4 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss.  Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, acceptable credit history, adequate cash flow, collateral with acceptable loan to value, additional repayment sources, and reliable earnings.  
   
Risk Grade 5 (Pass -Watch) – Watch loans have shown credit quality changes from the original status.  These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset.  These are loans that management feels need to be watched more closely than those rated as Pass and if left uncorrected may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets.

 

Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.

 

Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s). Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable.

 

Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

14
 

 

The following table presents information on risk ratings of the commercial, consumer, mortgage and lease receivable

 

portfolios, segregated by loan class as of September 30, 2014 and December 31, 2013:

 

September 30, 2014
Commercial Credit Exposure by Assigned Risk Grade  Commercial
Real Estate
   Commercial
Construction
   Commercial Lots
and Raw Land
   Commercial
and Industrial
 
   (In thousands) 
1-Excellent  $-   $-   $-   $- 
2-Above Average   3,022    286    29    1,077 
3-Average   51,443    7,016    1,643    4,029 
4-Acceptable   151,438    18,144    15,110    15,890 
5-Watch   26,142    3,253    4,207    1,657 
6-Special Mention   7,598    1,054    3,582    2,075 
7-Substandard   10,287    169    2,456    97 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $249,930   $29,922   $27,027   $24,825 

 

September 30, 2014
Consumer Credit Exposure by Assigned Risk Grade  Consumer
Real Estate
   Consumer
Construction
   Consumer Lots
and Raw Land
   Home Equity
Lines of Credit
   Consumer 
Other
 
   (In thousands) 
Pass  $18,039   $1,381   $10,020   $27,190   $3,385 
6-Special Mention   581    -    291    107    5 
7-Substandard   539    -    135    138    65 
8-Doubtful   -    -    -    -    - 
9-Loss   -    -    -    -    - 
Total  $19,159   $1,381   $10,446   $27,435   $3,455 

 

September 30, 2014
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade  Residential
Real Estate
   Residential
Construction
   Residential
Lots and Raw Land
   Lease
Receivables
 
   (In thousands) 
Pass  $63,964   $1,416   $866   $11,979 
6-Special Mention   693    -    -    - 
7-Substandard   1,302    -    12    75 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $65,959   $1,416   $878   $12,054 

 

December 31, 2013
Commercial Credit Exposure by Assigned Risk Grade  Commercial
Real Estate
   Commercial
Construction
   Commercial Lots
and Raw Land
   Commercial and
Industrial
 
   (In thousands) 
1-Excellent  $-   $-   $-   $- 
2-Above Average   3,148    161    125    579 
3-Average   37,492    4,664    1,157    4,831 
4-Acceptable   141,942    12,147    12,969    13,011 
5-Watch   26,340    3,797    5,388    2,313 
6-Special Mention   10,101    3,725    5,019    5,181 
7-Substandard   8,257    103    3,023    193 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $227,280   $24,597   $27,681   $26,108 

 

15
 

 

December 31, 2013
Consumer Credit Exposure by Assigned Risk Grade  Consumer
Real Estate
   Consumer
Construction
   Consumer Lots
and Raw Land
   Home Equity
Lines of Credit
   Consumer
Other
 
   (In thousands) 
Pass  $20,058   $1,549   $12,380   $27,110   $3,414 
6-Special Mention   655    -    2,238    300    18 
7-Substandard   508    -    108    136    115 
8-Doubtful   -    -    -    -    - 
9-Loss   -    -    -    -    - 
Total  $21,221   $1,549   $14,726   $27,546   $3,547 

 

December 31, 2013
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade  Residential
Real Estate
   Residential
Construction
   Residential
Lots and Raw Land
   Lease
Receivables
 
   (In thousands) 
Pass  $64,972   $1,201   $899   $8,161 
6-Special Mention   1,345    -    5    18 
7-Substandard   1,109    -    -    - 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $67,426   $1,201   $904   $8,179 

 

Note 7. Allowance for Loan and Lease Losses. The following table presents a roll forward summary of activity in the allowance for loan and lease losses (“ALLL”), by loan category, for the nine months ended September 30, 2014 and 2013:

 

   September 30, 2014 
   Beginning   Charge-           Ending   Total 
   Balance   Offs   Recoveries   Provisions   Balance   Loans 
  (In thousands) 
Collectively evaluated:    
Residential real estate  $903   $(34)  $-   $67   $936   $64,835 
Residential construction   17    -    -    3    20    1,416 
Residential lots and raw land   13    -    -    (1)   12    878 
Commercial real estate   3,647    (174)   26    260    3,759    232,499 
Commercial construction   343    -    1    92    436    29,753 
Commercial lots and raw land   415    -    -    (20)   395    23,390 
Commercial and Industrial   430    (3)   9    (66)   370    24,778 
Lease receivables   113    (1)   -    49    161    12,054 
Consumer real estate   316    -    27    (83)   260    18,660 
Consumer construction   23    -    -    (3)   20    1,381 
Consumer lots and raw land   203    (232)   -    181    152    9,746 
Home equity lines of credit   463    (12)   7    (39)   419    27,381 
Consumer other   60    (11)   18    (16)   51    3,408 
  Total   6,946    (467)   88    424    6,991    450,179 
Individually evaluated:                              
Residential real estate   -    -    -    -    -    1,124 
Commercial real estate   510    (564)   5    217    168    17,431 
Commercial construction   -    -    1    (1)   -    169 
Commercial lots and raw land   -    (104)   -    328    224    3,637 
Commercial and Industrial   23    (49)   -    26    -    47 
Consumer real estate   25    (54)   -    48    19    499 
Consumer lots and raw land   105    (28)   -    20    97    700 
Home equity lines of credit   -    (1)   5    1    5    54 
Consumer other   -    (37)   -    37    -    47 
  Total   663    (837)   11    676    513    23,708 
  Grand Total  $7,609   $(1,304)  $99   $1,100   $7,504   $473,887 

 

16
 

 

   September 30, 2013 
   Beginning   Charge-           Ending   Total 
   Balance   Offs   Recoveries   Provisions   Balance   Loans 
   (In thousands) 
Collectively evaluated:                              
Residential real estate  $1,178   $-   $-   $(272)  $906   $64,283 
Residential construction   45    -    -    (27)   18    1,138 
Residential lots and raw land   14    -    -    (1)   13    912 
Commercial real estate   3,342    (104)   14    233    3,485    203,172 
Commercial construction   350    (12)   1    9    348    21,862 
Commercial lots and raw land   504    -    -    (4)   500    23,654 
Commercial and Industrial   353    (18)   5    31    371    21,992 
Lease receivables   136    -    -    (27)   109    7,467 
Consumer real estate   342    (28)   14    (9)   319    19,453 
Consumer construction   11    -    -    1    12    814 
Consumer lots and raw land   547    -    -    (234)   313    14,683 
Home equity lines of credit   490    (11)   -    33    512    26,612 
Consumer other   88    (197)   21    151    63    5,360 
  Total   7,400    (370)   55    (116)   6,969    411,402 
Individually evaluated:                              
Residential real estate   -    (424)   -    481    57    2,369 
Commercial real estate   35    (215)   500    186    506    19,257 
Commercial construction   -    -    -    -    -    715 
Commercial lots and raw land   303    (24)   12    (246)   45    6,062 
Commercial and Industrial   -    (1)   -    1    -    49 
Consumer real estate   12    (1)   2    3    16    582 
Consumer lots and raw land   110    (89)   -    84    105    903 
Home equity lines of credit   -    (1)   3    7    9    42 
Consumer other   -    -    -    -    -    95 
Total   460    (755)   517    516    738    30,074 
Grand Total  $7,860   $(1,125)  $572   $400   $7,707   $441,476 

 

Note 8. Troubled Debt Restructurings. The following table details performing TDR loans at September 30, 2014 and December 31, 2013, segregated by class of financing receivables:

 

   September 30, 2014   December 31, 2013 
  (Dollars in thousands) 
Performing TDR loans accounted for on an accrual basis:    
Residential real estate  $-   $287 
Commercial real estate   1,148    1,887 
Commercial construction   -    2,762 
Commercial lots and raw land   -    - 
Commercial and Industrial   10    13 
Consumer real estate   166    171 
Consumer lots and raw land   61    69 
Home equity lines of credit   -    - 
Consumer other   58    18 
Total performing TDR loans accounted for on an accrual basis  $1,443   $5,207 
Percentage of total loans, net   0.3%   1.1%

 

The following table presents a roll forward of performing and non-performing TDR loans for the nine months ended September 30, 2014:

 

Performing TDRs  Beginning
Balance
   Additions
(1)
   Charge-
Offs (2)
   Other (3)   Ending Balance 
September 30, 2014  (In thousands) 
Residential mortgage  $287   $-   $-   $(287)  $- 
Commercial   4,662    -    -    (3,504)   1,158 
Consumer   258    46    -    (19)   285 
Total  $5,207   $46   $-   $(3,810)  $1,443 

 

17
 

 

Non-Performing TDRs  Beginning
Balance
   Additions
(1)
   Charge-
Offs (2)
   Other (4)   Ending
Balance
 
September 30, 2014  (In thousands) 
Residential mortgage  $859   $-   $-   $(19)  $840 
Commercial   2,650    1,459    (554)   (1,159)   2,396 
Consumer   51    -    -    -    51 
Total  $3,560   $1,459   $(554)  $(1,178)  $3,287 

1.Includes new TDRs and increases to existing TDRs.
2.Post modification charge-offs.
3.Includes principal payments, paydowns and performing loans previously restructured at market rates that are no longer reported as TDRs.
4.Includes principal payments, paydowns and loans previously designated as non-performing that are currently performing in compliance with their modified terms.

 

In determining the allowance for loan and lease losses, the Bank considers TDRs and subsequent defaults in restructuring in its estimate. As a result, the allowance may be increased, adjustments may be made in the allocation of the allowance, or charge-offs may be taken to further write down the carrying value of the loan. The Bank’s primary objective in granting concessions to borrowers having financial difficulties is an attempt to protect as much of its investment as possible. The Bank faces significant challenges when working with borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged sales and rental absorption periods. While borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, the Bank finds it mutually beneficial to work constructively with its borrowers, and that prudent restructurings are often in the best interest of the Bank and the borrower. The Bank offers a variety of TDR programs on a loan-by-loan basis in which, for economic or legal reasons related to an individual borrower’s financial condition, it grants a concession to the borrower that would not otherwise be considered. The restructuring of a troubled loan may include, but is not limited to any one or combination of the following: a modification of the loan terms such as a reduction of the contractual interest rate, principal, payment amount or accrued interest; an extension of the maturity date at a stated interest rate lower than the current market rate for a new debt with similar risks; a change in payment type, e.g. from principal and interest, to interest only with all principal and interest due at maturity; a substitution or acceptance of additional collateral; and a substitution or addition of new debtors for the original borrower.

 

The Bank’s restructuring success includes but is not limited to any one or combination of the following: improves the prospects for repayment of principal and interest; reduces the prospects of further write downs and charge-offs; reduces the prospects of potential additional foreclosures; helps borrowers to maintain a creditworthy status; and ultimately will reduce the volume of classified, criticized and/or non-accrual loans. The Bank identifies loans for potential restructuring on a loan-by-loan basis using a variety of sources which may include, but is not limited to any one or combination of the following: being approached or contacted by the borrower to modify loan terms; review of borrower’s financial statements indicates borrower may be experiencing financial difficulties; past due payment reports; loans extending past their stated maturity date; and non-accrual loan reports.

 

On a loan-by-loan basis, the Bank restructures loans that were either on non-accrual basis or on accrual basis prior to restructuring. If a loan was on nonaccrual basis prior to restructuring, it remains on nonaccrual basis until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least nine months. The Bank has not immediately placed any restructured loan on accrual status that was on nonaccrual status prior to restructuring. If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis and placement on nonaccrual is not required.

 

The Bank performs restructurings on certain troubled loan workouts, whereby existing loans are restructured into a multiple note structure (i.e., Note A and Note B structure). The Bank separates a portion of the current outstanding debt into a new legally enforceable note (Note A) that is reasonably assured of repayment and performance according to prudently modified terms. The portion of the debt that is not reasonably assured of repayment (Note B) is adversely classified and charged-off as appropriate. The following table provides information on multiple note restructures for certain commercial real estate loan workouts as of September 30, 2014 and 2013, respectively:

 

   September 30, 2014   September 30, 2013 
  (In thousands) 
Note A Structure    
Commercial real estate (1)  $275   $- 
           
Note B Structure          
Commercial real estate (2)  $174   $- 
Reduction of interest income (3)  $2   $- 

 

18
 

 

(1)If Note A was on nonaccrual status, it may be placed back on accrual status based on sustained historical payment performance of generally nine months.
(2)Note B is immediately charged-off upon restructuring; however, payment in full is due at maturity of the note.
(3)Reflects amount of interest income reduction during the nine months ended September 30, 2014 and 2013, respectively, as a result of multiple note restructures.

 

The benefit of this workout strategy is for the A note to remain a performing asset for which the borrower has the willingness and ability to meet the restructured payment terms and conditions. In addition, this workout strategy reduces the prospects of further write downs and charge offs, and also reduces the prospects of a potential foreclosure. Following this restructuring, the Note A credit classification generally improves from “substandard” to an unclassified risk grade.

 

The general terms of the new loans restructured under the Note A and Note B structure differ as follows:

·Note A: First lien position; fixed or adjustable current market interest rate; fixed month term to maturity; payments – interest only to maturity, or full principal and interest to maturity. Note A is underwritten in accordance with the Bank’s customary underwriting standards and is on an accrual basis.
·Note B: Second lien position; fixed or adjustable below current market interest rate; fixed month term to maturity; payments – due in full at maturity. Note B is underwritten in accordance with the Bank’s customary underwriting standards, except for the below market interest rate and payment terms, and is on a nonaccrual basis.

 

Note 9. Other Real Estate Owned. The following table reflects the changes in other real estate owned (“OREO”) during the nine months ended September 30, 2014 and 2013:

 

   Beginning           Fair Value   End 
   of Period   Additions   Sales, net   Adjustments   of Period 
  (In thousands) 
September 30, 2014    
OREO  $9,354   $1,412   $(2,590)  $(73)  $8,103 
                          
September 30, 2013                         
OREO  $12,893   $2,305   $(5,718)  $(484)  $8,996 

 

Fair value adjustments made are recorded in order to adjust the carrying values of OREO properties to estimated fair market values. In most cases, estimated fair market values are derived from an initial appraisal, an updated appraisal or other forms of internal evaluations. In certain instances when a listing agreement is renewed for a lesser amount, carrying values will be adjusted to the lesser fair value amount. Additionally, in certain instances when an offer to purchase is received near the end of a quarterly accounting period for less than the carrying value, and the sale does not close until the next accounting period, the carrying value will be adjusted to the lesser fair value amount.

 

Note 10. Fair Value Measurement. Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. The Bank groups financial assets at fair value in the three levels listed below based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

 

Level 1: inputs to the valuation methodology are quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available. The types of assets carried at Level 1 fair value generally include investments such as U. S. Treasury and U. S. government agency securities.

 

Level 2: inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets and price quotations can vary substantially either over time or among market makers. The types of assets carried at Level 2 fair value generally include mortgage-backed securities issued by Government Sponsored Enterprises (“GSEs”), municipal bonds, corporate debt securities, mortgage loans held for sale and bank-owned life insurance.

 

Level 3: inputs to the valuation methodology are unobservable to the extent that observable inputs are not available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. The types of assets carried at Level 3 fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations, of which the Bank has no such assets or liabilities. Level 3 also includes impaired loans and other real estate owned.

 

19
 

 

The following table presents assets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013:

   Fair Value   Quoted Prices In
Active Markets for
Identical Assets
   Significant
Observable
Inputs-Other
   Significant
Unobservable
Inputs
 
   (In thousands) 
Description  9/30/14   Level 1   Level 2   Level 3 
Securities available for sale:                    
Government securities  $22,252   $22,252   $-   $- 
Mortgage-backed securities   102,264    -    102,264    - 
Municipal securities   50,159    -    50,159    - 
Corporate bonds   13,290    -    13,290    - 
Mortgage loans held for sale   5,540    -    5,540    - 
Bank-owned life insurance   14,992    -    14,992    - 
Forward starting interest rate swap   (254)   -    (254)   - 
Total September 30, 2014  $208,243   $22,252   $185,991   $- 
                     

Description  12/31/13   Level 1   Level 2   Level 3 
Securities available for sale:                    
Government securities  $4,101   $4,101   $-   $- 
Mortgage-backed securities   95,453    -    95,453    - 
Municipal securities   43,892    -    43,892    - 
Corporate bonds   6,854    -    6,854    - 
Mortgage loans held for sale   2,992    -    2,992    - 
Bank-owned life insurance   11,094    -    11,094    - 
Forward starting interest rate swap   (36)   -    (36)   - 
Total December 31, 2013  $164,350   $4,101   $160,249   $- 

 

The following table presents assets measured at fair value on a non-recurring basis as of September 30, 2014 and December 31, 2013:

 

   Fair Value   Quoted Prices In
Active Markets for
Identical Assets
   Significant
Observable
Inputs-Other
   Significant
Unobservable
Inputs
 
   (In thousands) 
Description  9/30/14   Level 1   Level 2   Level 3 
Impaired loans, net  $23,195   $-   $-   $23,195 
Other real estate owned   8,103    -    -    8,103 
Total September 30, 2014  $31,298   $-   $-   $31,298 
                     
Description   12/31/13   Level 1    Level 2    Level 3 
Impaired loans, net  $26,872   $-   $-   $26,872 
Other real estate owned   9,354    -    -    9,354 
Total December 31, 2013  $36,226   $-   $-   $36,226 

 

Impaired loans at September 30, 2014 and December 31, 2013 includes $21.2 million and $23.6 million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC 310-10-35 resulted in no allowance.

 

Quoted market price for similar assets in active markets is the valuation technique for determining fair value of securities available for sale and held to maturity. Unrealized gains on available for sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics.

 

The Company does not record loans held for investment at fair value on a recurring basis. However, when a loan is considered impaired an impairment write down is taken based on the loan’s estimated fair value. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans not requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are not included above.

 

20
 

 

Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as non-recurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the impaired loan as non-recurring Level 3.

 

OREO is recorded at fair value upon transfer of the loans to foreclosed assets, based on the appraised market value of the property. OREO is reviewed quarterly and values are adjusted as determined appropriate. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is impaired below the appraised value and there is no observable market price, the Company classifies the foreclosed asset as non-recurring Level 3. Fair value adjustments of $62,100 and $73,300, respectively, were made to OREO during the three and nine months ended September 30, 2014, compared to $108,615 and $484,316, respectively, made during the three and nine months ended September 30, 2013.

 

Net gains realized on sales of OREO and included in earnings for the three and nine months ended September 30, 2014 and 2013, respectively, are reported in other revenues as follows:

 

   Three Months
Ended
9/30/14
   Three Months
Ended
9/30/13
   Nine months
Ended
9/30/14
   Nine months
Ended
9/30/13
 
Net gains on sales of OREO  $8,949   $68,233   $82,369   $403,067 

 

No liabilities were measured at fair value on a recurring or non-recurring basis at September 30, 2014 or December 31, 2013.

 

Note 11. Fair Value of Financial Instruments. The following table represents the recorded carrying values, estimated fair values and the fair value hierarchy within which the fair value measurements of the Company’s financial instruments are categorized at September 30, 2014 and December 31, 2013:

 

   Level in  September 30, 2014   December 31, 2013 
   Fair Value  Estimated   Carrying   Estimated   Carrying 
   Hierarchy  Fair Value   Amount   Fair Value   Amount 
     (In thousands) 
Financial assets:       
Cash and due from banks  Level 1  $10,550   $10,550   $11,816   $11,816 
Interest-bearing deposits in other banks  Level 1   9,556    9,556    12,419    12,419 
Securities available for sale  Level 1   22,252    22,252    4,101    4,101 
Securities available for sale  Level 2   165,713    165,713    146,199    146,199 
Securities held to maturity  Level 2   512    507    511    506 
Loans held for sale  Level 2   5,540    5,540    2,992    2,992 
Loans and leases HFI, net, less impaired loans  Level 2   446,601    442,314    419,472    416,479 
Impaired loans HFI, net  Level 3   23,195    23,195    26,872    26,872 
Stock in FHLB of Atlanta  Level 2   2,294    2,294    849    849 
Accrued interest receivable  Level 2   2,323    2,323    2,335    2,335 
Mortgage servicing rights  Level 3   2,446    1,171    3,409    1,220 
Bank-owned life insurance  Level 2   14,992    14,992    11,094    11,094 
Forward starting interest rate swap  Level 2   (254)   (254)   (36)   (36)
                        
Financial liabilities:                       
Deposits  Level 2  $602,179   $602,048   $587,158    585,704 
Borrowed money:                       
Advances from FHLB  Level 2   37,500    37,500    -    - 
Junior subordinated debentures  Level 2   10,310    10,310    10,310    10,310 

 

Fair values have been estimated using data which management considers as the best available, and estimation methodologies deemed suitable for the pertinent category of financial instrument. The estimation methodologies used by the Bank were as follows:

 

Cash and Due from Banks and Interest –Bearing Deposits in Other Banks: The carrying amounts for cash and due from banks and interest bearing deposits in other banks are equal to their fair value. Fair value hierarchy Input level 1.

 

Investment Securities Available for Sale and Held to Maturity: The estimated fair value of investment securities is provided in Note 4 of the Notes to Consolidated Financial Statements. These are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Fair value hierarchy Input levels 1 and 2.

 

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Loans Held for Sale. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. Fair value hierarchy Input level 2.

 

Loans and Leases Held for Investment, Net, less Impaired Loans: Fair values are estimated for portfolios of loans and leases held for investment with similar financial characteristics. Loans and leases are segregated by collateral type and by fixed and variable interest rate terms. The fair value of each category is determined by discounting scheduled future cash flows using current interest rates offered on loans or leases with similar characteristics. Fair value hierarchy Input level 2.

 

Impaired Loans Held for Investment, Net: Fair values for impaired loans and leases are estimated based on discounted cash flows or underlying collateral values, where applicable. Fair value hierarchy Input Level 3.

 

Stock in Federal Home Loan Bank of Atlanta: The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank. Fair value hierarchy Input level 2.

 

Deposits and Advances from FHLB: The fair value of demand deposits is the amount payable on demand at the reporting date. The fair values of certificates of deposits and FHLB advances are estimated using the rates currently offered for similar instruments with similar remaining maturities. Fair value hierarchy Input level 2.

 

Accrued Interest Receivable and Junior Subordinated Debentures: The carrying amount of accrued interest receivable and junior subordinated debentures approximates fair value because of the short maturities of these instruments. Fair value hierarchy Input level 2.

 

Mortgage Servicing Rights (“MSRs”): The fair value of MSRs is estimated for those loans sold with servicing retained. The loans are stratified into pools by product type and within product type by interest rate and maturity. The fair value of the MSR is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing costs and other factors. Fair value hierarchy Input level 3.

 

Bank-Owned Life Insurance: The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the issuer. Fair value hierarchy Input level 2.

 

Forward Starting Interest Rate Swap: The Company has entered into a forward starting pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap is December 30, 2014. Fair value hierarchy Input level 2.

 

Financial Instruments with Off-Balance Sheet Risk: With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments.

 

Note 12. Deposits. The following table presents the distribution of the Bank’s deposit accounts as of September 30, 2014 and December 31, 2013:

 

   9/30/14   12/31/13 
  (In thousands) 
Demand accounts:    
Non-interest bearing checking  $99,219   $96,445 
Interest bearing checking   130,421    128,161 
Money market   52,052    43,388 
Savings accounts   90,190    69,543 
Certificate accounts   230,166    248,167 
Total deposits  $602,048   $585,704 

 

At September 30, 2014, the scheduled maturities of certificate accounts were as follows:

 

   Less than
$100,000
   $100,000
or more
   Total 
   (In thousands) 
Three months or less  $17,287   $12,071   $29,358 
Over three months through one year   40,889    31,662    72,551 
Over one year through three years   45,558    42,642    88,200 
Over three years to five years   18,636    21,421    40,057 
Total time deposits  $122,370   $107,796   $230,166 

 

The aggregate amount of time deposits with balances of $100,000 or more was $107,796,042 and $123,492,907 at September 30, 2014 and December 31, 2013, respectively.

 

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Note 13. Stock-Based Compensation. The Company had two stock-based compensation plans at September 30, 2014. The shares outstanding are for grants under the Company’s 1997 Stock Option Plan (the “1997 Plan”) and the 2008 Equity Incentive Plan (the “2008 Plan”). The 1997 Plan matured on April 8, 2008 and no additional options may be granted under the 1997 Plan. At September 30, 2014, the 1997 Plan had 38,250 granted unexercised stock option shares. At September 30, 2014, the 2008 Plan includes 132,500 granted unexercised stock option shares, 13,900 granted nonvested restricted stock award shares and 809,850 shares available to be granted.

 

Stock Option Grants. Options granted under the 2008 Plan are granted at the closing price of the Company’s common stock on the NASDAQ Stock Market on the date of grant. Stock options expire ten years from the date of grant and vest over service periods ranging from one year to five years. The Company settles stock option exercises with authorized unissued shares. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant.

 

No options were granted during either of the quarters ended September 30, 2014 or 2013, respectively.

 

A summary of option activity under the Plans as of September 30, 2014 and 2013, and changes during the three and nine month periods ended September 30, 2014 and 2013, respectively, is presented below:

 

  Options
Outstanding
   Price   Aggregate
Intrinsic Value
 
Quarter Ended September 30, 2014:            
Outstanding at December 31, 2013   160,375   $11.84      
Granted   18,000    8.36      
Forfeited   (2,250)   6.52      
Expired   (1,875)   19.88      
Exercised   -    -      
Outstanding at March 31, 2014   174,250    11.46   $257,090 
Granted   1,000    8.06      
Forfeited   -    -      
Expired   -    -      
Exercised   -    -      
Outstanding at June 30, 2014   175,250    11.44   $197,365 
Granted   -    -      
Forfeited   -    -      
Expired   (4,500)   14.97      
Exercised   -    -      
Outstanding at September 30, 2014   170,750    11.35   $205,710 
Vested and Exercisable at September 30, 2014   106,950   $14.45   $77,486 
                
Quarter Ended September 30, 2013:               
Outstanding at December 31, 2012   154,004   $12.86      
Granted   -    -      
Forfeited   -    -      
Expired   -    -      
Exercised   -    -      
Outstanding at March 31, 2013   154,004    12.86   $87,520 
Granted   22,500    6.52      
Forfeited   (8,000)   12.77      
Expired   -    -      
Exercised   -    -      
Outstanding at June 30, 2013   168,504    12.02   $84,100 
Granted   -    -      
Forfeited   (750)   29.85      
Expired   -    -      
Exercised   -    -      
Outstanding at September 30, 2013   167,754    11.94   $72,700 
Vested and Exercisable at September 30, 2013   107,254   $15.62   $15,110 

 

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The following weighted-average assumptions were used for grants awarded in the three and nine months ended September 30, 2014 and 2013:

 

   Three Months
Ended
9/30/14
   Three Months
Ended 
9/30/13
   Nine Months
Ended 
9/30/14
   Nine Months
Ended 
9/30/13
 
Dividend growth rate   0.0%   0.0%   1.0%   0.0%
Expected volatility   0.0%   0.0%   53.0%   37.1%
Average risk-free interest rate   0.0%   0.0%   1.85%   1.4%
Expected lives - years   -    -    6    6 

 

The following table summarizes additional information about the Company’s outstanding options and exercisable options as of September 30, 2014, including weighted-average remaining contractual term expressed in years ("Life") and weighted average exercise price (“Price”):

 

   Outstanding   Exercisable 
Range of Exercise Price  Shares   Life   Price   Shares   Price 
$4.00 – 10.00   94,500    7.79   $5.97    30,700   $5.58 
$10.01 – 17.00   27,000    4.95    11.01    27,000    11.01 
$17.01 – 26.00   39,750    2.77    20.36    39,750    20.36 
$26.01 – 34.00   9,500    1.94    28.14    9,500    28.14 
    170,750    5.85   $11.35    106,950   $14.45 

 

A summary of nonvested option shares as of September 30, 2014 and 2013, and vesting changes during the three and nine months ended September 30, 2014 and 2013, is presented below:

 

  Shares   Price 
Period Ended September 30, 2014:        
Nonvested at December 31, 2013   58,750   $5.38 
Granted   18,000    8.36 
Forfeited   (2,250)   6.52 
Vested   (7,000)   5.40 
Nonvested at March 31, 2014   67,500    6.14 
Granted   1,000    8.06 
Forfeited   -    0.00 
Vested   (4,700)   6.21 
Nonvested at June 30, 2014   63,800    6.16 
Granted   -    0.00 
Forfeited   -    0.00 
Vested   -    0.00 
Nonvested at September 30, 2014   63,800   $6.16 
           
Period Ended September 30, 2013:          
Nonvested at December 31, 2012   50,166   $5.68 
Granted   -    0.00 
Forfeited   -    0.00 
Vested   (11,166)   8.87 
Nonvested at March 31, 2013   39,000    4.77 
Granted   22,500    6.52 
Forfeited   -    0.00 
Vested   (1,000)   5.05 
Nonvested at June 30, 2013   60,500    5.42 
Granted   -    0.00 
Forfeited   -    0.00 
Vested   -    0.00 
Nonvested at September 30, 2013   60,500   $5.42 

 

There were no income tax benefits realized from the exercise of stock options for the three and nine months ended September 30, 2014 or 2013, and there was no intrinsic value for options exercised during the three and nine months ended September 30, 2014 or 2013, as no options were exercised during the respective periods.

 

Total compensation expense charged to income for stock options was $8,784 and $25,397, respectively, for the three and nine months ended September 30, 2014, compared to net compensation expense charged to income and net compensation benefit credited to income of $5,549 and $11,546, respectively, for the three and nine months ended September 30, 2013. As of September 30, 2014, total unrecognized compensation cost on granted unexercised shares was $123,926, and is expected to be recognized during the next five years.

 

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Restricted Stock Awards. The Company measures the fair value of restricted shares based on the price of its common stock on the grant date and compensation expense is recorded over the vesting period. During the three and nine months ended September 30, 2014, none and 13,900 restricted stock awards, respectively, were granted with a four year vesting period. Total compensation expense recognized for restricted stock awards for the three and nine months ended September 30, 2014 was $7,263 and $19,368, respectively. As of September 30, 2014, there was $96,836 of total unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan, which will be recognized over a remaining period of 3.5 years. A summary of nonvested restricted stock awards as of September 30, 2014 and vesting changes during the three and nine months ended September 30, 2014 is presented below:

 

   Shares   Price 
Nonvested at December 31, 2013   -   $- 
Granted   13,900    8.36 
Vested   -    - 
Forfeited   -    - 
Nonvested at March 31, 2014   13,900   $8.36 
Granted   -    - 
Vested   -    - 
Forfeited   -    - 
Nonvested at June 30, 2014   13,900   $8.36 
Granted   -    - 
Vested   -    - 
Forfeited   -    - 
Nonvested at September 30, 2014   13,900   $8.36 

 

The following table reflects the combined impact of fair value compensation cost recognition for stock options and restricted stock awards on income before income taxes, net income, basic earnings per share and diluted earnings per share for the three and nine month periods ended September 30, 2014 and 2013, respectively:

 

   Three Months
Ended
 9/30/14
   Three Months
Ended
 9/30/13
   Nine Months
Ended
9/30/14
   Nine Months
Ended
 9/30/13
 
Increase (decrease) net income before income taxes  $(16,047)  $(5,549)  $(44,765)  $11,546 
Increase (decrease) net income  $(14,013)  $(5,549)  $(39,342)  $11,546 
Increase (decrease) basic earnings per share  $0.00   $0.00   $0.00   $0.00 
Increase (decrease) diluted earnings per share  $0.00   $0.00   $0.00   $0.00 

 

Note 14. Regulatory Capital. The Bank is subject to various regulatory capital requirements administered by federal and state 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 financial statements. Management believes, as of September 30, 2014, that the Bank meets all capital adequacy requirements to which it is subject. The Company’s most significant asset is its investment in the Bank. Consequently, the information concerning capital ratios is essentially the same for the Company and the Bank.

 

The Bank's actual regulatory capital amounts and ratios as of September 30, 2014, and December 31, 2013, are listed below:

 

   September 30, 2014   December 31, 2013 
   Amount   Ratio   Amount   Ratio 
   (Dollars in thousands) 
Total Risk Based Capital (to Risk Weighted Assets)  $84,493    16.2%  $81,213    16.8%
Tier 1 Capital (to Risk Weighted Assets)   77,948    14.9%   75,150    15.6%
Tier 1 Leverage Capital (to Average Assets)   77,948    11.0%   75,150    11.2%

 

Note 15. Recent Accounting Pronouncements. The following are Accounting Standards Updates (“ASU”) recently issued by the Financial Accounting Standards Board (“the FASB”) and their expected impact on the Company. Other accounting standards issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s consolidated financial statements.

 

In January 2014, the FASB issued ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. This ASU provides accounting guidance for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects qualifying for low-income housing tax credit. The guidance permits reporting entities to make an accounting policy election to account for investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. This ASU is effective for annual and interim periods beginning after December 15, 2014. The Company will evaluate the impact it may have on its consolidated financial statements.

 

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In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU clarifies when an in substance foreclosure occurs and creditors are considered to have received physical possession of real estate property collateralizing a consumer mortgage loan such that the loan receivable is derecognized and the real estate property recognized. This ASU is effective for annual and interim periods beginning after December 15, 2014. The Company will evaluate the impact it may have on its consolidated financial statements.

 

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this ASU change the criteria for reporting discontinued operations of all public and nonpublic entities. The amendments also require new disclosures about discontinued operations and disposals of components of an entity that do not qualify for discontinued operations reporting. This ASU is effective prospectively for annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015. The Company will evaluate the impact it may have on its consolidated financial statements.

 

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The amendments in this ASU require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements; require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty; require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction; and require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the tenor of those transactions. This ASU is effective for first interim or annual period beginning after December 15, 2014. The Company will evaluate the impact it may have on its consolidated financial statements.

 

In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The amendments in this ASU apply to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target can be achieved after the requisite service period. This ASU is effective for annual and interim periods beginning after December 15, 2015. The Company will evaluate the impact it may have on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-13, Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity. This ASU addresses the measurement difference between the fair value of a collateralized financing entity’s financial assets from the fair value of its financial liabilities, even though the financial liabilities have recourse only to the financial assets. The amendments in this ASU are effective for public business entities for annual and interim periods beginning after December 15, 2015. The Company will evaluate the impact it may have on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. Under certain government-sponsored loan guarantee programs, such as those offered by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA), qualifying creditors can extend mortgage loans to borrowers with a guarantee that entitles the creditor to recover all or a portion of the unpaid principal balance from the government if the borrower defaults. The objective of this ASU is to reduce diversity in practice by addressing the classification of foreclosed mortgage loans that are fully or partially guaranteed under government programs. The amendments affect creditors that hold government-guaranteed mortgage loans, including those guaranteed by the FHA and the VA. The amendments in this ASU are effective for public business entities for annual and interim periods beginning after December 15, 2014. The Company will evaluate the impact it may have on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in this ASU are effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. The Company will evaluate the impact it may have on its consolidated financial statements.

 

Note 16. Interest Rate Hedging. The Company has executed certain strategies targeted at hedging the impact of rising interest rates on its future earnings. The Company has entered into a forward starting pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap is December 30, 2014, and it has a five year term.

 

26
 

 

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

First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. The discussion below focuses primarily on the Bank's results of operations. The Bank has one significant operating segment, providing commercial and retail banking services to its markets located in the state of North Carolina. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol "FSBK".

 

Entry Into a Material Definitive Agreement. On September 2, 2014, the Bank entered into a Purchase and Assumption Agreement with Bank of America, N.A. (BOA) to acquire nine branches located in North Carolina. On that date, the nine branches had deposits totaling approximately $261.4 million. Subject to regulatory approval and the satisfaction of customary closing conditions, the transaction is expected to close in the fourth quarter of 2014. Looking forward to the fourth quarter, our financial results will be impacted by numerous non-recurring transaction expenses related to the branch acquisition and the addition of both bankers and internal support personnel to leverage the acquired deposit base and to service these new customers. An immaterial amount of loans are being transferred through the transaction and we will invest the deposits using a mix of cash, short-term and intermediate term investment securities until the funds can be converted to higher yielding assets.

 

Comparison of Financial Condition at September 30, 2014, and December 31, 2013. Total assets increased to $734.7 million at September 30, 2014, from $674.7 million at December 31, 2013. Earning assets increased to $676.6 million at September 30, 2014 from $617.2 million at December 31, 2013. The ratio of earning assets to total assets was 92.1% at September 30, 2014, compared to 91.5% at December 31, 2013. The increase in total assets and earning assets was primarily the result of growth in investment securities available for sale and in loans and leases held for investment.

 

Interest-bearing deposits with banks declined to $9.6 million at September 30, 2014, from $12.4 million at December 31, 2013. Overnight deposits are available to fund securities purchases, loan originations, deposit withdrawals, liquidity management activities and daily operations of the Bank.

 

Investment securities available for sale increased to $188.0 million at September 30, 2014, from $150.3 million at December 31, 2013. During the nine months ended September 30, 2014, there were $45.2 million of purchases, $788,000 of sales, $10.9 million of principal repayments, a $4.9 million increase in unrealized holding gains, and $743,000 of net accretion of premiums and discounts. The increased securities purchase activity is primarily attributable to pre-investing a portion of the BOA branch purchase transaction proceeds, which are currently being funded with short-term FHLB advances. The Bank may sell investment securities and securitize mortgage loans held for sale into mortgage-backed securities in order to support a more balanced sensitivity to future interest rate changes and to support adequate liquidity levels.

 

Investment securities held to maturity were $507,000 and $506,000 at September 30, 2014 and December 31, 2013, respectively. During the nine months ended September 30, 2014, the Bank implemented a leverage strategy to add bonds to the investment portfolio of similar quality, structure and duration that is intended to enhance income generation capabilities. See “Note 4. Investment Securities” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Total loans held for sale increased to $5.5 million at September 30, 2014, from $3.0 million at December 31, 2013, reflecting the net effect of current mortgage lending activity. During the nine months ended September 30, 2014, there were $14.7 million of loan sales, $16.8 million of loan originations net of principal payments and $448,000 of net realized gains. Proceeds from mortgage loan sales are primarily used to fund the Bank’s liquidity needs, including loan originations, deposit withdrawals, repayment of borrowings, investment purchases and general bank operations. Loans serviced for others declined to $310.3 million at September 30, 2014, from $325.4 million at December 31, 2013, as principal repayments exceeded the volume of new loan sales. See “Note 5. Loans Held for Sale” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Total loans and leases held for investment increased by $22.0 million during the current nine month period, to $473.0 million at September 30, 2014, from $451.0 million at December 31, 2013. This increase reflects our fifth consecutive quarterly increase of growth in loans and leases held for investment. During the nine months ended September 30, 2014, there were $23.4 million of originations net of principal payments and $1.4 million of transfers to other real estate owned (“OREO”).

 

27
 

 

Improving asset quality metrics continues as a key component of the Bank’s short-term and long-term performance objectives. Loans held for investment on nonaccrual status, including restructured loans (“TDRs”) on nonaccrual status declined to $4.5 million at September 30, 2014, from $5.6 million at December 31, 2013. The decline in non-accrual loans results primarily from the resolution of a previously reported $1.7 million relationship during the third quarter of 2014. The ratio of loans held for investment on nonaccrual status to total loans held for investment was 1.0% at September 30, 2014, compared to 1.3% at December 31, 2013.

 

Loans are generally placed on nonaccrual status, and accrued unpaid interest is reversed, when management determines that collectability of interest, but not necessarily principal, is doubtful. This generally occurs when payments are delinquent in excess of 90 days. Consumer loans more than 180 days past due are generally charged off or a specific allowance is provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible. Management has thoroughly evaluated all nonperforming loans and believes they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased risks in the loan portfolio, adverse changes in economic conditions or other factors will not require additional adjustments to the allowance for loan and lease losses. Aside from the loans identified on nonaccrual status, there were no loans at September 30, 2014 where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms.

 

Allowance for Loan and Lease Losses. The Bank maintains the allowance for loan and lease losses (“ALLL”) at levels management believes is adequate to absorb probable losses inherent in the loan and lease portfolio. The Bank has developed policies and procedures for assessing the adequacy of the ALLL that reflect the assessment of credit risk and impairment analysis. This assessment includes an analysis of qualitative and quantitative trends in the levels of classified loans. In developing this analysis, the Bank relies on historical loss experience, estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require adjustments in the ALLL.

 

The Bank uses various modeling, calculation methods and estimation tools for measuring credit risk and performing impairment analysis, which is the basis used in developing the ALLL. The factors supporting the ALLL do not diminish the fact that the entire ALLL is available to absorb probable losses in the loan and leases portfolio. The Bank’s principal focus is on the adequacy of the ALLL. Based on the overall credit quality of the loan and lease portfolio, management believes the ALLL is adequate and has been established pursuant to generally accepted accounting principles, and has taken into account the views of its regulators and the current economic environment.

 

The assessment of ALLL adequacy includes an analysis of actual historical loss percentages of both classified and pass loans, as well as qualitative risk factors allocated among specific categories of loans. In developing this analysis, the Bank relies on actual loss history for the most recent eight quarters and uses management’s best judgment in assessing credit risk. The assessment of qualitative factors includes various subjective components assessed in terms of basis points used in determining the ALLL adequacy. The evaluation of qualitative risk factors will result in a positive or negative adjustment to the ALLL methodology. Adjustments for each qualitative risk component may range from +25 basis points to -10 basis points. A component score of 0 basis points indicates no effect on the ALLL. A component rating of +25 basis points indicates the assessed maximum potential of increased risk to the ALLL adequacy. A -10 basis point component rating indicates the most positive effect on the ALLL.

 

Management reassesses the ALLL methodology quarterly, and believes their accounting decisions remain accurate. However, there can be no assurance in the future that regulators, increased risks in the loan and lease portfolio, changes in economic conditions and other factors will not require additional adjustments to the ALLL. There were no changes in accounting policy and methodology used to estimate the ALLL during the nine months ended September 30, 2014.

 

The ALLL was $7.5 million at September 30, 2014, compared to $7.6 million at December 31, 2013, reflecting provisions for credit losses and net charge-offs. During the nine months ended September 30, 2014, there were $1.1 million of provisions for credit losses and $1.2 million of net charge-offs. The ratio of the ALLL to loans and leases held for investment was 1.59% at September 30, 2014, compared to 1.69% and December 31, 2013. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)”and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.

 

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Based on an impairment analysis of loans held for investment, there were $23.7 million of loans classified as impaired, net of $364,000 in write-downs at September 30, 2014, compared to $27.5 million classified as impaired, net of $305,000 in write-downs at December 31, 2013. At September 30, 2014 and December 31, 2013, the ALLL included $513,000 and $663,000 specifically provided for impaired loans, respectively.

 

A loan is considered impaired, based on current information and events, if it is probable that the Bank is unable to collect scheduled payments of principal and interest when due according to the contractual terms of the loan arrangement. All collateral-dependent loans are measured for impairment based on the fair value of the collateral, while uncollateralized loans and other loans determined not to be collateral dependent are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate.

 

The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payments status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, and various other matters. See “Note 6. Loans Held for Investment”, “Note 7. Allowance for Loan and Lease Losses” and “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

OREO acquired from foreclosures declined to $8.1 million at September 30, 2014, from $9.4 million at December 31, 2013. During the nine months ended September 30, 2014, there were $2.6 million of disposals, $73,000 of valuation adjustments and $1.4 million of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that ultimate sales will be equal to or greater than the carrying values. See “Note 9. Other Real Estate Owned” and “Note 10. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

The Bank’s investment in bank-owned life insurance (“BOLI”) increased to $15.0 million at September 30, 2014, from $11.1 million at December 31, 2013. The Bank intends to utilize the investment returns from the BOLI to recover a portion of the cost of providing benefit plans to our employees.

 

Prepaid expenses and other assets declined to $6.8 million at September 30, 2014, from $9.6 million at December 31, 2013, primarily reflecting a $3.1 million reduction in net deferred tax assets associated with the unrealized holding gains on investment securities available for sale. See “Consolidated Statements of Comprehensive Income” for additional information.

 

Total deposits increased to $602.0 million at September 30, 2014, from $585.7 million at December 31, 2013. For the current nine month period, non-maturity deposits (personal and business checking accounts and money market accounts) and savings accounts increased by $34.3 million to $371.8 million at September 30, 2014, from $337.5 million at December 31, 2013, and were partially offset by an $18.0 million decline in certificates of deposit (“CDs”). CDs declined to $230.2 million, or 38.2% of total deposits at September 30, 2014, from $248.2 million, or 42.4% of total deposits at December 31, 2013.

 

The Bank attempts to manage its cost of deposits by monitoring the volume and rates paid on maturing CDs in relationship to current funding needs and market interest rates. The Bank did not renew all maturing CDs during the nine months ended September 30, 2014, but was able to reprice some of the maturing CDs at lower rates, and a portion migrated to non-maturity deposits within the Bank. See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” and “Interest Expense” below for additional information regarding deposits and the cost of funds.

 

There were $37.5 million of FHLB advances outstanding at September 30, 2014, compared to none at December 31, 2013, reflecting $17.5 million of short-term advances, and $20.0 million of fixed rate long-term funding acquired in connection with a strategy targeted at hedging the potential impact of rising interest rates on future earnings. At September 30, 2014, the weighted average cost of short-term and long-term FHLB advances was 0.36% and 2.19%, respectively. The Bank uses FHLB borrowings as a supplemental funding source for earning asset growth, for providing an effective means of managing its overall cost of funds, or to manage its exposure to interest rate risk. The current increase in the level of short-term advances is the result of the pre-investment strategy noted above. In anticipation of the fourth quarter closing of the BOA branch purchase transaction, we have begun purchasing investment securities funded with short-term FHLB advances. Once the BOA transaction is finalized and the deposit funds are received, the short-term advances will be repaid. See “Note 16. Interest Rate Hedging” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

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Stockholders' equity increased to $80.4 million at September 30, 2014, from $74.9 million at December 31, 2013. This increase reflects the $3.7 million of net income earned for the nine months ended September 30, 2014 and a $2.9 million increase in accumulated other comprehensive income; net of $723,000 cash dividend payments, and $457,000 used to acquire 55,876 shares of the Company’s common stock pursuant to an announced repurchase plan. See "Consolidated Statements of Changes in Stockholders' Equity" for additional information.

 

Accumulated other comprehensive income increased to $3.0 million at September 30, 2014, from $103,000 at December 31, 2013, reflecting an increase in the mark-to-market adjustment in net unrealized gains in the available for sale investment securities portfolio, based on current market prices. See “Consolidated Statements of Comprehensive Income” and “Note 3. Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

The tangible equity to assets ratio was 10.36% at September 30, 2014, compared to 10.47% at December 31, 2013. There were 9,598,007 common shares outstanding at September 30, 2014, compared to 9,653,883 at December 31, 2013. The tangible book value per common outstanding share increased to $7.93 at September 30, 2014, from $7.32 at December 31, 2013.

 

The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of September 30, 2014, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position is categorized as well capitalized. There are no conditions or events since September 30, 2014 that management believes have changed the Bank's well capitalized category. See “Note 14. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” and “Liquidity and Capital Resources” below for additional information.

 

Comparison of Operating Results – Three and Nine Months Ended September 30, 2014 and 2013. Net income for the three months ended September 30, 2014 declined to $1.3 million, or $0.14 per diluted common share, from net income of $1.5 million, or $0.16 per diluted common share earned for the comparative 2013 three month period. Net income for the nine months ended September 30, 2014 declined to $3.7 million, or $0.39 per diluted common share, compared to net income of $4.9 million, or $0.50 per diluted common share earned for the first nine months of 2013.

 

When compared to the three months ended September 30, 2013, net income for the three months ended September 30, 2014 was primarily impacted by decreases in non-interest income and additional loan loss provision expense; and partially offset by an increase in net interest income, and decreases in non-interest expenses and income tax expense.

 

When compared to the nine months ended September 30, 2013, net income for the nine months ended September 30, 2014 was primarily impacted by decreases in net interest income, non-interest income and additional loan loss provision expense; and partially offset by decreases in non-interest expenses and income tax expense.

 

The decreases in non-interest income for the respective three and nine month periods were primarily attributable to lower volumes of sales of mortgage loans, OREO and investment securities and the related reduced amounts of net gains recognized.

 

Interest Income. Interest income increased to $7.3 million for the three months ended September 30, 2014, from $7.2 million for the three months ended September 30, 2013, but declined to $21.6 million for the nine months ended September 30, 2014, from $22.5 million for the nine months ended September 30, 2013. The year-over-year decline in interest income is due primarily to a decline in yields on earning assets, and secondarily to changes in the composition and volume of our earning asset base.

 

The tax equivalent yield on average earning assets declined to 4.52% and 4.58% for the three and nine months ended September 30, 2014, from 4.69% and 4.84% for the three and nine months ended September 30, 2013. Average earning assets increased to $654.7 million and $640.8 million for the three and nine months ended September 30, 2014, from $623.1 million and $630.4 million for the 2013 three and nine month periods.

 

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Interest Expense. Interest expense increased to $716,000 for the three months ended September 30, 2014, from $694,000 for the three months ended September 30, 2013, but declined to $2.0 million for the nine months ended September 30, 2014, from $2.2 million for the nine months ended September 30, 2013. Interest expense was primarily impacted by increased interest expense on borrowings and offset by a reduction in interest paid on deposits between the comparative reporting periods, as well as changes in the mix and volume of average interest-bearing liabilities, including deposits and borrowings.

 

The cost of average interest-bearing liabilities was 0.53% and 0.51% for the three and nine months ended September 30, 2014, compared to 0.55% and 0.56% for the three and nine months ended September 30, 2013. The Bank has managed its cost of interest-bearing liabilities by a combination of growth in lower cost non-maturity deposits, pricing new CDs and repricing maturing CDs in the lower interest rate environment and the use of lower- cost short-term FHLB advances as a supplemental funding source, while being partially offset by additional cost of long-term FHLB advances implemented in the hedging strategy noted above. Although a portion of higher priced maturing longer-term CDs left the Bank, the residual renewed into lower priced CDs or migrated to non-maturity deposit products within the Bank.

 

Average interest-bearing liabilities increased to $536.1 million and $522.0 million for the three and nine months ended September 30, 2014, from $504.7 million and $514.6 million for the comparable 2013 three and nine month periods. Average noninterest-bearing demand deposits increased to $96.6 million and $96.0 million for the three and nine months ended September 30, 2014, from $95.9 million and $92.6 million for the comparable 2013 three and nine month periods.

 

Net Interest Income. Net interest income increased to $6.6 million for the three months ended September 30, 2014, from $6.5 million for the three months ended September 30, 2013. Net interest income declined to $19.6 million for the nine months ended September 30, 2014, from $20.4 million for the nine months ended September 30, 2013. The tax equivalent net interest margin declined to 4.09% and 4.16% for the three and nine months ended September 30, 2014, from 4.25% and 4.38% for the comparative 2013 three and nine month periods.

 

While the Bank has taken steps to help protect it against the potential impacts of a rising rate environment, we anticipate that should interest rates remain unchanged, the repricing of higher yielding long-term assets, coupled with the issuance of organic loan growth in this current low rate environment may result in continued compression of our asset yields and net interest margin. As noted above, we have added defensive investments to our investment portfolio so that our balance sheet is better poised to respond to future increases in interest rates.

 

Yield/Cost Analysis. The following table contains comparative information relating to the Company’s average balance sheet and reflects the yield on average earning assets and the average cost of interest-bearing liabilities for the three and nine months ended September 30, 2014 and 2013, presented on a tax equivalent yield basis. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the cost of average interest-bearing liabilities. The tax equivalent net interest margin represents tax adjusted net interest income divided by average earning assets.

 

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Yield/Cost Analysis  Quarter Ended September 30, 2014   Quarter Ended September 30,  2013 
           (Dollars in thousands)         
           Average           Average 
   Average       Yield/   Average       Yield/ 
   Balance   Interest   Cost   Balance   Interest   Cost 
Interest earning assets:                              
Loans receivable  $477,477   $6,068    5.08%  $444,939   $6,055    5.41%
Investments and deposits  (1) (5)   177,223    1,248    2.82%   178,153    1,165    2.92%
Total earning assets  (1)   654,700    7,316    4.52%   623,092    7,220    4.69%
Nonearning assets (6)   62,391              57,649           
Total assets  $717,091             $680,741           
Interest bearing liabilities:                              
Deposits  $499,667    523    .42%  $494,429    612    .49%
Borrowings   26,170    112    1.68%   0    0    .00%
Junior subordinated debentures   10,310    81    3.09%   10,310    82    3.17%
Total interest-bearing liabilities   536,147    716    .53%   504,739    694    .55%
Noninterest bearing demand deposits   96,643    0    .00%   95,919    0    .00%
Total sources of funds   632,790    716    .45%   600,658    694    .46%
Other liabilities and stockholders’ equity:                              
Other liabilities   4,058              5,514           
Stockholders' equity   80,243              74,569           
Total liabilities and stockholders' equity  $717,091             $680,741           
Net interest income       $6,600             $6,526      
Interest rate spread  (1) (2)             3.99%             4.14%
Net funding spread  (1) (3)             4.07%             4.23%
Net interest margin  (1) (4)             4.09%             4.25%
Ratio of earning assets to interest bearing liabilities             122.11%             123.45%

 

Yield/Cost Analysis  Nine Months Ended September 30,
2014
   Nine Months Ended September 30, 
2013
 
           (Dollars in thousands)         
           Average           Average 
   Average       Yield/   Average       Yield/ 
   Balance   Interest   Cost   Balance   Interest   Cost 
Interest earning assets:                              
Loans receivable  $469,566   $17,967    5.10%  $452,269   $18,715    5.53%
Investments and deposits  (1) (5)   171,231    3,642    2.84%   178,112    3,834    3.11%
Total earning assets  (1)   640,797    21,609    4.58%   630,381    22,549    4.84%
Nonearning assets (6)   59,900              60,047           
Total assets  $700,697             $690,428           
Interest bearing liabilities:                              
Deposits  $495,054    1,609    .43%  $500,706    1,908    .51%
Borrowings   16,668    157    1.24%   3,610    7    .25%
Junior subordinated debentures   10,310    243    3.10%   10,310    259    3.31%
Total interest-bearing liabilities   522,032    2,009    .51%   514,626    2,174    .56%
Noninterest bearing demand deposits   95,989    0    .00%   92,561    0    .00%
Total sources of funds   618,021    2,009    .43%   607,187    2,174    .48%
Other liabilities and stockholders’ equity:                              
Other liabilities   4,127              6,424           
Stockholders' equity   78,549              76,817           
Total liabilities and stockholders' equity  $700,697             $690,428           
Net interest income       $19,600             $20,375      
Interest rate spread  (1) (2)             4.07%             4.28%
Net funding spread  (1) (3)             4.15%             4.36%
Net interest margin  (1) (4)             4.16%             4.38%
Ratio of earning assets to interest bearing liabilities             122.75%             122.49%

 

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(1)Yield shown as a tax-adjusted yield.
(2)The difference between the yield on average earning assets and the cost of average interest-bearing liabilities.
(3)The difference between the yield on average earning assets and the cost of average funding sources, including demand accounts.
(4)Net interest income (tax adjusted basis), divided by average earning assets.
(5)Average balance based on Amortized Cost.
(6)Average balance includes unrealized gain (loss) on investment securities.

 

Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired and general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $400,000 and $1.1 million of provisions for credit losses in the three and nine months ended September 30, 2014, compared to none and $400,000 recorded in the three and nine months ended September 30, 2013. The increase in year-to-date provisions for credit losses is primarily attributable to the net growth in loans and leases held for investment, as previously discussed. Provisions for credit losses are necessary to maintain the ALLL at a level that management believes is adequate to absorb probable future losses in the loan portfolio. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)” and “Allowance for Loan and Lease Losses” and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.

 

Noninterest Income. Total noninterest income declined to $2.2 million and $6.3 million for the three and nine months ended September 30, 2014, from $2.7 million and $8.1 million for the three and nine months ended September 30, 2013. Noninterest income consists of deposit fees and service charges; loan fees and charges; mortgage loan servicing fees; gain on sale and other fees on mortgage loans, gain on investment securities and OREO sales; and other miscellaneous income. Fees and service charges on deposits, and fees on loans and loan servicing fees earned during each period are influenced by the volume of deposits and loans outstanding, the volume of the various types of deposit and loan account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.

 

Deposit fees and service charges totaled $1.1 million and $3.2 million for the three and nine months ended September 30, 2014 and 2013, respectively. Deposit fees and service charges increased to 49.8% and 50.3% of total non-interest income for the three and nine months ended September 30, 2014, from 39.3% and 39.0% for the three and nine months ended September 30, 2013. We anticipate additional service charge revenue from deposits going forward as we focus on growing our deposit base through new product offerings and customer acquisition.

 

Gain on sale and other fees on mortgage loans declined to $429,000 and $1.1 million for the three and nine months ended September 30, 2014, from $645,000 and $2.2 million for the comparative 2013 three and nine month periods. Loan fees and charges and mortgage loan servicing fees declined to $287,000 and $842,000 for the three and nine months ended September 30, 2014, compared to $380,000 and $1.1 million for the respective 2013 three and nine month periods. The Bank has experienced a recent slowdown in mortgage lending activity, due to increases in mortgage rates from their historic low levels and the current economic environment, resulting in reduced revenue generated from the sale and servicing of mortgage loans and loan fees and charges during the respective 2014 reporting periods.

 

The Bank may sell or securitize fixed-rate residential mortgage loans to reduce interest rate and credit risk exposure, and to provide a more balanced sensitivity to future interest rate changes, while retaining certain other held for sale mortgage loans for future securitization into available for sale mortgage-backed securities. Proceeds from mortgage loan sales provide liquidity to support the Bank’s operating, financing and lending activities.

 

Gains on sales of investment securities available for sale were none and $14,000 for the three and nine months ended September 30, 2014, compared to $268,000 and $548,000 for the respective 2013 three and nine month periods. The investment securities sold during 2013 were low coupon mortgage-backed securities that would not perform as well as alternative investments in a rising rate environment. Proceeds from investment securities sales also provide liquidity to support the Bank’s operating, financing and lending activities.

 

Included in other noninterest income is revenue from BOLI investments. BOLI earnings increased to $133,000 and $398,000 for the three and nine months ended September 30, 2014, from $103,000 and $188,000 for the comparative 2013 three and nine month periods. The Bank intends to utilize the investment returns from the BOLI to recover a portion of the cost of providing benefit plans to our employees.

 

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Net gains recognized from the sale of OREO were $9,000 and $82,000 for the three and nine months ended September 30, 2014, compared to $68,000 and $403,000 for the three and nine months ended September 30, 2013, as the Bank continues in its efforts of disposing of these nonperforming assets. See “Note 9. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Total core non-interest income, excluding net gains and losses from OREO and securities sales, was $2.2 million and $6.2 million for the three and nine months ended September 30, 2014, compared to $2.4 million and $7.2 million for the respective 2013 three and nine month periods.

 

Noninterest Expense. Total noninterest expense declined to $6.5 million and $19.6 million for the three and nine months ended September 30, 2014, from $6.9 million and $20.6 million for the respective 2013 three and nine month periods. The year-over-year variation in noninterest expenses was primarily attributable to a significant reduction in OREO valuation and maintenance expenses, as well as lower deposit insurance premiums.

 

Compensation and fringe benefits, the largest component of noninterest expense, was $3.8 million and $11.5 million for both the three and nine month periods ended September 30, 2014 and 2013, respectively, reflecting efforts placed on managing human resources expense. The Bank will continue managing staffing levels to ensure it meets ongoing customer needs and to support future growth.

 

FDIC insurance assessments declined to $137,000 and $421,000 for the three and nine months ended September 30, 2014, from $228,000 and $700,000 for the respective 2013 three and nine month periods, reflecting a reduction in the deposit insurance assessment calculation base.

 

Data processing costs were $567,000 and $1.7 million for the three and nine months ended September 30, 2014, compared to $559,000 and $1.8 million for the respective 2013 three and nine month periods. Data processing costs fluctuate in conjunction with changes in the number of customer accounts and transaction activity volumes.

 

Expenses attributable to ongoing maintenance, property taxes and insurance and valuation adjustments for OREO properties declined to $167,000 and $396,000 for the three and nine months ended September 30, 2014, from $288,000 and $1.0 million for the respective 2013 three and nine month periods.

 

Premises and equipment, advertising, amortization of intangibles and other expense in aggregate, were relatively consistent during the respective three and nine month reporting periods.

 

Income Taxes. Income tax expense declined to $565,000 and $1.5 million for the three and nine months ended September 30, 2014, from $767,000 and $2.6 million for the respective 2013 three and nine month periods. The effective income tax rates were 29.63% and 29.02% for the three and nine months ended September 30, 2014, compared to 33.28% and 34.94% for the respective 2013 three and nine month periods. The increased investment in tax-exempt municipal bonds has resulted in lowering the Company’s income tax burden. See “Critical Accounting Policies” below for additional information.

 

Key Performance Ratios. Some of our key performance ratios are return on average assets (“ROA”), return on average equity (“ROE”) and efficiency. ROA was .74% and .71% for the three and nine months ended September 30, 2014, compared to .90% and .94% for the three and nine months ended September 30, 2013. ROE was 6.70% and 6.42% for the three and nine months ended September 30, 2014, compared to 8.18% and 8.47% for the three and nine months ended September 30, 2013. The efficiency ratio measures the proportion of net operating revenues that are absorbed by overhead expenses. The efficiency ratio (noninterest expenses as a percentage of net interest income plus noninterest income) was 72.52% and 74.26% for the three and nine months ended September 30, 2014, compared to 75.05% and 72.32% for the three and nine months ended September 30, 2013.

 

Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its cash needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. FDIC policy requires banks to maintain an average daily balance of liquid assets in an amount which it deems adequate to protect the safety and soundness of the bank. The FDIC currently has no specific level which it requires.

 

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At September 30, 2014, the Bank had cash, deposits in banks, investment securities and loans held for sale totaling $214.1 million, compared to $178.0 million at December 31, 2013. The Bank calculates its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. Based on its calculation guidelines, the Bank’s liquidity ratio was 33.44% at September 30, 2014, compared to 28.74% at December 31, 2013, which management believes is adequate.

 

The Bank believes it can meet future liquidity needs with existing funding sources. The Bank's primary sources of funds are deposits, principal payments on loans and mortgage-backed securities, earnings and funds provided from operations, the ability to borrow from the FHLB of Atlanta and other lines of credit, and the availability of loans and investment securities held for sale. At September 30, 2014, the Bank had $108.9 million of credit availability with the FHLB, of which there was lendable collateral value totaling $71.4 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit. In addition, at September 30, 2014, the Bank had $70.0 million of pre-approved, but unused lines of credit.

 

The FDIC requires banks to meet a minimum leverage capital requirement of Tier 1 capital (consisting of retained earnings and common stockholders’ equity, less any intangible assets) to average total assets ratio of 4%. The FDIC also requires banks to meet a ratio of total capital to risk-weighted assets of 8%, of which at least 4% must be in the form of Tier 1 capital. The Bank was in compliance with all regulatory capital requirements at September 30, 2014, and December 31, 2013. See “Note 14. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

In July 2013, the Board of Governors of the Federal Reserve System announced its approval of a final rule to implement the Basel III regulatory capital reforms, among other changes required by the Dodd-Frank Act. The framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, taking into account the impact of risk. The final rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5%, as well as a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The rule also raises the minimum Tier 1 capital to risk-weighted assets ratio from 4% to 6% and includes a minimum leverage ratio of 4% for all banking institutions. For the largest, most internationally active banking organizations, the rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures. In terms of quality of capital, the final rule emphasizes common equity Tier 1 capital and implements strict eligibility criteria for regulatory capital instruments. It also improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. The phase-in for smaller banking organizations, such as the Company and the Bank, begins in January 2015, while the phase-in period for larger banks started in January 2014. Management is evaluating the impact of the implementation of these new regulatory capital standards on the Company and the Bank, and expects both of them to continue to be well-capitalized under the new rules.

 

Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.

 

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Loan Impairment and Allowance for Loan and Lease Losses. A loan or lease is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan or lease is impaired. The internal asset classification procedures include a thorough review of significant loans, leases and lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc.

 

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The ALLL is increased by charges to income and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the ALLL is based on past loan and lease loss experience, known and inherent risks in loans and leases and unfunded loan commitments, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management believes that it has established the ALLL in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment, there can be no assurance in the future that regulators or risks in its loans and leases portfolio will not require additional adjustments to the ALLL.

 

Income Taxes. Deferred tax asset and liability balances are determined by application to temporary differences in the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Off-Balance Sheet Arrangements. 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 and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend 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.

 

Forward Looking Statements. The Private Securities Litigation Reform Act of 1995 states that disclosure of forward looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward looking statements that involve risk and uncertainty. In order to comply with terms of the safe harbor, the Company notes that a variety of risks and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward looking statements. There are risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business. They include, but are not limited to, economic growth, interest rate movements, timely development of technology enhancements for products, services and operating systems, the impact of competitive products, services and pricing, customer requirements, regulatory changes and similar matters. Readers of this report are cautioned not to place undue reliance on forward looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk. Smaller reporting companies are not required to provide information required by this item.

 

Item 4.  Controls and Procedures. As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.

 

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In addition, there have been no changes in the Company’s internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item l. Legal Proceedings: The Company is currently not engaged in any material legal proceedings. From time to time, the Bank is a party to legal proceedings within the ordinary course of business wherein it enforces its security interest in loans, and other matters of similar nature.

 

Item 1A. Risk Factors: Smaller reporting companies are not required to provide information required by this item.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: The following table sets forth information regarding the Company's repurchases of its common stock during the quarter ended September 30, 2014:

 

Period  Total Number of
Shares Purchased
   Average Price Paid
per Share
   Total Number of
Shares Purchased
as Part of Publicly
Announced Plan
   Maximum Number of
Shares Yet to Be
Purchased Under the
Plan
 
                 
July 2014 Beginning date: July 1 Ending date:  July 31   -    -    -    334,296 
                     
May 2014 Beginning date: August 1 Ending date:  August 31   -    -    -    334,296 
                     
September  2014 Beginning date: September 1 Ending date:  September 30   -    -    -    334,296 

 

Shares may be purchased under a repurchase program announced on October 29, 2013. Under this program, the Company announced that it may purchase up to 487,560 shares of its common stock over a one year period, expiring on October 29, 2014. There were no share purchases during the quarter ended September 30, 2014.

 

Item 3. Defaults Upon Senior Securities: Not applicable

 

Item 4. Mine Safety Disclosures: Not applicable.

 

Item 5. Other Information: Not applicable

 

Item 6. Exhibits: The following exhibits are filed herewith:

 

Number   Title
10.20   Purchase and Assumption Agreement dated as of September 2, 2014, between Bank of America, N.A. and First South Bank (Incorporated herein by reference from Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on September 3, 2014 (File No. 0-22219))
     
31.1   Rule 13a-14(a) Certification of Chief Executive Officer
     
31.2   Rule 13a-14(a) Certification of Chief Financial Officer
     
32   Section 1350 Certification
     
101   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Financial Condition as of September 30, 2014 (unaudited) and December 31, 2013; (ii) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited); (iii) Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited); (iv) Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2014 and 2013 (unaudited); (v) Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (unaudited); and (vi) Notes to Consolidated Financial Statements (unaudited) as of September 30, 2014 and December 31, 2013, and for the Three and Nine Months Ended September 30, 2014 and 2013.

 

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SIGNATURES

 

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.

 

  FIRST SOUTH BANCORP, INC.  
       
  By: /s/ Scott C. McLean  
    Scott C. McLean  
    Executive Vice President  
    Chief Financial Officer  
    (Principal Financial and Accounting Officer)  
       
    Date: November 13, 2014  

 

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