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EX-31.1 - EXHIBIT 31.1 - SOUTHCOAST FINANCIAL CORPex31-1.htm

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 X 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

 

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2015

 

OR

 

     

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

 

 THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from _________to_________

 

Commission File No.

0-25933

 

SOUTHCOAST FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

South Carolina

 

57-1079460

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification No.)

 

530 Johnnie Dodds Boulevard

Mt. Pleasant, South Carolina 29464

(Address of principal executive offices)

 

843-884-0504

(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.

 

Large accelerated filer   [   ]

 

Accelerated filer   [   ]

Non-accelerated filer   [   ] (Do not check if a smaller reporting company)

 

Smaller reporting company [ X ]

 

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

 

YES [   ]    NO     [ X ]

 

State the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

 

7,103,751 shares of common stock, no par value, as of July 31, 2015

 

 
 

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

INDEX

 

 

Page No.

PART I - FINANCIAL INFORMATION  

 

 

 

Item 1.     Financial Statements (Unaudited)

 

 
     

Condensed Consolidated Balance Sheets – June 30, 2015 and December 31, 2014 

 2

 

 

 

 

Condensed Consolidated Statements of Income – Six months ended June 30, 2015 and 2014 

 3

 

 

 

 

Condensed Consolidated Statements of Income – Three months ended June 30, 2015 and 2014

 4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income – Six and three months ended June 30, 2015 and 2014 

 5

 

 

 

 

Condensed Consolidated Statements of Changes in Shareholders' Equity – Six months ended June 30, 2015 and 2014

 6

 

 

 

 

Condensed Consolidated Statements of Cash Flows - Six months ended June 30, 2015 and 2014

 7

 

 

 

 

Notes to Condensed Consolidated Financial Statements 

 8-32

 

 

 

 

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

 33-46

 

 

 

 

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

 46

 

 

 

 

Item 4.     Controls and Procedures

 46

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

Item 6.     Exhibits

47

 

 

 

 

Signatures

47

 

 

 

 

Exhibit Index

48

 

 

 
 

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

Condensed Consolidated Balance Sheets

 

 

PART I - FINANCIAL INFORMATION

 

Item 1 - Financial Statements        

 

(Dollars in thousands)

               
                 
   

June 30,

   

December 31,

 
   

2015

   

2014

 
   

(Unaudited)

         

Assets

               

Cash and cash equivalents:

               

Cash and due from banks

  $ 45,970     $ 33,572  

Federal funds sold

    1,219       -  

Total cash and cash equivalents

    47,189       33,572  
                 

Investment securities

               

Available for sale

    33,409       35,269  

Federal Home Loan Bank Stock, at cost

    3,824       4,000  
                 

Loans held for sale

    360       -  
                 

Loans, net of allowance of $4,986 and $5,602

    378,056       358,546  
                 

Premises and equipment, net

    19,556       20,455  

Other real estate owned, net

    2,777       3,686  

Company owned life insurance

    13,144       12,984  

Deferred tax asset, net

    4,830       5,636  

Other assets

    2,502       2,685  
                 

Total assets

  $ 505,647     $ 476,833  
                 

Liabilities

               

Deposits

               

Noninterest-bearing

  $ 64,118     $ 48,700  

Interest-bearing

    297,070       282,334  
                 

Total deposits

    361,188       331,034  
                 

Federal funds purchased

    -       3,065  

Securities sold under agreements to repurchase

    588       737  

Federal Home Loan Bank Borrowings

    80,000       80,000  

Junior subordinated debentures

    10,310       10,310  

Other liabilities

    3,113       4,382  
                 

Total liabilities

    455,199       429,528  
                 

Shareholders’ Equity

               

Common stock (no par value; 20,000,000 shares authorized; 7,103,751 shares issued and outstanding at June 30, 2015 and 7,096,574 at December 31, 2014)

    54,694       54,643  

Accumulated deficit

    (3,349 )     (6,200 )

Accumulated other comprehensive loss

    (897 )     (1,138 )
                 

Total shareholders’ equity

    50,448       47,305  
                 

Total liabilities and shareholders’ equity

  $ 505,647     $ 476,833  

 

 

See Notes to Condensed Consolidated Financial Statements

 

 
-2-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

Condensed Consolidated Statements of Income

(Unaudited)

(Dollars in thousands)

 

   

For the Six Months Ended

 
   

June 30,

 
   

2015

   

2014

 

Interest income

               

Loans, including fees

  $ 9,075     $ 8,417  

Investment securities

    491       579  

Cash and federal funds sold

    23       16  
                 

Total interest income

    9,589       9,012  
                 

Interest expense

               

Deposits and borrowings

    1,705       1,809  
                 

Net interest income

    7,884       7,203  

Provision for loan losses

    (900 )     -  
                 

Net interest income after provision for loan losses

    8,784       7,203  
                 

Noninterest income

               

Service fees on deposit accounts

    762       738  

Gain on sale of mortgage loans held for sale

    61       21  

Company owned life insurance earnings

    160       163  

Gain on sale of available for sale securities

    -       109  

Gain on sale of premises and equipment

    750       -  

Other

    102       87  

Total noninterest income

    1,835       1,118  
                 

Noninterest expenses

               

Salaries and employment benefits

    3,653       3,449  

Occupancy

    545       585  

Furniture and equipment

    861       843  

Software

    27       43  

Insurance

    260       300  

Professional fees

    426       376  

Telephone, postage, and supplies

    160       168  

Gain on sale of other real estate owned

    (118 )     (156 )

Other real estate owned impairment provision, and other expenses, net of rental income

    4       61  

Other operating expenses

    417       576  

Total noninterest expenses

    6,235       6,245  
                 

Income before income taxes

    4,384       2,076  

Income tax expense

    1,533       724  
                 

Net income

  $ 2,851     $ 1,352  
                 

Basic net income per common share

  $ .40     $ .19  
                 

Diluted net income per common share

  $ .40     $ .19  
                 

Weighted average shares outstanding

               

Basic

    7,101,865       7,087,860  
                 

Diluted

    7,101,865       7,087,860  

 

 

See Notes to Condensed Consolidated Financial Statements

 

 
-3-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Condensed Consolidated Statements of Income

(Unaudited)

(Dollars in thousands)

 

   

For the Three Months Ended

 
   

June 30,

 
   

2015

   

2014

 

Interest income

               

Loans, including fees

  $ 4,471     $ 4,182  

Investment securities

    239       278  

Cash and federal funds sold

    15       10  
                 

Total interest income

    4,725       4,470  
                 

Interest expense

               

Deposits and borrowings

    856       897  
                 

Net interest income

    3,869       3,573  

Provision for loan losses

    -       -  
                 

Net interest income after provision for loan losses

    3,869       3,573  
                 

Noninterest income

               

Service fees on deposit accounts

    374       383  

Gain on sale of mortgage loans held for sale

    41       15  

Company owned life insurance earnings

    82       82  

Gain on sale of available for sale securities

    -       109  
Gain on sale of premises and equipment     -       -  

Other

    57       41  

Total noninterest income

    554       630  
                 

Noninterest expenses

               

Salaries and employment benefits

    1,823       1,690  

Occupancy

    268       289  

Furniture and equipment

    437       420  

Software

    14       22  

Insurance

    128       155  

Professional fees

    224       184  

Telephone, postage, and supplies

    73       85  

Gain on sale of other real estate owned

    (93 )     (51 )

Other real estate owned impairment provision, and other expenses, net of rental income

    -       23  

Other operating expenses

    221       298  

Total noninterest expenses

    3,095       3,115  
                 

Income before income taxes

    1,328       1,088  

Income tax expense

    455       379  
                 

Net income

  $ 873     $ 709  
                 

Basic net income per common share

  $ .12     $ .10  
                 

Diluted net income per common share

  $ .12     $ .10  
                 

Weighted average shares outstanding

               

Basic

    7,103,751       7,089,902  
                 

Diluted

    7,103,751       7,089,902  

 

 

See Notes to Condensed Consolidated Financial Statements

 

 
-4-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)

 

   

For the Six Months Ended

 
   

June 30,

 
   

2015

   

2014

 

Net income

  $ 2,851     $ 1,352  
                 

Other comprehensive income:

               

Unrealized gains on available for sale securities

    377       1,109  

Tax effect

    (136 )     (399 )

Reclassification of gains included in net income

    -       (109 )

Tax effect

    -       39  

Total other comprehensive income

    241       640  
                 

Comprehensive income

  $ 3,092     $ 1,992  

 

 

 

   

For the Three Months Ended

 
   

June 30,

 
   

2015

   

2014

 

Net income

  $ 873     $ 709  
                 

Other comprehensive income (loss):

               

Unrealized gains (losses) on available for sale securities

    (425 )     602  

Tax effect

    153       (217 )

Reclassification of gains included in net income

    -       (109 )

Tax effect

    -       39  

Total other comprehensive income (loss)

    (272 )     315  
                 

Comprehensive income

  $ 601     $ 1,024  

 

 

See Notes to Condensed Consolidated Financial Statements

 

 
-5-

 

 

SOUTHCOAST FINANCIAL CORPORATION

Condensed Consolidated Statements of Changes in Shareholders' Equity

For the six months ended June 30, 2015 and 2014

(Unaudited)

(Dollars in thousands)

 

               

Accumulated

Other

         
    Common Stock     Accumulated    

Comprehensive

         
   

Shares

    Amount    

Deficit

   

Loss

   

Total

 
                                         

Balance, January 1, 2014

    7,082,062     $ 54,544     $ (9,937 )   $ (2,038 )   $ 42,569  
                                         

Comprehensive income

                    1,352       640       1,992  
                                         

Employee stock purchase plan

    7,840       52       .-       -       52  
                                         

Balance, June 30, 2014

    7,089,902     $ 54,596     $ (8,585 )   $ (1,398 )   $ 44,613  
                                         

Balance, January 1, 2015

    7,096,574     $ 54,643     $ (6,200 )   $ (1,138 )   $ 47,305  
                                         

Comprehensive income

                    2,851       241       3,092  
                                         

Employee stock purchase plan

    7,177       51       .-       -       51  
                                         

Balance, June 30, 2015

    7,103,751     $ 54,694     $ (3,349 )   $ (897 )   $ 50,448  

 

 

See Notes to Condensed Consolidated Financial Statements

 

 
-6-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

 

For the Six Months Ended

 
   

June 30,

 
   

2015

   

2014

 

Operating activities

               

Net income

  $ 2,851     $ 1,352  

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

               

Decrease in deferred income taxes

    670       604  

Provision for loan losses

    (900 )     -  

Depreciation and amortization

    400       447  

Discount accretion and premium amortization

    71       68  

Gain on sales of available for sale securities

    -       (109 )

Gain on sale of other real estate owned

    (118 )     (156 )

Change in deferred gain on sale of other real estate owned

    (66     (51

Impairment charges on other real estate owned

    -       6  

Originations of loans held for sale

    (4,034 )     (825 )

Proceeds from sales of loans held for sale

    3,735       1,116  

Gain on sale of mortgage loans held for sale

    (61 )     (21 )

Gain on sale of premises and equipment

    (750 )     -  

Company owned life insurance earnings

    (160 )     (163 )

Decrease in other assets

    183       210  

Decrease in other liabilities

    (1,137 )     (93 )

Net cash provided by operating activities

    684       2,385  
                 

Investing activities

               

Calls, maturities, and paydowns of investment securities available-for-sale

    2,166       1,356  

Purchases of investment securities available for sale

    -       (3,000 )

Sales of investment securities available-for-sale

    -       3,228  

Purchases of Federal Home Loan Bank stock

    (1,299 )     (518 )

Sales of Federal Home Loan Bank stock

    1,475       642  

Net increase in loans

    (17,935 )     (18,029 )

Purchases of premises and equipment

    (46 )     (76 )

Proceeds from sales of premises and equipment

    1,295       -  

Proceeds from sales of other real estate owned

    286       833  

Capital expenditures related to other real estate owned

    -       (14 )

Net cash used by investing activities

    (14,058 )     (15,578 )
                 

Financing activities

               

Net increase in deposits

    30,154       18,642  

Decrease in federal funds purchased

    (3,065 )     (3,115 )

Decrease(increase) in securities sold under agreements to repurchase

    (149 )     208  

Net proceeds from issuances of stock

    51       52  

Net cash provided by financing activities

    26,991       15,787  
                 

Increase in cash and cash equivalents

    13,617       2,594  

Cash and cash equivalents, beginning of period

    33,572       28,460  

Cash and cash equivalents, end of period

  $ 47,189     $ 31,054  
                 

Cash paid for:

               

Interest

  $ 1,685     $ 2,043  

Income Taxes

  $ 912       104  

Supplemental noncash investing and financing activities:

               

Real estate acquired in settlement of loans

  $ -     $ 646  

Change in unrealized losses on available-for-sale securities

  $ (377 )   $ (1,000 )

Loans to finance sales of other real estate owned

  $ 675     $ 260  

 

See Notes to Condensed Consolidated Financial Statements

 

 
-7-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1 - Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X of the Securities and Exchange Commission. Accordingly they do not include all information and notes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

Note 2 - Organization

 

Southcoast Financial Corporation (the “Company”) is a South Carolina corporation organized in 1999 for the purpose of being a holding company for Southcoast Community Bank (the “Bank”). On April 29, 1999, pursuant to a Plan of Exchange approved by the shareholders, all of the outstanding shares of capital stock of the Bank were exchanged for shares of common stock of the Company. The Company presently engages in no business other than that of owning the Bank and another subsidiary, Southcoast Investment Corporation, and has no employees.

 

Note 3 - Net Income Per Share

 

Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements, if any. The Company had no potentially dilutive shares during the periods presented in this report.

 

Note 4 Recently Issued Accounting Standards

 

There were no recently issued authoritative pronouncements that had a material impact on the Company’s accounting, reporting, or disclosures of financial information as of June 30, 2015.

 

 
-8-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 5Investment Securities

 

The amortized cost and fair value of investment securities are as follows:

 

(Amounts in thousands)

 

June 30, 2015

 
   

Amortized

   

Gross Unrealized

   

Estimated

 
   

Cost

   

Gains

   

Losses

   

Fair Value

 

Available for sale

                               

Mortgage backed

                               

Government sponsored enterprises

  $ 23,167     $ -     $ 394     $ 22,773  

Municipal securities

    3,430       218       -       3,648  

Other

    8,213       26       1,251       6,988  
                                 

Total

  $ 34,810     $ 244     $ 1,645     $ 33,409  

 

 

   

December 31, 2014

 
   

Amortized

   

Gross Unrealized

   

Estimated

 
   

Cost

   

Gains

   

Losses

   

Fair Value

 
Available for sale                                

Mortgage backed

                               

Government sponsored enterprises

  $ 24,915     $ 103     $ 80     $ 24,938  

Municipal securities

    3,924       260       -       4,184  

Other

    8,208       37       2,098       6,147  
                                 

Total

  $ 37,047     $ 400     $ 2,178     $ 35,269  

 

The following tables show gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2015 and December 31, 2014.

 

Available for Sale

(Amounts in thousands)

 

June 30, 2015

 
   

Less than

   

Twelve Months

                 
   

Twelve Months

   

or More

   

Total

 
           

Unrealized

           

Unrealized

           

Unrealized

 
   

Fair Value

   

Losses

   

Fair Value

   

Losses

   

Fair Value

   

Losses

 
                                                 

Mortgage backed

  $ 22,773     $ 394     $ -     $ -     $ 22,773     $ 394  

Other

    -       -       2,001       1,251       2,001       1,251  
                                                 

Total

  $ 22,773     $ 394     $ 2,001     $ 1,251     $ 24,774     $ 1,645  

 

 

   

December 31, 2014

 
   

Less than

   

Twelve Months

                 
   

Twelve Months

   

or More

   

Total

 
           

Unrealized

           

Unrealized

           

Unrealized

 
   

Fair Value

   

Losses

   

Fair Value

   

Losses

   

Fair Value

   

Losses

 
                                                 

Mortgage backed

  $ -     $ -     $ 15,990     $ 80     $ 15,990     $ 80  

Other

    -       -       1,610       2,098       1,610       2,098  
                                                 

Total

  $ -     $ -     $ 17,600     $ 2,178     $ 17,600     $ 2,178  
 
-9-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 5Investment Securities(continued)

 

Securities classified as available-for-sale are recorded at fair market value. Unrealized losses on securities in a continuous loss position for twelve months or more totaled $1,251,000, or 76% of unrealized losses, and $2,178,000, or 100% of unrealized losses, at June 30, 2015 and December 31, 2014, respectively. The majority of the unrealized losses for both periods related to Other securities, which were comprised of three individual securities. It is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost. Unrealized losses on Other securities declined by approximately $847,000 at June 30, 2015 when compared to December 31, 2014, primarily due to a $829,000 reduction in unrealized losses on an individual security. This security trades infrequently, but its increased valuation was based on a recent trade.

 

The unrealized loss attributable to Other securities primarily relates to valuations on two individual collateralized debt obligations which consist of pooled trust preferred securities. The Company believes, based on industry analyst reports, credit ratings, and third party other-than-temporary loss impairment evaluations, that the deterioration in the value of these securities is attributable to a combination of the lack of liquidity in both of these securities and credit quality concerns for one of the two securities. These securities are considered Level 3 securities in the fair value hierarchy as they both trade in less than liquid markets.

 

One of the Company’s collateralized debt obligations with an amortized cost of approximately $1,825,000 and fair value of approximately $1,217,000 is receiving contractual interest payments, while the other with an amortized cost of approximately $1,738,000 and fair value of approximately $1,143,000 is credited with payment-in-kind interest in lieu of cash interest payments. Due to the over-collateralized credit position of the security currently receiving interest payments, no other-than-temporary impairment was recognized on this security. Payment-in-kind interest consists of capitalization of interest amounts due on a security. In accordance with terms outlined in its offering circular, the security not currently paying interest has its deferred interest capitalized and added to the principal balance of the security. Future interest payments are accrued on these larger principal balances. The Company has discontinued the accrual of interest on this security due to its payment-in-kind status.

 

Payment-in-kind interest was triggered on this security due to deferrals of interest payments by individual issuers within the pool of issuers. Individual issuers are allowed to defer their interest payments for a period of up to five years. The security is divided into several tranches, with the A tranche securities being the most senior in terms of payment priority and Income Notes being the least senior. The Company owns notes in the C tranche of the security. Each tranche must pass an overcollateralization test in order for note holders in subordinate tranches to receive their contractual interest payments. The overcollateralization test is based on total performing collateral in the pool divided by total outstanding debt within the tranche. The senior most pool failing its overcollateralization test will receive principal paydowns on its outstanding notes in addition to contractual interest payments in order to cure its failure. These additional payments will be diverted from note holders in subordinate tranches who will instead receive payment-in-kind interest. At June 30, 2015, there was $234,234,000 of performing collateral in the pool. The table below summarizes balance and overcollateralization data for the individual tranches at June 30, 2015.

 

(Amounts in thousands)

Tranche

 

Current Balance

   

Required

Overcollateralization %

   

Current

Overcollateralization %

 

A

  $ 170,078       128.00 %     138.35 %

B

    38,116       115.00 %     113.02 %

C

    48,234       106.20 %     91.76 %

D

    28,392       100.30 %     82.62 %

Income Notes

    18,000    

N/A

   

N/A

 

 

As shown above, tranches B and below currently fail their overcollateralization test. According to the structured payment terms as described in the offering circular for this security, interest payments are currently being diverted from tranches subordinate to B to pay down total principal balances in the B tranche. If and when these payments reduce the principal balance in the B tranche by enough to pass its overcollateralization requirement, the C tranche securities will begin to receive contractual interest payments, and additional payments will be diverted from subordinate tranches in order to meet its overcollateralization requirement. This payment structure, known as a waterfall, is designed to continue until all tranches meet their overcollateralization requirement. However, this outcome is dependent on the level of future interest deferrals and defaults by individual issuers. Any shortfalls to contractual principal and interest payments due will be borne in reverse order of payment priority, with the most subordinate tranche having the largest loss and the senior most tranche having the smallest loss. As a note holder in the C tranche of this structure, the Company’s principal and interest claims are subordinate to the principal and interest claims of note holders in the A and B tranches. More specifically, the Company and other C note holders would stand to lose 100% of their principal and interest before note holders in the B tranche lost their first dollar, and B note holders would lose 100% of their investment before A note holders experienced any loss.

 

 
-10-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 5Investment Securities(continued)

  

The Company engaged a firm specializing in security valuations to evaluate the security receiving payment-in-kind interest for other-than- temporary impairment (“OTTI”). This firm uses the OTTI evaluation model to compare the present value of expected cash flows to the previous estimate to measure whether there are any adverse changes in cash flows during the quarter. The OTTI model considers the structure and term of the trust preferred security and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The allocation of payments to the note classes follows the payment priority hierarchy for the individual tranches. The OTTI evaluation prepared as of June 30, 2015 predicts the Company will resume receipt of its contractual principal and interest payments by the end of 2015, which is when the B tranche is projected to pass its overcollateralization test. These projections are based on assumptions developed from current financial data for the underlying issuers and may change in subsequent periods based on future financial data which could alter the assumptions.

 

The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant information including announcements of interest payment deferrals or defaults of the underlying issuers. The OTTI evaluation model assumes no recoveries on defaults. The result of the firm’s analysis indicated approximately $176,000 of credit loss as of March 31, 2011, which was recognized as an other-than-temporary loss in the first quarter of 2011 and reported in noninterest income. No credit losses had been recognized on these securities prior to 2011, and there have been no changes to credit losses recognized in earnings for any subsequent periods. Due to the credit loss recognized on this security, the Company has not accrued into interest income any of the payment-in-kind interest due on the security. Consequently, the security’s payment-in-kind interest is not reflected in the book value of the security. Total other-than-temporary impairment in accumulated other comprehensive income was $381,000 for the security (Security B in the table below) at June 30, 2015.

 

The following table provides certain relevant details on each of our collateralized debt obligations as of June 30, 2015, including the book value, fair value, and unrealized losses on the securities, as well as certain information about the overall pools and the current status of their underlying issuers. “Excess Subordination” is a measure of the excess performing collateral in the pool beyond the total level of debt outstanding in the pool with an equal or greater level of preference in the payment structure. It is expressed in the tables below as a percentage of performing collateral. It represents the percentage reduction in performing collateral that would precede an inability of the security to make contractually required payments to the Company.

 

June 30, 2015

 

(Amounts in thousands)

               
   

Security A

   

Security B

 
                 

Book Value

  $ 1,825     $ 1,738  

Fair Value

  $ 1,217     $ 1,143  

Unrealized Loss

  $ 608     $ 595  

Number of underlying financial institution issuers

    47       39  

Number of deferrals and defaults

    9       12  

Additional expected deferrals/ defaults*

    N/A       0/2  

Excess Subordination as a percentage of performing collateral^

    33.21 %  

 

N/A  

 

* No assessment of these numbers was made for Security A as it was not modeled for cash flows due to its current payment status and its excess subordination. For Security B, this includes issuers for which there is an estimated probability of deferral or default of 50% or greater. None of the remaining performing collateral was projected as a future deferral or default, due to low Texas ratios; two deferring issuers were projected to default.

 

^Security B is in a support tranche and has no excess subordination.

 

 
-11-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 5Investment Securities(continued)

 

The credit quality of the collateralized debt obligations is directly related to the financial strength and ability to make contractual interest payments of the underlying issuers in these securities, most of which are banks or bank holding companies. As such, these securities may show additional OTTI in future periods if the financial condition of the underlying

issuers further deteriorates.

 

The amortized costs and fair values of investment securities available for sale at June 30, 2015 by contractual maturity are shown in the following table. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Amounts in thousands)  

Amortized

   

Fair

 
   

Cost

   

Value

 

Due after one but within five years

  $ 440     $ 462  

Due after five but within ten years

    2,218       2,364  

Due after ten years

    4,835       3,682  

Mortgage backed

    23,167       22,773  

Equity securities with no maturity

    4,150       4,128  
                 

Total investment securities available-for-sale

  $ 34,810     $ 33,409  

 

Investment securities with an aggregate amortized cost of $23,555,000 and estimated fair value of $23,282,000 at June 30, 2015, were pledged to secure public deposits and for other purposes, as required or permitted by law.

 

Investment securities with an aggregate amortized cost of $1,498,000 and estimated fair value of $1,466,000 at June 30, 2015, were pledged to secure securities sold under agreements to repurchase.

 

Investment securities with an aggregate amortized cost of $22,777,000 and estimated fair value of $22,809,000 at December 31, 2014, were pledged to secure public deposits and for other purposes, as required or permitted by law.

 

Investment securities with an aggregate amortized cost of $2,591,000 and estimated fair value of $2,593,000 at December 31, 2014, were pledged to secure securities sold under agreements to repurchase.

 

 
-12-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 - Loans

 

The composition of loans by major loan category is presented below:

 

(Dollars in thousands)  

June 30,

   

December 31,

 
   

2015

   

2014

 

Real estate secured loans:

               

Residential 1-4 Family

  $ 233,199     $ 217,518  

Multifamily

    4,769       5,108  

Commercial

    89,830       87,906  

Construction and land development

    31,399       29,060  
                 

Total real estate secured loans

    359,197       339,592  

Commercial and industrial

    20,041       22,022  

Consumer

    3,296       2,206  

Other

    508       328  
                 

Total gross loans

    383,042       364,148  

Allowance for loan losses

    (4,986 )     (5,602 )
                 
    $ 378,056     $ 358,546  

 

The Company uses a numerical grading system from 1 to 9 to assess the credit risk inherent in its loan portfolio, with Grade 1 loans having the lowest credit risk and Grade 9 loans having the highest credit risk. Loans with credit grades from 1 to 5 are considered passing grade, or acceptable, loans. Loans with grades from 6 to 9 are considered to have less than acceptable credit quality. Generally, impaired loans have credit grades of 7 or higher. Following is a listing and brief description of the various risk grades. The grading of individual loans may involve the use of estimates.

 

Credit

Grade

 

Description

 
     

1

 

Loans secured by cash collateral.

2

 

Loans secured by readily marketable collateral.

3

 

Top quality loans with excellent repayment sources and no significant identifiable risk of collection.

4

 

Acceptable loans with adequate repayment sources and little identifiable risk of collection.

5

 

Acceptable loans with signs of weakness as to repayment or collateral, but with mitigating factors that minimize the risk of loss.

6

 

Watch List or Special Mention loans with underwriting tolerances and/or exceptions with no mitigating factors that may, due to economic or other factors, increase the risk of loss.

7

 

Classified substandard loans inadequately protected by the paying capacity or net worth of the obligor, or of the collateral with weaknesses that jeopardize the liquidation of the debt.

8

 

Classified doubtful loans in which collection or liquidation in full is highly improbable.

9

 

Classified loss loans that are uncollectible and of such little value that continuance as an asset is not warranted.

 

 
-13-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

The following tables provide a summary of our credit risk profile by loan categories as of June 30, 2015 and December 31, 2014 (including nonaccrual loans).

 

(Dollars in thousands)

Credit Risk Profile by Creditworthiness Category

As of June 30, 2015 and December 31, 2014

 

   

Real Estate Secured

 
   

Residential 1-4 Family

   

Multi Family

   

Commercial

   

Construction and Land

Development

 
   

2015

   

2014

   

2015

   

2014

   

2015

   

2014

   

2015

   

2014

 
Grade                                                                
1   $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
2     -       -       -       -       -       -       -       -  
3     121,172       107,353       1,310       1,350       17,812       14,965       14,552       11,197  
4     58,173       56,164       1,079       1,111       29,787       28,180       7,211       7,310  
5     46,352       46,873       2,045       2,309       32,575       33,081       8,900       9,571  
6     1,518       1,587       335       -       5,082       2,042       64       269  
7     5,358       4,930       -       338       4,574       9,638       672       703  
8     626       611       -       -       -       -       -       10  
9     -       -       -       -       -       -       -       -  
                                                                 
Total   $ 233,199     $ 217,518     $ 4,769     $ 5,108     $ 89,830     $ 87,906     $ 31,399     $ 29,060  

 

 

   

Non-Real Estate Secured

                 
   

Commercial

   

Consumer

   

Other

   

Total

 
   

2015

   

2014

   

2015

   

2014

   

2015

   

2014

   

2015

   

2014

 
Grade                                                                
1   $ 514     $ 2,223     $ 376     $ 397     $ -     $ -     $ 890     $ 2,620  
2     -       -       -       -       -       -       -       -  
3     2,481       2,205       1,104       480       92       94       158,523       137,644  
4     6,969       6,628       630       220       389       181       104,238       99,794  
5     8,931       9,589       1,103       977       27       53       99,933       102,453  
6     12       18       -       -       -       -       7,011       3,916  
7     1,134       1,359       83       132       -       -       11,821       17,100  
8     -       -       -       -       -       -       626       621  
9     -       -       -       -       -       -       -       -  
                                                                 
Total   $ 20,041     $ 22,022     $ 3,296     $ 2,206     $ 508     $ 328     $ 383,042     $ 364,148  

 

 
-14-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

The following tables provide a summary of past due loans by loan category as of June 30, 2015 and December 31, 2014.

 

(Dollars in thousands)

Past Due Loans

For the Periods Ended June 30, 2015 and December 31, 2014

 

June 30, 2015

 

30-59

Days Past

Due

   

60-89

Days Past

Due

   

Greater

Than 90

Days

   

Total Past

Due

   

Current

   

Total Loans Receivable

   

Recorded

Investment

> 90 Days

and Accruing

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,109     $ 695     $ 978     $ 2,782     $ 230,417     $ 233,199     $ -  

Multifamily Residential

    335       -       -       335       4,434       4,769       -  

Commercial Real Estate

    673       30       1,252       1,955       88,875       89,830       45  

Construction and Land Development

    207       -       180       387       31,012       31,399       180  

Non-Real Estate Secured

                                                    -  

Commercial and Industrial

    98       7       262       367       19,674       20,041       -  

Consumer and Other

    91       1       -       92       3,712       3,804       -  
                                                         

Total

  $ 2,513     $ 733     $ 2,672     $ 5,918     $ 378,124     $ 383,042     $ 225  

 

 

December 31, 2014

 

30-59

Days Past

Due

   

60-89

Days Past

Due

   

Greater

Than 90

Days

   

Total Past

Due

   

Current

   

Total Loans Receivable

   

Recorded

Investment

> 90 Days

and Accruing

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,748     $ 955     $ 1,972     $ 4,675     $ 212,843     $ 217,518     $ -  

Multifamily Residential

    -       -       -       -       5,108       5,108       -  

Commercial Real Estate

    794       1,930       1,073       3,797       84,109       87,906       -  

Construction and Land Development

    -       52       10       62       28,998       29,060       -  

Non- Real Estate Secured

                                                    -  

Commercial and Industrial

    235       66       146       447       21,575       22,022       -  

Consumer and Other

    8       15       13       36       2,498       2,534       -  
                                                         

Total

  $ 2,785     $ 3,018     $ 3,214     $ 9,017     $ 355,131     $ 364,148     $ -  

 

 
-15-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

The following table provides a summary of nonaccrual loans as of June 30, 2015 and December 31, 2014.

 

(Dollars in thousands)

   

June 30,

   

December 31,

 
   

2015

   

2014

 
                 

1-4 Family Residential

  $ 2,434     $ 2,956  

Multifamily Residential

    -       -  

Commercial Real Estate

    1,302       1,096  

Construction and Land Development

    -       10  

Commercial and Industrial

    762       859  

Consumer and Other

    13       48  
                 

Total

  $ 4,511     $ 4,969  

 

 

At June 30, 2015 and December 31, 2014, nonaccrual loans totaled $4.5 million and $5.0 million, respectively. The gross interest income that would have been recorded under the original terms of nonaccrual loans totaled $133,000 and $226,000 for the six months ended June 30, 2015 and June 30, 2014, respectively. At June 30, 2015 and December 31, 2014, impaired loans (which include nonaccrual loans and troubled debt restructurings (TDRs)) totaled $5.5 million and $5.6 million, respectively. The recorded investment in impaired loans individually evaluated for impairment, which include nonaccrual loans over $250,000 and TDRs, totaled $3.7 million and $3.9 million at June 30, 2015 and December 31, 2014, respectively. At June 30, 2015 loans over ninety days past due and still accruing interest totaled $225,000. There were no such loans at December 31, 2014.

 

At June 30, 2015 and December 31, 2014, all TDRs, including those on nonaccrual status, totaled $2.1 million and $3.9 million, respectively. The gross interest income that would have been recognized on TDRs according to the original loan terms during the six months ended June 30, 2015 totaled approximately $25,000; actual interest income recognized on these loans according to the restructured terms totaled $18,000. The gross interest income that would have been recognized on TDRs according to the original loan terms during the year ended December 31, 2014 totaled approximately $38,000; actual interest income recognized on these loans according to the restructured terms totaled approximately $11,000. During the quarter ended June 30, 2015, there were no loans that had their original loan terms restructured, and no loans that had previously had their original terms restructured went into nonaccrual. During the same period, no loans that had their original terms restructured paid off, and no amounts related to TDRs were charged off. TDRs did not have a material effect on the allowance for loan losses as of June 30, 2015 or December 31, 2014.

 

The following tables provide a year to date analysis of activity within the allowance for loan losses.

 

(Dollars in thousands)

 

June 30,

   

June 30,

 
   

2015

   

2014

 
                 

Balance, beginning of year

  $ 5,602     $ 6,041  

Provision for loan losses

    (900 )     -  

Net recoveries

    284       105  

Balance, end of quarter

  $ 4,986     $ 6,146  

 

 
-16-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

 

   

For the Six Months Ended June 30, 2015

 
   

Beginning Balance

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 

(Dollars in thousands)

                                 

General

Reserves

   

Specific

Reserves

   

Total

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,595     $ (35 )   $ -     $ (163 )   $ 1,319     $ 78     $ 1,397  

Multifamily Residential

    61       -       144       (125 )     80       -       80  

Commercial Real Estate

    1,424       -       190       (777 )     837       -       837  

Construction and Land Development

    312       -       18       118       448       -       448  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    496       (81 )     10       122       444       103       547  

Consumer and Other

    32       (6 )     44       (41 )     29       -       29  

Other

                                                       

Other General Reserves

    1,363       -       -       17       1,380       -       1,380  

Unallocated

    319       -       -       (51 )     268       -       268  

Total

  $ 5,602     $ (122 )   $ 406     $ (900 )   $ 4,805     $ 181     $ 4,986  

 

 

 

   

For the Six Months Ended June 30, 2014

 
   

Beginning Balance

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 

(Dollars in thousands)

                                 

General

Reserves

   

Specific

Reserves

   

Total

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,829     $ (52 )   $ 9     $ (506 )   $ 1,143     $ 137     $ 1,280  

Multifamily Residential

    58       -       -       139       48       149       197  

Commercial Real Estate

    1,031       (106 )     -       171       1,096       -       1,096  

Construction and Land Development

    585       (56 )     18       86       633       -       633  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    690       (42 )     181       (116 )     712       1       713  

Consumer and Other

    24       (1 )     45       (47 )     21       -       21  

Other

                                                       

Other General Reserves

    1,339       -       -       112       1,451       -       1,451  

Unallocated

    485       -       -       161       646       -       646  

Total

  $ 6,041     $ (257 )   $ 253     $ -     $ 5,750     $ 287     $ 6,037  

 

 
-17-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

   

For the Three Months Ended June 30, 2015

 
   

Beginning Balance

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 

(Dollars in thousands)

                                 

General

Reserves

   

Specific

Reserves

   

Total

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,515     $ -     $ -     $ (118 )   $ 1,319     $ 78     $ 1,397  

Multifamily Residential

    27       -       144       (91 )     80       -       80  

Commercial Real Estate

    813       -       -       24       837       -       837  

Construction and Land Development

    212       -       1       235       448       -       448  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    703       (81 )     4       (79 )     444       103       547  

Consumer and Other

    21       -       43       (35 )     29       -       29  

Other

                                                       

Other General Reserves

    1,275       -       -       105       1,380       -       1,380  

Unallocated

    309       -       -       (41 )     268       -       268  

Total

  $ 4,875     $ (81 )   $ 192     $ -     $ 4,805     $ 181     $ 4,986  

 

 

   

For the Three Months Ended June 30, 2014

 
   

Beginning Balance

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 

(Dollars in thousands)

                                 

General

Reserves

   

Specific

Reserves

   

Total

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,509     $ (52 )   $ -     $ (177 )   $ 1,143     $ 137     $ 1,280  

Multifamily Residential

    186       -       -       11       48       149       197  

Commercial Real Estate

    1,014       (106 )     -       188       1,096       -       1,096  

Construction and Land Development

    521       (56 )     18       150       633       -       633  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    769       -       87       (143 )     712       1       713  

Consumer and Other

    34       (1 )     1       (13 )     21       -       21  

Other

                                                       

Other General Reserves

    1,551       -       -       (100 )     1,451       -       1,451  

Unallocated

    562       -       -       84       646       -       646  

Total

  $ 6,146     $ (215 )   $ 106     $ -     $ 5,750     $ 287     $ 6,037  

 

 
-18-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 – Loans - (Continued)

 

   

For the Year Ended December 31, 2014

 
   

Beginning

Balance

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 

(Dollars in thousands)

                                 

General

Reserves

   

Specific

Reserves

   

Total

 

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,829     $ (52 )   $ 46     $ (228 )   $ 1,532     $ 63     $ 1,595  

Multi Family Residential

    58       (155 )     11       147       61       -       61  

Commercial Real Estate

    1,031       (159 )     342       210       1,424       -       1,424  

Construction and Land Development

    585       (114 )     21       (180 )     312       -       312  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    690       (42 )     218       (370 )     496       -       496  

Consumer and Other

    24       (1 )     46       (37 )     32       -       32  

Other

                                                       

Other General Reserves

    1,339       -       -       24       1,363       -       1,363  

Unallocated

    485       -       -       (166 )     319       -       319  

Total

  $ 6,041     $ (523 )   $ 684     $ (600 )   $ 5,539     $ 63     $ 5,602  

 

Impaired loans with a balance of $250,000 or more are evaluated individually for impairment. All other loans are collectively evaluated for impairment. The following tables provide summaries and totals of loans individually and collectively evaluated for impairment as of June 30, 2015 and December 31, 2014.

 

 

Loans Receivable:

 

As of June 30, 2015

 
                   

(Dollars in thousands)

 

Individually evaluated

for impairment

   

Collectively evaluated

for impairment

   

Total

 

Real Estate Secured

                       

1-4 Family Residential

  $ 2,009     $ 231,190     $ 233,199  

Multifamily Residential

    -       4,769       4,769  

Commercial Real Estate

    1,215       88,615       89,830  

Construction and Land Development

    -       31,399       31,399  

Non-Real Estate Secured

                       

Commercial and Industrial

    517       19,524       20,041  

Consumer and Other

    -       3,804       3,804  

Total

  $ 3,741     $ 379,301     $ 383,042  

 

Loans Receivable:

 

As of December 31, 2014

 
                   

(Dollars in thousands)

 

Individually evaluated

for impairment

   

Collectively evaluated

for impairment

   

Total

 

Real Estate Secured

                       

1-4 Family Residential

  $ 2,251     $ 215,267     $ 217,518  

Multifamily Residential

    -       5,108       5,108  

Commercial Real Estate

    1,096       86,810       87,906  

Construction and Land Development

    -       29,060       29,060  

Non-Real Estate Secured

                       

Commercial and Industrial

    545       21,477       22,022  

Consumer and Other

    -       2,534       2,534  

Total

  $ 3,892     $ 360,256     $ 364,148  

 

 
-19-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

(Dollars in thousands)

Impaired Loans

For the Six Months ended June 30, 2015

 

   

Unpaid

Principal

Balance

   

Recorded

Investment

(1)

   

Related

Allowance

   

Life to Date

Charge offs

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
                                                 

With no related allowance recorded

                                               

1-4 Family Residential

  $ 1,600     $ 1,479     $ -     $ 121     $ 1,496     $ 19  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,215       1,215       -       -       1,234       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    414       414       -       -       427       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

With an allowance recorded

                                               

1-4 Family Residential

  $ 565     $ 530     $ 78     $ 35     $ 635     $ -  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    -       -       -       -       -       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    103       103       103       -       103       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

                                               

1-4 Family Residential

  $ 2,165     $ 2,009     $ 78     $ 156     $ 2,131     $ 19  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,215       1,215       -       -       1,234       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    517       517       103       -       530       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

  $ 3,897     $ 3,741     $ 181     $ 156     $ 3,895     $ 19  

 

(1) Impaired balance; excludes accrued interest receivable and deferred fees and costs due to immateriality.

 

 
-20-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 – Loans - (Continued)

 

(Dollars in thousands)

Impaired Loans

For the Six Months Ended June 30, 2014

 

   

Unpaid

Principal

Balance

   

Recorded

Investment

(1)

   

Related

Allowance

   

Life to Date

Charge offs

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 

With no related allowance recorded

                                               

1-4 Family Residential

  $ 1,919     $ 1,837     $ -     $ 82     $ 1,833     $ -  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,816       1,816       -       -       1,851       6  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    460       460       -       -       470       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

With an allowance recorded

                                               

1-4 Family Residential

  $ 1,178     $ 1,057     $ 137     $ 121     $ 1,059     $ -  

Multifamily Residential

    986       986       149       -       986       -  

Commercial Real Estate

    -       -       -       -       -       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    111       111       1       -       114       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

                                               

1-4 Family Residential

  $ 3,097     $ 2,894     $ 137     $ 203     $ 2,892     $ -  

Multifamily Residential

    986       986       149       -       986       -  

Commercial Real Estate

    1,816       1,816       -       -       1,851       6  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    571       571       1       -       584       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

  $ 6,470     $ 6,267     $ 287     $ 203     $ 6,313     $ 6  

 

(1) Impaired balance; excludes accrued interest receivable and deferred fees and costs due to immateriality.

 

 
-21-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 - Loans (continued)

 

Impaired Loans

For the Three Months Ended June 30, 2015

 

(Dollars in thousands)

 

   

Unpaid

Principal

Balance

   

Recorded

Investment

(1)

   

Related

Allowance

   

Life to Date

Charge offs

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
                                                 

With no related allowance recorded

                                               

1-4 Family Residential

  $ 1,600     $ 1,479     $ -     $ 121     $ 1,482     $ 9  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,215       1,215       -       -       1,222       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    414       414       -       -       419       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

With an allowance recorded

                                               

1-4 Family Residential

  $ 565     $ 530     $ 78     $ 35     $ 533     $ -  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    -       -       -       -       -       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    103       103       103       -       104       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

                                               

1-4 Family Residential

  $ 2,165     $ 2,009     $ 78     $ 156     $ 2,015     $ 9  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,215       1,215       -       -       1,222       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    517       517       103       -       523       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

  $ 3,897     $ 3,741     $ 181     $ 156     $ 3,760     $ 9  

 

(1) Impaired balance; excludes accrued interest receivable and deferred fees and costs due to immateriality.

 

 
-22-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 - Loans (continued)

 

(Dollars in thousands)

 

Impaired Loans

For the Three Months Ended June 30, 2014

 

   

Unpaid

Principal

Balance

   

Recorded

Investment

(1)

   

Related

Allowance

   

Life to Date

Charge offs

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
                                                 

With no related allowance recorded

                                               

1-4 Family Residential

  $ 1,919     $ 1,837     $ -     $ 82     $ 1,807     $ -  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,816       1,816       -       -       1,834       3  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    460       460       -       -       465       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

With an allowance recorded

                                               

1-4 Family Residential

  $ 1,178     $ 1,057     $ 137     $ 121     $ 1,058     $ -  

Multifamily Residential

    986       986       149       -       986       -  

Commercial Real Estate

    -       -       -       -       -       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    111       111       1       -       113       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

                                               

1-4 Family Residential

  $ 3,097     $ 2,894     $ 137     $ 203     $ 2,865     $ -  

Multifamily Residential

    986       986       149       -       986       -  

Commercial Real Estate

    1,816       1,816       -       -       1,834       3  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    571       571       1       -       578       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

  $ 6,470     $ 6,267     $ 287     $ 203     $ 6,263     $ 3  

 

(1) Impaired balance; excludes accrued interest receivable and deferred fees and costs due to immateriality.

 

 
-23-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6 - Loans (continued)

 

(Dollars in thousands)

 

Impaired Loans

For the Year Ended December 31, 2014

 

   

Unpaid

Principal

Balance

   

Recorded

Investment

(1)

   

Related

Allowance

   

Life to Date

Charge offs

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
                                                 

With no related allowance recorded

                                               

1-4 Family Residential

  $ 1,859     $ 1,738     $ -     $ 121     $ 1,787     $ 12  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,096       1,096       -       -       1,127       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    545       545       -       -       565       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

With an allowance recorded

                                               

1-4 Family Residential

  $ 513     $ 513     $ 63     $ -     $ 517     $ -  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    -       -       -       -       -       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    -       -       -       -       -       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

                                               

1-4 Family Residential

  $ 2,372     $ 2,251     $ 63     $ 121     $ 2,304     $ 12  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    1,096       1,096       -       -       1,127       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    545       545       -       -       565       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

  $ 4,013     $ 3,892     $ 63     $ 121     $ 3,996     $ 12  

 

(1) Impaired balance; excludes accrued interest receivable and deferred fees and costs due to immateriality.

 

 
-24-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 7Repurchase Agreements

 

The Company utilizes retail repurchase agreements as a source of funding. Retail repurchase agreements are classified as short term debt obligations of the bank and will be deemed to mature every business day following the creation of the obligation. These obligations are contractually required to be fully collateralized by securities that are the direct obligation of, or which are fully guaranteed by, the United States or one of its agencies. The customers’ security interest in the securities pledged is perfected through the notification of the pledge to the securities’ safekeeping agent. The fair market values of the securities pledged are monitored on a daily basis to ensure that all borrowings are fully secured.

 

At June 30, 2015 retail repurchase agreements totaled $588,000 and were fully secured by a Freddie Mac mortgage backed security with a fair market value of $1.5 million.

 

Note 8Deferred Taxes

 

The Company maintains a valuation allowance of $261,000 related to its holding company net operating loss carryforward for state income taxes. Throughout the Company’s history, the holding company has consistently produced operating losses on a stand alone basis, and the realizability of this loss carryforward is considered unlikely. As of June 30, 2015, gross deferred tax assets totaled approximately $5.1 million, while deferred tax assets net of the valuation allowance totaled approximately $4.8 million.

 

During the six months and three months ended June 30, 2015, the Company recognized $1,533,000 and $455,000, respectively, of income tax expense. Of these amounts, $1,387,000 and $409,000 were for Federal income taxes. During the six months and three months ended June 30, 2014, the Company recognized $724,000 and $379,000, respectively, of income tax expense. Of these amounts, $657,000 and $339,000 were for Federal income taxes. Amounts related to Federal income taxes for 2015 and 2014 primarily represented direct reductions to the Company’s deferred tax asset related to its net operating loss carryforward. The deferred tax asset attributable to the Company’s net operating loss carryforward totaled approximately $1.9 million and $3.2 million at December 31, 2014 and December 31, 2013, respectively. Also during the six months ended June 30, 2015 and June 30, 2014, the Company’s gross unrealized securities losses declined by approximately $377,000 and $1,109,000, respectively, which decreased the deferred tax asset related to unrealized available for sale securities losses by approximately $136,000 and $399,000, respectively.

 

Note 9Fair Value Measurements

 

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

 

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

 

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage backed securities, municipal bonds, corporate debt securities, and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, real estate appraisals, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, asset- backed securities in less liquid markets, retained residual interests in securitizations, residential mortgage servicing rights, and other real estate owned when adjusting for selling costs, and impaired loans.

 

 
-25-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

The Company used the following methods and assumptions to estimate fair value:

 

Available for Sale Investment Securities

 

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available (Leve1 1). If quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Securities classified as Level 3 include asset-backed securities in less liquid markets. The fair values of level 3 available for sale investment securities are determined by a third party pricing service and reviewed by the Company’s Chief Financial Officer for reasonableness. The fair value of the trust preferred securities is computed based upon discounted cash flows estimated using interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation to the note classes.  Current estimates of expected cash flows are based on the most recent trustee reports and any other relevant market information, including announcements of interest payment deferrals or defaults of underlying issuers.  The payment, default and recovery assumptions are believed to reflect the assumptions of market participants. Cash flows are discounted at appropriate market rates, including consideration of credit spreads and illiquidity discounts.

 

Loans Held for Sale

 

Mortgage loans held for sale are carried at the lower of cost or market value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company categorizes loans subjected to nonrecurring fair value adjustments as Level 2. There were no fair value adjustments to mortgage loans held for sale as of June 30, 2015 and December 31, 2014.

 

 Impaired Loans 

 

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired.  Impaired loans are carried at the lesser of their principal balance or their fair value. The Company considers problem loans with principal balances of $250,000 or greater individually for impairment. The fair value of loans individually evaluated for impairment is estimated using one of several methods, including the present value of expected cash flows, market price of the loan, if available, or fair value of the underlying collateral less estimated costs to sell.  At June 30, 2015, all impaired loans deemed collateral dependent were evaluated based on the fair value of the underlying collateral less estimated costs to sell, while those not deemed collateral dependent were evaluated based on the present value of expected cash flows. Those impaired loans not requiring a specific allowance for loan losses allocation represent loans with fair values exceeding their recorded investments. Impaired loans for which a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. If the fair value of an impaired loan is based on an observable market price of the loan, the Company records the impaired loan as nonrecurring Level 2. When the fair value of an impaired loan is based on discounted cash flows or the fair value of the underlying collateral less estimated cost to sell, the Company records the impaired loan as nonrecurring Level 3.

 

Other real estate owned

 

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals.

 

For both collateral dependent impaired loans and other real estate owned the Company uses appraisals prepared by certifiedappraisal professionals whose qualifications and licenses have been reviewed and verified by the Company. These appraisals may utilize a single valuation approach or a combination of approaches, including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically lead to a Level 3 classification of the inputs for determining fair value. Once the Company receives an appraisal on an impaired loan, the Chief Credit Officer and Chief Financial Officer review the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics, as well as the Company’s own loss experience. For appraisals received on other real estate owned, the Chief Financial Officer and Chief Operating Officer use a similar approach. The Company may take additional discounts against the appraisals based on the circumstances surrounding individual properties.

 

 
-26-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

Assets measured at fair value on a recurring basis are as follows as of June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   

June 30, 2015

 
   

Quoted

Market Price in

Active Markets

(Level 1)

   

Significant

Other Observable

Inputs

(Level 2)

   

Significant Unobservable

Inputs

(Level 3)

   

Total

 

Available-for-sale investment securities

                               

Mortgage backed

                               

Government sponsored enterprises

  $ -     $ 22,773     $ -     $ 22,773  

Municipals

    -       3,648       -       3,648  

Other

    -       4,128       2,860       6,988  
                                 

Total assets at fair value

  $ -     $ 30,549     $ 2,860     $ 33,409  

 

   

December 31, 2014

 
   

Quoted

Market Price in

Active Markets

(Level 1)

   

Significant

Other Observable

Inputs

(Level 2)

   

Significant Unobservable

Inputs

(Level 3)

   

Total

 

Available-for-sale investment securities

                               

Mortgage backed

                               

Government sponsored enterprises

  $ -     $ 24,938     $ -     $ 24,938  

Municipals

    -       4,184       -       4,184  

Other

    -       4,139       2,008       6,147  
                                 

Total assets at fair value

  $ -     $ 33,261     $ 2,008     $ 35,269  

 

 

Investments in collateralized debt obligations and a single-issue trust preferred security comprise the Company’s Level 3 assets as shown above. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

There were no transfers between Level 1 and Level 2 during 2015 or 2014.

 

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

 

 
-27-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

The following table reconciles the changes in recurring Level 3 financial instruments for the six months ended

June 30, 2015 and 2014 (dollars in thousands):

 

   

June 30,

   

June 30,

 
   

2015

   

2014

 
                 

Beginning of Year Balance

  $ 2,008     $ 1,836  

Discount Accretion

    5       5  

Reduction in Unrealized Loss

    847       319  
                 

Ending Balance

  $ 2,860     $ 2,160  

 

The following table presents quantitative information about Level 3 fair value measurements at June 30, 2015 (dollars in thousands):

 

Security Type

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

Rates

                   

Collateralized Debt Obligations

  $ 2,360  

Discounted cash flows and recent trade

 

Discount rate

 

Approximately 8%

              Weighted default probability for deferring issuers   Approximately 36%
              Recovery rate on deferring issuers   10% - 15%
              Default probability for current issuers   0.33% - 7.50%

Trust Preferred Security

  $ 500  

Discounted cash flows

 

Discount rate

 

Approximately 4%

 

The significant unobservable inputs used in the fair value measurement of the Company’s collateralized debt obligations investments are prepayment rates, probability of default, and loss severity in the event of default. Significant increases/(decreases) in any of those inputs in isolation would result in a significantly lower/(higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

 

In addition to the collateralized debt obligations included in the table above, the Company owns a trust preferred security backed by a single issuer for which meaningful pricing data is not readily available. The security’s book value of $500,000 is assumed to equal its fair value. The discount rate shown for the security in the table above approximates the security’s yield at June 30, 2015.

 

No changes in unrealized gains and losses for Level 3 asssets were recorded in earnings for either of the six month periods ended June 30, 2015 or June 30, 2014.

 

 
-28-

 

 

SOUTHCOAST FINANCIAL CORPORATION


Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

Assets measured at fair value on a nonrecurring basis are as follows as of June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   

June 30, 2015

 
   

Quoted

Market Price in

Active Markets

(Level 1)

   

Significant

Other Observable

Inputs

(Level 2)

   

Significant Unobservable

Inputs

(Level 3)

   

Total

 

Impaired Loans

                               

1 - 4 Family Residential

  $ -     $ -     $ 1,850     $ 1,850  

Commercial Real Estate

    -       -       1,237       1,237  

Other Real Estate Owned

                               

Construction and Land Development

    -       -       54       54  
                                 

Total assets at fair value

  $ -     $ -     $ 3,141     $ 3,141  

 

   

December 31, 2014

 
   

Quoted

Market Price in

Active Markets

(Level 1)

   

Significant

Other Observable

Inputs

(Level 2)

   

Significant Unobservable

Inputs

(Level 3)

   

Total

 

Impaired Loans

                               

1 - 4 Family Residential

  $ -     $ -     $ 2,124     $ 2,124  

Commercial Real Estate

    -       -       1,105       1,105  

Other Real Estate Owned

                               

1 - 4 Family Residential

    -       -       334       334  

Construction and Land Development

    -       -       54       54  
                                 

Total assets at fair value

  $ -     $ -     $ 3,617     $ 3,617  

 

Impaired loans measured at fair value had a recorded investment of $3,052,000 with a valuation allowance of $181,000 at June 30, 2015, resulting in an additional provision for loan losses of $132,000 for the six months ended June 30, 2015. This additional provision included $30,000 for 1-4 Family residential loans, and $102,000 for a single commercial and industrial loan for which a full reserve was established. The additional provision for loan losses for the three months ended June 30, 2015 totaled $30,000. This additional provision related to a single 1 – 4 Family Residential loan.

 

Impaired loans measured for impairment using the fair value of the collateral had a recorded investment of $3,065,000 with a valuation allowance of $63,000 at December 31, 2014, resulting in an additional provision for loan losses of $40,000 for the year ended December 31, 2014. This additional provision was assigned to 1 – 4 Family Residential loans.

 

Impaired loans measured at fair value had a recorded investment of $3,110,000 with a valuation allowance of $287,000 at June 30, 2014, resulting in an additional provision for loan losses of $207,000 for the six months ended June 30, 2014. This additional provision included $1,000 for Commercial and Industrial loans, $67,000 for 1 – 4 Family Residential loans, and $139,000 for Multifamily loans. The additional provision for loan losses for the three months ended June 30, 2014 totaled $71,000. This additional provision included $1,000 for Commercial and Industrial loans, $67,000 for 1 – 4 Family Residential loans, and $3,000 for Multifamily loans.

 

Other real estate owned measured at fair value less estimated costs to sell at June 30, 2015, had a net carrying amount of $50,000, which was comprised of the outstanding balance of $165,000, net of a valuation allowance of $115,000. No impairment provisions were made during the six months or three months ended June 30, 2015. Other real estate owned measured at fair value less costs to sell at December 31, 2014, had a net carrying amount of $361,000, which was comprised of the outstanding balance of $482,000, net of a valuation allowance of $121,000. This valuation allowance included $6,000 of impairment provision made during the year ended December 31, 2014, which related entirely to 1-4 Family Residential real estate.

 

 
-29-

 

 

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

Other real estate owned measured at fair value less estimated costs to sell at June 30, 2014, had a net carrying amount of $361,000, which was comprised of the outstanding balance of $482,000, net of a valuation allowance of $121,000. This valuation allowance included an impairment provision of $6,000 made during the six months ended June 30, 2014, all of which related to 1 – 4 Family Residential property. No impairment provision was made for the three months ending June 30, 2014.

 

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

  

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2015 and December 31, 2014:

 

   

Valuation Techniques

 

Unobservable Inputs

  Range  

Impaired Loans

                 
                   

1 - 4 Family Residential

 

Sales comparison approach

 

Bank Owned Discount

  10% - 20%  
Multifamily Residential                  
Construction and Land Development                  
                   

Commercial Real Estate

 

Sales comparison approach

 

Bank Owned Discount

   10% - 20%  
    Income approach   Capitalization Rate    8% - 12%  
                   

Other Real Estate Owned

                 
                   

Commercial Office Properties

 

Sales comparison approach

 

Bank Owned Discount

   10% - 20%  
    Income approach   Capitalization Rate    8% - 12%  
                   

Commercial Lots

 

Sales comparison approach

 

Bank Owned Discount

   10% - 20%  
Residential 1 – 4 Family Lots                  
Residential 1 – 4 Family Homes                  
Residential 1 – 4 Family Under Construction                  
Multifamily Residential                  

 
-30-

 

 

SOUTHCOAST FINANCIAL CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

The estimated fair values of the Company’s financial instruments are as follows (dollars in thousands):

 

  Fair Value Measurements at June 30, 2015 Using:  
   

Carrying

                                 
   

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 

Financial assets

                                       

Cash and cash equivalents

  $ 47,189     $ 47,189     $ -     $ -     $ 47,189  

Available for sale investment securities

    33,409       -       30,549       2,860       33,409  

Federal Home Loan Bank Stock

    3,824    

N/A

   

N/A

   

N/A

   

N/A

 
                                         

Loans, net

    378,056       -       -       374,592       374,592  

Accrued interest receivable

    1,202       -       90       1,112       1,202  
                                         

Financial liabilities

                                       

Deposits

    361,188       233,880       127,620       -       361,500  

Short term borrowings

    588       -       588       -       588  

Advances from Federal Home Loan Bank

    80,000       -       83,292       -       83,292  

Junior subordinated debentures

    10,310       -       -       5,086       5,086  

Accrued interest payable

    432       1       430       1       432  

 

  Fair Value Measurements at December 31, 2014 Using:  
   

Carrying

                                 
   

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 

Financial assets

                                       

Cash and cash equivalents

  $ 33,572     $ 33,572     $ -     $ -     $ 33,572  

Available for sale investment securities

    35,269       -       33,261       2,008       35,269  

Federal Home Loan Bank Stock

    4,000    

N/A

   

N/A

   

N/A

   

N/A

 

Loans, net

    358,546       -       -       355,310       355,310  

Accrued interest receivable

    1,169       -       97       1,072       1,169  
                                         

Financial liabilities

                                       

Deposits

    331,034       210,391       120,950       -       331,341  

Short term borrowings

    3,802       -       3,802       -       3,802  

Advances from Federal Home Loan Bank

    80,000       -       83,488       -       83,488  

Junior subordinated debentures

    10,310       -       -       5,018       5,018  

Accrued interest payable

    777       -       776       1       777  

 

Valuation Methodologies – Assets and Liabilities not recorded at Fair Value

 

The following is a description of the valuation methodologies used for assets and liabilities that are not recorded at fair value, but whose fair value must be estimated and disclosed:

 

Cash and Cash Equivalents

 

The carrying amounts of cash and short-term instruments approximate fair values and are classified Level 1.

 

FHLB Stock

 

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.  

 

 
-31-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 9Fair Value Measurements (continued)

 

Loans

 

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values, resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

 

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors, resulting in a Level 2 classification.

 

Deposits

 

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount), resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date, resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits, resulting in a Level 2 classification.

 

Short-term Borrowings

 

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values, resulting in a Level 2 classification.

 

Other Borrowings

 

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements, resulting in a Level 2 classification.

 

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements, resulting in a Level 3 classification.

 

Accrued Interest Receivable/Payable

 

The carrying amounts of accrued interest are assigned Levels 1, 2, or 3 classifications commensurate with the assets or liabilities with which they are associated.

 

Off-balance Sheet Instruments

 

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

 

 
-32-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

The following discussion and analysis should be read in conjunction with the financial statements and related notes appearing herein and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Results of operations for the period ending June 30, 2015 are not necessarily indicative of the results to be attained for any other period.

 

This Report on Form 10-Q may contain forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and similar matters. All statements that are not historical facts are "forward-looking statements." The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. Forward-looking statements include statements with respect to management's beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond the Company's control, and which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. These forward-looking statements can be identified through use of words such as "may," "will," "anticipate," "assume," "should," "indicate," "would," "believe," "contemplate," "expect," "seek," "estimate," "continue," "plan," "point to," "project," “projection,” "predict," "could," "intend," "target," "potential," and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

 

 

o

future economic and business conditions;

 

o

lack of sustained growth and disruptions in the economy of the Greater Charleston area, including, but not limited to, falling real estate values and increasing levels of unemployment;

 

o

government monetary and fiscal policies;

 

o

the effects of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities;

 

o

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment, and insurance services, as well as competitors that offer banking products and services by mail, telephone, computer and/or the Internet;

 

o

the effects of credit rating downgrades on the value of investment securities issued or guaranteed by various governments and government agencies, including the United States of America;

 

o

credit risks;

 

o

higher than anticipated levels of defaults on loans;

 

o

perceptions by depositors about the safety of their deposits;

 

o

the failure of assumptions underlying the establishment of the allowance for loan losses and other estimates, including the value of collateral securing loans;

 

o

changes in assumptions underlying allowances on deferred tax assets;

 

o

changes in assumptions underlying, or accuracy of, analysis relating to other-than-temporary impairment of assets; 

 

o

accuracy of fair value measurements and the methods and assumptions used to estimate fair value; 

 

o

the risks of opening new offices, including, without limitation, the related costs and time of building customer relationships and integrating operations as part of these endeavors and the failure to achieve expected gains, revenue growth and/or expense savings from such endeavors;

 

o

changes in laws and regulations, including tax, banking and securities laws and regulations and deposit insurance assessments;

 

o

the effect of agreements with regulatory authorities, which restrict various activities and impose additional administrative requirements without commensurate benefits;

 

o

changes in the requirements of regulatory agencies;

 

o

changes in accounting policies, rules and practices;

 

o

changes in technology or products that may be more difficult or costly, or less effective than anticipated;

 

o

cybersecurity risk related to our dependence on internal security systems and the technology of outside service providers, as well as the potential impacts of third party security breaches;

 

o

the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic conditions and economic confidence;

 

o

loss of consumer or investor confidence; and

 

o

other factors and information described in any of the reports that we file with the Securities and Exchange Commission under the Securities Exchange Act of 1934.

  

 
-33-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The Company has no obligation, and does not undertake, to update, revise or correct any of the forward-looking statements after the date of this report. The Company has expressed its expectations, beliefs, and projections in good faith and believes they have a reasonable basis. However, there is no assurance that these expectations, beliefs or projections will result or be achieved or accomplished.

 

Results of Operations

 

The Company’s net income for the six months ended June 30, 2015 was $2,851,000 or $0.40 per basic share, compared to net income of $1,352,000, or $0.19 per basic share, for the six months ended June 30, 2014. The average number of basic shares outstanding for the six months ended June 30, 2015 was 7,101,865 compared to 7,087,860 for the six months ended June 30, 2014.

 

The Company’s net income for the three months ended June 30, 2015 was approximately $873,000 or $0.12 per basic share, compared to net income of approximately $709,000, or $0.10 per basic share, for the three months ended June 30, 2014. The average number of basic shares outstanding for the three months ended June 30, 2015 was 7,103,751 compared to 7,089,902 for the three months ended June 30, 2014.

 

Net Interest Income

 

Net interest income is the difference between the interest earned on interest earning assets and the interest paid for funds acquired to support those assets, and is the principal source of the Company’s earnings. Net interest income was $7.9 million for the six months ended June 30, 2015, compared to $7.2 million for the six months ended June 30, 2014. Net interest income was $3.9 million for the three months ended June 30, 2015, compared to $3.6 million for the three months ended June 30, 2014. Net interest income for the six months ended June 30, 2015 included $275,000 of additional interest income that was recognized as a result of loan payoffs on two nonaccruing loans. These payoffs occurred during the three months ended March 31, 2015, and added approximately 0.31% to annualized loan yields for the three months ended March 31, 2015. Loan yields for the three months ended March 31, 2015 were 5.12%.

 

Changes that affect net interest income include changes in the average rate earned on interest earning assets, changes in the average rate paid on interest bearing liabilities, and changes in the volumes of interest earning assets and interest bearing liabilities. The increase in the Company’s net interest income for the six months and three months ended June 30, 2015 compared to the same periods of 2014 was due to increased interest income and decreased interest expense between the two periods. The increase in interest income related primarily to interest income on loans. The decrease in interest expense was primarily driven by lower interest expense on deposits, partially offset by a small increase in interest expense on other borrowings. Interest expense on deposits decreased between the two periods due primarily to changes in rate, as the Company was able to lower its cost of funds on both its time deposits and savings and interest bearing transaction accounts.

 

Average earning assets for the six months ended June 30, 2015 increased 8.5 percent to $423.5 million from the $390.2 million reported for the six months ended June 30, 2014. The increase was primarily attributable to an increase of $33.2 million in average loans. The increase in average loans between the two periods was primarily due to growth in the Company’s loan portfolio.

 

Average interest bearing liabilities for the six months ended June 30, 2015 increased 3.9 percent to $363.1 million from the $349.6 million reported for the six months ended June 30, 2014. The increase was attributable to an increase of $26.5 million in average savings and transacation accounts, partially offset by decreases of $12.6 million and $400,000 in average time deposits and other borrowings, respectively. The decrease in average time deposits was attributable to a decrease of $18.4 million in retail time deposits, partially offset by a $5.8 million increase in brokered and wholesale time deposits, respectively. The decrease in average other borrowings primarily related to repurchase agreements and federal funds purchased, partially offset by an increase in average Federal Home Loan Bank Borrowings.

 

 
-34-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Net Interest Income(continued)

 

The following table compares the average balances, yields and rates for the interest sensitive segments of the Company’s balance sheets for the six months ended June 30, 2015 and 2014.

 

   

For the six months ended

   

For the six months ended

 

(Dollars in thousands)

 

June 30, 2015

   

June 30, 2014

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 
   

Balance

   

Expense

   

Rate(1)

   

Balance

   

Expense

   

Rate(1)

 

Assets

                                               

Cash and Federal funds sold

  $ 19,636     $ 23       0.23 %   $ 13,186     $ 16       0.24 %

Investments – taxable

    35,774       415       2.34       42,044       503       2.41  

Investments - nontaxable (2)

    3,826       119       6.31       3,920       118       6.07  
                                                 

Total investments and federal funds sold

    59,236       557       1.90       59,150       637       2.17  
                                                 

Loans (3)(4)

    364,290       9,075       5.00       331,042       8,417       5.11  
                                                 

Total earning assets/interest income

    423,526       9,632       4.57 %     390,192       9,054       4.66 %

Other assets

    50,391                       56,150                  
                                                 

Total assets

  $ 473,917                     $ 446,342                  
                                                 

Liabilities

                                               

Savings and transaction accounts

  $ 163,362       297       0.37 %   $ 136,828       340       0.50 %

Time deposits

    124,707       421       0.68       137,318       489       0.71  

Other borrowings

    64,761       898       2.80       65,114       891       2.74  

Subordinated debt

    10,310       89       1.74       10,310       89       1.74  
                                                 

Total interest bearing liabilities/interest expense

    363,140       1,705       0.94 %     349,570       1,809       1.04 %
                                                 

Non-interest bearing liabilities

    61,853                       53,181                  
                                                 

Total liabilities

    424,993       1,705       0.81 %     402,751       1,809       0.90 %
                                                 

Equity

    48,924                       43,591                  
                                                 

Total liabilities and equity

  $ 473,917                     $ 446,342                  
                                                 

Net interest income/margin (5)

          $ 7,927       3.76 %           $ 7,245       3.72 %
                                                 

Net interest spread (6)

                    3.63 %                     3.62 %

 

(1) Annualized

(2) Yield is calculated on a tax equivalent basis.

(3) Does not include nonaccruing loans.

(4) Income includes loan fees of $333,000 in 2015 and $341,000 in 2014.

(5) Net interest income divided by total earning assets.

(6) Total interest earning assets yield less interest bearing liabilities rate.

 

 
-35-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Net Interest Income(continued)

 

As shown above, for the six months ended June 30, 2015 the average yield on earning assets was 4.57 percent, while the average cost of interest bearing liabilities was 0.94 percent. For the six months ended June 30, 2014 the average yield on earning assets was 4.66 percent and the average cost of interest-bearing liabilities was 1.04 percent. The moderate decrease in the overall asset yield reflects decreases in yields on loans and investments and federal funds sold, for which yields decreased by 0.11 percent and 0.27 percent, respectively. Due to a change in earning asset mix between the periods, overall asset yields only declined by 0.09 percent, as average loans accounted for nearly the entire growth in average earning assets between the periods. Because average loans carry a higher yield than average investments and federal funds sold, the overall asset yield decrease was reduced. The decrease in the cost of average interest bearing liabilities was primarily due to decreases in average rates paid on savings and transaction accounts. The net interest margin was 3.76 percent and 3.72 percent for the six months ended June 30, 2015 and 2014, respectively. The increase in the net interest margin was attributable to an increase of $682,000 in net interest income, which was comprised of an increase in interest income of $578,000 and a decrease in interest expense of $104,000. The increase in interest income was primarily due to a $658,000 increase in interest income on loans, partially offset by a decrease of $80,000 in interest income on investments and federal funds sold. The interest expense reduction was primarily attributable to a $68,000 decrease in interest expense on time deposits.

 

The following tables present changes in the Company’s net interest income which are primarily a result of changes in the volume and rates of its interest-earning assets and interest-bearing liabilities.

 

   

Analysis of Changes in Net Interest Income

 

(Dollars in thousands)

 

For the six months ended June 30, 2015

 
   

Versus six months ended June 30, 2014 (1)

 
   

Volume

   

Rate

   

Net Change

 

Interest income:

                       
                         

Cash and Federal funds sold

  $ 8     $ (1 )   $ 7  

Investments - taxable

    (75 )     (13 )     (88 )

Investments - nontaxable (2)

    (3 )     4       1  
                         

Total investments and federal funds sold

    (70 )     (10 )     (80 )
                         

Net loans (3)(4)

    847       (189 )     658  
                         

Total interest income

    777       (199 )     578  
                         

Interest expense:

                       
                         

Savings and transaction accounts

    65       (108 )     (43 )

Time deposits

    (45 )     (23 )     (68 )

Other borrowings

    (5 )     12       7  

Subordinated debt

    -       -       -  
                         

Total interest expense

    15       (119 )     (104 )
                         

Net interest income

  $ 762     $ 80     $ 682  

 

 

(1)

Changes in rate/volume have been allocated to each category on a consistent basis between rate and volume.

 

(2)

Yield is calculated on a tax equivalent basis.

 

(3)

Income includes loan fees of $333,000 in 2015 and $341,000 in 2014.

 

(4)

Does not include nonaccruing loans.

 

 
-36-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Net Interest Income(continued)

 

Average earning assets for the three months ending June 30, 2015 increased 8.8 percent to $431.7 million from the $396.7 million reported for the three months ending June 30, 2014. The increase was primarily attributable to increases of $32.1 million, and $9.5 million in average loans, and average cash and federal funds sold, respectively, partially offset by a decrease of $6.4 million in average taxable investments. The increase in average loans between the two periods was primarily due to growth in the Company’s loan portfolio.

 

Average interest bearing liabilities for the three months ending June 30, 2015 increased 3.8 percent to $365.6 million from $352.1 million for the three months ending June 30, 2014. The increase was primarily attributable to an increase of $26.7 million in average savings and transacation accounts, partially offset by a decrease of $11.9 million in average time deposits. The decrease in average time deposits was attributable to a decrease of $12.5 million in average retail time deposits, partially offset by an increase of $600,000 in brokered and wholesale time deposits.

 

 
-37-

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Net Interest Income(continued)

 

The following table compares the average balances, yields and rates for the interest sensitive segments of the Company’s balance sheets for the three months ended June 30, 2015 and 2014.

 

(Dollars in thousands)

 

For the three months ended

   

For the three months ended

 
   

June 30, 2015

   

June 30, 2014

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 
   

Balance

   

Expense

   

Rate(1)

   

Balance

   

Expense

   

Rate(1)

 

Assets

                                               

Cash and Federal funds sold

  $ 24,256     $ 15       0.25 %   $ 14,737     $ 10       0.26 %

Investments – taxable

    35,184       201       2.29       41,619       240       2.32  

Investments - nontaxable (2)

    3,728       60       6.52       3,920       59       6.04  
                                                 

Total investments and federal funds sold

    63,168       276       1.76       60,276       309       2.06  
                                                 

Loans (3)(4)

    368,568       4,471       4.87       336,440       4,182       4.99  
                                                 

Total earning assets/interest income

    431,736       4,747       4.41 %     396,716       4,491       4.54 %

Other assets

    46,933                       54,870                  
                                                 

Total assets

  $ 478,669                     $ 451,586                  
                                                 

Liabilities

                                               

Savings and transaction accounts

  $ 164,636       143       0.35 %   $ 137,979       162       0.47 %

Time deposits

    127,834       217       0.68       139,719       244       0.70  

Other borrowings

    62,818       451       2.88       64,076       446       2.80  

Subordinated debt

    10,310       45       1.74       10,310       44       1.70  
                                                 

Total interest bearing liabilities/interest expense

    365,598       856       0.94       352,084       896       1.02  
                                                 

Non-interest bearing liabilities

    63,786                       55,384                  
                                                 

Total liabilities

    429,384       856       0.80       407,468       896       0.88  
                                                 

Equity

    49,285                       44,118                  
                                                 

Total liabilities and equity

  $ 478,669                     $ 451,586                  
                                                 

Net interest income/margin (5)

          $ 3,891       3.65 %           $ 3,595       3.65 %
                                                 

Net interest spread (6)

                    3.47 %                     3.52 %

 

(1)

Annualized

 

(2)

Yield is calculated on a tax equivalent basis.

 

(3)

Does not include nonaccruing loans.

 

(4)

Income includes loan fees of $182,000 in 2015 and $170,000 in 2014.

 

(5)

Net interest income divided by total earning assets.

 

(6)

Total interest earning assets yield less interest bearing liabilities rate.

 

 
-38-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Net Interest Income(continued)

 

As shown above, for the three months ended June 30, 2015 the average yield on earning assets was 4.41 percent, while the average cost of interest bearing liabilities was 0.94 percent. For the three months ended June 30, 2014 the average yield on earning assets was 4.54 percent and the average cost of interest-bearing liabilities was 1.02 percent. The moderate decrease in the overall asset yield is primarily due to loan yields, which decreased to 4.87% for the three months ended June 30, 2015 from 4.99% for the three months ended June 30, 2014. Another factor in the overall asset yield decrease was a change in the earning asset mix between the two periods, as average interest bearing cash and federal funds sold comprised 5.6% of average earning assets during the three months ended June 30, 2015, compared to 3.7% for the three months ended June 30, 2014. Partially offsetting the earning asset yield decrease was an increase in yields on nontaxable investments, which had tax equivalent yields of 6.52% and 6.04% for the three months ended June 30, 2015 and June 30, 2014, respectively. The increase in yields on nontaxable investments was due to the recognition of additional interest income on a municipal security that had a remaining unaccreted discount at the time of its call by the issuer during the quarter. The decrease in the cost of average interest bearing liabilities was primarily due to decreases in average rates paid on savings and transaction accounts. The net interest margin was 3.65 percent for each of the three month periods ended June 30, 2015 and 2014.

 

The following tables present changes in the Company’s net interest income which are primarily a result of changes in the volume and rates of its interest-earning assets and interest-bearing liabilities.

 

   

Analysis of Changes in Net Interest Income

 

(Dollars in thousands)

 

For the three months ended June 30, 2015

 
   

Versus three months ended June 30, 2014 (1)

 
   

Volume

   

Rate

   

Net Change

 

Interest income:

                       
                         

Cash and Federal funds sold

  $ 6     $ (1 )   $ 5  

Investments - taxable

    (37 )     (2 )     (39 )

Investments - nontaxable(2)

    (3 )     4       1  
                         

Total investments and federal funds sold

    (34 )     1       (33 )
                         

Net loans (3)(4)

    400       (111 )     289  
                         

Total interest income

    366       (110 )     256  
                         

Interest expense:

                       
                         

Savings and transaction accounts

    31       (50 )     (19 )

Time deposits

    (21 )     (6 )     (27 )

Other borrowings

    (8 )     13       5  

Subordinated debt

    -       1       1  
                         

Total interest expense

    2       (42 )     (40 )
                         

Net interest income

  $ 364     $ (68 )   $ 296  

 

 

(1)

Changes in rate/volume have been allocated to each category on a consistent basis between rate and volume.

 

(2)

Yield is calculated on a tax equivalent basis.

 

(3)

Income includes loan fees of $182,000 in 2015 and $170,000 in 2014.

 

(4)

Does not include nonaccruing loans.

 

 
-39-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Noninterest Income and Expenses

 

Noninterest income for the six months ended June 30, 2015 was approximately $1,835,000, compared to approximately $1,118,000 for the six months ended June 30, 2014, an increase of approximately $717,000. The increase was primarily due to a $750,000 gain recognized on the sale of premises and equipment during the six months ended June 30, 2015. The premises disposed of was an unoccupied lot adjacent to the Company’s headquarters and main office. There were no such gains during the six months ended June 30, 2014. Also contributing to the increase in noninterest income were increases of $40,000 and $24,000 in gains on the sale of mortgage loans, and service fees on deposit accounts, respectively. These increases in noninterest income were partially offset by a decrease of $109,000 in gains on the sale of available for sale securities between the two periods. For the six months ended June 30, 2014 there were gains on the sale of available for sale securities of $109,000. There were no such gains for the six months ended June 30, 2015.

 

Noninterest income for the three months ended June 30, 2015 was approximately $554,000, compared to approximately $630,000 for the six months ended June 30, 2014, a decrease of approximately $76,000. This was primarily due to a decrease of approximately $109,000 in gains on sale of available for sale securities between the two periods. For the three months ended June 30, 2014 there were gains on the sale of available for sale securities of $109,000. There were no such gains for the three months ended June 30, 2015. This decrease was partially offset by a $26,000 increase in gains on mortgage loans held for sale between the two periods.

 

Noninterest expenses for the six months ended June 30, 2015 were $6,235,000, compared to $6,245,000 for the six months ended June 30, 2014, a decrease of $10,000. The largest contributing factors to this decrease were a $57,000 decrease in other real estate impairment provisions and operating expenses, net of rental income, a $40,000 decrease in in occupancy expenses, and a $40,000 decrease in insurance costs. Additionally, there was a $95,000 decrease in noninterest expenses related to the Allowance for Unfunded Commitments. The Allowance for Unfunded Commitments provides for future losses on contractual commitments to extend credit that have not yet been funded. The adequacy of the Allowance for Unfunded Commitments is analyzed on a quarterly basis. These decreases in noninterest expenses were partially offset by a $204,000 increase in salaries and benefits.

 

Noninterest expenses for the three months ended June 30, 2015 were $3,095,000, compared to $3,115,000 for the three months ended June 30, 2014, a decrease of $20,000. There was a $42,000 decrease in noninterest expenses due to increased gains on the sale of other real estate, which are accounted for as an offset to noninterest expense. Additionally, insurance expense and other expenses decreased by $27,000 and $77,000, respectively. The decrease in insurance expense was primarily attributable to lower FDIC premiums. The decrease in other expenses was attributable to many small differences in miscelleaneous expenses. These decreases were partially offset by a $133,000 increase in salaries and benefits between the two periods.

 

Income Taxes

 

The Company’s income tax expense for the six months ended June 30, 2015 totaled $1,533,000, comprised of $1,387,000 for Federal income taxes and $146,000 for South Carolina income taxes. The Company’s income tax expense for the six months ended June 30, 2014 totaled $724,000, comprised of $657,000 for Federal income taxes and $67,000 for South Carolina income taxes. The effective tax rates were 35% and 34.9% for the six months ended June 30, 2015 and June 30, 2014, respectively.

 

The Company’s income tax expense for the three months ended June 30, 2015 totaled $455,000, comprised of $409,000 for Federal income taxes and $46,000 for South Carolina income taxes. The Company’s income tax expense for the three months ended June 30, 2014 totaled $379,000, comprised of $339,000 for Federal income taxes and $40,000 for South Carolina income taxes. The effective tax rates were 34.3% and 34.8% for the three months ended June 30, 2015 and June 30, 2014, respectively.

 

 
-40-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Liquidity

 

Liquidity is the ability to meet current and future obligations through liquidation or maturity of existing assets or the acquisition of additional liabilities. Adequate liquidity is necessary to meet the requirements of customers for loans and deposit withdrawals in the most timely and economical manner. Some liquidity is ensured by maintaining assets which may be immediately converted into cash at minimal cost (amounts due from banks and federal funds sold). However, the most manageable sources of liquidity are composed of liabilities, with the primary focus of liquidity management being on the ability to obtain deposits within the Bank’s service area. Core deposits (total deposits less certificates of deposit $250,000 or more, wholesale and brokered deposits) provide a relatively stable funding base, and were equal to 93.5% of total deposits as of June 30, 2015. Asset liquidity is provided from several sources, including amounts due from banks and federal funds sold and funds from maturing loans. The Bank is a member of the Federal Home Loan Bank of Atlanta (”FHLBA”) and, as such has the ability to borrow against pledges of its 1-4 family residential mortgage loans and its commercial real estate loans. Available borrowings under this line totaled $28.7 million at June 30, 2015. The Company also has federal funds accommodations of $10 million with Alostar Bank of Commerce, $10 million with Zions Bank, $5 million with Center State Bank, and $8 million with First Tennessee Bank. These accommodations may be withdrawn at any time at the sole discretion of these institutions. Additionally, the Company has a borrowing line with the Federal Reserve Bank of Richmond’s discount window. The Company has pledged its portfolios of construction and land development loans, and commercial and industrial loans against this borrowing line. Total available borrowings under this line were $25.8 million at June 30, 2015.

 

Loans

 

Gross loans totaled approximately $383,042,000 and $364,148,000 at June 30, 2015 and December 31, 2014, respectively. At June 30, 2015, the Company had $4.5 million of nonaccrual loans and $225,000 of loans 90 days delinquent and still accruing interest. Of these, $3.9 million are secured by real estate. The primary risk of loss on these loans is a potential deterioration of real estate collateral values. At December 31, 2014, the Company had $5.0 million of nonaccrual loans and no loans 90 days past due and still accruing interest. At June 30, 2014, the Company had $7.5 million of nonaccrual loans and $102,000 of loans 90 days past due and still accruing interest. The allowance for loan losses was 1.30 percent of loans as of June 30, 2015, compared to 1.54 percent as of December 31, 2014 and 1.73 percent as of June 30, 2014.

 

For six months ended June 30, 2015 the Company credited its loan loss provision $900,000. For the six months ended June 30, 2014 the Company recorded no loan loss provision. Net recoveries for the six months ended June 30, 2015 and June 30, 2014 totaled approximately $284,000 and $105,000, respectively. The need for future loan loss provisions will be influenced by loan defaults, loan delinquency levels, loan chargeoffs beyond what has already been provided for on individual loans, the level of loans with credit grades of 6 through 9, and the need for additional specific reserves on loans individually evaluated for impairment, among other factors. In reviewing the adequacy of the allowance for loan losses at each quarter end, management takes into consideration the historical loan losses, current levels of past due loans by loan type, the historical severity of loan losses by loan type, loan to value exceptions in our loan portfolio, potential repayment risk for floating and adjustable rate loans due to the potential for rising interest rates, risks posed by unseasoned loans during periods of growth in the loan portfolio, and collateral values of impaired loans deemed to be collateral dependent. As referenced in Note 6, the Company’s general reserves portion of its allowance for loan losses decreased by $734,000 during the six months ended June 30, 2015, from $5,539,000 at December 31, 2014 to $4,805,000 at June 30, 2015. The main factor leading to the loan loss provision credit of $900,000 for the six months ended June 30, 2015 was a reduction in required general reserves related to loan default and loss severities risks totaling approximately $522,000. This reduction was the result of the inclusion of 2014 loan defaults and chargeoffs and recoveries data into the calculation of historical averages for these factors. Due to a comparatively low level of defaults, and net recoveries totaling $161,000 during 2014, the Company’s historical average defaults and loss severities were lessened significantly by the inclusion of 2014 data. Additionally, the Company’s required general reserves also decreased by approximately $251,000 due to a combination of loan upgrades and migrations from general reserves to specific reserves for impaired loans that had calculated impairments of zero.

 

For the six months ended June 30, 2015, net recoveries to average loans outstanding totaled 0.16% on an annualized basis while the allowance for loan losses to gross loans totaled 1.30% at June 30, 2015. For the six months ended June 30, 2014, net recoveries to average loans outstanding totaled 0.06% on an annualized basis while the allowance for loan losses to gross loans totaled 1.73% at June 30, 2014.

 

 
-41-

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Loans (continued)

 

Management identifies and maintains a list of potential problem loans. These are loans that are internally risk graded substandard or below but which are not included in nonaccrual status and are not past due 90 days or more. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of the borrower which raises serious doubts as to the ability of such borrower to comply with the current loan repayment terms. At June 30, 2015 potential problem loans totaled $7.9 million. The Company’s potential problem loans were comprised of $672,000 of construction and land development real estate loans, $3.3 million of nonfarm, nonresidential real estate loans, $3.5 million of 1-4 family real estate loans, and $410,000 of various loan types not secured by real estate, primarily commercial and industrial loans. At December 31, 2014 potential problem loans totaled $12.0 million. The Company’s potential problem loans at December 31, 2014 were comprised of $703,000 of construction and land development real estate loans, $7.0 million of nonfarm, nonresidential real estate loans, $3.5 million of 1-4 family real estate loans, $338,000 of multifamily real estate loans, and $513,000 of various loan types not secured by real estate, primarily commercial and industrial loans. As the majority of potential problem loans are real estate secured, management closely tracks the current values of real estate collateral when assessing the collectibility of these loans.

 

Other Real Estate Owned

 

Other real estate owned totaled approximately $2.6 million as of June 30, 2015, $3.5 million at December 31, 2014, and $4.9 million as of June 30, 2014, net of a valuation reserve. Sales of other real estate owned totaled approximately $1 million and $833,000 for the six months ended June 30, 2015, and 2014, respectively. The Company generated loans to facilitate the sales of other real estate owned totaling $675,000 and $260,000 during the six months ended June 30, 2015 and June 30, 2014, respectively. Impairment charges on other real estate owned totaled $0 and $6,000 for the six months ended June 30, 2015, and 2014, respectively.

 

Deposits

 

Deposits increased $30.1 million during the first six months of 2015 to $361.2 million at June 30, 2015. Included in this amount were increases of $15.4 million in noninterest bearing deposits and $14.7 million in interest bearing deposits. The increase in interest bearing deposits was due to increases of $6.6 million, $1.9 million, and $6.2 million in time deposits, interest bearing transaction accounts, and savings and money market demand accounts, respectively. The growth in time deposits was primarily attributable to a $6 million increase in retail time deposits. Brokered and wholesale time deposits totaled $12.9 million and $12.3 million at June 30, 2015 and December 31, 2014, respectively.

 

 
-42-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Federal Home Loan Bank Borrowings

 

Other borrowings are primarily comprised of FHLBA advances. FHLBA advances are collateralized by pledged FHLBA stock and certain residential mortgage and commercial real estate loans. FHLBA advances outstanding at June 30, 2015 and December 31, 2014 are summarized as follows:

 

June 30, 2015

 

(Dollars in Thousands)

               

Maturity

 

Rate

   

Balance

 
                 

March 2016

    2.04 %   $ 10,000  

March 2016

    0.36 %     18,000  
May 2016     0.75 %     2,000  

March 2017

    2.31 %     2,000  

May 2017

    1.07 %     2,000  

March 2018

    2.33 %     5,000  

April 2018

    3.03 %     5,000  

May 2018

    1.38 %     2,000  

March 2019

    3.56 %     5,000  

March 2019

    3.51 %     5,000  

May 2019

    1.69 %     2,000  

May 2020

    2.01 %     2,000  

March 2021

    3.71 %     5,000  

March 2021

    3.74 %     5,000  

March 2021

    3.80 %     5,000  

March 2021

    3.87 %     5,000  
                 

Balance

          $ 80,000  

 

December 31, 2014

               

(Dollars in Thousands)

 

Maturity

 

Rate

   

Balance

 
                 

February 2015

    0.36 %   $ 18,000  

March 2016

    2.04 %     10,000  

May 2016

    0.75 %     2,000  

March 2017

    2.31 %     2,000  

May 2017

    1.07 %     2,000  

March 2018

    2.33 %     5,000  

April 2018

    3.03 %     5,000  

May 2018

    1.38 %     2,000  

March 2019

    3.56 %     5,000  

March 2019

    3.51 %     5,000  

May 2019

    1.69 %     2,000  

May 2020

    2.01 %     2,000  

March 2021

    3.71 %     5,000  

March 2021

    3.74 %     5,000  

March 2021

    3.80 %     5,000  

March 2021

    3.87 %     5,000  
                 

Balance

          $ 80,000  

  

 
-43-

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Junior Subordinated Debentures

 

On August 5, 2005 Southcoast Capital Trust III (the "Capital Trust"), a non-consolidated subsidiary of the Company, issued and sold a total of 10,310 floating rate securities, with a $1,000 liquidation amount per security (the "Capital Securities"). Institutional buyers bought 10,000 of the Capital Securities denominated as preferred securities and the Company bought the other 310 Capital Securities which are denominated as common securities. The proceeds of those sales, $10.3 million, were used by the Capital Trust to buy $10.3 million of junior subordinated debentures from the Company which are reported on its consolidated balance sheets. The Capital Securities mature or are mandatorily redeemable upon maturity on September 30, 2035, or upon earlier optional redemption as provided in the indenture. Since September 30, 2010, the Company has had the right to redeem the Capital Securities in whole or in part. See Note 11 to the consolidated financial statements for the year ended December 31, 2014, and the information set forth in Exhibit 13 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Junior Subordinated Debentures” filed with our Form 10-K for the year ended December 31, 2014, for more information about the terms of the junior subordinated debentures.    

 

 
-44-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

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

 

Capital Resources

 

The Company’s total shareholders’ equity increased by approximately $3.1 million during the first six months of 2015, primarily due to net income of $2,851,000, other comprehensive income of $241,000, and proceeds from stock issuances of approximately $51,000 pursuant to our Employee Stock Purchase Plan. The Company’s Tier 1 capital to average assets ratio was 12.02 percent as of June 30, 2015 compared to 11.98 percent as of December 31, 2014.

 

The Federal Reserve Board and other bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the risk-based standard, capital is classified into two tiers. The Company’s and the Bank’s Tier 1 capital consists of common shareholders’ equity minus a portion of deferred tax assets plus, in the case of the Company, junior subordinated debt subject to certain limitations. Tier 1 Capital includes Common Equity Tier 1 and Additional Tier 1, which consists of additions for certain items to Common Equity Tier 1. None of these additions apply to the Company or the Bank; therefore, for both entities Common Equity Tier 1 capital equals Tier 1 capital. The Company’s and the Bank’s Tier 2 capital consists of the allowance for loan losses subject to certain limitations and, in the case of the Company, its junior subordinated debt in excess of 25% of its Tier 1 capital. A bank holding company’s qualifying capital base for purposes of its risk-based capital ratio consists of the sum of its Tier 1 and Tier 2 capital. The regulatory minimum requirements are illustrated in the chart below. The Company and the Bank are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. These requirements are set by regulation and are shown in the table below. These requirements are applicable to all but the most highly-rated institutions that are not anticipating or experiencing significant growth and have well-diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity and good earnings. The regulators may require individual bank holding companies and banks to maintain higher levels of capital depending on the regulators’ assessment of the risks faced by the bank holding company or the bank. As of June 30, 2015, the Company and the Bank exceeded each of the capital requirements shown in the following table.

 

   

Capital Ratios

 
                   

Minimum Basel III Phase In

   

Minimum Basel III Fully Phased In

   

Well Capitalized

 
   

Actual

   

Requirement

   

Requirement

   

Requirement

 

(Dollars in thousands)

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

The Bank

                                                               

Total capital (to risk-weighted assets)

  $ 56,886       16.13 %   $ 28,219       8.00 %   $ 37,038       10.50 %   $ 35,274       10.00 %

Tier 1 capital (to risk-weighted assets)

    52,458       14.87 %     21,165       6.00 %     29,983       8.50 %     28,219       8.00 %

Common equity Tier 1 capital (to risk- weighted assets)

    52,458       14.87 %     15,873       4.50 %     24,692       7.00 %     22,928       6.50 %

Tier 1 capital (to average assets)

    52,458       11.02 %     19,042       4.00 %     19,042       4.00 %     23,802       5.00 %
                                                                 

The Company

                                                               

Total capital (to risk-weighted assets)

  $ 64,349       17.89 %   $ 28,773       8.00% (1)   $ 37,765       8.00% (1)  

N/A

   

N/A

 

Tier 1 capital (to risk-weighted assets)

    59,742       16.61 %     21,580       6.00% (1)     30,571       6.00% (1)  

N/A

   

N/A

 

Common equity Tier 1 capital (to risk- weighted assets)

    59,742       16.61 %     16,185       4.50% (1)     25,176       4.50% (1)  

N/A

   

N/A

 

Tier 1 capital (to average assets)

    59,742       12.02 %     19,883       4.00% (1)     19,883       4.00% (1)  

N/A

   

N/A

 

 

(1)

Minimum requirements for bank holding companies with greater than $1 billion in consolidated total assets (the Company is not currently subject to these requirements)

 

 
-45-

 

SOUTHCOAST FINANCIAL CORPORATIONz

 

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

 

Off Balance Sheet Risk

 

The Company makes contractual commitments to extend credit and issues standby letters of credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to customers at predetermined interest rates for a specified period of time. In addition to commitments to extend credit, the Company also issues standby letters of credit which are assurances to a third party that it will not suffer a loss if the customer fails to meet a contractual obligation to the third party. At June 30, 2015, the Company had issued commitments to extend credit of approximately $27.3 million and letters of credit of approximately $241,000 through various types of commercial lending arrangements. Approximately $16.5 million of these commitments to extend credit had variable rates.

 

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at June 30, 2015.

 

   

Within One

Month

   

After One

Through

Three

Months

   

After Three

Through

Twelve

Months

   

Within One

Year

   

Greater

Than

One Year

   

Total

 
                                                 

Unused commitments to extend credit

  $ 557     $ 945     $ 8,689     $ 10,191     $ 17,138     $ 27,329  

Standby letters of credit

    -       -       167       167       74       241  

Totals

  $ 557     $ 945     $ 8,856     $ 10,358     $ 17,212     $ 27,570  

 

Based on historical experience, many of the commitments and letters of credit will expire unfunded. Accordingly, the amounts shown in the table above do not necessarily reflect the Company’s need for funds in the periods shown. Further, through its various sources of liquidity, the Company believes it will be able to fund these obligations as they arise. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on the Company’s credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

 

Item 3. - Quantitative and Qualitative Disclosures About Market Risk.

 

Information about the Company’s exposure to market risk was disclosed in its Annual Report on Form 10-K for the year ended December 31, 2014, which was filed with the Securities and Exchange Commission on March 12, 2015. There have been no material quantitative or qualitative changes in market risk exposure since the date of that filing.

 

Item 4. - Controls and Procedures.

 

Based on the evaluation required by 17 C.F.R. Sections 240.13a-15(b) or 240.15d-15(b) of the Company’s disclosure controls and procedures (as defined in 17 C.F.R. Section 240.13a-15(e) and 240.15d-15(e), the Company's chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the period covered by this quarterly report, were effective.

 

There has been no change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 
-46-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

PART II - OTHER INFORMATION

 

Item 6. Exhibits

 

31-1 Rule 13a-14(a) Certifications of CEO
   
31-2   Rule 13a-14(a) Certifications of CFO
   
32 Section 1350 Certification

 

101.INS**

XBRL Instance

   

101.SCH**

XBRL Taxonomy Extension Schema

   

101.CAL**

XBRL Taxonomy Extension Calculation

   

101.DEF**

XBRL Taxonomy Extension Definition

   

101.LAB**

XBRL Taxonomy Extension Labels

   

101.PRE**

XBRL Taxonomy Extension Presentation

 

 

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.

 

 

Date:

August 6, 2015

By:

/s/ L. Wayne Pearson
     

L. Wayne Pearson

     

Chief Executive Officer

 

Date:

August 6, 2015

By:

/s/ William C. Heslop
     

William C. Heslop

     

Chief Financial Officer

 

 
-47-

 

 

SOUTHCOAST FINANCIAL CORPORATION

 

Exhibit Index

 

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

   

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

   

32

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit is not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 but is instead furnished as provided by applicable rules of the Securities and Exchange Commission.

   

101.INS**

XBRL Instance

   

101.SCH**

XBRL Taxonomy Extension Schema

   

101.CAL**

XBRL Taxonomy Extension Calculation

   

101.DEF**

XBRL Taxonomy Extension Definition

   

101.LAB**

XBRL Taxonomy Extension Labels

   

101.PRE**

XBRL Taxonomy Extension Presentation

 

** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 

 

-48-