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EX-32 - EXHIBIT 32 - SOUTHCOAST FINANCIAL CORPex32.htm
EX-23 - EXHIBIT 23 - SOUTHCOAST FINANCIAL CORPex23.htm
EX-31.2 - EXHIBIT 31.2 - SOUTHCOAST FINANCIAL CORPex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SOUTHCOAST FINANCIAL CORPex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-K

 

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

THE SECURITIES EXCHANGE ACT OF 1934

 

 For the Fiscal Year Ended December 31, 2015

 

 File Number 0-25933

  

SOUTHCOAST FINANCIAL CORPORATION

(Exact name of Registrant as specified in its Charter)

 

South Carolina

 

57-1079460

(State or Other Jurisdiction of Incorporation or Organization)

 

(IRS Employer Identification Number)

 

530 Johnnie Dodds Boulevard, Mt. Pleasant, South Carolina 29464

(Address of Principal Executive Office, Zip Code)

 

Registrant’s Telephone Number, Including Area Code: (843) 884-0504

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of each class:

 

Name of each exchange on which registered:

Common Stock, No Par Value

 

NASDAQ Global Market

 

Securities Registered Pursuant to Section 12(g) of the Act:     None

 

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

 

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

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

 

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

 

Large accelerated filer [ ]

 

Accelerated filer [ ]

Non-accelerated filer [ ]

 

Smaller reporting company [X]

(Do not check if smaller reporting company)

   

 

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

 

The aggregate market value of the Common Stock held by non-affiliates on June 30, 2015, the last business day of the Registrant’s most recently completed second fiscal quarter, was approximately $50,605,830. The Registrant has no non-voting common equity outstanding. For purposes of the foregoing calculation only, all directors and executive officers of the Registrant have been deemed affiliates.

 

As of February 29, 2016, there were 7,103,751 shares of the Registrant’s Common Stock, no par value, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

 
 

 

 

10-K CROSS REFERENCE INDEX

 

PART I

     

Item 1.

Business.

2

Item 1A.

Risk Factors

10

Item 1B.

Unresolved Staff Comments.

17

Item 2.

Properties.

18

Item 3.

Legal Proceedings.

18

Item 4.

Mine Safety Disclosures.

18

     

PART II

     

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

18

Item 6.

Selected Financial Data

19

Item 7.

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

19

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

44

Item 8.

Financial Statements and Supplementary Data.

44

Item 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

88

Item 9A.

Controls and Procedures.

88

Item 9B.

Other Information.

88

     

PART III

     

Item 10.

Directors, Executive Officers and Corporate Governance.

89

Item 11.

Executive Compensation.

92

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

101

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

102

Item 14.

Principal Accountant Fees and Services.

103

     

PART IV

     

Item 15.

Exhibits and Financial Statement Schedules

104

 

 
 

 

 

CAUTIONARY NOTICE WITH RESPECT TO

FORWARD-LOOKING STATEMENTS

 

Statements included in this report which are not historical in nature are intended to be, and are hereby identified as “forward looking statements” for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended. Words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential,” and other similar words and expressions of the future identify forward-looking statements. The Company cautions readers that forward looking statements, including without limitation, those relating to the Company’s future business prospects, revenues, working capital, adequacy of the allowance for loan losses, liquidity, capital needs, interest costs, income, new offices, and the economy, are subject to certain risks and uncertainties that could cause actual results to differ from those indicated in the forward looking statements, due to several important factors identified in this report, among others, and other risks and factors identified from time to time in the Company’s other reports filed with the Securities and Exchange Commission.

 

These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and assumptions made by management. Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies, objectives, goals, anticipations, and intentions concerning the Company’s future financial and operating performance. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict, particularly in light of the fact that the Company is a relatively new company with limited operating history. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements. The risks and uncertainties include, but are not limited to:

 

 

the potential negative economic impacts of the recent historic flooding in our market area on the homes and businesses of our borrowers;

 

future economic and business conditions;

 

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;

 

government monetary and fiscal policies;

 

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;

 

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;

 

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;

 

credit risks;

 

higher than anticipated levels of defaults on loans;

 

perceptions by depositors about the safety of their deposits;

 

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

 

changes in assumptions underlying allowances on deferred tax assets;

 

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

 

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

 

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;

 

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

 

changes in requirements of regulatory authorities;

 

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

 

changes in accounting policies, rules and practices;

 

 
 

 

 

 

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

 

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;

 

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

 

loss of consumer or investor confidence;

 

risks relating to the proposed merger between the Company and BNC Bancorp, including disruption of the Company’s business operations and customer relationships and employee relationships, diversion of management’s time, as well as the impact of such disruptions and the expenses incurred in connection with the merger if the merger is not completed; and

 

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

 

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.

 

PART I

 

Item 1.

Business.

 

 

General

 

Southcoast Financial Corporation (the “Company”) is a South Carolina corporation organized in 1999 under the laws of South Carolina 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 and the Company became the owner of all of the outstanding capital stock of the Bank. The Company presently engages in no significant business other than that of owning the Bank and has no employees.

 

The Bank is a South Carolina state bank incorporated in June, 1998, which commenced operations as a commercial bank in July, 1998. The Bank operates from its offices in Mt. Pleasant, Charleston, Moncks Corner, Johns Island, Summerville, Goose Creek and North Charleston, South Carolina. The main office is located at 530 Johnnie Dodds Boulevard, in Mt. Pleasant; other Mt. Pleasant offices are located at 602 Coleman Boulevard and 3305 South Morgan’s Point Road; the Charleston offices are located at 802 Savannah Highway and 1654 Sam Rittenberg Boulevard; the Moncks Corner office is located at 337 East Main Street; the Johns Island office is located at 2753 Maybank Highway; the Summerville office is located at 302 N. Main Street; the Goose Creek office is located at 597 Old Mount Holly Road; and the North Charleston office is located at 8420 Dorchester Road.

 

The Bank offers a full array of commercial banking services. Deposit services include business and personal checking accounts, NOW accounts, savings accounts, money market accounts, various term certificates of deposit, IRA accounts, and other deposit services. Most of the Bank’s deposits are attracted from individuals and small businesses. The Bank does not offer trust services.

 

The Bank offers secured and unsecured, short-to-intermediate term loans, with floating and fixed interest rates for commercial, consumer and residential purposes. Consumer loans include, among others: car loans, home equity improvement loans (secured by first and second mortgages), personal expenditure loans, education loans, overdraft lines of credit, and the like. The Bank makes commercial loans to small and middle market businesses. Commercial loans may be unsecured if they are of short duration and made to a customer with demonstrated ability to pay, but most often they are secured. Collateral for commercial loans may be listed securities, equipment, inventory, accounts receivable or other business assets but will usually be local real estate. The Bank usually makes commercial loans to businesses to provide working capital, expand physical assets or acquire assets. Commercial loans will typically not exceed a 20-year maturity and will usually have regular amortization payments. Commercial loans to most business entities require guarantees by their principals. The Bank also makes loans guaranteed by the U. S. Small Business Administration.

 

 
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The Bank makes loans secured by real estate mortgages that are usually for the acquisition, improvement or construction and development of residential and other properties. Residential real estate loans consist primarily of first and second mortgage loans on single family homes, with some mortgage loans on multifamily homes. Loan-to-value ratios for these loans are generally limited to 80% at the time the loan is made. Non-farm, non-residential loans are secured by business and commercial properties usually acquired using the loan proceeds. Loan-to-value ratios on these loans are also generally limited to 80%. The repayment of both residential and business real estate loans is dependent primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary or liquidation source of repayment.

 

Real estate construction loans typically consist of financing for the construction of 1-4 family dwellings and some non-farm, non-residential real estate. Usually, loan-to-value ratios for these loans are limited to 80% and permanent financing commitments are required prior to the advancement of loan proceeds.

 

Management believes that the loan portfolio is adequately diversified. Management is not aware of any significant concentrations of loans made to any particular individuals, industries or groups of related individuals or industries; however, the Bank’s loans are concentrated in residential mortgage loans, commercial real estate loans, and construction and land development loans. The loan portfolio consists primarily of mortgage loans and extensions of credit to businesses and individuals in the Bank’s service areas within Charleston, Dorchester and Berkeley Counties of South Carolina. The economy of these areas is diversified and does not depend on any single industry or group of related industries. Approximately 93% of loans are secured by real estate located in those three counties or other coastal areas of South Carolina. The Bank does not make any foreign loans.

 

In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.), and loans with high loan-to-value ratios. Management has determined that there is no concentration of credit risk associated with its lending policies or practices with respect to these types of products and practices. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan’s being fully paid (i.e., balloon payment loans). These loans are underwritten and monitored to manage the associated risks. Therefore, management believes that these particular practices do not subject the Company to unusual credit risk.

 

Other services the Bank offers include residential mortgage loan origination services, safe deposit boxes, business courier service, night depository service, electronic banking, MasterCard brand credit cards, tax deposits, and 24-hour automated teller machines.

 

At March 1, 2016, the Bank employed 85 persons full-time. The Company has no employees. Management of the Bank believes that its employee relations are excellent.

 

Competition

 

The Bank competes in the Charleston - North Charleston MSA. As of June 30, 2015, 34 banks, savings and loans, and savings banks with 204 branch locations competed in the Charleston - North Charleston MSA. As of June 30, 2015, the Bank held 3.21% of total deposits in the MSA of $11.4 billion.

 

Banks generally compete with other financial institutions through the products and services offered, the pricing of services, the level of service provided, the convenience and availability of services, and the degree of expertise and personal concern with which services are offered. South Carolina law permits statewide branching by banks and savings institutions, and many financial institutions in the state have branch networks. Consequently, commercial banking in South Carolina is highly competitive. Furthermore, out-of-state banks may commence operations and compete in the Bank’s primary service area. Many large banking organizations, several of which are controlled by out-of-state ownership, currently operate in the Bank’s market area.

 

 
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In the conduct of certain areas of its business, the Bank competes with commercial banks, savings and loan associations, credit unions, consumer finance companies, insurance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation and restriction imposed upon the Bank. Many of these competitors have substantially greater resources and lending limits than the Bank and offer certain services, such as international banking services and trust services, that the Bank does not provide. Moreover, most of these competitors have more numerous branch offices located throughout their market areas, a competitive advantage that the Bank does not have to the same degree. Such competitors may also be in a position to make more effective use of media advertising, support services, and electronic technology than can the Bank.

 

The banking industry is significantly affected by prevailing economic conditions as well as by government policies and regulations concerning, among other things, monetary and fiscal affairs, the housing industry and financial institutions. Deposits at banks are influenced by a number of economic factors, including interest rates, competing instruments, levels of personal income and savings, and the extent to which interest on retirement savings accounts is tax deferred. Lending activities are also influenced by a number of economic factors, including demand for and supply of housing, conditions in the construction industry, and availability of funds. Primary sources of funds for lending activities include savings deposits, income from investments, loan principal repayments, and proceeds from sales of loans to conventional participating lenders.

 

Pending Merger Transaction

 

On August 14, 2015, the Company entered into a definitive agreement with BNC Bancorp (“BNC”) the holding company for Bank of North Carolina, pursuant to which BNC will acquire all of the common stock of the Company in a stock transaction. Under the terms of the agreement, which has been approved by the Boards of Directors of both companies and by the shareholders of the Company (approval of shareholders of BNC is not required), the Company’s shareholders will receive shares of BNC common stock based upon the volume weighted average price of BNC common stock for a 20-day trading period prior to the closing of the merger ("VWAP"), subject to minimum and maximum exchange ratios as follow: if the VWAP immediately prior to the merger is equal to or greater than $22.00, then each share of the Company’s common stock will be converted into 0.6068 shares of BNC common stock; if the VWAP immediately prior to the merger is less than $22.00 but greater than $19.00, then each share of the Company’s common stock will be converted into $13.35 payable in shares of BNC common stock (with the exchange ratio equal to $13.35 divided by the VWAP); and if the VWAP is equal to or less than $19.00, then each share of the Company’s common stock will be converted into 0.7026 shares of BNC common stock. The merger is currently awaiting regulatory approval, and is expected to close in the second quarter of 2016. For further information, please see the Proxy Statement/Prospectus of the Company/BNC filed with the Securities and Exchange Commission on December 23, 2015.

 

Available Information

 

The Company electronically files with the Securities and Exchange Commission (SEC) its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its periodic reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “1934 Act), and proxy materials pursuant to Section 14 of the 1934 Act. The SEC maintains a site on the Internet, www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The Company does not have a website, but the Bank maintains a website at ww.southcoastbank.com. Reports of beneficial ownership of securities filed on behalf of the Company’s directors and executive officers pursuant to Section 16 of the Securities Exchange Act of 1934 and the Company’s other SEC filings, including financial statements in interactive data format, are also available on the Bank’s website. Persons who are unable to obtain such filings from the SEC website or the Bank’s website may obtain free copies from the Company upon request to William C. Heslop, Senior Vice President, Southcoast Financial Corporation, 530 Johnnie Dodds Boulevard, Mt. Pleasant, South Carolina 29464.

 

 
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EFFECT OF GOVERNMENT REGULATION

 

The Company and the Bank operate in a highly regulated environment, and their business activities are governed by statute, regulation, and administrative policies. Relevant information about the regulatory framework that applies to the Company and the Bank is provided below. This regulatory framework is intended primarily for the benefit and protection of the Bank’s depositors and the Deposit Insurance Fund, and not for the protection of the Company’s shareholders or creditors.

 

Financial institutions are being subjected to increased scrutiny and enforcement activity by state and federal banking agencies, the United States Department of Justice, the Securities and Exchange Commission, and other state and federal regulatory agencies. This increased scrutiny and enforcement activity entails significant potential increases in compliance requirements and associated costs.

 

To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to such statutes and regulations. Any change in applicable law or regulation may have a material effect on the business of the Company and the Bank.

 

General

 

As a bank holding company registered under the Bank Holding Company Act (“BHCA”), the Company is subject to supervision, and to regular inspection by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is a state bank subject to regulation by the South Carolina State Board of Financial Institutions (“State Board”) and the FDIC. The Company is also subject to regulation by the State Board. The following discussion summarizes certain aspects of those laws and regulations that affect the Company and the Bank. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, the state legislature, and before the various bank regulatory agencies, and such proposals have increased in the wake of the recent financial crisis. The likelihood and timing of any changes and the impact such changes might have on the Company and the Bank are difficult to determine.

 

Under the BHCA, the Company’s activities and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity which the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Company may engage in a broader range of activities if it becomes a “financial holding company” pursuant to the Gramm-Leach-Bliley Act, which is described below under the caption “Gramm-Leach-Bliley Act.” The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or from merging or consolidating with another bank holding company without prior approval of the Federal Reserve. In making such determinations, the Federal Reserve is required to consider whether the performance of such activities by a bank holding company or its subsidiaries can reasonably be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

 

Additionally, the BHCA prohibits the Company from engaging in or from acquiring ownership or control of more than 5% of the outstanding voting stock of any company engaged in a non-banking business unless such business is determined by the Federal Reserve to be so closely related to banking as to be properly incident thereto. The BHCA generally does not place territorial restrictions on the activities of such non-banking related activities.

 

As noted above, the Company is also subject to regulation and supervision by the State Board. A South Carolina bank holding company must provide the State Board with information with respect to the financial condition, operations, management and inter-company relationships of the holding company and its subsidiaries. The State Board also may require such other information as is necessary to keep itself informed about whether the provisions of South Carolina law and the regulations and orders issued thereunder by the State Board have been complied with, and the State Board may examine any bank holding company and its subsidiaries.

 

 
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Obligations of the Company to its Subsidiary Bank

 

A number of obligations and restrictions are imposed on bank holding companies and their depository institution subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Deposit Insurance Fund in the event the depository institution is in danger of becoming insolvent or is insolvent. For example, under the Federal Deposit Insurance Act, as amended (“FDIA”), and the policy of the Federal Reserve, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the “cross-guarantee” provisions of the FDIA, require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in its best interest. The FDIC’s claim for damages is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

 

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision gives depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of the Bank.

 

Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

 

Capital Adequacy Guidelines for Bank Holding Companies and State Banks

 

The various federal bank regulators, including the Federal Reserve and the FDIC have adopted risk-based and leverage capital adequacy guidelines for assessing bank holding company and bank capital adequacy. These standards define what qualifies as capital and establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risks. These guidelines were substantially revised in 2013 to increase the amounts of capital required. The revised requirements are being phased in beginning in 2015.

 

Failure to meet capital guidelines could subject the Bank to a variety of enforcement remedies, ranging from, for example, a prohibition on the taking of brokered deposits to the termination of deposit insurance by the FDIC or the appointment of a receiver for the Bank.

 

The risk-based capital standards of both the Federal Reserve Board and the FDIC explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agencies in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agencies as a factor in evaluating a bank’s capital adequacy. The Federal Reserve Board also has issued additional capital guidelines for bank holding companies that engage in certain trading activities.

 

As set forth under the caption “Management’s Discussion and Analysis – Capital Resources,” which is included in Part II, Item 7 of this Form 10-K, the Company and the Bank exceeded all applicable capital requirements at December 31, 2015.

 

 
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Payment of Dividends

 

The Company is a legal entity separate and distinct from its bank subsidiary. Most of the revenues of the Company are expected to result from dividends paid to the Company by the Bank. There are statutory and regulatory requirements applicable to the payment of dividends by subsidiary banks as well as by the Company to its shareholders. The Company has never paid dividends, and it is not anticipated that the Company will pay cash dividends in the near future.

 

Certain Transactions by the Company with its Affiliates

 

Federal law regulates transactions among the Company and its affiliates, including the amount of the Bank’s loans to or investments in nonbank affiliates and the amount of advances to third parties collateralized by securities of an affiliate. Further, a bank holding company and its affiliates are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

 

FDIC Insurance Assessments

 

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC (“DIF”). The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings associations and credit unions to $250,000 per account. The FDIC maintains the DIF by assessing depository institutions insurance premiums on FDIC insured institutions. The Bank’s FDIC assessment expense during 2015 totaled $286,000.

 

FDIC insured institutions are also required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

 

The FDIC is authorized to conduct examinations of, and to require reporting by, FDIC insured institutions, and it may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC may terminate the deposit insurance of any insured depository institution if it determines, after notice and hearing, that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, remain insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

 

Regulation of the Bank

 

The Bank is subject to regulation and examination by the State Board and the FDIC. In addition, the Bank is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit laws and laws relating to branch banking.

 

The Bank’s loan operations are also subject to certain federal consumer credit laws and regulations promulgated thereunder, including, but not limited to: the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; the Home Mortgage Disclosure Act, requiring financial institutions to provide certain information concerning their mortgage lending practices; the Equal Credit Opportunity Act and the Fair Housing Act, prohibiting discrimination on the basis of certain prohibited factors in extending credit; the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies; and the Real Estate Settlement Procedures Act, governing certain aspects of the settlement process for residential mortgage loans.

 

 
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The deposit operations of the Bank are also subject to the Truth in Savings Act, requiring certain disclosures about rates paid on savings accounts; the Expedited Funds Availability Act, which deals with disclosure of the availability of funds deposited in accounts and the collection and return of checks by banks; the Right to Financial Privacy Act, which imposes a duty to maintain certain confidentiality of consumer financial records; the Electronic Funds Transfer Act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and the Check Clearing for the 21st Century Act, which gives “substitute checks” such as digital check images, and copies made from the image, the same legal standing as the original paper check.

 

The Bank is also subject to the Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures; the Bank Secrecy Act, dealing with, among other things, the reporting of certain currency transactions; and the USA Patriot Act, dealing with, among other things, requiring the establishment of anti-money laundering programs including standards for verifying customer information at account opening.

 

The Bank is also subject to the requirements of the Community Reinvestment Act (the “CRA”). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution’s actual performance in meeting community credit needs is evaluated as part of the examination process, and also is considered by federal regulators in evaluating and acting on applications for mergers, acquisitions and opening of branches or other facilities.

 

Other Safety and Soundness Regulations

 

Prompt Corrective Action. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.”

 

A bank that is “undercapitalized” becomes subject to “prompt corrective action” provisions of the FDIA: restricting payment of capital distributions and management fees; requiring the FDIC to monitor the condition of the bank; requiring submission by the bank of a capital restoration plan; prohibiting the acceptance of employee benefit plan deposits; restricting the growth of the bank’s assets and requiring prior approval of certain expansion proposals. A bank that is “significantly undercapitalized” is additionally subject to restrictions on compensation paid to senior management of the bank. A bank that is “critically undercapitalized” is further subject to restrictions on the activities of the bank and restrictions on payments of subordinated debt of the bank, as well as a requirement that the bank be placed in receivership within 90 days in most cases. The purpose of these provisions is to require banks with less than adequate capital to act quickly to restore their capital and to have the FDIC move promptly to take over banks that are unwilling or unable to take such steps.

 

Brokered Deposits. Under current FDIC regulations, “well capitalized” banks may accept brokered deposits without restriction, “adequately capitalized” banks may accept brokered deposits with a waiver from the FDIC (subject to certain restrictions on payment of rates), while “undercapitalized” banks may not accept brokered deposits. The regulations provide that the definitions of “well capitalized”, “adequately capitalized” and “undercapitalized” are the same as the definitions adopted by the agencies to implement the prompt corrective action provisions described in the previous paragraph. Management does not believe that these regulations will have a material adverse effect on the operations of the Bank.

 

Interstate Banking

 

Under federal law, the Company and any other adequately capitalized bank holding company located in South Carolina can acquire a bank located in any other state, and a bank holding company located outside South Carolina can acquire any South Carolina-based bank, in either case subject to certain deposit percentage and other restrictions. The authority of a bank to establish and operate branches within a state continues to be subject to applicable state branching laws, but interstate branching is permitted to the same extent it would be permitted under state law if the branching bank’s home office were located in the state in which the branch will be located.

 

 
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Gramm-Leach-Bliley Act

 

The Gramm-Leach-Bliley Act expanded the activities in which a bank holding company and a bank can engage through affiliations created under a holding company structure or through a financial subsidiary if certain conditions are met. Significantly, the permitted financial activities for financial holding companies include authority to engage in merchant banking and insurance activities, including insurance portfolio investing. The Act also established a minimum federal standard of privacy to protect the confidentiality of a consumer’s personal financial information and gives the consumer the power to choose how personal financial information may be used by financial institutions. The regulations adopted pursuant to the Act govern the consumer’s right to opt-out of further disclosure of nonpublic personal financial information and require the Bank to provide initial and annual privacy notices. The Act and regulations also required the Bank to develop and maintain a comprehensive plan for the safeguarding of customer information which encompasses all aspects of the Bank’s technological environment, business practices, and Bank facilities.

 

Although the Act and the regulations created new opportunities for the Company to offer expanded services to customers in the future, the Company has not determined what the nature of the expanded services might be or whether and when the Company might find it feasible to offer them. The Act has increased competition from larger financial institutions that are currently more capable than the Company of taking advantage of the opportunity to provide a broader range of services. However, the Company continues to believe that its commitment to providing high quality, personalized service to customers will permit it to remain competitive in its market area.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in 2010, significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act has had, and will continue to have, extensive effects on all financial institutions, and includes provisions that will affect how community banks, thrifts, and small bank and thrift holding companies are regulated in the future. The Dodd-Frank Act included changes to the financial regulatory systems, enhanced bank capital requirements, created the Financial Stability Oversight Council, provided for mortgage reform provisions regarding a customer’s ability to repay, changed the assessment base for federal deposit insurance, made permanent the $250,000 limit for federal deposit insurance, added corporate governance requirements for public companies with regard to executive compensation including providing shareholders the right to vote on executive compensation, repealed the federal prohibitions on the payment of interest on demand deposits, and amended the Electronic Funds Transfer Act to give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions, among other measures. The Dodd-Frank Act also established the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which was given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act included a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments.

 

The Dodd-Frank Act requires regulatory agencies to implement new regulations that establish the parameters of the new regulatory framework and provide a clearer understanding of the legislation’s effect on banks. The Company continues to evaluate proposed and final regulations related to the Dodd-Frank Act as they are implemented in order to determine the impact each will have on current and future operations. The majority of the resulting regulations affecting the Company have been implemented, and the Company has experienced a moderate loss of income associated with debit transactions and moderate increased compliance costs associated with other provisions of the Dodd-Frank Act.

 

Legislative Proposals

 

Proposed legislation which could significantly affect the business of banking is introduced in Congress and the General Assembly of South Carolina from time to time. For example, numerous bills are pending in Congress and the South Carolina Legislature to provide various forms of relief to homeowners from foreclosure of mortgages as a result of publicity surrounding economic problems resulting from subprime mortgage lending and the economic adjustments in national real estate markets. Broader problems in the financial sector of the economy which became apparent in 2008 have led to numerous calls for legislative restructuring of the regulation of the sector. Management of the Company cannot predict the future course of such legislative proposals or their impact on the Company and the Bank should they be adopted.

 

 
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Fiscal and Monetary Policy

 

Banking is a business which depends to a large extent on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings. Thus, the earnings and growth of the Company and the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits. The nature and timing of any changes in such policies and their impact on the Company and the Bank cannot be predicted.

 

Further Information

 

Further information about the business of the Company and the Bank is set forth in this Form 10-K under Item 7 -”Management’s Discussion and Analysis of Financial Condition and Results of Operation.”

 

Item 1A.

Risk Factors

 

 

Risks Related to Our Industry

 

There can be no assurance that recent government actions will help stabilize the U.S. financial system.

 

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, various branches and agencies of the U.S. government have put in place laws, regulations and programs to address capital and liquidity issues in the banking system. There can be no assurance, however, as to the actual long-term impact that such laws, regulations and programs will have on the financial markets, including the extreme levels of volatility, liquidity and confidence issues, and limited credit availability recently experienced. The failure of such laws, regulations and programs to continue to help stabilize the financial markets and a continuation or worsening of current national and international financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

 

Recent levels of market volatility are unprecedented.

 

Over the past several years, the volatility and disruption of financial and credit markets reached unprecedented levels for recent times. In some cases, the markets produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If recent and current levels of market disruption and volatility continue, recur, or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

 

We could be adversely affected by the soundness of other financial institutions.

 

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers, dealers, commercial banks, investment banks, and government sponsored enterprises. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, our credit risk may be exacerbated when the collateral we hold cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or other obligation due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.

 

 
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Our primary source of funding for our operations is deposits from customers in our local market. Should other banks in or near our market areas fail, it could cause our deposit customers to lose confidence in banks and cause them to withdraw or substantially restrict their deposits with us. If such activity reached a high enough level, it could substantially disrupt our business. There is no assurance that such disruptions, were they to occur, would not materially and adversely affect our results of operations or earnings.

 

Market developments in recent years may adversely affect our industry, business and results of operations.

 

Dramatic declines in the housing market during recent years, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps, other derivative securities, as well as loans, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The resulting lack of available credit, lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could materially and adversely, directly or indirectly, affect our business, financial condition and results of operations.

 

We are subject to governmental regulation which could change and increase our cost of doing business or have an adverse effect on our business.

 

We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Most of this regulation is designed to protect our depositors and other customers, not our shareholders. Our compliance with the requirements of these agencies is costly and may limit our growth and restrict certain of our activities, including, payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, locations of offices, and compensation of our officers. We are also subject to capitalization guidelines established by federal authorities and our failure to meet those guidelines could result in limitations being imposed on our activities or, in an extreme case, in our bank’s being placed in receivership.

 

Various laws, including the Federal Deposit Insurance Act, the Emergency Economic Stabilization Act of 2008 (“EESA”), and the Dodd-Frank Act, and related regulations are structured to spread the governmental costs of problems in the financial industry broadly over the financial industry in order to prevent the taxpayers from having to pay such costs. As a result, assessments by the FDIC to pay for deposit insurance have increased, and will likely continue to increase, perhaps substantially, and the total our bank will be required to pay could increase enough to materially affect our income and our ability to operate profitably. Additionally, EESA contains a provision for the financial industry to be required to absorb, in an as yet undetermined fashion, any losses suffered by the government on account of its acquiring troubled assets under the Troubled Assets Relief Program of EESA. The Dodd-Frank Act made numerous changes in the way financial institutions are regulated, and creates a new agency to regulate consumer protection as well as expanding and modifying consumer protection laws.

 

We are also subject to the extensive and expensive requirements imposed on public companies by the Sarbanes-Oxley Act of 2002 and related regulations

 

The laws and regulations applicable to the banking industry could change at any time, and some regulations required by the Dodd-Frank Act are yet to be adopted, thus we cannot predict the impact of these changes on our business or profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

 

 
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We are susceptible to changes in monetary policy and other economic factors which may adversely affect our ability to operate profitably.

 

Changes in governmental, economic and monetary policies may affect the ability of our bank to attract deposits and make loans. The rates of interest payable on deposits and chargeable on loans are affected by governmental regulation and fiscal policy as well as by national, state and local economic conditions. National and international economic conditions and governmental efforts to control such conditions affect us directly and indirectly. All of these matters are outside of our control and affect our ability to operate profitably.

 

Risks Related to Our Business

 

We depend on the services of a number of key personnel, and a loss of any of those personnel could disrupt our operations and result in reduced revenues.

 

The success of our business depends to a great extent on our customer relationships. Our growth and development to date have depended in large part on the efforts of our senior management team. These senior officers have primary contact with our customers and are extremely important in maintaining personalized relationships with our customer base, a key aspect of our business strategy, and in increasing our market presence. The unexpected loss of services of one or more of these key employees could have a material adverse effect on our operations and possibly result in reduced revenues if we were unable to find suitable replacements promptly.

 

We may be unable to successfully manage our sustained growth.

 

We grew rapidly in our first 12 years of operations. Although we have not grown significantly since 2009, and do not expect to continue to grow as fast in the future as we have in the past, it is our intention to continue to expand our asset base. Our future profitability will depend in part on our ability to manage growth successfully. Our ability to manage growth successfully will depend on our ability to maintain cost controls and asset quality while attracting additional loans and deposits, as well as on factors beyond our control, such as economic conditions and interest rate trends. If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially adversely affect our financial performance.

 

Our future growth or regulatory requirements may require us to raise additional capital in the future, but that capital may not be available when it is needed or be unavailable on favorable terms.

 

Although we are currently well capitalized, we may need to raise additional capital in the future to support additional growth or to meet increasing regulatory requirements. Our ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. If we cannot raise additional capital on acceptable terms when needed, our ability to further expand our operations through internal growth and acquisitions could be limited and, if we cannot continue to meet regulatory capital requirements, our existence could also be limited.

 

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate markets could hurt our business.

 

A significant portion of our loan portfolio is secured by real estate, which provides an alternate source of repayment in the event of default by the borrower. However, the property may deteriorate in value before the loan is repaid, as was the case in recent years. The real estate market was substantially impacted by the recent recessionary economic environment, increased levels of inventories of unsold homes, and higher foreclosure rates. As a result, property values declined substantially. In some cases, this downturn resulted in impairment to the value of our collateral and our ability to sell the collateral upon foreclosure. Real estate values in our markets have recently begun to improve, but any future deterioration in the real estate market may result in a negative impact on the level of credit quality in our loan portfolio, and may lead to an additional increase in our provisions for loan losses, which could adversely impact our business, financial condition, and results of operations.

 

We are exposed to higher credit risk by commercial real estate, commercial business, and construction lending.

 

Commercial real estate, commercial business and construction lending usually involves higher credit risks than single-family residential lending. These types of loans may involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, as well as the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically depends on being able to either refinance the loan or sell the underlying property in a timely manner.

 

 
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Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of construction (including interest) and the availability of permanent financing. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate, or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by foreclosure.

 

Commercial business loans are originated primarily based on the identified cash flow and general liquidity of the borrower, and secondarily on the value of the underlying collateral and/or repayment capacity of any guarantor. The borrower’s cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use. In addition, business assets may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral value provided by the borrower and liquidity of the guarantor.

 

Commercial real estate, commercial business, and construction loans are also more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review, and monitoring cannot eliminate all of the risks related to these loans. Furthermore, the banking regulators are more closely scrutinizing commercial real estate lending, and may require banks with higher levels of commercial real estate loans to implement enhanced underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels.

 

Our assets include significant amounts of real estate acquired through foreclosure or in settlement of loans, which we may not be able to sell without incurring additional losses.

 

We have acquired, and may continue to acquire, significant amounts of real estate through foreclosure or settlement of loans in default. When we acquire such real estate, it is written down to its estimated fair market value less the estimated costs of selling. If we cannot sell the property for that amount we will incur additional loss which, for one or more properties, could materially reduce our earnings.

 

If our loan customers do not pay us as they have contracted to, we may experience losses, and the allowance for loan losses may not be adequate to cover such losses.

 

Our principal revenue producing business is making loans. If the loans are not repaid, we will suffer losses. Even though we maintain an allowance for loan losses, the amount of the allowance may not be adequate to cover the losses we experience. We attempt to mitigate this risk by a thorough review of the creditworthiness of loan customers. Nevertheless, there is risk that our credit evaluations will prove to be inaccurate due to changed circumstances or otherwise, which could result in a significant adverse effect on our earnings.

 

We depend on the accuracy and completeness of information about customers and counterparties.

 

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. Our financial condition and results of operations could be negatively impacted to the extent we incorrectly assess the creditworthiness of our borrowers, fail to detect or respond to deterioration in asset quality in a timely manner, or rely on financial statements that do not comply with accounting principles generally accepted in the United States (“GAAP”) or are materially misleading.

 

 
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Our business is concentrated in Greater Charleston, and a prolonged downturn in the economy of the Charleston area, decline in Charleston area real estate values or other events in our market area may adversely affect our business.

 

Substantially all of our business is located in the Greater Charleston area. As a result, our financial condition and results of operations are affected by changes in the Charleston economy. Over the past several years, we have experienced the adverse effects of the economic recession in the form of increased nonpayment and delinquent payment of loans, and decreases in the value of collateral securing loans and of real estate acquired through foreclosures. As was the case over the past several years, economic recession and general decline in Charleston area real estate values or other adverse economic conditions would be expected to result in decreases in demand for our services, increases in nonpayment of loans and decreases in the value of collateral securing loans. The existence of adverse economic conditions, declines in real estate values or the occurrence of other adverse economic conditions in Charleston and South Carolina could have a material adverse effect on our business, future prospects, financial condition or results of operations.

 

We operate in an area susceptible to hurricane and other weather related damage which could disrupt our business and reduce our profitability.

 

Nearly all of our business and our customers are located in coastal South Carolina, an area that often experiences damage from hurricanes and other weather phenomena. We attempt to mitigate such risk with insurance and by requiring insurance on property we take as collateral. However, catastrophic weather damage to a large portion of our market area could cause substantial disruptions to our business and our customers’ businesses which would reduce our profitability for some period.

 

We face strong competition from larger, more established competitors which may adversely affect our ability to operate profitably.

 

We encounter strong competition from financial institutions operating in the greater Charleston, South Carolina area. In the conduct of our business, we also compete with credit unions, insurance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation as we are. Many of these competitors have substantially greater resources and lending abilities than we have and offer services, such as investment banking, trust and international banking services that we do not provide. We believe that we have competed, and will continue to be able to compete, effectively with these institutions because of our experienced bankers and personalized service, as well as through loan participations and other strategies and techniques. However, we cannot promise that we are correct in our belief. If we are wrong, our ability to operate profitably may be negatively affected.

 

Technological changes affect our business, and we may have fewer resources than many of our competitors to invest in technological improvements.

 

The financial services industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services. In addition to enabling financial institutions to serve customers better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success may depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many of our competitors have substantially greater resources to invest in technological improvements.

 

 
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A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.

 

We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As client, public, and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunications outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and, as described below, cyber attacks.

 

Although we have information security procedures and controls in place, our technologies, systems, networks, and our clients’ devices may become the target of cyber attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, or otherwise disrupt our or our clients’ or other third parties’ business operations. Third parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide services or security solutions for our operations, and other third parties, including the South Carolina Department of Revenue, which had records exposed in a 2012 cyber attack, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

 

While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, litigation, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

 

The accuracy of our financial statements and related disclosures could be affected because we are exposed to conditions or assumptions different from the judgments, assumptions or estimates used in our critical accounting policies.

 

 

The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies included in this report describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. If future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, our audited consolidated financial statements and related disclosures could be materially affected.

 

 
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Our controls and procedures may fail or be circumvented, which could have a material adverse effect on our business, result of operations and financial condition.

 

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

 

Higher FDIC deposit insurance premiums and assessments could adversely impact our financial condition.

 

Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC. Although we cannot predict what the insurance assessment rates will be in the future, either deterioration in our risk-based capital ratios or adjustments to the base assessment rates could have a material diverse impact on our business, financial condition, results of operations, and cash flows.

 

Our profitability and liquidity are affected by changes in interest rates and economic conditions.

 

Our profitability depends upon our net interest income, which is the difference between interest earned on our interest-bearing assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Our net interest income is adversely affected when market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments or, conversely, when the interest we earn on loans and investments decreases faster than the interest we pay on deposits and borrowings. Interest rates, and consequently our results of operations, are affected by general economic conditions (domestic and foreign) and fiscal and monetary policies. Monetary and fiscal policies may materially affect the level and direction of interest rates. Increases in interest rates generally decrease the market values of interest-bearing investments and loans held and therefore may adversely affect our liquidity and earnings. Increased interest rates also generally affect the volume of mortgage loan originations, the resale value of mortgage loans originated for resale, and the ability of borrowers to perform under existing loans of all types. Decreases in interest rates generally have the opposite effect on market values of interest-bearing assets, the volume of mortgage loan originations, the resale value of mortgage loans originated for resale, and the ability of borrowers to perform under existing loans of all types from the effect of increases in interest rates.

 

Risks Related to Our Common Stock

 

Our common stock has a limited trading market, which may limit your ability to sell your stock.

 

Our common stock is traded on the Nasdaq Global Market under the symbol “SOCB.” Since January 1, 2015, the average daily trading volume has been less than 10,000 shares. Accordingly, a shareholder who wishes to sell a large number of shares may experience a delay in selling the shares or have to sell them at a lower price in order to sell them promptly.

 

The market price of our common stock may decline.

 

The market prices of many financial institution equity securities, including ours, declined significantly from 2008 to 2012 in response to the financial crises affecting the banking system and financial markets and the lingering effects of the related recession. There can be no assurance that significant declines in the market price of our common stock will not be experienced in the future.

 

 
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We may issue additional securities, which could affect the market price of our common stock and dilute your ownership.

 

We may issue additional securities to raise additional capital, to support growth, or to make acquisitions. Sales of a substantial number of shares of our common stock, or the perception by the market that those sales could occur, could cause the market price of our common stock to decline or could make it more difficult for us to raise capital through the sale of common stock or to use our common stock in future acquisitions. The issuance of substantial amounts of additional securities could reduce your proportionate ownership of the Company.

 

We do not plan to pay cash dividends in the foreseeable future.

 

We have never paid cash dividends and do not plan to pay cash dividends in the foreseeable future. We plan to use the funds that might otherwise be available to pay dividends to increase our capital.

 

Declaration and payment of dividends are within the discretion of our board of directors. Our bank will be our most likely source of funds with which to pay cash dividends. Our bank’s declaration and payment of future dividends to us are within the discretion of the bank’s board of directors, and are dependent upon its earnings, financial condition, its need to retain earnings for use in the business and any other pertinent factors. Payment of dividends is also subject to various regulatory requirements and considerations. Furthermore, as long as there are preferred securities of the Southcoast Capital Trust III outstanding and the Company has elected to defer making interest payments with respect to the preferred securities as permitted by the terms of the preferred securities, the Company may not declare or pay dividends on its common stock or redeem or repurchase any shares of its common stock, subject to certain minor exceptions, including payment of stock dividends.

 

Provisions in our articles of incorporation and South Carolina law may discourage or prevent takeover attempts, and these provisions may have the effect of reducing the market price for our stock.

 

Our articles of incorporation include several provisions that may have the effect of discouraging or preventing hostile takeover attempts, and therefore of making the removal of incumbent management difficult. The provisions include staggered terms for our board of directors and requirements of supermajority votes to approve certain business transactions. In addition, South Carolina law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of our board of directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding common stock. To the extent that these provisions are effective in discouraging or preventing takeover attempts, they may tend to reduce the market price for our stock.

 

Our common stock is not insured, so you could lose your total investment.

 

Our common stock is not a deposit, savings account or obligation of our bank and is not insured by the Federal Deposit Insurance Corporation or any other government agency. Should our business fail, you could lose your total investment.

 

There are additional risks related to our common stock in connection with our proposed merger with BNC Bancorp.

 

A number of additional risks to our common stock in connection with the Company’s proposed merger with BNC Bancorp are set forth under the caption “Risk Factors” in the joint Proxy Statement/Prospectus of the Company and BNC Bancorp, filed December 23, 2015, which risk factors are incorporated herein by reference.

 

Item 1B.

Unresolved Staff Comments.

 

None.

 

 
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Item 2.

Properties.

 

The Company owns the real property at 530-534 Johnnie Dodds Boulevard, Mt. Pleasant, South Carolina, where its main offices are located. The Company also owns the following properties in Charleston and Berkeley Counties of South Carolina, where its branch offices are located: 602 Coleman Boulevard, Mt. Pleasant; 3305 South Morgan’s Point Road, Mt. Pleasant; 802 Savannah Highway, Charleston; 1654 Sam Rittenberg Boulevard, Charleston; 337 East Main Street, Moncks Corner; 597 Old Mount Holly Road, Goose Creek; and 8420 Dorchester Road, North Charleston. The Company leases the properties at 302 N. Main Street, Summerville; and 2753 Maybank Highway, Johns Island. All properties are believed to be well suited for the Company’s needs.

 

In addition, the Company owns a parcel of undeveloped land in Bluffton, South Carolina, and a parcel of undeveloped land on Hilton Head Island, South Carolina, both of which were acquired in 2006 for possible future branch expansion.

 

At December 31, 2015, the Bank also held four properties acquired through foreclosure or in settlement of loans. All of the properties were being marketed for sale.

 

Item 3.

Legal Proceedings.

 

The Bank is from time to time a party to various legal proceedings arising in the ordinary course of business, but management of the Bank is not aware of any pending or threatened litigation or unasserted claims or assessments that are expected to result in losses, if any, that would be material to the Company’s business and operations.

 

Item 4.

Mine Safety Disclosures.

 

Not applicable.

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

 

The common stock of the Company is listed on the Nasdaq Global Market under the symbol "SOCB." The reported high and low sales prices for each quarter of 2015 and 2014 are shown in the following table.

 

2015

 

Low

   

High

 
                 

Fourth Quarter

  $ 12.58     $ 17.90  

Third Quarter

  $ 7.94     $ 13.47  

Second Quarter

  $ 7.16     $ 9.16  

First Quarter

  $ 6.82     $ 7.75  
                 

2014

               
                 

Fourth Quarter

  $ 4.92     $ 7.21  

Third Quarter

  $ 6.69     $ 7.45  

Second Quarter

  $ 6.32     $ 7.45  

First Quarter

  $ 5.78     $ 7.42  

 

As of December 31, 2015, there were approximately 1,395 holders of record of the Company's common stock, excluding individual participants in security position listings.

 

The Company has never paid any cash dividends, and to support its continued capital growth, does not expect to pay cash dividends in the near future. The dividend policy of the Company is subject to the discretion of the Board of Directors and depends upon a number of factors, including earnings, financial condition, cash needs and general business conditions, as well as applicable regulatory considerations. At present, the Company’s principal source of funds with which it could pay dividends would be dividend payments from the Bank. South Carolina banking regulations require the prior written consent of the South Carolina Commissioner of Banking for the payment of cash dividends by state banks.

 

 
18

 

 

Under the terms of the Indenture relating to its junior subordinated debentures, as a consequence of deferral of interest payments, the Company has agreed not to declare or pay dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to its common stock, subject to certain exceptions, including the issuance of stock dividends. See Note 11 to the Company’s Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K for the year ended December 31, 2015, for further information about the junior subordinated debentures and the deferral of interest payments.

 

The Merger Agreement between the Company and BNC Bancorp also restricts the Company’s ability to pay dividends.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The information required by Item 201(d) of Regulation S-K is set forth in Item 12 of this Form 10-K.

 

Unregistered Sales of Equity Securities

 

There were no sales of equity securities by the Company during the year ended December 31, 2015 that were not registered under the Securities Act of 1933.

.

Purchases of Equity Securities by the Company and Affiliated Purchasers

 

The Company did not purchase any shares of its equity securities during the fourth quarter of 2015.

 

Item 6.

Selected Financial Data

 

Not required.

 

Item 7.

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

 

 
19

 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following discussion is intended to assist you in understanding the financial condition and results of operations of Southcoast Financial Corporation and subsidiaries and should be read in conjunction with the consolidated financial statements and related notes included in this report. Many of the amounts and percentages in this section have been rounded for convenience of presentation, but actual recorded amounts have been used in computations. Accordingly, some numbers may differ slightly if recomputed using the numbers as presented.

 

Overview

 

We had net income for the year ended December 31, 2015 of $4.1 million, or $0.57 per basic share, compared to net income for the year ended December 31, 2014 of $3.7 million, or $0.53 per basic share.

 

During 2015 and 2014, improvements in the credit quality of the Company’s loan portfolio allowed the Company to record credits to provision for loan losses of $939,000 and $600,000, respectively. As illustrated in Note 4 to the financial statements, the Company recorded net recoveries to its Allowance for Loan Losses of $131,000 and $161,000 during 2015 and 2014, respectively. Nonaccrual loans totaled $3.1 million at December 31, 2015, $5.0 million at December 31, 2014, and $9.9 million at December 31, 2013. Classified loans totaled $12.1 million at December 31, 2015, $17.7 million at December 31, 2014, and $23.1 million at December 31, 2013. The combination of these factors reduced the Company’s required Allowance for Loan Losses during 2015 and 2014, and led to the aforementioned credits to the provision for loan losses during 2015 and 2014.

 

Net interest income increased in 2015 to $16.0 million, as compared to $14.6 million for 2014, as a result of changes in the rate and volume of average earning assets and average interest bearing liabilities.

 

Our average earning assets increased by $35.3 million in 2015. The increase was due to a $36.1 million increase in average loans, partially offset by a $0.8 million decrease in average investments and interest bearing cash and federal funds sold. The decrease in average investments and interest bearing cash and federal funds sold was comprised of a $4.4 million increase in interest bearing cash and federal funds sold and a $5.2 million decrease in average investments. The investment portfolio’s paydowns and maturities were not replaced with purchases of new investments as a result of management’s decision to reduce the size of its securities portfolio due to the current low yield environment. The loan growth was primarily mortgage loan related.

 

Net income for 2015 of $4.1 million contributed to a $4.6 million increase in average shareholders’ equity, which represented a 10.3% increase compared to 2014. Also contributing to the increase in average shareholders’ equity between the periods was $422,000 of other comprehensive income resulting from an increase in the value of the Company’s investments available for sale. Average earning assets increased 8.9% and total net interest income increased 9.8% in 2015.

 

Noninterest income increased by $879,000, or 41.0%, in 2015. The increase in noninterest income was primarily the result of increases of $734,000 and $185,000 in gains on sales of premises and equipment and gains on sales of mortgage loans held for sale, respectively, partially offset by a $109,000 decrease in gains on sales of investment securities.

 

Noninterest expenses increased by $1.6 million, or 13.5%, in 2015. The increase was primarily attributable to an increase of $943,000 in salaries and employee benefits between the two periods. Also contributing to the increase in noninterest expenses was a $683,000 increase in professional fees. The causes of these increases are covered in the noninterest expenses discussion.

 

 
20

 

 

Management’s Discussion and Analysis

 

Critical Accounting Policies

 

We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant policies are described in the notes to the consolidated financial statements.

 

Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities. Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management in these critical accounting policies are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

We believe accounting policies related to investment securities, the Allowance for Loan Losses, other real estate owned, and income taxes require the most significant judgments and estimates used in preparation of our consolidated financial statements. Refer to the discussion under the captions “Investment Portfolio,” “Allowance for Loan Losses,” “Real Estate Owned” and “Income Taxes” below and to Note 1 to our consolidated financial statements for a detailed description of our estimation process and methodology related to these items.

 

Comparison of Years Ended December 31, 2015 and 2014

 

Results of Operations

 

General

 

We had net income for the year ended December 31, 2015 of $4.1 million, or $0.57 per basic share, compared to net income for the year ended December 31, 2014 of $3.7 million, or $0.53 per basic share. We had net interest income of $16.0 million for 2015, as compared to $14.6 million for 2014. We also had noninterest income (principally earnings on Company Owned Life Insurance, service charges, gains on sale of assets, and fees and commissions) of $3.0 million in 2015 and $2.1 million in 2014. We credited the provision for loan losses $939,000 and $600,000 during the years ended December 31, 2015 and 2014, respectively. We had noninterest expenses (principally salaries and benefits, occupancy, furniture and equipment, and impairment of other real estate owned) of $13.6 million in 2015 and $12.0 million in 2014. Additionally, we had income tax expense of $2.3 million during 2015, compared to $1.6 million during 2014.

 

Net Interest Income

 

During the year ended December 31, 2015, net interest income was $16.0 million, as compared to $14.6 million for the year ended December 31, 2014. This increase was attributable to changes in the rate and volume of average interest earning assets and average interest bearing liabilities. Average interest earning assets increased to $430.8 million in 2015 from $395.5 million in 2014. The increase in volume was primarily attributable to a $36.1 million increase in average loans, partially offset by an $800,000 decrease in average investments and federal funds sold. The average yield on interest earning assets decreased from 4.62% to 4.54% from 2014 to 2015, while the average cost of interest bearing liabilities decreased from 1.03% to 0.94%. The net yield on average interest earning assets increased from 3.71% in 2014 to 3.74% in 2015. The decrease in net yield on average interest earning assets was due to declining yields in average loans and average investments and federal funds sold. Loan yield decreases were primarily attributable to a heavier mix of lower yielding consumer mortgage loans during 2015, and a decrease in yields on these consumer mortgage loans. Consumer mortgage loans comprised approximately 56% of average loans during 2015, and produced a yield of 4.19%. Consumer mortgage loans comprised approximately 53% of average loans during 2014, and produced a yield of 4.32%. The decrease in yields on average investments and federal funds sold was primarily attributable to a change in asset mix, as average interest bearing cash and federal funds sold, the lowest yielding asset class, comprised approximately 31% of average investments and federal funds sold during 2015, compared to approximately 23% during 2014. The increase in net interest income was due to an increase in interest income and a decrease in interest expense. The increase in the net yield on average interest earning assets was the result of lower funding costs, as the rate on average interest bearing liabilities decreased to 0.94% during 2015 from 1.03% during 2014. This decrease was primarily the result of decreases in rates paid on average savings and interest bearing demand deposits and time deposits. Rates paid on average savings and interest bearing demand deposits totaled 0.36% and 0.47% during 2015 and 2014, respectively. Rates paid on average time deposits totaled 0.69% and 0.71% during 2015 and 2014, respectively. Also contributing to the increase in net yield on average earning assets was a $10.4 million increase in average noninterest bearing deposits, which provided interest free funding for a portion of the growth in average earning assets.

 

 
21

 

 

Management’s Discussion and Analysis

 

Net Interest Income – (continued)

 

Comparison of Years Ended December 31, 2014 and 2013

 

Net Interest Income

 

During the year ended December 31, 2014, net interest income was $14.6 million, as compared to $13.7 million for the year ended December 31, 2013. This increase was attributable to changes in the rate and volume of average interest earning assets and average interest bearing liabilities. Average interest earning assets increased to $395.5 million in 2014 from $379.8 million in 2013. The increase in volume was primarily attributable to an $18.8 million increase in average loans, partially offset by a $3.1 million decrease in average investments and federal funds sold. The average yield on interest earning assets decreased from 4.65% to 4.62% from 2013 to 2014, while the average cost of interest bearing liabilities decreased from 1.12% to 1.03%. The net yield on average interest earning assets increased from 3.63% in 2013 to 3.71% in 2014. The increase in net yield on average interest earning assets was due to the increase in net interest income which outpaced the growth in earning assets. The increase in net interest income was due to an increase in interest income and a decrease in interest expense. Contributing to the increases in the net yield on average interest earning assets and net interest income was a $3.8 million reduction in average nonaccrual loans and other real estate owned, from $16.4 million for the year ended December 31, 2013, to $12.6 million for the year ended December 31, 2014. Nonaccrual loans and other real estate owned suppress a Company’s net interest margin, as they require funding, but do not produce interest income. When liquidated, the cash received for these assets is available to fund interest earning assets or reduce interest bearing liabilities, either of which would have the effect of increasing net interest income.

 

 
22

 

 

Management’s Discussion and Analysis

 

Net Interest Income – (continued)

 

The following table sets forth, for the periods indicated, information related to our average balance sheets and average yields on assets and average rates paid on liabilities. Such yields and rates are derived by dividing income or expense by the average balance of the corresponding assets or liabilities.

 

   

For the year ended

   

For the year ended

           

For the year ended

 
   

December 31, 2015

   

December 31, 2014

           

December 31, 2013

 

(Dollars in thousands)

 

Average

Balance

   

Income/

Expense

   

Yield/

Rate

   

Average

Balance

 

 

Income/

Expense

   

Yield/

Rate

   

Average

Balance

   

Income/

Expense

   

Yield/

Rate

 
                                                                         

Cash and Federal Funds Sold

  $ 17,068     $ 41       0.24 %   $ 12,700     $ 31       0.24 %   $ 12,258     $ 31       0.25 %

Investments - taxable

    34,975       816       2.33 %     39,831       952       2.39 %     42,934       936       2.18 %

Investments - nontaxable (1)

    3,627       222       6.12 %     3,921       236       6.02 %     4,332       265       6.12 %

Total investments and federal funds sold

    55,670       1,079       1.94 %     56,452       1,219       2.16 %     59,524       1,232       2.07 %

Loans (2)(3)

    375,179       18,463       4.92 %     339,081       17,046       5.03 %     320,286       16,425       5.13 %
                                                                         

Total Earning Assets

    430,849       19,542       4.54 %     395,533       18,265       4.62 %     379,810       17,657       4.65 %

Other Assets

    48,668                       52,002                       53,544                  
                                                                         

Total Assets

  $ 479,517                     $ 447,535                     $ 433,354                  
                                                                         
                                                                         

Savings and demand deposits

  $ 166,733     $ 594       0.36 %   $ 137,878     $ 651       0.47 %   $ 122,844     $ 676       0.55 %

Time deposits

    120,787       835       0.69 %     133,378       951       0.71 %     145,990       1,198       0.82 %

Other borrowings

    68,600       1,827       2.66 %     67,204       1,801       2.68 %     64,132       1,798       2.80 %

Subordinated debt

    10,310       181       1.76 %     10,310       178       1.73 %     10,310       186       1.80 %
                                                                         

Total interest bearing liabilities/interest expense

  $ 366,430       3,437       0.94 %   $ 348,770       3,581       1.03 %   $ 343,276       3,858       1.12 %
                                                                         
                                                                         

Non-interest bearing liabilities

    63,515                       53,828                       51,661                  
                                                                         

Total Liabilities

    429,945                       402,598                       394,937                  
                                                                         

Equity

    49,572                       44,937                       38,417                  
                                                                         

Total Liabilities and Equity

  $ 479,517                     $ 447,535                     $ 433,354                  
                                                                         

Net interest income/margin (4)

          $ 16,105       3.74 %           $ 14,684       3.71 %           $ 13,799       3.63 %
                                                                         

Net interest spread (5)

                    3.60 %                     3.59 %                     3.53 %

 

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

(2) Does not include nonaccruing loans.

(3) Income includes loan fees of $684,000 in 2015, $676,000 in 2014, and $577,000 in 2013.

(4) Net interest income divided by total earning assets

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

 

 
23

 

 

Management’s Discussion and Analysis

 

Net Interest Income – (continued)

 

The following table presents changes in our net interest income which are primarily a result of changes in the volumes (change in volume times old rate), changes in rates (change in rate times old volume), and changes in rate/volume (change in rate times the change in volume) of our interest earning assets and interest bearing liabilities.

 

   

Analysis of Change in Net Interest Income

 
   

For the Year ended December 31, 2015

versus the year ended December 31, 2014 (1)

   

For the Year ended December 31, 2014 versus

the year ended December 31, 2013 (1)

 

(Dollars in thousands)

 

Volume

   

Rate

   

Net Change

   

Volume

   

Rate

   

Net Change

 
                                                 
                                                 

Cash and Federal funds sold

  $ 10     $ -     $ 10     $ 1     $ (1 )   $ -  

Investments - taxable

    (116 )     (20 )     (136 )     (67 )     83       16  

Investments - non taxable (2)

    (18 )     4       (14 )     (25 )     (4 )     (29 )

Total investments and federal funds sold

    (124 )     (16 )     (140 )     (91 )     78       (13 )

Net loans (3)(4)

    1,815       (398 )     1,417       964       (343 )     621  

Total interest income

    1,691       (414 )     1,277       873       (265 )     608  
                                                 
                                                 

Savings deposits

  $ 136     $ (193 )   $ (57 )   $ 83     $ (108 )   $ (25 )

Time deposits

    (90 )     (26 )     (116 )     (103 )     (144 )     (247 )

Other borrowings

    38       (12 )     26       86       (83 )     3  

Subordinated Debt

    -       3       3       -       (8 )     (8 )
                                                 

Total interest expense

    84       (228 )     (144 )     66       (343 )     (277 )
                                                 

Net interest income

  $ 1,607     $ (186 )   $ 1,421     $ 807     $ 78     $ 885  

 

(1) Volume - rate changes have been allocated to each category on a consistent basis between rate and volume.

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

(3) Includes loan fees of $684,000 in 2015, $676,000 in 2014, and $577,000 in 2013.

(4) Does not include nonaccruing loans.

 

During 2016, management expects changes in interest rates to have little effect on the Company’s net interest income. Therefore, any improvements in net interest income for 2016 are expected to be largely the result of increases in volume and changes in the mix of interest-earning assets and liabilities. Additionally, any further reductions in overall levels of average nonperforming assets would provide margin improvement, as the proceeds from disposal of these assets could be invested into interest bearing assets or utilized to repay interest bearing liabilities as they come due. Management expects to continue to use aggressive marketing strategies to increase our bank's market share for both deposits and quality loans within its service areas in the greater Charleston, South Carolina, metropolitan area. These strategies involve offering attractive interest rates and continuing our Bank's commitment to providing outstanding customer service.

 

Market Risk - Interest Rate Sensitivity

 

Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, deposit, and borrowing activities. Management actively monitors and manages our interest rate risk exposure. Although we manage other non-market risks, such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be our most significant market risk that could potentially have the largest material effect on our financial condition and results of operations. Other types of market risk such as foreign currency exchange risk and commodity price risk do not affect us directly.

 

 
24

 

 

Management’s Discussion and Analysis

 

Market Risk - Interest Rate Sensitivity(continued)

 

Achieving consistent growth in net interest income is the primary goal of our asset/liability function. We attempt to control the mix and maturities of assets and liabilities to achieve consistent growth in net interest income despite changes in market interest rates. We seek to accomplish this goal while maintaining adequate liquidity and capital. We believe our asset/liability mix is sufficiently balanced so that the effect of interest rates moving in either direction is not expected to be material over time.

 

Interest rate sensitivity management is concerned with the timing and magnitude of repricing assets compared to liabilities and is an important part of asset/liability management. It is the objective of interest rate sensitivity management to generate stable growth in net interest income and to control the risks associated with interest rate movement. Management constantly reviews interest rate risk exposure and the expected interest rate environment so that adjustments in interest rate sensitivity can be made in a timely manner.

 

Our Bank’s Asset/Liability Committee uses a simulation model to assist in achieving consistent growth in net interest income while managing interest rate risk. The model takes into account interest rate changes as well as changes in the mix and volume of assets and liabilities. The model simulates our Bank’s balance sheet and income statement under several different rate scenarios. The model’s inputs (such as interest rates and levels of loans and deposits) are updated on a quarterly basis in order to obtain the most accurate forecast possible. The forecast presents information over a twelve-month period. It reports a base case in which interest rates remain flat and variations that occur when rates increase or decrease 100, 200, 300, and 400 basis points. According to the model, as of December 31, 2015, our Bank is positioned so that net interest income would decrease $32,000, and net income would decrease $21,000 if rates were to rise100 basis points in the next twelve months. Likewise, net interest income would decrease $295,000, and net income would decrease $192,000, if interest rates were to decline 100 basis points in the next twelve months. The potential volatility suggested by these hypothetical interest rate movements is considered to be low and is well within the Bank’s policy limits for such scenarios. Given the Federal Funds target rate of between 25 and 50 basis points at December 31, 2015, management considers a substantial decline in interest rates highly unlikely. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates and loan prepayments, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions our Bank could undertake in response to changes in interest rates or the effects of responses by others, including borrowers and depositors.

 

The “Interest Sensitivity Analysis” below indicates that, on a cumulative basis through twelve months, repricing rate sensitive liabilities exceeded rate sensitive assets, resulting in a liability sensitive position at December 31, 2015 of $ 160.5 million for a cumulative gap ratio of (34.93%). When interest sensitive liabilities exceed interest sensitive assets for a specific repricing "horizon," a negative interest sensitivity gap occurs. The gap is positive when interest sensitive assets exceed interest sensitive liabilities. For a bank with a negative gap, such as our Bank, rising interest rates would be expected to have a negative effect on net interest income and falling rates would be expected to have the opposite effect. However, as noted above, our simulation model indicates that rising rates would have a relatively minor negative effect on our net interest income. The simulation model differs from the “Interest Rate Sensitivity Analysis” primarily in its assumptions related to interest bearing transaction accounts, savings and money market accounts, and time deposits. The simulation model assumes that a change of 100 basis points in an indexed interest rate, such as the Federal Funds rate, would produce only a fractional change in rates paid on these types of deposit accounts, and these changes would not be immediate, but would lag behind the market rate changes. Due to the sophistication of the inputs and assumptions used in our simulation model, we believe that it produces more realistic outcomes of potential interest rate scenarios than the “Interest Rate Sensitivity Analysis.”

 

The table below reflects the balances of interest-earning assets and interest-bearing liabilities at the earlier of their repricing or maturity dates. Interest-earning deposits in other banks are reflected at the deposits' maturity dates. Loans not accruing interest are not included in the table. Repurchase agreements, Federal Home Loan Bank borrowings and subordinated debt (collectively, Other borrowings) are reflected in the earliest contractual repricing interval due to the immediately available nature of these funds. Interest-bearing liabilities with no contractual maturity, such as interest-bearing transaction accounts and savings deposits, are reflected in the earliest repricing interval due to contractual arrangements which give management the opportunity to vary the rates paid on these deposits within a 30-day or shorter period. However, our Bank is under no obligation to vary the rates paid on those deposits within any given period. Fixed rate time deposits are reflected at their contractual maturity dates. Fixed rate advances are reflected at their contractual maturity dates, and variable rate advances are reflected in the earliest repricing interval because they were borrowed under the daily rate credit option, and reprice daily. Fixed rate advances with conversion features that may become variable rate are reflected at the earlier of their repricing or maturity dates.

 

 
25

 

 

Management’s Discussion and Analysis

 

Market Risk - Interest Rate Sensitivity(continued)

 

Interest Sensitivity Analysis

December 31, 2015

 

 

(Dollars in thousands)

 

 

 

Within

Three

Months

   

After

Three

Through

Twelve

Months

   

One

Through

Five Years

   

Greater

Than Five

Years

   

Total

 

Assets

                                       

Interest earning assets:

                                       

Interest earning deposits in other banks

  $ 34,904     $ -     $ -     $ -     $ 34,904  

Investment securities

    11,637       516       457       24,026       36,636  

Loans held for sale

    1,711       -       -       -       1,711  

Loans (1)

    63,785       67,532       81,217       173,613       386,147  

Total Earning Assets

  $ 112,037     $ 68,048     $ 81,674     $ 197,639     $ 459,398  
                                         

Liabilities

                                       

Interest bearing liabilities:

                                       

Interest bearing transaction accounts

  $ 65,930     $ -     $ -     $ -     $ 65,930  

Savings and money market

    114,175       -       -       -       114,175  

Time deposits - $100,000 and over

    14,802       31,826       4,100       -       50,728  

Other time deposits

    13,952       36,806       2,111       -       52,869  

Total interest bearing deposits

  $ 208,859     $ 68,632     $ 6,211       -     $ 283,702  

Other borrowings

    61,070       2,000       25,000       20,000       108,070  

Total interest bearing liabilities

  $ 269,929     $ 70,632     $ 31,211     $ 20,000     $ 391,772  

Interest sensitivity gap

  $ (157,892 )   $ (2,584 )   $ 50,463     $ 177,639          

Cumulative interest sensitivity gap

  $ (157,892 )   $ (160,476 )   $ (110,013 )   $ 67,626          

Ratio of cumulative gap to earning assets

    -34.37 %     -34.93 %     -23.95 %     14.72 %        

 

 

(1)

Does not include nonaccruing loans.

 

Provision for Loan Losses

 

The Allowance for Loan Losses, established through charges to the provision for loan losses, allows for estimated loan losses inherent in our loan portfolio. Loan losses or recoveries are charged or credited directly to the allowance. The level of the allowance is based on management's judgment of the amount needed to maintain an allowance adequate to provide for probable losses in the loan portfolio as of the balance sheet date, though the exact amount of such losses and, in some cases, the specific loans cannot yet be identified. We credited the provision for loan losses $939,000 and $600,000 during the years ended December 31, 2015 and 2014, respectively. We believe the Allowance for Loan Losses adequately reserved for probable incurred losses for each of these periods. See “Allowance for Loan Losses” below.

 

Noninterest Income

 

Noninterest income, which consists primarily of service fees on deposits, gains and fees on loans sold, other fee income, company owned life insurance earnings, and gains on sales of securities and fixed assets, totaled approximately $3.0 million for the year ended December 31, 2015, as compared to approximately $2.1 million for the year ended December 31, 2014, an increase of approximately $879,000. The majority of the increase in noninterest income was the result of a $734,000 increase in gains on sales of premises and equipment, which was primarily due to the sale of a parcel of land owned by the Company.

 

 
26

 

 

Management’s Discussion and Analysis

 

Noninterest Income – (continued)

 

This transaction is discussed in more detail in Note 5 to the Company’s financial statements. Also contributing to the increase in noninterest income during 2015 was an increase of $185,000 in gains on sales of mortgage loans held for sale, as the Company’s sales proceeds for these loans totaled approximately $13.3 million during 2015, compared to $1.8 million during 2014. The increase in proceeds was the result of the Company’s decision to sell more of its mortgage production in order to limit the interest rate risk posed by keeping the loans in its own portfolio. Partially offsetting these increases was a $109,000 decrease in gains on sales of investment securities. The Company had no sales of investments during 2015.

 

Noninterest Expenses

 

Noninterest expenses, which consist primarily of salaries and employee benefits, occupancy, furniture and equipment, insurance expenses, and costs associated with other real estate owned, totaled $13.6 million for the year ended December 31, 2015, as compared to $12.0 million for the year ended December 31, 2014, an increase of $1.6 million. The majority of the increase was attributable to an increase of $943,000 in salaries and employee benefits between the two periods. This increase was primarily attributable to increases of $292,000 and $271,000 in bonus expense and employee life insurance expense, respectively. Approximately $230,000 of the increase in bonus expense was due to executive bonuses, and the rest was due to companywide holiday bonuses. The increase to employee life insurance expense was the result of the sale of a life insurance policy covering the Company’s Chief Executive Officer to the Chief Executive Officer during 2014. The proceeds of $271,000 from the sale of the policy were applied as a credit to life insurance expense, as they represented a partial refund of previous premiums paid. Additionally, base salary expense increased by approximately $258,000, or nearly 5%, which was primarily attributable to raises. Finally, life and health insurance premiums paid by the Company on behalf of its employees increased by approximately $60,000 due to rising insurance costs. Professional fees increased by approximately $683,000 during 2015, primarily due to merger related costs incurred by the Company in preparation for its upcoming merger with BNC Bancorp. The majority of these additional merger related fees were paid to attorneys and investment bankers in connection with the facilitation of the merger. Furniture and equipment expenses increased by approximately $218,000 during 2015, due to a $262,000 increase in software maintenance contracts, which was partially offset by a $42,000 decrease in depreciation expense. The increase in the software maintenance contracts was primarily related to data conversion fees paid as a result of the pending merger, while the decrease in depreciation expense was the result of an increase in fully depreciated assets. Insurance expense decreased by approximately $93,000 during 2015. Of this amount, approximately $88,000 related to a reduction in FDIC premiums. Other operating expenses decreased by approximately $161,000, and were primarily attributable to reductions of $95,000 and $45,000 in the unfunded commitments provision and foreclosure expenses, respectively. These reductions were attributable to continued improvements in the credit quality of the Company’s loan portfolio. The Company’s activities related to other real estate owned, including gains on sales, rental income, and impairments and other expenses, contributed net reductions to noninterest expense totaling $325,000 and $414,000 during 2015 and 2014, respectively.

 

Income Taxes

 

We recorded income tax expense of $2.3 million during 2015, compared to income tax expense of $1.6 million in 2014. See Note 13 to the current year’s audited financial statements for a full discussion of the Company’s income taxes and deferred tax asset.

 

 
27

 

 

Management’s Discussion and Analysis

 

Financial Condition

 

Investment Portfolio

 

As of December 31, 2015, our available-for-sale investment portfolio comprised approximately 6.37% of our total assets. The following table summarizes the carrying value amounts of available-for-sale securities we held at December 31, 2015, 2014, and 2013. All securities are held available-for-sale and are stated at estimated fair value.

 

 Securities Portfolio Composition

 

   

December 31,

 
   

2015

   

2014

   

2013

 

(Dollars in thousands)

 

Amortized

Cost

   

Net

Unrealized Holding

Gain/

(Loss)

   

Fair

Value

   

Amortized

Cost

   

Net

Unrealized Holding

Gain/

(Loss)

   

Fair

Value

   

Amortized

Cost

   

Net

Unrealized Holding Gain/ (Loss)

   

Fair

Value

 

Available-for Sale

                                                                       

Mortgage-backed securities

                                                                       

Government sponsored Enterprises (1)

  $ 21,502     $ (184 )   $ 21,318     $ 21,318     $ 23     $ 24,938     $ 30,889     $ (1,020 )   $ 29,869  

U.S. States and political subdivisions

    3,433       249       3,682       3,924       260       4,184       3,918       150       4,068  

Other Investments (2)

    8,218       (1,183 )     7,035       8,208       (2,061 )     6,147       8,199       (2,314 )     5,885  

Total

  $ 33,153     $ (1,118 )   $ 32,035     $ 37,047     $ (1,778 )   $ 35,269     $ 43,006     $ (3,184 )   $ 39,822  

 

 

 

(1)

Includes securities secured by pools of mortgages from various issuers, including FNMA and FHLMC

 

(2)

Includes trust preferred and other equity securities.

 

The unrealized loss attributable to Other Investments for December 31, 2015 primarily relates to our investments in two pooled trust preferred securities. The table below outlines these investments.

 

(Dollars in thousands)

Security

Description

 

Credit

Tranche

 

Interest

Payment

Status

 

Tax

Equivalent

Book Yield

   

Book Value

   

Unrealized

Holding Loss

   

Fair Value

 
                                         

ALESCO 9A

 

A2

 

Active

    1.53 %   $ 1,829     $ 653     $ 1,176  

PreTSL 27

 

C1

 

PIK

    1.59 %   $ 1,739       583       1,156  
                    $ 3,568     $ 1,236     $ 2,332  

 

The value of these securities has been adversely affected by a lack of liquidity in the market for these securities as well as the current coupon interest rates on the securities. The book yields on these securities represent a combination of the coupon interest rates and accretive discounts on these securities. These securities pay variable rates of interest based on three month LIBOR. The current tax equivalent book yields shown above reflect three month LIBOR at December 31, 2015. Current market rates of interest for capital borrowings vary based on issuer, but the tax equivalent book yields reflected in the above table are significantly lower than current market rates for such borrowings.

 

The first security above is currently paying interest and has excess subordination of 33.47%. This means that, for the credit tranche owned by the Company, the total dollar value of performing issuers in the pool exceeds total Class A notes outstanding by 33.47%. Accordingly, the Company is receiving contractual interest payments on these securities. Based on the over collateralized position of this security and the current nature of its interest payments this security was deemed not to have other than temporary impairment, as projected cash flows support the book value of the security.

 

 
28

 

 

Management’s Discussion and Analysis

 

Securities Portfolio Composition – (continued)

 

The second security above is a Class C note and is currently receiving payment in kind (PIK) interest. This means that in lieu of cash interest payments, interest is being capitalized and added to the Company’s principal investment in the security. Class A note holders of this security have had their principal paid down and currently satisfy their over collateralization requirements. The Class A notes are currently receiving cash payments of contractual interest. The Class B Notes have begun to receive principal payments to meet their over collateralization requirements. If and when these requirements are met by the Class B notes, the Class C Notes will begin to receive principal payments to meet their over collateralization requirements, followed by the Class D Notes. Management has engaged a third party firm specializing in securities valuations to evaluate this security’s principal and PIK interest for potential other-than-temporary impairment. This firm performed a discounted cash flow analysis through December 2037, the date of maturity for this security, which showed approximately $176,000 of credit loss as of March 31, 2011. This analysis was performed with relevant assumptions about projected default probabilities for the underlying issuers in this security. However, management has discontinued accrual of interest on this security due to the PIK interest on the security and the overall credit deterioration in the security. If the underlying issuers in this security show additional financial deterioration, the Company may recognize other than temporary impairment in the future.

 

See Note 3 to the audited financial statements for further information about these securities.

 

The following table presents maturities and weighted average yields of securities available-for-sale at December 31, 2015. Available-for-sale securities are stated at estimated fair value. There were no available-for-sale securities with maturities in time periods not presented in the table. Equity securities have no maturity and are shown as a separate category. Maturities for mortgage-backed securities are not listed due to their tendency to have frequent prior to maturity paydowns.

 

Securities Portfolio Maturities and Yields

 

   

December 31, 2015

 

(Dollars in Thousands)

 

Fair Value

   

Yield

 

Government sponsored enterprises

               

Mortgage backed

  $ 21,318       2.34 %
                 

U.S. States and political subdivisions (1)

               

Due within one year

    516       6.89 %

Due from one to five years

    457       6.27 %

Due from five to ten years

    2,130       5.92 %

Due after ten years

    579       5.29 %

Total

  $ 3,682       6.01 %
                 

Other investments

               

Due after ten years

  $ 2,832       1.84 %

Equity securities with no maturities or stated yields

    4,203       -  

Total

  $ 7,035          

 

(1) Yields are calculated on a tax equivalent basis.

 

 

Loan Portfolio

 

Management believes the loan portfolio is adequately diversified. The loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers. The only concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions of which management is aware are for residential mortgage loans, commercial real estate loans, and construction and land development loans geographically concentrated in the Company’s market area. The Company does not make foreign loans. Because we operate a community bank, nearly all of the loans are to borrowers in, or secured by real estate located in, or near, our market area. See Note 1 to Consolidated Financial Statements, “Concentration of Credit Risk,” for further information.

 

 
29

 

 

Management’s Discussion and Analysis

 

Loan Portfolio – (continued)

 

The amounts of loans outstanding are shown in the following table according to type of loan for the following dates:

 

Loan Portfolio Composition

   

December 31,

 

 

 

2015

   

2014

   

2013

   

2012

   

2011

 
(Dollars in Thousands)                                        

Real estate secured loans:

                                       

Residential 1-4 Family

  $ 241,111     $ 217,518     $ 188,406     $ 174,421     $ 166,414  

Multifamily

    4,747       5,108       4,828       5,555       5,144  

Commercial

    85,501       87,906       79,963       80,284       81,253  

Construction

    34,311       29,060       34,232       40,305       39,241  

Total real estate secured loans

    365,670       339,592       307,429       300,565       292,052  

Commercial and Industrial

    20,666       22,022       22,208       24,511       25,135  

Consumer

    2,623       2,206       1,960       1,915       2,037  

Other

    337       328       309       478       515  
                                         

Total Gross Loans

    389,296       364,148       331,906       327,469       319,739  

Allowance for Loan Losses

    (4,794 )     (5,602 )     (6,041 )     (8,159 )     (10,691 )
                                         
    $ 384,502     $ 358,546     $ 325,865     $ 319,310     $ 309,048  

 

A certain degree of risk is inherent in the extension of credit. Management has established loan and credit policies designed to control both the types and amounts of risks assumed and to ultimately minimize losses. Such policies include limitations on loan-to-collateral values for various types of collateral, requirements for appraisals of real estate collateral, problem loan management practices and collection procedures, and nonaccrual and charge-off guidelines.

 

Commercial loans primarily represent loans made to businesses and may be made on either a secured or an unsecured basis. Approximately 27.27% of our bank's loan portfolio at December 31, 2015 was comprised of commercial loans, 80.53% of which were secured by real estate (shown in the table above as “Real Estate Secured Loans – Commercial”). Commercial loans not secured by real estate were classified as “Commercial and Industrial,” as set forth in the table above. When taken, collateral on loans not secured by real estate may consist of liens on receivables, equipment, inventories, furniture and fixtures and other business assets. Commercial loans are usually made to businesses to provide working capital, expand physical assets or acquire assets. Commercial loans will generally not exceed a 20-year maturity and will usually have regular amortization payments. Commercial loans to most business entities require guarantees of their principals. Commercial lending involves significant risk because repayment usually depends on the cash flows generated by a borrower's business, and the debt service capacity of a business can deteriorate because of downturns in national and local economic conditions, as well as situations particular to a borrower’s business or industry. Initial and continuing financial analysis of a borrower's financial information is required to control this risk.

 

Construction and land development loans represent 8.81% of the loan portfolio and typically consist of financing for the construction of 1-4 family dwellings and some non-farm, non-residential real estate. Usually, loan-to-value ratios are not to exceed 80%, and permanent financing commitments are required prior to the advancement of loan proceeds. Included in total real estate construction and land development loans at December 31, 2015, were $12.4 million in residential construction loans, $3.7 million in residential land development loans, $6.2 million in residential lot loans, $4.5 million in commercial lot loans, $2.9 million in other commercial construction loans, $2.1 million in loans secured by raw land, and $2.5 million in other commercial purpose land loans.

 

Residential real estate loans comprised approximately 63.15% of our Bank's loan portfolio at December 31, 2015. Residential real estate loans consist mainly of first and second mortgage loans on single family homes, with some multifamily real estate loans. First mortgage loans comprised approximately 90.54% of total residential real estate loans at December 31, 2015. Loan-to-value ratios for these instruments are generally not to exceed 80%.

 

 
30

 

 

Management’s Discussion and Analysis

 

Loan Portfolio Composition – (continued)

 

Total loans outstanding increased by $25.1 million between December 31, 2014 and December 31, 2015. This increase is attributable to increases of approximately $23.5 million in residential 1–4 family loans, $5.3 million in construction and land development loans, and $426,000 of consumer and other loans, partially offset by decreases of $2.4 million, $1.4 million, and $361,000 of commercial real estate loans, commercial and industrial loans, and multifamily real estate loans, respectively. During 2015, the Company recorded net recoveries of $131,000 to its Allowance for Loan Losses, and no foreclosed loans were transferred into other real estate owned. As discussed in Note 6 to the audited financial statements, the Company made loans totaling approximately $3.5 million and $2.2 million to facilitate the sale of other real estate owned during 2015 and 2014, respectively. During 2015, the Company recognized gains on Company financed sales of other real estate owned totaling $44,000 that were previously deferred due to inadequate borrower down payments. During 2014, the Company realized deferred gains of $337,000 on sales of other real estate owned.

 

Maturity and Interest Sensitivity Distribution of Loans

 

The following table sets forth the maturity distribution of our loans, by type, at December 31, 2015, as well as the type of interest requirement on such loans.

 

 

One Year or

Less

   

Over One

Year

Through

Five Years

   

Over Five

Years

   

Total

 
(Dollars in Thousands)                                

Real estate secured loans:

                               

Residential 1-4 Family

  $ 3,965     $ 10,958     $ 226,188     $ 241,111  

Multifamily

    1,068       1,704       1,975       4,747  

Commercial

    2,309       27,811       55,381       85,501  

Construction

    10,092       12,384       11,835       34,311  

Total real estate secured loans

    17,434       52,857       295,379       365,670  

Commercial and Industrial

    7,063       8,007       5,596       20,666  

Consumer

    662       1,431       530       2,623  

Other

    -       35       302       337  
    $ 25,159     $ 62,330     $ 301,807     $ 389,296  
                                 

Predetermined rate, maturity greater than one year

    -     $ 46,942     $ 164,500     $ 211,442  

Variable rate or maturity within one year

  $ 25,159     $ 15,388     $ 137,307     $ 177,854  

 

 

Nonperforming Loans And Other Problem Assets

 

When a loan is 90 days past due on interest or principal or there is serious doubt as to collectability, the accrual of interest income is generally discontinued unless the estimated net realizable value of collateral is sufficient to assure the likelihood of collection of the principal balance and accrued interest. When the collectability of a significant amount of principal is in serious doubt, the principal balance is reduced to the estimated fair value of collateral by a charge-off to the Allowance for Loan Losses, and any subsequent collections are credited first to the remaining principal balance and then to the Allowance for Loan Losses as a recovery of the amount charged off. A nonaccrual loan is not returned to accrual status unless principal and interest are current and the borrower has demonstrated the ability to continue making payments as agreed. When a loan’s terms have been modified from the original note and the modified terms represent a concession made by the Company due to a borrower’s financial difficulty, a troubled debt restructuring exists. Troubled debt restructurings contain terms the Company would not customarily offer in the ordinary course of business. See Notes 1 and 4 to the audited financial statements for additional information about nonperforming loans and other problem assets. At December 31, 2015, we had $3.1 million of nonaccrual loans, $218,000 of loans 90 days or more past due and still accruing interest, and $1.5 million of troubled debt restructurings, $933,000 of which were also included in nonaccrual loans. The gross interest income which would have been recorded under the original terms of the nonaccrual loans amounted to approximately $152,000 in 2015. No interest on nonaccruing loans was included in net income for 2015. No interest income on loans 90 days or more past due was recognized during 2015. The gross interest income that would have been recognized according to the original loan terms on loans that are troubled debt restructurings during 2015 and 2014 totaled approximately $40,000 and $41,000, respectively; actual interest income recognized on these loans according to the restructured terms totaled $37,000 and $11,000, respectively.

 

 
31

 

 

Management’s Discussion and Analysis

 

Nonperforming Loans And Other Problem Assets – (continued)

 

 

The following table presents information on nonperforming loans and real estate acquired in settlement of loans:

 

 

   

December 31,

 
   

2015

   

2014

   

2013

   

2012

   

2011

 
(Dollars in Thousands)                                        

Nonperforming loans:

                                       

Nonaccrual loans

  $ 3,149     $ 4,969     $ 9,854     $ 9,714     $ 21,268  

Past due 90 days or more

    218       -       -       -       -  

Accruing restructured loans

    608       613       405       2,013       1,064  

Total nonperforming loans

    3,975       5,582       10,259       11,727       22,332  
                                         

Real estate acquired in settlement of loans

    327       3,686       5,249       9,619       9,323  

Total nonperforming assets

  $ 4,302     $ 9,268     $ 15,508     $ 21,326     $ 31,655  
                                         

Nonperforming assets as a percentage of loans and other real estate owned

    1.10 %     2.52 %     4.60 %     6.33 %     9.62 %

Allowance for loan losses as a percentage of nonperforming loans

    120.60 %     100.36 %     58.88 %     69.69 %     47.87 %

 

 

The declining levels of nonperforming loans and nonperforming assets during 2015 and 2014 compared to the prior periods presented in the above table reflect a steady recovery from the effects of the severe economic downturn which began in 2008. This downturn impacted developers, builders, and others associated with the real estate business most significantly, but also impacted local businesses and consumers, as unemployment levels were elevated and consumer spending was negatively impacted throughout this timeframe. As real estate values have risen and unemployment rates have fallen over the last several years, the Company has experienced considerable asset quality improvement. Further reductions to the Company’s nonperforming assets likely depend on a continuation of these positive economic trends.

 

The Company’s total nonaccrual loans at December 31, 2015 and 2014 included loans with partial charge offs totaling $589,000 and $621,000, respectively. These amounts are detailed in Note 4 to the audited financial statements.

 

Potential Problem Loans

 

Management identifies and maintains a list of potential problem loans. These are loans with risk grades of 7 (substandard) that are actively accruing interest 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 doubt about the borrower’s ability to continue to comply with current loan repayment terms. At December 31, 2015 potential problem loans totaled $9.1 million, a decrease of $2.9 million when compared to potential problem loans of $12.0 million at December 31, 2014. A description of loan risk grades is included in the “Allowance for Loan Losses” portion of this discussion. Approximately $8.7 million of December 31, 2015 problem loans represented loans secured by real estate, compared to $11.5 million of problem loans at December 31, 2014. Management closely tracks the current values of real estate collateral when assessing the collectability of potential problem loans secured by real estate.

  

 
32

 

 

Management’s Discussion and Analysis

 

Allowance for Loan Losses

 

The Allowance for Loan Losses is increased by provisions which are direct charges to operating expense. Losses on loans are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Recoveries of previously charged off loans, are credited to the allowance. Sales of other real estate owned do not impact the Allowance for Loan Losses, and any gains or losses as a result of these sales are accounted for separately in noninterest expenses.

 

In reviewing the adequacy of the Allowance for Loan Losses, management considers the historical loan losses we experienced, current economic conditions affecting the ability of our borrowers to repay, the volume of loans and the trends in delinquent, nonaccrual, and potential problem loans, information about specific borrower situations, and the quality and value of collateral securing nonperforming and problem loans, and other factors. After charging off all known losses, management considers the Allowance for Loan Losses adequate to cover its estimate of inherent losses in the loan portfolio as of December 31, 2015.

 

In calculating the amount required for the Allowance for Loan Losses, management applies a consistent methodology that is updated quarterly and is designed in accordance with generally accepted accounting principles and regulatory guidance. The methodology utilizes the loan risk grading system outlined below and detailed loan reviews to assess credit risks and the overall quality of the loan portfolio. Also, the calculation provides for management's assessment of trends in national and local economic conditions that might affect the general quality of the loan portfolio. Regulators review the adequacy of the Allowance for Loan Losses as part of their examination of our Bank and may require adjustments to the allowance based upon information available to them at the time of the examination. During 2015, the Company had $131,000 in net recoveries to the Allowance for Loan Losses. The Company credited the loan loss provision for $939,000 during the year due to the net recoveries, lower delinquencies, lower levels of classified and nonaccrual loans.

 

At December 31, 2015 the Allowance for Loan Losses totaled $4.8 million. Our Allowance for Loan Losses has a general reserve component and a specific reserve component. The general reserve is allocated to pools of loans based on loan type, with each loan type assigned a reserve percentage. The reserve percentage is based on historical charge-off percentages and economic risk factors indexed for current delinquency rates for each loan type. Historical charge-offs are calculated by taking an average of the Company’s most recent four or eight quarter loss experience. At December 31, 2015, the Company used a twelve quarter loss history. Economic risk factors considered in the calculation include loans with loan to value ratios higher than policy guidelines, adjustable and variable rate loans, which can experience repayment stress during times of rising interest rates, growth in the loan portfolio, lending personnel changes, and incomplete loan documentation. The Company uses a weighted degree of risk for each of these factors based on the levels of delinquency for each loan type.

 

As noted above, 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.

 

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 worth of the obligor, or of the collateral, and 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.

 

 
33

 

 

Management’s Discussion and Analysis

 

Allowance for Loan Losses(continued)

 

The general reserve calculation described above accounts for repayment risk that is allocable to all loans within each loan type. There are additional risks that apply only to certain pools of loans that are not segregated by loan type. These risk factors relate to certain higher risk loans such as variable rate loans and loans with excessive loan to value ratios, capital concentrations by collateral type, and new loan production levels. A reserve for these factors is calculated using a standard methodology and is included in the other general reserves portion of the calculation and combined with the result of the calculations described above and the total unallocated Allowance for Loan Losses to arrive at the total general reserve. The unallocated portion of the general reserve totaled approximately $311,000 and $319,000 at December 31, 2015 and 2014, respectively. These amounts provide reserves against environmental factors such as continued higher than normal unemployment, home price deterioration, and continued weakness in commercial real estate caused by higher vacancy rates and the lower resultant rental rates that can lead to additional levels of losses in our loan portfolio. They also provide reserves for portfolio risk factors not specifically identified by the general reserve calculation, such as chronic slow paying loans exhibiting borrower stress that are not delinquent at the end of any given month, and therefore are not captured in the delinquency risk factor. The specific reserve calculation is comprised of loans evaluated for impairment on an individual basis. Generally, management evaluates an individual loan for impairment when a loan or group of related loans exceeds $250,000 and we do not expect to receive contractual principal and interest payments in accordance with the note. Generally, these loans have internal risk classifications of 7, 8, or 9, as seen in the chart above. The amount of impairment, and therefore, the required reserve, is the difference, if any, between the principal balance of the loan and the fair value of the most likely payment source, which is generally the liquidation of the underlying collateral, but may also include the present value of expected future cash flows or the loan’s observable market price. Collateral fair value is determined based on the most recent appraisal available, adjusted to account for the age of the appraisal, estimated selling costs, and estimated holding period costs. An additional discount is also calculated based on the presumption that the collateral will be bank owned. The amounts of these discounts vary among properties based on property type, estimated time to sell, and any other factors of which management may be aware. Loans evaluated for impairment on an individual basis are not evaluated as part of the general reserve calculation.

 

The tables below show the allocation of the Company’s Allowance for Loan Losses by loan type and by general reserve and specific reserve for the years ended December 31, 2015, 2014, 2013, 2012, and 2011.

 

Detail of Allowance for Loan Losses Allocation

 

   

Year Ended December 31, 2015

 
   

General Reserve

   

Specific Reserve

   

Total

   

Percentage of Total

 

(Dollars in thousands)

                               
                                 

Construction and Land Development

  $ 232     $ -     $ 232       4.84 %

1-4 Family Residential

    1,262       41       1,303       27.18  

Multifamily Residential

    27       -       27       0.56  

Commercial Real Estate

    1,426       -       1,426       29.75  

Commercial and Industrial

    429       -       429       8.95  

Consumer and Other

    15       -       15       0.31  

Other General Reserves

    1,050       -       1,050       21.90  

Unallocated

    312       -       312       6.51  
                                 

Total Allowance

  $ 4,753     $ 41     $ 4,794       100.00 %

 

 
34

 

 

Management’s Discussion and Analysis

 

Allowance for Loan Losses(continued)

 

 

   

Year Ended December 31, 2014 

 
   

General Reserve

   

Specific Reserve

   

Total

   

Percentage of Total

 

(Dollars in thousands)

                               
                                 

Construction and Land Development

  $ 312     $ -     $ 312       5.56 %

1-4 Family Residential

    1,532       63       1,595       28.48  

Multifamily Residential

    61       -       61       1.08  

Commercial Real Estate

    1,424       -       1,424       25.43  

Commercial and Industrial

    496       -       496       8.85  

Consumer and Other

    32       -       32       0.56  

Other General Reserves

    1,363       -       1,363       24.35  

Unallocated

    319       -       319       5.69  

Total Allowance

  $ 5,539     $ 63     $ 5,602       100.00 %

 

   

Year Ended December 31, 2013 

 
   

General Reserve

   

Specific Reserve

   

Total

   

Percentage of Total

 

(Dollars in thousands)

                               
                                 

Construction and Land Development

  $ 577     $ 8     $ 585       9.68 %

1-4 Family Residential

    1,630       199       1,829       30.28  

Multifamily Residential

    49       9       58       0.96  

Commercial Real Estate

    1,031       -       1,031       17.07  

Commercial and Industrial

    690       -       690       11.42  

Consumer and Other

    24       -       24       0.40  

Other General Reserves

    1,339       -       1,339       22.16  

Unallocated

    485       -       485       8.03  

Total Allowance

  $ 5,825     $ 216     $ 6,041       100.00 %

 

   

Year Ended December 31, 2012 

 
   

General Reserve

   

Specific Reserve

   

Total

   

Percentage of Total

 

(Dollars in thousands)

                               
                                 

Construction and Land Development

  $ 512     $ 94     $ 606       7.43 %

1-4 Family Residential

    1,944       368       2,312       28.34  

Multifamily Residential

    39       -       39       0.48  

Commercial Real Estate

    1,188       76       1,264       15.49  

Commercial and Industrial

    1,285       39       1,324       16.23  

Consumer and Other

    55       -       55       0.67  

Other General Reserves

    1,939       -       1,939       23.77  

Unallocated

    620       -       620       7.59  

Total Allowance

  $ 7,582     $ 577     $ 8,159       100.00 %

 

 
35

 

 

Management’s Discussion and Analysis

 

Allowance for Loan Losses(continued)

 

 

   

Year Ended December 31, 2011

 
   

General Reserve

   

Specific Reserve

   

Total

   

Percentage of Total

 

(Dollars in thousands)

                               
                                 

Construction and Land Development

  $ 625     $ 8     $ 633       5.92 %

1-4 Family Residential

    1,763       1,098       2,861       22.93  

Multifamily Residential

    175       122       297       2.78  

Commercial Real Estate

    1,691       718       2,409       22.53  

Commercial and Industrial

    1,898       -       1,898       17.75  

Consumer and Other

    41       -       41       0.38  

Other General Reserves

    1,515       -       1,515       14.17  

Unallocated

    1,037       -       1,037       13.54  

Total Allowance

  $ 8,745     $ 1,946     $ 10,691       100.00 %

 

 
36

 

 

Management’s Discussion and Analysis

 

Allowance for Loan Losses(continued)

 

The table, "Historical Loan Loss Experience," summarizes loan balances at the end of each period indicated, averages for each period, changes in the allowance arising from charge-offs and recoveries, and additions to the allowance which have been charged to expense.

 

Historical Loan Loss Experience

   

Year Ended December 31,

 
   

2015

   

2014

   

2013

   

2012

   

2011

 

(Amounts in thousands)

                                       
                                         

Total Loans Outstanding at end of period

  $ 389,296     $ 364,148     $ 331,906     $ 327,469     $ 319,739  
                                         

Average amount of loans outstanding

  $ 375,179     $ 346,943     $ 329,213     $ 324,891     $ 329,523  
                                         

Balance of Allowance for Loan Losses at beginning of year

  $ 5,602     $ 6,041     $ 8,159     $ 10,691     $ 9,513  

Loans charged off Construction and Land Development

    -       114       972       617       4,021  

1-4 Family Residential

    73       52       388       1,968       1,119  

Multifamily Residential

    -       155       -       -       502  

Commercial Real Estate

    -       159       423       883       2,116  

Commercial and Industrial

    261       42       1,263       65       1,464  

Consumer and Other

    6       1       86       54       28  

Total Chargeoffs

    340       523       3,132       3,587       9,250  
                                         

Recoveries of loans previously charged off Construction and Land Development

    28       21       32       67       124  

1-4 Family Residential

    -       46       499       64       125  

Multifamily Residential

    155       11       1       18       -  

Commercial Real Estate

    190       342       3       1       30  

Commercial and Industrial

    54       218       13       23       125  

Consumer and Other

    44       46       66       2       1  

Total Recoveries

    471       684       614       175       405  
                                         

Net charge-offs

    (131 )     (161 )     2,518       3,412       8,845  

Additions to allowance charged to expense

    (939 )     (600 )     400       880       10,023  
                                         

Balance of Allowance for Loan Losses at end of year

  $ 4,794     $ 5,602     $ 6,041     $ 8,159     $ 10,691  
                                         
                                         

Ratios

                                       

Net charge-offs during period to average loans outstanding during period

    -0.03 %     -0.05 %     0.76 %     1.05 %     2.68 %

Net charge-offs to loans at end of period

    -0.03 %     -0.04 %     0.76 %     1.04 %     2.77 %

Allowance for Loan Losses to average loans

    1.28 %     1.61 %     1.83 %     2.51 %     3.24 %

Allowance for Loan Losses to loans at end of period

    1.23 %     1.54 %     1.82 %     2.49 %     3.34 %

Allowance for Loan Losses to nonperforming loans at end of period

    120.60 %     100.04 %     58.88 %     69.69 %     47.87 %

Net charge-offs to Allowance for Loan Losses

    -2.73 %     -2.87 %     41.68 %     41.82 %     82.73 %

Net charge-offs to Provision for Loan Losses

    13.95 %     26.83 %     629.50 %     387.73 %     88.25 %

 

 
37

 

 

Management’s Discussion and Analysis

 

Allowance for Loan Losses(continued)

 

As shown in the table above, during 2015, the Company experienced its strongest loan portfolio performance in the last five years. Because of lower chargeoffs, lower loan delinquencies, and lower levels of special mention and substandard loans, the Company maintained a lower level of Allowance for Loan Losses.

 

Real Estate Owned

At December 31, 2015 and 2014, we had $327,000 and $3.7 million, respectively, of real estate owned pursuant to foreclosure or deed in lieu of foreclosure. Other real estate owned is initially recorded at its estimated fair market value less estimated selling costs. The estimated fair market value is determined by current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. Subsequently, other real estate owned is carried at the lower of carrying value or fair value less costs to sell. The carrying value is generally reevaluated annually on the anniversary of acquisition. Any declines to fair value less costs to sell are recorded as charges to the impairment provision for other real estate owned. Discounts to appraised values are included for estimated selling costs and holding period costs. An additional discount is also calculated based on the properties being bank owned. The amounts of these discounts vary among properties based on property type, estimated time to sell, and any other factors of which management may be aware.

 

Real Estate Owned by Property Type

(Dollars in Thousands)

   

Year Ended December 31,

 
   

2015

   

2014

 

Commercial Office Properties

  $ -     $ 598  

Commercial Lots

    327       2,777  

Residential 1-4 Family Homes

    -       311  

Total Other Real Estate Owned

  $ 327     $ 3.686  

 

The Company actively markets other real estate owned with the goal of maximizing the realized value of the properties. During 2015, sales proceeds from other real estate owned totaled $3.6 million, and the Company recognized $325,000 in net gains on the sale of other real estate owned.

 

Deposits

 

The average amounts and the average rates we paid on deposits for the years ended December 31, 2015, 2014, and 2013 are summarized below:          

 

   

Year Ended December 31,

 
   

2015

   

2014

   

2013

 

 

 

Amount

   

Average

Rate

Paid

   

Amount

   

Average

Rate

Paid

   

Amount

   

Average

Rate

Paid

 
(Dollars in Thousands)                                                

Noninterest bearing demand

  $ 56,839       0.00 %   $ 46,351       0.00 %   $ 45,117       0.00 %

Interest bearing transaction accounts

    64,790       0.49 %     62,131       0.71 %     59,239       0.84 %

Savings and money market

    101,943       0.27 %     75,747       0.28 %     63,606       0.28 %

Time deposits - $100,000 and over

    52,890       0.78 %     54,365       0.78 %     59,669       0.77 %

Other time deposits

    67,897       0.62 %     79,013       0.67 %     86,321       0.85 %

Total deposits

  $ 344,359       0.41 %   $ 317,607       0.50 %   $ 313,952       0.60 %

 

 
38

 

 

Management’s Discussion and Analysis

 

Deposits(continued)

 

As of December 31, 2015, we had $50.7 million in time deposits of $100,000 or more. Of these time deposits of $100,000 or more, all were retail time deposits. We had no brokered or wholesale time deposits at December 31, 2015. Of the time deposits greater than $100,000, approximately $13.0 million had maturities within three months, $16.5 million had maturities over three through six months, $16.1 million had maturities over six through twelve months, and $5.1 million had maturities over twelve months.

 

Junior Subordinated Debentures

 

In 2005, we established Southcoast Capital Trust III (the “Capital Trust”), as a non-consolidated subsidiary. The Capital Trust issued and sold a total of 10,310 floating rate securities, with a $1,000 liquidation amount per security. Institutional buyers bought 10,000 of the floating rate securities denominated as preferred securities and we bought the other 310 floating rate 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 us which are reported on our consolidated balance sheets.

 

The Capital Securities issued by Capital Trust III mature or are mandatorily redeemable on September 30, 2035. We have the optional right to redeem these securities on or after September 30, 2010. The preferred securities of Capital Trust III total $10.3 million, of which $10.0 million qualify as Tier 1 capital under Federal Reserve Board guidelines, subject to limitations. The Company’s investment in the common securities of Capital Trust III totaled $310,000 at December 31, 2014 and December 31, 2013, and is included in “Available for Sale Securities” on its consolidated balance sheets. See Note 11 to the consolidated financial statements for more information about the terms of the junior subordinated debentures.

 

Contractual Obligations

 

The following table shows the payments due on our contractual obligations for the periods shown as of December 31, 2015.

 

   

Payments due by period

 
       

 

 

Total

   

<1 year

   

1-3 years

   

3-5 years

   

>5 years

 
(Dollars in thousands)                                        

Long-term debt obligations

  $ 101,310     $ 41,000     $ 16,000     $ 14,000     $ 30,310  

Operating lease obligations

  $ 962     $ 195     $ 362     $ 251     $ 154  

Total

  $ 102,272     $ 41,195     $ 16,362     $ 14,251     $ 30,464  

 

Short-Term Borrowings

 

At December 31, 2015, 2014, and 2013, we had outstanding borrowings due within one year of $47.8 million, $21.8 million, and $11.8 million, respectively. Of these borrowings due within one year, Federal Home Loan Bank advances totaled $41.0 million, $18.0 million, and $7.0 million at December 31, 2015, 2014, and 2013, respectively. At December 31, 2014, and December 31, 2013 there were no fixed rate borrowings. Fixed rate borrowings totaled $32.0 million at December 31, 2015. The weighted average interest rate on fixed rate borrowings at December 31, 2015 was 0.93%. Variable rate borrowings totaled $15.8 million, $21.8 million, and $11.8 million at December 31, 2015, 2014, and 2013, respectively. Weighted average interest rates on variable rate borrowings were 0.55%, 0.37%, and 0.36% at December 31, 2015, 2014, and 2013, respectively. Of the short term borrowings, $41.0 million were from the Federal Home Loan Bank of Atlanta (“FHLBA”) and were collateralized by FHLBA stock, residential mortgage loans, and commercial real estate loans, and $1.4 million were securities sold under agreements to repurchase collateralized by investment securities with a market value of $2.1 million. Also included in short term borrowings at December 31, 2014 were $5.4 million of variable rate federal funds purchased. The maximum amount of short term borrowings outstanding at any month end was $47.8 million for 2015, $32.2 million for 2014, and $20.1 million for 2013. The approximate average amount of such borrowings outstanding and average weighted interest rate was $15.6 million and 1.20% for 2015, $5.2 million and 0.23% for 2014, and $5.7 million and 0.25% for 2013, respectively.

 

Return on Equity and Assets

 

The following table shows the return on assets (net income or loss divided by average assets), return on equity (net income or loss divided by average equity), dividend payout ratio (dividends declared per share divided by net income or loss per share) and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2015, 2014, and 2013.

 

 
39

 

 

Management’s Discussion and Analysis

 

Return on Equity and Assets - (continued)

 

 

   

Year ended December 31,

 
   

2015

   

2014

   

2013

 

Return on assets

    0.85 %     0.83 %     2.09 %

Return on equity

    8.19 %     8.32 %     23.60 %

Dividend payout ratio

    0.00 %     0.00 %     0.00 %

Equity to asset ratio

    10.34 %     10.04 %     8.86 %

 

The return on equity decreased slightly from 8.32% in 2014 to 8.19% in 2015. The return on assets increased slightly from 0.83% in 2014 to 0.85% in 2015. The return on equity decreased from 23.60% in 2013 to 8.32% in 2014, due to a decrease of $5.3 million in net income, with net income of $3.7 million for 2014, compared to net income of $9.1 million for 2013. The Company’s $6.6 million income tax benefit recognized during 2013, a result of its deferred tax asset valuation allowance reversal, contributed 17.15% and 1.52% to its return on equity and return on assets, respectively.

 

Liquidity

 

The most manageable sources of liquidity are comprised of liabilities, with the primary focus of liquidity management being on the ability to obtain deposits within our Bank's service area. Core deposits (total deposits less certificates of deposit for $100,000 or more, wholesale, and brokered time deposits) provide a relatively stable funding base and were equal to 85.1% of total deposits at December 31, 2015. Asset liquidity is provided from several sources, including amounts due from banks and federal funds sold and funds from maturing loans. Our Bank is a member of the FHLBA and, as such, has the ability to borrow against the security of its 1-4 family residential mortgage loans and commercial real estate loans. At December 31, 2015, our Bank had borrowed $91.0 million from the FHLBA and had the ability to borrow an additional $27.7 million based on a predetermined formula. Our Bank also has $27.6 million available through lines of credit with other banks, and $27.1 million available from the Federal Reserve Discount Window as additional sources of liquidity funding. At December 31, 2015, we had outstanding commitments to originate up to $26.6 million in loans as well as standby letters of credit of $441,000. Management believes that our Bank’s overall liquidity sources are adequate to meet its operating needs in the ordinary course of business.

 

Capital Resources

 

The Company’s total shareholders’ equity increased by approximately $4.5 million during 2015, primarily due to net income of $4,062,000 and other comprehensive income of $422,000. The Company’s Tier 1 capital to average assets ratio was 12.77 percent as of December 31, 2015.

 

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 150%. 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.

 

 
40

 

 

Management’s Discussion and Analysis

 

Capital Resources – (continued)

 

As of December 31, 2015, the most recent notification of the regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.

 

As of December 31, 2015, the Company and the Bank exceeded each of the applicable capital requirements shown in the following table.

 

                    Capital Ratios        

December 31, 2015

                 

Minimum Basel III 

   

Minimum Basel III

   

 
   

Actual

   

Phase In

Requirement

   

Fully Phased In

Requirement

   

Well Capitalized

Requirement

 

 

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 
(Dollars in thousands)                                                                

The Bank

                                                               

Total capital (to risk-weighted assets)

  $ 58,788       16.75 %   $ 28,077       8.00 %   $ 36,841       10.50 %   $ 35,097       10.00 %

Tier 1 capital (to risk-weighted assets)

    54,390       15.50 %     21,058       6.00 %     29,832       8.50 %     28,077       8.00 %

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

    54,390       15.50 %     15,793       4.50 %     24,568       7.00 %     22,813       6.50 %

Tier 1 capital (to average assets)

    54,390       11.36 %     19,150       4.00 %     19,150       4.00 %     23,938       5.00 %

The Company

                                                               

Total capital (to risk-weighted assets)

  $ 67,364       18.84 %   $ 28,602       8.00% (1)   $ 37,540       10.50% (1)     N/A       N/A  

Tier 1 capital (to risk-weighted assets)

    62,866       17.58 %     21,451       6.00% (1)     30,389       8.50% (1)     N/A       N/A  

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

    62,866       17.58 %     16,088       4.50% (1)     25,026       7.00% (1)     N/A       N/A  

Tier 1 capital (to average assets)

    62,866       12.77 %     19,695       4.00% (1)     19,695       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).

 

 

Off-Balance Sheet Arrangements

 

At December 31, 2015, we had issued commitments to extend credit of $26.6 million for home equity lines of credit, construction loans and commercial lines of credit. The commitments expire over periods from six months to ten years. Standby letters of credit totaled $441,000 at December 31, 2015.

 

Past experience indicates that many of these commitments to extend credit and standby letters of credit will expire unused. However, through our various sources of liquidity, we believe that we will have the necessary resources to fund these obligations should the need arise. See Note 15 to the audited financial statements for further information about financial instruments with off-balance sheet risk.

 

We are not involved in other off-balance sheet contractual relationships, and we have no unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments or significantly impact earnings.

 

Inflation

 

Since the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same as the magnitude of the change in inflation.

 

 
41

 

 

Management’s Discussion and Analysis

 

Inflation – (continued)

 

While the effect of inflation on banks is normally not as significant as is its influence on those businesses which have large investments in plant and inventories, it does have an effect. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above-average growth in assets, loans and deposits. Also, general increases in the prices of goods and services will result in increased operating expenses.

 

 
42

 

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

The management of Southcoast Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.  Internal control over financial reporting is a process designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are executed in accordance with appropriate management authorization, and accounting records are reliable for the preparation of financial statements in accordance with generally accepted accounting principles.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management has assessed the effectiveness of Southcoast Financial Corporation’s internal control over financial reporting as of December 31, 2015. In making our assessment, management has utilized the framework published in 2013 by the Committee of Sponsoring Organizations ("COSO") of the Treadway Commission "Internal Control-Integrated Framework."  Based on our assessment, management has concluded that, as of December 31, 2015 the Company’s internal control over financial reporting was effective.

 

 

 

 Date:  March 24, 2016

 

 

 

 

 

 

 

 

 /s/L. Wayne Pearson 

 

 /s/William C. Heslop  

L. Wayne Pearson

 

 William C. Heslop

 President and Chief Executive Officer   

 

 Senior Vice President and Chief Financial Officer

 

 
43

 

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

 

 

The information required by this item is set forth under the captions “Management’s Discussion and Analysis – Market Risk – Interest Rate Sensitivity” and “–Off Balance Sheet Arrangements” in Part II, Item 7 of this Annual Report on Form 10-K.

 

Item 8.

Financial Statements and Supplementary Data.

 

 
44

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

The Board of Directors

Southcoast Financial Corporation and Subsidiaries

Mount Pleasant, South Carolina

 

 

We have audited the accompanying consolidated balance sheets of Southcoast Financial Corporation and Subsidiaries (the “Company”) as of December 31, 2015 and 2014 and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southcoast Financial Corporation and Subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

 

/s/Crowe Horwath LLP

 

Atlanta, Georgia

March 25, 2016

 

 
45

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidated Balance Sheets

 

 

 

 

December 31,

 
 

2015

   

2014

 
(Dollars in thousands)                

Assets

               

Cash and due from banks

  $ 40,944     $ 33,572  
                 

Investment securities

               

Available for sale

    32,035       35,269  

Federal Home Loan Bank stock, at cost

    4,291       4,000  

Loans held for sale

    1,711       -  

Loans, net of allowance of $4,794 and $5,602

    384,502       358,546  

Property and equipment, net

    19,277       20,455  

Other real estate owned, net

    327       3,686  

Company owned life insurance

    13,303       12,984  

Deferred tax asset, net

    3,783       5,636  

Other assets

    2,637       2,685  
                 

Total assets

  $ 502,810     $ 476,833  
                 

Liabilities

               

Deposits

               

Noninterest bearing

  $ 55,755     $ 48,700  

Interest bearing

    283,702       282,334  
                 

Total deposits

    339,457       331,034  
                 

Federal funds purchased

    5,396       3,065  

Securities sold under agreements to repurchase

    1,364       737  

Advances from Federal Home Loan Bank

    91,000       80,000  

Junior subordinated debentures

    10,310       10,310  

Other liabilities

    3,443       4,382  
                 

Total liabilities

    450,970       429,528  
                 
                 
                 

Shareholders’ equity

               

Common stock (no par value; 20,000,000 shares authorized, 7,103,751 and 7,096,574 shares issued in 2015 and 2014, respectively)

    54,694       54,643  

Accumulated deficit

    (2,138 )     (6,200 )

Accumulated other comprehensive loss

    (716 )     (1,138 )
                 

Total shareholders’ equity

    51,840       47,305  
                 

Total liabilities and shareholders’ equity

  $ 502,810     $ 476,833  

 

 

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

 

 
46

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Income

 

 

   

For the years ended December 31,

 
   

2015

   

2014

 
(Dollars in thousands)                

Interest income

               

Loans and fees on loans

  $ 18,463     $ 17,046  

Investment securities

    958       1,104  

Cash and federal funds sold

    41       31  

Total interest income

    19,462       18,181  
                 

Interest expense

               

Deposits

    1,429       1,601  

Other borrowings

    1,827       1,802  

Junior subordinated debentures

    181       178  

Total interest expense

    3,437       3,581  

Net interest income

    16,025       14,600  
                 

Provision (credit) for loan losses

    (939 )     (600 )

Net interest income after provision for loan losses

    16,964       15,200  
                 

Noninterest income

               

Service fees on deposit accounts

    1,550       1,509  

Gain on sale of mortgage loans held for sale

    214       29  

Gain on sale of investment securities

    -       109  

Gain on sale of premises and equipment

    734       -  

Company owned life insurance earnings

    319       326  

Other

    208       173  

Total noninterest income

    3,025       2,146  
                 

Noninterest expenses

               

Salaries and employee benefits

    7,573       6,630  

Occupancy

    1,080       1,142  

Furniture and equipment

    1,888       1,670  

Advertising and public relations

    200       188  

Professional fees

    1,431       748  

Travel and entertainment

    262       274  

Telephone, postage and supplies

    326       328  

Insurance

    519       612  

Gain on sale of other real estate owned

    (325 )     (641 )

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

    -       227  

Other operating expenses

    666       827  

Total noninterest expenses

    13,620       12,005  

Income before income taxes

    6,369       5,341  
                 

Income tax expense

    2,307       1,604  

Net income

  $ 4,062     $ 3,737  
                 

Basic net income per common share

  $ 0.57     $ 0.53  
                 

Weighted average number of common shares outstanding

               

Basic

    7,102,811       7,091,361  

 

 

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

 

 
47

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income

 

(Dollars in thousands)

 

   

For the years ended

December 31,

 
   

2015

   

2014

 

Net income

  $ 4,062     $ 3,737  
                 

Other comprehensive income:

               

Unrealized gains on available for sale securities

    660       1,515  

Tax effect

    (238 )     (546 )

Reclassification adjustment for gains included in net income

    -       (109 )

Tax effect

    -       40  

Total other comprehensive income

    422       900  
                 

Comprehensive income

  $ 4,484     $ 4,637  

 

 

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

 

 

 
48

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Shareholders' Equity

Years ended December 31, 2015 and 2014

 

(Dollars in thousands)

                          Accumulated          
      Common Stock            

other

      Total   
         

Accumulated

   

comprehensive

   

shareholders'

 
   

Shares

   

Amount

   

deficit

   

loss

   

equity

 

Balance, January 1, 2014

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

Net income

                    3,737               3,737  

Other comprehensive income, net of tax

                            900       900  

Comprehensive income

                                    4,637  

Employee stock purchase plan

    14,512       99       -       -       99  

Balance, December 31, 2014

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

Net income

                    4,062               4,062  

Other comprehensive income, net of tax

                            422       422  

Comprehensive income

                                    4,484  

Employee stock purchase plan

    7,177       51       -       -       51  

Balance, December 31, 2015

    7,103,751     $ 54,694     $ (2,138 )   $ (716 )   $ 51,840  

 

 

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

 

 
49

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

 

 

 

For the years ended December 31,

 
   

2015

   

2014

 
(Dollars in thousands)                

Operating activities

               

Net income

  $ 4,062     $ 3,737  

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

               

Decrease in deferred income taxes

    1,615       1,374  

Provision for loan losses

    (939 )     (600 )

Provision for impairment of other real estate owned

    -       6  

Depreciation and amortization

    767       842  

Discount accretion and premium amortization

    143       134  

Origination of mortgage loans held for sale

    (14,756 )     (1,459 )

Proceeds from sales of mortgage loans held for sale

    13,259       1,759  

Gain on sale of mortgage loans held for sale

    (214 )     (29 )

Gain on sale of investment securities

    -       (109 )

Gain on sale of property and equipment

    (734 )     -  

Gain on sale of other real estate owned

    (325 )     (641 )

Change in deferred gain on sale of other real estate owned

    44       337  

Change in deferred compensation

    253       231  

Company owned life insurance earnings

    (319 )     (326 )

Decrease in other assets

    48       79  

Decrease in other liabilities

    (1,192 )     (708 )

Net cash provided by operating activities

    1,712       4,627  

Investing activities

               

Calls, maturities, and paydowns of available for sale securities

    3,751       5,705  

Proceeds from sales of available for sale securities

    -       3,229  

Purchases of available for sale securities

    -       (3,000 )

Purchases of Federal Home Loan Bank stock

    (3,041 )     (2,588 )

Sales of Federal Home Loan Bank stock

    2,750       2,217  

Increase in loans, net

    (21,492 )     (31,375 )

Purchases of property and equipment

    (149 )     (146 )

Capital expenditures on other real estate owned

    -       (14 )

Proceeds from sales of other real estate owned

    115       1,168  

Proceeds from sales of property and equipment

    1,294       -  

Net cash used for investing activities

    (16,772 )     (24,804 )

Financing activities

               

Net increase in deposits

    8,423       15,206  

Increase (decrease) in federal funds purchased and repurchase agreements

    2,958       (1,016 )

Proceeds from Federal Home Loan Bank Borrowings

    104,000       88,000  

Paydowns of Federal Home Loan Bank Borrowings

    (93,000 )     (77,000

Net proceeds from issuances of stock

    51       99  

Net cash provided by financing activities

    22,432       25,289  
                 

Net increase in cash and cash equivalents

    7,372       5,112  

Cash and cash equivalents, beginning of year

    33,572       28,460  
                 

Cash and cash equivalents, end of year

  $ 40,944     $ 33,572  

Cash paid for

               

Interest

  $ 3,545     $ 3,941  

Income taxes

  $ 970     $ 218  
                 

Supplemental noncash investing and financing activities:

               

Real estate acquired in settlement of loans

  $ -     $ 747  

Loans to finance sales of other real estate owned

  $ 3,525     $ 1,453  

 

 

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

 

 
50

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

 

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”). During 2004, Southcoast Investments, Inc. was formed as a wholly-owned subsidiary of the Company, primarily for the purpose of holding properties of the Company and Bank. The Company's primary purpose is that of owning the Bank. The Company is regulated by the Federal Reserve Board. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The Bank was incorporated in 1998 and operates as a South Carolina chartered bank providing full banking services to its customers. The Bank is subject to regulation by the South Carolina State Board of Financial Institutions and the Federal Deposit Insurance Corporation. During 2005, the Company formed Southcoast Capital Trust III for the purpose of issuing trust preferred securities.

 

Pending Merger Transaction - On August 14, 2015, the Company entered into a definitive agreement with BNC Bancorp (“BNC”) the holding company for Bank of North Carolina, pursuant to which BNC will acquire all of the common stock of the Company in a stock transaction.  Under the terms of the agreement, which has been approved by the Boards of Directors of both companies and by the shareholders of the Company (approval of shareholders of BNC is not required), the Company’s shareholders will receive shares of BNC common stock based upon the volume weighted average price of BNC common stock for a 20-day trading period prior to the closing of the merger ("VWAP"), subject to minimum and maximum exchange ratios as follow: if the VWAP immediately prior to the merger is equal to or greater than $22.00, then each share of the Company’s common stock will be converted into 0.6068 shares of BNC common stock; if the VWAP immediately prior to the merger is less than $22.00 but greater than $19.00, then each share of the Company’s common stock will be converted into $13.35 payable in shares of BNC common stock (with the exchange ratio equal to $13.35 divided by the VWAP); and if the VWAP is equal to or less than $19.00, then each share of the Company’s common stock will be converted into 0.7026 shares of BNC common stock. The merger is currently awaiting regulatory approval, and is expected to close in the second quarter of 2016.  For further information, please see the Proxy Statement/Prospectus of the Company/BNC filed with the Securities and Exchange Commission on December 23, 2015

 

Estimates – The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates.

 

Concentration of Credit Risk – Most of the Company’s business activity is with customers located in the adjoining South Carolina counties of Charleston, Berkeley, and Dorchester. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in these counties. Tourism, shipping, technology, and aerospace are major industries in the Company’s market area. Though the Company does not have a direct credit concentration in any of these industries, a downturn in any of them could negatively impact the local economy, which in turn could pose a credit risk to the Company.

 

Risk characteristics present in the Company’s loan portfolio vary by portfolio segment but are largely influenced by current loan to value ratios for real estate secured loans. At December 31, 2015, 94% of the Company’s outstanding loan balances were secured by real estate. After several years of declines, real estate values in the Company’s market area have largely recovered over the last several years. However, any future declines in real estate values may pose credit risk to the Company. Residential 1-4 Family loans comprise 62% of the Company’s outstanding loan balances. An increase in foreclosures on these loan types in the Company’s market area could increase unsold homes inventory, leading to decreases in market value. Such a scenario would increase the credit risk for existing loans made prior to the market value declines. Loans secured by commercial real estate comprise 22% of the Company’s outstanding loan balances and may be at risk of deterioration during times of decreasing market rental rates and increasing levels of office space vacancies. These conditions may occur during general economic downturns or during downturns in the specific industries significant to the Company’s market area.

 

Cash and Cash Equivalents - Cash and cash equivalents may consist of cash on hand and due from banks, federal funds sold and securities purchased under agreements to resell. Generally, federal funds are sold for a one-day period and securities purchased under agreements to resell mature in less than 90 days.

 

 
51

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES (Continued)

 

Investment Securities - The Company classifies investments in equity and debt securities into three categories:

 

Available-for-sale: These are securities which are not classified as either held to maturity or as trading securities. These securities are reported at fair value. Unrealized gains and losses are reported, net of income taxes, as separate components of shareholders’ equity (accumulated other comprehensive income). Gains or losses on dispositions of securities are based on the difference between the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Premiums and discounts are amortized into interest income by a method that approximates a level yield.

 

Held-to-maturity: These are debt securities which the Company has the ability and intent to hold until maturity. These securities are stated at cost, adjusted for amortization of premiums and the accretion of discounts. The Company has no held to maturity securities.

 

Trading: These are securities which are bought and held principally for the purpose of selling in the near future. Trading securities are reported at fair market value, and related unrealized gains and losses are recognized in the income statement. The Company has no trading securities.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.  For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income.  The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

 

Loans Held-for-Sale - Loans held-for-sale consist of 1 - 4 family residential mortgage loans, which are reported at the lower of cost or fair value on an aggregate loan basis. Net unrealized losses, if any, are recognized through a valuation allowance. Loans held for sale were reported at cost at December 31, 2015 and 2014, as there were no unrealized losses at either date. Gains or losses realized on the sales of loans are recognized at the time of sale and are determined by the difference between the net sales proceeds and the carrying value of loans sold.

 

Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives.  Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked.  The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans.  Changes in the fair values of these derivatives are included in net gains on sales of loans.

 

Loans and Interest Income on LoansLoans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the principal balance outstanding, net of purchase premiums and discounts, and an allowance for loan losses. The allowance for loan losses is deducted from total loans on the balance sheet. Interest income is recognized on an accrual basis over the term of the loan based on the principal amount outstanding.

 

All types of loans are generally placed on non-accrual status when principal or interest becomes contractually ninety days past due, or when payment in full is not anticipated, unless the estimated net realizable value of collateral is sufficient to assure the likelihood of collection of the principal balance and accrued interest. When a loan of any type is placed on non-accrual status, interest accrued but not received is generally reversed against interest income. If collectability is in doubt, cash receipts on all types of non-accrual loans are not recorded as interest income, but are instead used to reduce principal. Loans of all types are not returned to accrual status unless there has been an improvement in the borrower’s financial condition, generally supported by at least six months of timely loan payments, and in the case of certain commercial loans, financial statements. Past due status for all types of loans is based on the contractual terms of the loans.

 

 
52

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES (Continued)

 

Allowance for Loan Losses - The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

 

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and are classified as impaired. Loans modified in a troubled debt restructuring accrue interest if their terms are at market rate and if they are performing in accordance with their modified terms. Loans modified in a troubled debt restructuring do not accrue interest if their terms are below market rate or if they are not performing in accordance with their modified terms. For accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting.

 

If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from the collateral. Generally, the Company accounts for impaired loans based on the value of the loans’ underlying collateral if it is considered more likely than not that repossession of the collateral is the most likely form of collection of the outstanding balance. For loans not deemed to be dependent on collateral liquidation as the most likely source of repayment, the present value of expected cash flows is used to determine impairment. Troubled debt restructurings performing in accordance with their modified terms are measured for impairment using the present value of expected cash flows.

 

For nonaccruing impaired loans, all cash receipts are to be applied to principal. Once the reported principal balance has been reduced to zero, future cash receipts are to be applied to interest income to the extent that any interest has been foregone. Further cash receipts are to be recorded as recoveries to the Allowance for Loan Losses of any amounts previously charged off.

 

Generally, all types of impaired loans with balances of $250,000 or greater are evaluated for impairment on an individual basis. To the extent impairment is calculated for a loan evaluated on an individual basis, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from the collateral. All types of impaired loans with balances less than $250,000 are generally collectively evaluated for impairment, and accordingly, they are not identified for impairment disclosures.

 

In determining the required general reserves portion of the allowance for loan losses, management calculates historical losses experienced by loan type. Management also calculates a historical weighted average delinquency rate by loan type, with loans past due 30-59 days given single weight, loans past due 60-89 days given double weight, and loans past due 90 days or more given triple weight. Current weighted delinquency rates for loans in the various pools are then calculated and indexed to the historical weighted average delinquency rates. The total balance by general reserve loan type is then multiplied by the average historical losses as adjusted by the indexed historical past due rate and this amount is added to required general reserves. Management currently utilizes a twelve quarter time horizon for historical losses and delinquencies. In determining the proper historical time horizon, management considers the time horizon which most appropriately reflects the current condition of the portfolio.

 

 
53

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES (Continued)

 

Management provides additional general reserves by loan type for loans with grades of 3 through 9 which are not individually evaluated for impairment by multiplying the total balances of these loans by the average default probabilities for the corresponding loan grades for the five most recent years. These amounts are then multiplied by the average loss severities by loan type for the five most recent years, and then added to required general reserves. Management elected to use five year historical periods for its default probability and loss severity calculations in order to derive meaningful sample sizes across a range of economic conditions.

 

Several environmental factors are also incorporated into the general reserves portion of the allowance for loan losses. These include reserves for loans with loans to value higher than the Company’s policy guidelines, loans with variable or adjustable rates of interest, and general loan portfolio growth.

 

Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

 

Property and Equipment – Land is carried at cost. Property, furniture and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Leases are amortized over their useful lives or the lease term whichever is shorter. Maintenance and repairs are charged to operations, while major improvements are capitalized. Upon retirement, sale, or other disposition, the cost and accumulated depreciation are eliminated from the accounts, and gain or loss is included in income from operations.

 

Other Real Estate OwnedOther real estate owned includes real estate acquired through foreclosure or deed in lieu of foreclosure. Other real estate owned is initially recorded at its estimated fair market value less estimated selling costs. Any write-downs at the dates of acquisition are charged to the allowance for loan losses. Expenses to maintain such assets, subsequent write-downs, and gains and losses on disposal are included in other expenses.

 

Loan Commitments and Related Financial Instruments - Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

 

Employee Benefit Plans - Employee 401(k) and profit sharing plan expense is the amount of matching contributions.  Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service.

 

Company Owned Life Insurance – Company owned life insurance represents the cash value of policies on certain current and former officers of the Bank.

 

Income Taxes - Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

 

 
54

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES(Continued)

 

Earnings Per Common Share - Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. The Company has no potentially dilutive financial instruments outstanding.

 

Comprehensive Income - Comprehensive income consists of net income and other comprehensive income (loss).  Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.

 

Loss Contingencies - Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are currently any such matters that would have a material effect on the financial statements.

 

Dividend Restrictions - Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to shareholders.

 

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

 

Statement of Cash Flows - Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements.

 

Reclassifications - Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or shareholders’ equity.

 

Recently Issued Accounting Pronouncements

 

 

In May 2014, the FASB issued ASU 2014-09 – Revenue from Contracts with Customers (“ASU 2019-09”).  ASU 2014-09 provides guidance that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective prospectively, for annual and interim periods, beginning after December 15, 2017. The Company is currently evaluating the impact this standard will have on the Company’s results of operations, financial position or disclosures.

 

In June 2014, the FASB issued ASU 2014-11 – Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures (“ASU 2014-11”). ASU 2014-11 impacted FASB ASC 860 Transfers and Servicing by changing the accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements. The amendments also require new disclosures. An entity is required to disclose information on transfers accounted for as sales in transactions that are economically similar to repurchase agreements. An entity must also provide additional information about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The amendments in this update became effective for interim and annual periods beginning after December 15, 2014 and did not have a material impact on the consolidated financial statements.

 

In April 2015, the FASB issued ASU 2015-03 – Interest – Imputation of Interest (“ASU 2015-03”). ASU 2015-03 simplifies presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. ASU 2015-03 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, and early adoption is permitted. It should be applied on a retrospective basis. The Company is currently evaluating the impact this standard will have on the Company’s financial position or disclosures, but it is not expected to have a material impact.

 

 
55

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES(Continued)

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new standard requires the recognition of assets and liabilities arising from lease transactions on the balance sheet and the disclosure of key information about leasing arrangements. Accordingly, a lessee will recognize a lease asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation. Both the asset and liability will initially be measured at the present value of the future minimum lease payments over the lease term. Subsequent measurement, including the presentation of expenses and cash flows, will depend on the classification of the lease as either a finance or an operating lease. Initial costs directly attributable to negotiating and arranging the lease will be included in the asset. For leases with a term of 12 months or less, a lessee can make a policy election by class of underlying asset to not recognize an asset and corresponding liability. Lessees will also be required to provide additional qualitative and quantitative disclosures regarding the amount, timing and uncertainty of cash flows arising from leases. In transition, lessees are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The transition guidance also provides specific guidance for sale and leaseback transactions, build-to-suit leases and amounts previously recognized in accordance with the business combinations guidance for leases. For public companies, ASU 2016-02 is effective prospectively, for annual and interim periods, beginning after December 15, 2018. The Company does not expect this standard to have a material impact on its consolidated financial statements.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10). The amendments in this Update require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this Update also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition the amendments in this Update eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement for to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities.

 

For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019.

 

All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of this new accounting guidance on its consolidated financial statements.

 

NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS

 

The Bank is required to maintain average reserve balances, computed by applying prescribed percentages to its various types of deposits, either at the bank or on deposit with the Federal Reserve Bank. At December 31, 2015 and 2014, the Bank met these requirements. Reserve requirements totaled $4,498,000 and $4,264,000 at December 31, 2015 and 2014, respectively.

 

 
56

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements 

 

NOTE 3 - INVESTMENT SECURITIES

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

 

(Dollars in thousands)   

December 31, 2015

 
   

Amortized

   

Gross Unrealized

   

Estimated

 
   

Cost

   

Gains

   

Losses

   

Fair Value

 

Available for sale

                               

Mortgage backed

                               

Government sponsored enterprises

  $ 21,502     $ 7     $ 191     $ 21,318  

Municipal securities

    3,433       249       -       3,682  

Other

    8,218       53       1,236       7,035  
                                 

Total

  $ 33,153     $ 309     $ 1,427     $ 32,035  

 

   

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 December 31, 2015 and December 31, 2014.

 

Available for Sale

(Dollars in thousands)

 

December 31, 2015

 
   

Less than

   

Twelve Months

                 
   

Twelve Months

   

or More

   

Total

 
   

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

 
                                                 

Mortgage backed

  $ 16,896     $ 191     $ -     $ -     $ 16,896     $ 191  

Other

    -       -       2,332       1,236       2,332       1,236  
                                                 

Total

  $ 16,896     $ 191     $ 2,332     $ 1,236     $ 19,228     $ 1,427  

 

   

December 31, 2014

 
   

Less than

   

Twelve Months

                 
   

Twelve Months

   

or More

   

Total

 
   

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

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  

 

 
57

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 3 - INVESTMENT SECURITIES (Continued)

 

Securities classified as available-for-sale are recorded at fair value. Unrealized losses on securities in a continuous loss position for twelve months or more totaled $1,236,000, which included two securities comprising 100% of total unrealized losses, and $2,178,000, which included three securities comprising 96% of total unrealized losses, at December 31, 2015 and December 31, 2014, respectively. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost.

 

The unrealized loss attributable to “Other” securities relates primarily to valuations on two 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 $1,829,000 and fair value of approximately $1,176,000 is receiving contractual interest payments, while the other with an amortized cost of approximately $1,739,000 and fair value of approximately $1,156,000 is receiving 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. Contractual interest payments are calculated on these larger principal balances.

 

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 December 31, 2015, there was $230,628,000 of performing collateral in the pool. The table below summarizes balance and overcollateralization data for the individual tranches at December 31, 2015.

 

(Dollars in thousands)

 

Tranche

 

Current Balance

   

Required

Overcollateralization %

   

Current

Overcollateralization %

 

A

  $ 167,866       128.0 %     138.1 %

B

    37,756       115.0 %     112.7 %

C

    48,523       106.2 %     91.2 %

D

    28,685       100.3 %     81.9 %

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 established 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, an outcome already achieved for the A tranche note holders, as shown in the chart above. 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.

 

 
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SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 3 - INVESTMENT 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 December 31, 2015 predicts the Company will resume receipt of its contractual principal and interest payments during 2017, 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 underlying trust preferred securities. 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 $373,000 for the security (Security B in the table below) at December 31, 2015.

 

The following table provides certain relevant details on each of our collateralized debt obligations as of December 31, 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.

 

December 31, 2015

 

(Amounts in thousands)

               
   

Security A

   

Security B

 
                 

Amortized Cost

  $ 1,829     $ 1,739  

Fair Value

  $ 1,176     $ 1,156  

Unrealized Loss

  $ 653     $ 583  

Number of underlying financial institution issuers

    45       38  

Number of deferrals and defaults

    7       12  

Additional expected deferrals/ defaults*

    N/A       0/1  

Excess Subordination as a percentage of performing collateral^

    33.47 %     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; one deferring issuer was projected to default.

 

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

 

The credit quality of the pooled trust preferred securities 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 other-than-temporary impairment in future periods if the financial condition of the underlying issuers further deteriorates.

 

 
59

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 3 - INVESTMENT SECURITIES (Continued)

 

The amortized costs and fair values of investment securities available for sale at December 31, 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.

 

 

 

 

   

 

 
   

Amortized

Cost

   

Fair

Value

 
(Dollars in thousands)                

Due within one year

  $ 499     $ 516  

Due after one but within five years

    440       457  

Due after five but within ten years

    1,958       2,130  

Due after ten years

    4,604       3,411  

Mortgage backed

    21,502       21,318  

Equity securities with no maturity

    4,150       4,203  
                 

Total investment securities available-for-sale

  $ 33,153     $ 32,035  


The proceeds from sales of securities and the associated gains are listed below:

 

 

 

Twelve Months Ending December 31,

 
   

2015

   

2014

 
(Dollars in thousands)                

Proceeds

  $ -     $ 3,229  

Gross Gains

    -       109  

 

The tax provision related to the above net realized gains and losses was $0 and $40,000 for the periods ended December 31, 2015 and 2014.

 

Investment securities with an aggregate amortized cost of $19,274,000 and estimated fair value of $19,231,000 at December 31, 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 $2,115,000 and estimated fair value of $2,090,000 at December 31, 2015, were pledged to secure securities sold under agreements to repurchase.

 

NOTE 4 - LOANS

 

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

 

   

December 31,

2015

   

December 31,

2014

 
(Dollars in thousands)                

Real estate secured loans:

               

Residential 1-4 Family

  $ 241,111     $ 217,518  

Multifamily

    4,747       5,108  

Commercial

    85,501       87,906  

Construction and land development

    34,311       29,060  
                 

Total real estate secured loans

    365,670       339,592  

Commercial and industrial

    20,666       22,022  

Consumer

    2,623       2,206  

Other

    337       328  
                 

Total gross loans

    389,296       364,148  

Allowance for loan losses

    (4,794 )     (5,602 )
                 

Loans, net of allowance

  $ 384,502     $ 358,546  

 

 
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SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

 

NOTE 4 – LOANS (Continued)

 

 

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.

 

 
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SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

 

NOTE 4 – LOANS (Continued)

 

 

The following tables provide a summary of our credit risk profile by loan categories as of December 31, 2015 and December 31, 2014.

 

(Dollars in thousands)

Credit Risk Profile by Creditworthiness Category

 

 

     

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       130,016       107,353       1,352       1,350       19,079       14,965       14,566       11,197  
4       57,945       56,164       1,050       1,111       27,536       28,180       11,561       7,310  
5       45,911       46,873       2,014       2,309       30,072       33,081       7,489       9,571  
6       1,495       1,587       331       -       4,080       2,042       57       269  
7       5,555       4,930       -       338       4,734       9,638       638       703  
8       189       611       -       -       -       -       -       10  
9       -       -       -       -       -       -       -       -  
                                                                   

Total

    $ 241,111     $ 217,518     $ 4,747     $ 5,108     $ 85,501     $ 87,906     $ 34,311     $ 29,060  

 

 

     

Non-Real Estate Secured

                 
     

Commercial

   

Consumer

   

Other

   

Total

 
     

2015

   

2014

   

2015

   

2014

   

2015

   

2014

   

2015

   

2014

 

Grade

                                                                 
1     $ 2,352     $ 2,223     $ 448     $ 397     $ -     $ -     $ 2,800     $ 2,620  
2       -       -       -       -       -       -       -       -  
3       1,783       2,205       630       480       89       94       167,515       137,644  
4       8,301       6,628       420       220       227       181       107,040       99,794  
5       7,326       9,589       1,017       977       21       53       93,850       102,453  
6       5       18       -       -       -       -       5,968       3,916  
7       899       1,359       108       132       -       -       11,934       17,100  
8       -       -       -       -       -       -       189       621  
9       -       -       -       -       -       -       -       -  
                                                                   

Total

    $ 20,666     $ 22,022     $ 2,623     $ 2,206     $ 337     $ 328     $ 389,296     $ 364,148  

 

 
62

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

 

 

NOTE 4 – LOANS (Continued)

 

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

 

(Dollars in thousands)

 

Past Due Loans

 

 

December 31, 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

  $ 1,429     $ 207     $ 1,055     $ 2,691     $ 238,420     $ 241,111     $ 218  

Multifamily Residential

    -       -       -       -       4,747       4,747       -  

Commercial Real Estate

    2,848       49       302       3,199       82,302       85,501       -  

Construction and Land Development

    81       -       -       81       34,230       34,311       -  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    220       170       56       446       20,220       20,666       -  

Consumer and Other

    70       1       -       71       2,889       2,960       -  
                                                         

Total (1)

  $ 4,648     $ 427     $ 1,413     $ 6,488     $ 382,808     $ 389,296     $ 218  

 

 

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 (1)

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

 

 

(1)

Principal balances only; excludes accrued interest receivable and deferred fees and costs due to immateriality.

 

 
63

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

 

NOTE 4 – LOANS (Continued)

 

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

 

(Dollars in thousands)

 

   

December 31,

   

December 31,

 
   

2015

   

2014

 
                 

1-4 Family Residential

  $ 2,178     $ 2,956  

Multifamily Residential

    -       -  

Commercial Real Estate

    412       1,096  

Construction and Land Development

    -       10  

Commercial and Industrial

    551       859  

Consumer and Other

    8       48  
                 

Total

  $ 3,149     $ 4,969  

 

 

At December 31, 2015 and December 31, 2014, nonaccrual loans totaled $3.1 million and $5.0 million, respectively. The gross interest income which would have been recorded under the original terms of nonaccrual loans amounted to approximately $152,000 and $312,000 at December 31, 2015 and December 31, 2014, respectively. At December 31, 2015 and December 31, 2014, impaired loans, which include non-accrual loans and troubled debt restructurings (TDRs) totaled $3.8 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 $2.3 million and $3.9 million at December 31, 2015 and December 31, 2014, respectively. At December 31, 2015 there was one loan totaling $218,000 that was ninety days past due and still accruing interest. There were no such loans at December 31, 2014.

 

At December 31, 2015 and December 31, 2014, all TDRs, including those on nonaccrual status, totaled $1.5 million and $3.9 million, respectively. The gross interest income that would have been recognized on accruing TDRs according to the original loan terms during 2015 totaled approximately $40,000; actual interest income recognized on these loans according to the restructured terms totaled $37,000. Performing TDR loans totaled $608,000 at December 31, 2015. The gross interest income that would have been recognized on accruing TDRs according to the original loan terms during 2014 totaled approximately $41,000; actual interest income recognized on these loans according to the restructured terms totaled approximately $11,000. Performing TDR loans totaled $613,000 at December 31, 2014. During the year ended December 31, 2015, no loans had their original loan terms restructured. During the year ended December 31, 2015, there were no loans that had previously had their original terms restructured that went into nonaccrual. During the same period, one loan totaling $1.7 million that had previously had its original terms restructured paid off, and two loans totaling $173,000, that had previously had their original loan terms restructured, were charged off. TDRs did not have a material effect on the allowance for loan losses as of December 31, 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)

 

December 31,

   

December 31,

 
   

2015

   

2014

 
                 

Balance, beginning of year

  $ 5,602     $ 6,041  

Provision (credit) for loan losses

    (939 )     (600 )

Net recoveries

    131       161  
                 

Balance, end of year

  $ 4,794     $ 5,602  

 

 
64

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

 

NOTE 4 – LOANS (Continued)

 

   

For the Year Ended December 31, 2015

 
   

Beginning

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 
    Balance                          
                                   

General

   

Specific

   

Total

 
                                    Reserves     Reserves        

Real Estate Secured

                                                       

1-4 Family Residential

  $ 1,595     $ (73 )   $ -     $ (219 )   $ 1,262     $ 41     $ 1,303  

Multifamily Residential

    61       -       155       (189 )     27       -       27  

Commercial Real Estate

    1,424       -       190       (188 )     1,426       -       1,426  

Construction and Land Development

    312       -       28       (108 )     232       -       232  

Non-Real Estate Secured

                                                       

Commercial and Industrial

    496       (261 )     54       140       429               429  

Consumer and Other

    32       (6 )     44       (55 )     15       -       15  

Other

                                                       

Other General Reserves

    1,363       -       -       (313 )     1,050       -       1,050  

Unallocated

    319       -       -       (7 )     312       -       312  

Total

  $ 5,602     $ (340 )   $ 471     $ (939 )   $ 4,753     $ 41     $ 4,794  

 

 

 

   

For the Year Ended December 31, 2014

 
   

Beginning

   

Charge Offs

   

Recoveries

   

Provisions

   

Ending Allowance for Loan Losses

 
    Balance                          
                                   

General

   

Specific

   

Total

 
                                    Reserves     Reserves        

Real Estate Secured

                                                       

1-4 Family Residential

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

Multifamily 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  

 

 
65

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 4 – LOANS (Continued)

 

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 December 31, 2015 and December 31, 2014.

 

(Dollars in thousands)

 

Loans Receivable:

 

As of December 31, 2015

 
   

 

Individually evaluated

for impairment

   

Collectively evaluated

for impairment

   

Total

 

Real Estate Secured

                       

1-4 Family Residential

  $ 1,550     $ 239,561     $ 241,111  

Multifamily Residential

    -       4,747       4,747  

Commercial Real Estate

    362       85,139       85,501  

Construction and Land Development

    -       34,311       34,311  

Non Real Estate Secured

                       

Commercial and Industrial

    391       20,275       20,666  

Consumer and Other

    -       2,960       2,960  

Total

  $ 2,303     $ 386,993     $ 389,296  

 

Loans Receivable:

 

As of December 31, 2014

 
   

 

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  

  

 
66

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 4 – LOANS (Continued)

 

(Dollars in thousands)

 

Impaired Loans

For the Year Ended December 31, 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

  $ 1,415     $ 1,329     $ -     $ 86     $ 1,357     $ 37  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    362       362       -       -       380       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    391       391       -       -       416       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

With an allowance recorded:

                                               

1-4 Family Residential

  $ 221     $ 221     $ 41     $ -     $ 222     $ -  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    -       -       -       -       -       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    -       -       -       -       -       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total:

                                               

1-4 Family Residential

  $ 1,636     $ 1,550     $ 41     $ 86     $ 1,579     $ 37  

Multifamily Residential

    -       -       -       -       -       -  

Commercial Real Estate

    362       362       -       -       380       -  

Construction and Land Development

    -       -       -       -       -       -  

Commercial and Industrial

    391       391       -       -       416       -  

Consumer and Other

    -       -       -       -       -       -  
                                                 

Total

  $ 2,389     $ 2,303     $ 41     $ 86     $ 2,375     $ 37  

 

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

 

 

 
67

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 4 – 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.

 

 
68

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

 

NOTE 5 - PROPERTY AND EQUIPMENT

Components of property and equipment are as follows:

 

(Dollars in thousands)

           

December 31,

 
   

Estimated Useful Lives (years)

   

2015

   

2014

 
                           

Land

            $ 7,409     $ 7,866  

Furniture and equipment

   3 - 10       3,292       3,550  

Buildings and improvements

   5 - 40       15,620       15,740  

Construction in process

              130       80  
                26,451       27,236  

Less accumulated depreciation

              (7,174 )     (6,781 )
              $ 19,277     $ 20,455  

 

Construction in process related to one company owned property, and totaled $130,000 and $80,000 at December 31, 2015 and December 31, 2014, respectively. Depreciation expense for the years ended December 31, 2015 and 2014 was $766,000 and $842,000, respectively.

 

In 2015, the Company received sales proceeds totaling $1,294,000 on a parcel of land with a small building adjacent to its corporate headquarters. The property had a basis of $545,000, and the Company recognized a gain on sale of $749,000. Additionally, the Company recorded a $15,000 loss on the disposal of one of its vehicles. The vehicle was given to the Company’s Chief Executive Officer as bonus compensation.

 

The Company leases certain branch properties and equipment under operating leases. Two branch leases have current lease terms expiring in 2016 and 2023, one with two five-year renewal options remaining, and the other with one ten-year renewal option remaining. The Company had a lease agreement for eleven ATM machines, which expired in December 2015 and required monthly payments totaling $16,000, accounting for the nearly half of the Company’s annual lease expense during 2015 and 2014. The Company entered into a longer term lease agreement during 2011 for office space that expires in 2032 that is also being accounted for as an operating lease. Total lease expense paid for the leases discussed above and included in the statements of operations totaled $412,000 for each of the years ended December 31, 2015 and 2014, respectively.

 

Minimum future rental payments under non-cancelable operating leases having remaining terms in excess of one month, for each of the next five years in the aggregate are:

 

(Dollars in thousands)    

 

         

2016

  $ 195  

2017

    179  

2018

    183  

2019

    185  

2020

    66  

Thereafter

    154  
         

Total

  $ 962  

 

 
69

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

 

NOTE 6 – OTHER REAL ESTATE OWNED

The aggregate carrying amount of other real estate owned at December 31, 2015 and 2014 was $327,000 and $3,686,000, respectively. All of the Company’s other real estate owned represents properties acquired through foreclosure or deed in lieu of foreclosure. The following table details the change in this balance during 2015 and 2014.

 

(Dollars in thousands)

 

Year Ended December 31

 
             
   

2015

   

2014

 

Real estate acquired in settlement of loans, beginning of period

  $ 3,686     $ 5,249  

New real estate acquired in settlement of loans at lower of fair value or principal balance

    -       747  

Capital expenditures on real estate acquired in settlement of loans

    -       14  

Sales of real estate acquired in settlement of loans

    (3,640 )     (2,622 )

Gains on sale of real estate acquired in settlement of loans

    325       641  

Net change in deferred gain on real estate acquired in settlement of loans

    (44 )     (337 )

Less: Impairment recognized

    -       (6 )
                 

Real estate acquired in settlement of loans, end of period

  $ 327     $ 3,686  

 

Property in other real estate owned at December 31, 2015 consisted of commercial lots. Property in other real estate owned at December 31, 2014 consisted of commercial lots, residential 1-4 family homes, and commercial office properties.

 

During 2015 and 2014, the Company recorded sales proceeds on other real estate owned totaling $3,640,000 and $2,622,000, respectively. Sales proceeds on other real estate owned for which the Company made loans to facilitate the sale of the property during 2015 and 2014 totaled $3,328,000 and $1,557,000, respectively. The gross loans to facilitate these sales during 2015 and 2014 totaled $3,525,000 and $1,453,000, respectively. During the year ended 2015, gross loans to facilitate sales of other real estate owned consisted of two transactions, and were $197,000 greater than the sales proceeds to which the loans related. Of this amount, $193,000 related to one of the sales transactions for which 100% of the purchase price and closing costs were financed with cash at closing paid to a borrower that brought other unencumbered real estate collateral valued at approximately $1.1 million to the transaction, while the remaining amount related to seller closing costs in excess of borrower down payments in the other sales transaction. During the year ended December 31, 2015, the Company recognized as income $65,000 of gains previously deferred from sales that occurred prior to 2015 and realized deferred gains related to loans to facilitate sales of other real estate owned totaling $21,000 that occurred during 2015. During 2014, the Company recognized as income $337,000 of gains previously deferred from sales that occurred prior to 2014.

 

During 2015 and 2014, the Company recognized $0 and $6,000, respectively, of impairment expense on other real estate owned. These impairments were the result of periodic reappraisals of the properties and management’s estimates of short term liquidation values. At December 31, 2015 and 2014, the carrying amount of other real estate owned included valuation allowances totaling $115,000 and $121,000, respectively. These amounts were reflective of impairments taken on individual properties still held by the Company as of these two dates.

 

At December 31, 2015 and December 31, 2014, 1-4 family loans in the process of foreclosure totaled $0 and $41,000, respectively.

 

NOTE 7 – DEPOSITS

 

The following is a detail of deposit accounts:

 

(Dollars in thousands)

 

December 31,

 
   

2015

   

2014

 

Noninterest bearing deposits

  $ 55,755     $ 48,700  

Interest bearing

               

NOW

    65,930       62,210  

Money market

    80,729       70,166  

Savings

    33,446       29,315  

Time, less than $250,000

    91,060       114,410  

Time, $250,000 and over

    12,537       6,233  
                 

Total deposits

  $ 339,457     $ 331,034  

 

 
70

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

NOTE 7 – DEPOSITS (Continued)

 

At December 31, 2015 and 2014, the Bank had approximately $1,066,000 and $13,237,000, respectively, in time deposits from customers outside its market area. This includes $0 and $12,283,000 in brokered and wholesale deposits in 2015 and 2014, respectively. Contractual rates of interest on brokered and wholesale deposits outstanding at December 31, 2014, ranged from a low of 0.25% to a high of 0.30%.

 

At December 31, 2015 the scheduled maturities of time deposits are as follows:

 

(Dollars in thousands)    

 

2016

  $ 95,078  

2017

    7,882  

2018

    363  

2019

    20  

2020

    254  
    $ 103,597  

 

NOTE 8- SHORT-TERM BORROWINGS

 

Short-term borrowings payable include securities sold under agreements to repurchase which generally mature on a one to thirty day basis, federal funds purchased, and borrowings from the discount window of the Federal Reserve Bank of Richmond. Information concerning short-term borrowings is summarized as follows:

 

(Dollars in thousands)

 

December 31,

 
   

2015

   

2014

 

Balance at end of the year

  $ 6,760     $ 3,802  

Average balance during year

    1,302       2,343  

Average interest rate during year

    0.25 %     0.23 %

Maximum month-end balance during the year

  $ 9,126     $ 9,808  

 

The Company has collateralized the repurchase agreements with securities with an aggregate cost basis and fair value of $2,115,000 and $2,090,000 respectively, at December 31, 2015.

 

At December 31, 2015 and 2014, the investment securities underlying these agreements were all mortgage backed securities.  

 

 
71

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 9 - ADVANCES FROM FEDERAL HOME LOAN BANK

 

Advances from the Federal Home Loan Bank of Atlanta (“FHLBA”) are collateralized by FHLBA stock and pledges of certain residential mortgage loans and are summarized as follows:

 

 

(Dollars in thousands)

   

December 31

 

Maturity

 

Rate

   

2015

   

2014

 

February 2015

    0.36 %   $ -     $ 18,000  

January 2016

    0.40 %     15,000       -  

January 2016

    0.38 %     5,000       -  

March 2016

    2.04 %     10,000       10,000  

March 2016

    0.49 %     9,000       -  

May 2016

    0.75 %     2,000       2,000  

March 2017

    2.31 %     2,000       2,000  

May 2017

    1.07 %     2,000       2,000  

March 2018

    2.33 %     5,000       5,000  

April 2018

    3.03 %     5,000       5,000  

May 2018

    1.38 %     2,000       2,000  

March 2019

    3.56 %     5,000       5,000  

March 2019

    3.51 %     5,000       5,000  

May 2019

    1.69 %     2,000       2,000  

May 2020

    2.01 %     2,000       2,000  

March 2021

    3.71 %     5,000       5,000  

March 2021

    3.74 %     5,000       5,000  

March 2021

    3.80 %     5,000       5,000  

March 2021

    3.87 %     5,000       5,000  
            $ 91,000     $ 80,000  

 

Each of the fixed rate advances is subject to early termination options. The FHLBA reserves the right to terminate each agreement at an earlier date.

 

NOTE 10 - UNUSED LINES OF CREDIT

 

At December 31, 2015, the Bank had unused lines of credit to purchase federal funds totaling approximately $27.6 million from unrelated banks. These lines of credit are available on a one to fifteen day basis for general corporate purposes of the Bank. The lenders have reserved the right to withdraw the lines at their option. The Company may also borrow from the FHLBA based on a predetermined formula. Borrowings on this line totaled $91.0 million at December 31, 2015. Additional funds of approximately $27.7 million were available on the line. Advances are subject to approval by the FHLBA and may require the Company to pledge additional collateral. The Company has pledged approximately $166.8 million in loans as qualifying collateral for these borrowings. Also at December 31, 2015, the Company had an unused line of credit totaling approximately $27.1 million with the Federal Reserve Bank of Richmond to borrow funds from its discount window. The Company had pledged loans totaling approximately $43.4 million as collateral for these borrowings.

 

 

 
72

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 11 - 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 issued by the Capital Trust remain outstanding and mature or are mandatorily redeemable on September 30, 2035. The Company has the right to redeem these securities on or after September 30, 2010.

 

The Company’s investment in the common securities of the Capital Trust totaled $310,000 at December 31, 2015 and December 31, 2014, and is included in “Available for Sale Securities” on its consolidated balance sheets. The preferred securities of the Capital Trust, totaling $10.0 million, qualify as Tier 1 capital under Federal Reserve Board guidelines, subject to limitations.

 

The Capital Securities issued by the Capital Trust accrue and pay distributions quarterly at a rate per annum equal to the three-month LIBOR, which was 0.60 percent at December 31, 2015, plus 150 basis points. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of September 30, 2035. The Company’s payment of interest on the Capital Securities is subject to the Company’s compliance with Federal Reserve Board guidelines regarding the payment of dividends.

 

In accordance with the debenture terms noted above the Company deferred its quarterly dividend payment on these securities beginning with the December 2011 payment. Amounts so deferred compounded quarterly according to the same variable rate terms noted above. During this period of deferral the Company capitalized the dividend payments due, adding them to the principal outstanding for accrual purposes. The Company reinstated quarterly dividend payments beginning with the March 30, 2014 payment, when it also paid in full all interest arrearage in accordance with the requirements of the debenture terms. Accrued interest on these debentures totaled $1,200 and $1,000 at December 31, 2015 and December 31, 2014, respectively.

 

NOTE 12 - COMMITMENTS AND CONTINGENCIES

 

The Company is party to litigation and claims arising in the normal course of business. Management, after consultation with legal counsel, believes that the liabilities, if any, arising from such litigation and claims will not be material to the Company’s financial position.

 

 

 
73

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

 Notes to Consolidated Financial Statements

 

 

NOTE 13 - INCOME TAXES

 

Income tax expense (benefit) was as follows:

 

 

(Dollars in thousands)    

2015

   

2014

 

Current expense

               

Federal

  $ 470     $ 57  

State

    222       173  

Deferred expense (benefit)

               

Federal

    1,867       1,899  

State

    (40 )     (57 )

Change in valuation allowance

    26       38  

Total

  $ 2,545     $ 2,110  

 

Income tax expense is allocated as follows:

 

(Dollars in thousands) 

 

2015

   

2014

 
                 

Continuing operations

  $ 2,307     $ 1,604  

Other comprehensive gain

    238       506  

Total

  $ 2,545     $ 2,110  

 

The income tax effect of cumulative temporary differences for deferred tax assets at December 31, 2015 and 2014 is as follows:

 

(Dollars in thousands)

 

December 31,

 
   

2015

   

2014

 

Deferred tax assets:

               

Allowance for loan losses

  $ 1,630     $ 1,904  

Allowance for impairment of other real estate owned

    39       41  

Net operating loss (NOL) carryforward

    196       1,895  

Unrealized loss on investment securities

    402       640  

Deferred revenue

    31       107  

Deferred compensation

    792       697  

Depreciation

    249       162  

Other

    786       523  

Total deferred tax assets

    4,125       5,969  
                 

Deferred tax liabilities:

               

Prepaid expenses

    73       90  

Total deferred tax liabilities

    73       90  
                 

Net deferred tax asset

    4,052       5,879  
                 

Valuation allowance

    (269 )     (243 )

Total net deferred tax asset

  $ 3,783     $ 5,636  

 

 
74

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 13 - INCOME TAXES (Continued)

  

As of December 31, 2015, the Company maintained a full valuation allowance of $269,000 on its holding company state income tax items. Included in these items was a net operating loss carryforward totaling $165,000. Throughout the Company’s history, the holding company has consistently produced operating losses on a standalone basis, and the realizability of any of its deferred tax items continues to remain in doubt.

 

The Company has deferred tax assets totaling $31,000 relating to realizable Federal income tax net operating loss carryforwards of $91,000. These carryforwards expire in 2033. The Company believes it will generate sufficient profits to utilize its carryforwards prior to these expiration dates.

 

The provision for income taxes is reconciled to the amount of income tax computed at the federal statutory rate on income (loss) before income taxes for the years ended December 31, as follows:

 

 

 

(Dollars in thousands)

 

2015

   

2014

 
   

Amount

   

%

   

Amount

   

 

Tax expense at statutory rate

  $ 2,165       34 %   $ 1,816       34 %

Increase (decrease) in taxes resulting from:

                               

State tax (net of federal benefit)

    120       2       77       1  

Officers’ life insurance

    (85 )     (1 )     (287 )     (5 )

Municipal interest

    (47 )     (1 )     (49 )     (1 )

Merger expenses

    97       2       -       -  

Other tax preference items

    31       0       9       0  

Valuation allowance change

    26       0       38       1  

Tax expense

  $ 2,307       36 %   $ 1,604       30 %

 

 

The Company is no longer subject to examination by taxing authorities for years before 2012. The Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions.

 

 
75

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 14 - RELATED PARTY TRANSACTIONS

 

Directors, executive officers and their affiliates are customers of and have banking transactions with the Bank in the ordinary course of business. A summary of loan transactions with directors and executive officers, including their affiliates, is as follows:

 

 

(Dollars in thousands)

 

December 31,

 
   

2015

   

2014

 

Balance, beginning of year

  $ 1,586     $ 1,680  

New loans

    -       -  

Repayments

    (80 )     (94 )
                 

Balance, end of year

  $ 1,506     $ 1,586  

 

Deposits by directors and executive officers, including their affiliates, at December 31, 2015 and 2014 totaled $968,000 and $806,000, respectively.

 

NOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

 

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments include commitments to extend credit and standby letters of credit. They involve elements of credit and interest rate risk in excess of the amounts shown on the balance sheets.

 

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments is as follows:

 

(Dollars in thousands)

 

December 31,

 
   

2015

   

2014

 

Commitments to extend credit

  $ 26,566     $ 27,753  

Standby letters of credit

    441       62  

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

 

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral varies but may include accounts receivable, inventory, equipment, marketable securities and property. Since many letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements and the fair value of any liability associated with letters of credit is insignificant.

 

The Bank enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, if material, along with any related fees received from potential borrowers, are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans.

 

Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates. Due to the small amount and frequent turnover of loans held-for-sale, the derivative value is considered immaterial.

 

 
76

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

 Notes to Consolidated Financial Statements

 

NOTE 16 - EMPLOYEE BENEFIT PLANS

 

The Company maintains a 401(k) Plan for the benefit of all eligible employees. Upon ongoing approval of the Board of Directors, the Company matches 100 percent of employee contributions up to the first three percent of compensation, plus 50 percent of employee contributions on the next two percent of compensation, subject to certain adjustments and limitations. The Company may also make an elective three percent contribution to the Plan accounts of all eligible employees. Contributions made to the Plan in 2015 and 2014 amounted to $153,000 and $127,000, respectively.

 

The Company entered into a Supplemental Executive Retirement Plan (SERP) during 2008 with its Chief Executive Officer. The Company accrued deferred compensation expense of $253,000 and $231,000 in 2015 and 2014, respectively, in relation to this plan. The accrued liability for the SERP at December 31, 2015 and 2014 totaled $2,123,000 and $1,870,000, respectively.

 

The Company has entered into Endorsement Split Dollar Agreements with two of its executive officers relating to split dollar life insurance policies covering each of them. The Company is the sole owner of these life insurance policies and is required to maintain the policies in full force and effect and pay any premiums due on the policies. The agreements provide that if the executive’s death occurs before the earlier of the date of his termination of employment with the Company or the date that is six months after the executive attains age 70, the executive’s beneficiary will be entitled to the net death proceeds under the policies. The executive’s interest in the policies will be extinguished at the earlier of the date of his termination of employment or six months after the date on which he attains age 70, and the Company will be entitled to any remaining proceeds of the policies, provided a change in control has not occurred. In the event of a change in control prior to the termination of the executive’s employment, the Company is required to transfer to the executive ownership of the policy. The agreements also provide that the Company may not amend or terminate the executive’s interest in the policies unless the policies are replaced with comparable ones, including a new split dollar agreement. The agreements also provide for a claims and review procedure in the event persons have not received benefits under the agreement to which they believe they are entitled. If they had died on December 31, 2015, the death benefits payable to the executives’ beneficiaries upon the executive’s death would have totaled $2,741,000.

 

During 2014, the Company terminated an existing Endorsement Split Dollar Agreement with another of its executive officers. The terms of the split dollar agreement terminated were identical to those described above. In exchange for a payment of $271,000, which represented half of the policy’s cash surrender value, the Company sold ownership of the policy to the executive and relinquished all claims to future death benefits. The Company also agreed to make an annual payment of $120,000 to the executive, which he will use to timely pay the annual premium on the policy until the earliest of the executive’s separation from service, his death, or a change in control. If the annual premium for the policy is reduced for any reason, the annual payment to the executive will be reduced by the same amount. The death benefits associated with this policy total $7,500,000. Immediately prior to execution of the termination agreement, the death benefits payable to the executive’s beneficiaries would have totaled $6,780,000.

 

NOTE 17 - EMPLOYEE STOCK PURCHASE PLAN

 

From 2000 until 2015, the Company maintained successive five-year Employee Stock Purchase Plans for the benefit of officers and employees which allowed officers and employees to have the Company make payroll withholdings for the purpose of buying Company stock. The most recent plan expired in 2015 and was not replaced with a new plan. The purchase price under the plans was 85 percent of the closing quoted market price of the first or last business day of the quarter, whichever was less. Shares were purchased immediately following the last business date of the quarter. During 2015 and 2014, the Company issued 7,177 and 14,512 shares of common stock, respectively, under the 2010 plan. Proceeds from stock issuances during 2015 and 2014 totaled $51,000 and $99,000, respectively.

 

NOTE 18 - DIVIDENDS

 

There are no current plans to initiate payment of cash dividends and future dividend policy will depend on the Company’s earnings, capital requirements, financial condition and other factors considered relevant by the Board of Directors. The Bank’s ability to pay dividends to the Company is restricted by the laws and regulations of the State of South Carolina. Generally, these restrictions require the Bank to obtain the prior written consent of the South Carolina Commissioner of Banking to pay dividends. The Merger Agreement between the Company and BNC also restricts the Company’s ability to pay dividends.

 

 
77

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 19 - REGULATORY MATTERS

 

The Company’s total shareholders’ equity increased by approximately $4.5 million during 2015, primarily due to net income of $4,062,000 and other comprehensive income of $422,000. The Company’s Tier 1 capital to average assets ratio was 12.77 percent as of December 31, 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 150%. 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 Bank is 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 December 31, 2015, the most recent notification of the regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.

 

As of December 31, 2015, and December 31, 2014, the Company and the Bank exceeded each of the applicable capital requirements shown in the following table.

 

 

   

Capital Ratios

 

December 31, 2015

                 

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)

  $ 58,788       16.75 %   $ 28,077       8.00 %   $ 36,841       10.50 %   $ 35,097       10.00 %

Tier 1 capital (to risk-weighted assets)

    54,390       15.50 %     21,058       6.00 %     29,832       8.50 %     28,077       8.00 %

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

    54,390       15.50 %     15,793       4.50 %     24,568       7.00 %     22,813       6.50 %

Tier 1 capital (to average assets)

    54,390       11.36 %     19,150       4.00 %     19,150       4.00 %     23,938       5.00 %
                                                                 

The Company

                                                               

Total capital (to risk-weighted assets)

  $ 67,364       18.84 %   $ 28,602       8.00 % (1)   $ 37,540       10.50 % (1)      N/A       N/A  

Tier 1 capital (to risk-weighted assets)

    62,866       17.58 %     21,451       6.00 % (1)      30,389       8.50 % (1)      N/A       N/A  

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

    62,866       17.58 %     16,088       4.50 % (1)      25,026       7.00 % (1)      N/A       N/A  

Tier 1 capital (to average assets)

    62,866       12.77 %     19,695       4.00 % (1)      19,695       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).

 

 
78

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 19 - REGULATORY MATTERS (continued)

 

   

Capital Ratios

 

December 31, 2014

                 

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)

  $ 51,750       15.49 %   $ 26,733       8.00 %   $ 35,088       10.50 %   $ 33,417       10.00 %

Tier 1 capital (to risk-weighted assets)

    47,536       14.23 %     20,050       6.00 %     28,404       8.50 %     26,733       8.00 %

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

    47,536       14.23 %     15,038       4.50 %     23,392       7.00 %     21,721       6.50 %

Tier 1 capital (to average assets)

    47,536       10.61 %     17,921       4.00 %     17,921       4.00 %     22,402       5.00 %
                                                                 

The Company

                                                               

Total capital (to risk-weighted assets)

  $ 59,168       17.43 %   $ 27,152       8.00 % (1)   $ 35,638       10.50 % (1)     N/A       N/A  

Tier 1 capital (to risk-weighted assets)

    54,907       16.18 %     20,364       6.00 % (1)     28,850       8.50 % (1)     N/A       N/A  

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

    54,907       16.18 %     15,273       4.50 % (1)     23,758       7.00 % (1)     N/A       N/A  

Tier 1 capital (to average assets)

    54,907       11.98 %     18,331       4.00 % (1)     18,331       4.00 % (1)     N/A       N/A  

 

(1) Minimum requirements for bank holding companies with greater than $500 million in consolidated total assets (the Company was not subject to these requirements)

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

 

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.

 

 
79

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (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 December 31, 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 December 31, 2015, all impaired loans deemed collateral dependent were evaluated based on the fair value of the collateral less estimated costs to sell. Those impaired loans not requiring a specific allowance for loan losses allocation represent loans with fair values equal to or 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 costs 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 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 certified appraisal 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.

 

 
80

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

 Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Assets measured at fair value on a recurring basis are as follows as of December 31, 2015 and December 31, 2014

(Dollars in thousands):

   

December 31, 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

  $ -     $ 21,318     $ -     $ 21,318  

Municipals

    -       3,682       -       3,682  

Other

    -       4,203       2,832       7,035  
                                 

Total assets at fair value

  $ -     $ 29,203     $ 2,832     $ 32,035  

 

   

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 trust preferred securities 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.  

 

The following table reconciles the changes in recurring Level 3 financial instruments for the twelve months ended December 31, 2015 and 2014 (Dollars in thousands):

 

   

December 31,

   

December 31,

 
   

2015

   

2014

 
                 

Beginning of year balance

  $ 2,008     $ 1,836  

Discount accretion

    10       10  

Unrealized gain

    814       162  
                 

Ending balance

  $ 2,832     $ 2,008  

 

 
81

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

The following table presents quantitative information about Level 3 fair value measurements at December 31, 2015 (Dollars in thousands):

 

Security Type

 

Fair Value

   

Valuation

Technique

 

Unobservable Input

 

Rates

 
                             

Collateralized Debt Obligations

  $ 2,332     Discounted cash flows  

Discount rate

  Approximately   8%    
                Weighted default probability for deferring issuers   Approximately     26%    
                Recovery rate on deferring issuers     10% - 15%  
               

Default probability for current issuers

    1.00% - 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 rate at December 31, 2015.

 

There were no changes in unrealized gains and losses recorded in earnings for either of the years ended December 31, 2015 or December 31, 2014.

 

 
82

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

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

 

   

December 31, 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

  $ -     $ -     $ 1,398     $ 1,398  

Commercial Real Estate

    -       -       324       324  

Other Real Estate Owned

                               

Construction and Land Development

    -       -       54       54  
                                 

Total assets at fair value

  $ -     $ -     $ 1,776     $ 1,776  

 

 

 

   

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 that are measured for impairment using the fair value of the collateral had a recorded investment of $1,643,000 with a valuation allowance of $41,000 at December 31, 2015, with no additional provision for loan losses for the year ended December 31, 2015. Impaired loans that are 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. These additional provisions were all assigned to 1 – 4 Family Residential loans.

 

Other real estate owned measured at fair value less costs to sell had a net carrying amount of $50,000, which is made up of the outstanding balance of $165,000, net of a valuation allowance of $115,000, at December 31, 2015. This valuation allowance did not include any impairment made during the year ended December 31, 2015. Other real estate owned measured at fair value less costs to sell had a net carrying amount of $361,000, which is made up of the outstanding balance of $482,000, net of a valuation allowance of $121,000, at December 31, 2014. This valuation allowance included $6,000 of impairment made during the year ended December 31, 2014. All of this impairment related to 1-4 Family Residential real estate.

 

 
83

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

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 December 31, 2015 and December 31, 2014:

 

   

Valuation Techniques

   

Unobservable Inputs

 

Range

 

Impaired Loans

                   
                     

Residential 1-4 Family Homes

 

Sales comparison approach

   

Bank Owned Discount

  10% - 20%  

Commercial Real Estate

 

Sales comparison approach

   

Bank Owned Discount

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

Other Real Estate Owned

                   
                     

Commercial Real Estate

 

Sales comparison approach

   

Bank Owned Discount

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

Residential 1-4 Family Homes

 

Sales comparison approach

   

Bank Owned Discount

  10% - 205  

Residential 1-4 Family Home Lots

                   
Commercial Lots                    

 

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

 

    Fair Value Measurements at December 31, 2015 Using:  
   

Carrying

Amount

   

 

Level 1

   

 

Level 2

   

 

Level 3

   

 

Total

 

Financial assets

                                       

Cash and cash equivalents

  $ 40,944     $ 40,944     $ -     $ -     $ 40,944  

Available for sale investment securities

    32,035       -       29,203       2,832       32,035  

Federal Home Loan Bank Stock

    4,291       N/A       N/A       N/A       N/A  

Loans held for sale

    1,711       -       1,711       -       1,711  

Loans, net

    384,502       -       -       384,755       384,755  

Accrued interest receivable

    1,149       -       95       1,054       1,149  
                                         

Financial liabilities

                                       

Deposits

    339,457       235,860       103,652       -       339,512  

Short term borrowings

    6,760       -       6,760       -       6,760  

Advances from Federal Home Loan Bank

    91,000       -       94,004       -       94,004  

Junior subordinated debentures

    10,310       -       -       6,301       6,301  

Accrued interest payable

    324       -       323       1       324  

 

    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  

 

 
84

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

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.  

 

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 values of loans do not necessarily represent an exit price.

 

The fair values of loans held for sale are 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 to which they are associated.

 

 
85

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

 Notes to Consolidated Financial Statements

 

NOTE 20 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

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.

 

NOTE 21 - PARENT COMPANY FINANCIAL INFORMATION 

Following is condensed financial information of Southcoast Financial Corporation (parent company only):

 

 

CONDENSED BALANCE SHEETS

 

 

(Dollars in thousands)

 

December 31,

 
   

2015

   

2014

 

ASSETS

               

Cash

  $ 3,719     $ 4,593  

Investments available for sale

    192       102  

Investment in subsidiaries

    54,418       49,129  

Property and equipment, net

    3,863       3,877  

Receivables from subsidiaries

    802       -  

Other real estate owned, net

    184       184  

Deferred tax asset, net

    1,095       1,630  

Other assets

    70       70  
                 

Total assets

  $ 64,343     $ 59,585  
                 

LIABILITIES AND SHAREHOLDERS’ EQUITY

               

Accounts payable

  $ 2,193     $ 1,970  

Junior subordinated debentures

    10,310       10,310  

Shareholders’ equity

    51,840       47,305  
                 

Total liabilities and shareholders’ equity

  $ 64,343     $ 59,585  

 

CONDENSED STATEMENTS OF INCOME

 

(Dollars in thousands)

 

For the years ended December 31,

 
   

2015 

   

2014 

 

Income

               

Dividends from subsidiaries

  $ -     $ 3,000  

Interest and dividends

    4       2  

Expenses

    (1,166 )     (499 )

Income (loss) before income taxes

    (1,162 )     2,503  

Income tax benefit

    (299 )     (383 )

Income (loss) before equity in undistributed net income of subsidiaries

    (863 )     2,886  

Equity in undistributed net income of subsidiaries

    4,925       851  

Net income

  $ 4,062     $ 3,737  

 

 
86

 

 

SOUTHCOAST FINANCIAL CORPORATION AND SUBSIDIARIES 

 Notes to Consolidated Financial Statements

 

NOTE 21 - PARENT COMPANY FINANCIAL INFORMATION(Continued)

 

CONDENSED STATEMENTS OF CASH FLOWS

 

(Dollars in thousands)

 

For the years ended December 31,

 
   

2015

   

2014

 

Operating Activities

               

Net income

  $ 4,062     $ 3,737  

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

               

Equity in undistributed net income of subsidiaries

    (4,925 )     (851 )

Depreciation

    14       14  

(Increase) decrease in deferred taxes

    503       (293 )

(Increase) decrease in other assets

    (802 )     767  

Increase (decrease) in other liabilities

    223       (183 )
                 

Net cash provided (used) by operating activities

    (925 )     3,191  
                 

Investing activities

               

Purchase of property and equipment

    -       -  

Purchase of Other real estate owned from banking subsidiary

    -       (184 )

Capital contribution to banking subsidiary

    -       (232 )

Net cash used by investing activities

    -       (416 )
                 

Financing activities

               

Net proceeds from issuance of stock

    51       99  

Net cash provided by financing activities

    51       99  
                 

Net change in cash

    (874 )     2,874  
                 

Cash, beginning of year

    4,593       1,719  
                 

Cash, end of year

  $ 3,719     $ 4,593  

 

 
87

 

 

Item 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

 

Not Applicable

 

Item 9A.

Controls and Procedures.

 

Effectiveness of Disclosure Controls and Procedures

 

Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or 240.15d-15(b) of the Company’s disclosure controls and procedures (as defined in 17 C.F.R. Sections 240.13a-15(e) or 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 Annual Report on Form 10-K, were effective.

 

Management’s Annual Report on Internal Control over Financial Reporting

 

MANAGEMENT REPORT ON INTERNAL

CONTROL OVER FINANCIAL REPORTING

 

The management of Southcoast Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are executed in accordance with appropriate management authorization and accounting records are reliable for the preparation of financial statements in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management has assessed the effectiveness of Southcoast Financial Corporation’s internal control over financial reporting as of December 31, 2015. In making our assessment, management has utilized the framework published in 2013 by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission “Internal Control-Integrated Framework.” Based on our assessment, management has concluded that, as of December 31, 2015, the Company’s internal control over financial reporting was effective.

 

Date: March 24, 2016

 

s/L. Wayne Pearson

 

s/William C. Heslop

L. Wayne Pearson

 

William C. Heslop

President and Chief Executive Officer

 

Senior Vice President and Chief Financial Officer

 

Changes in Internal Control over Financial Reporting

 

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.

 

Item 9B.

Other Information.

 

No information was required to be disclosed in a Form 8-K during the fourth quarter of 2016 that was not so disclosed.

  

 
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PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance.

 

Directors

 

Set forth below is information about our current directors. Each director is also a director of our wholly owned subsidiary, Southcoast Community Bank (our “Bank”).

 

Name

Age

Business Experience During the Past Five Years

 

Director

Since

       

Directors whose terms of office

continue until the Annual Meeting of Shareholders in 2018:

       

Tommy B. Baker

70

Owner- Baker Motors of Charleston (automobile dealership).

2005

       

William A. Coates

66

Attorney and shareholder, Roe, Cassidy, Coates & Price, P.A., Greenville, South Carolina (attorneys) since January 1, 2002; attorney and shareholder, Love, Thornton, Arnold & Thomson, P.A., Greenville, South Carolina (attorneys) 1980-2001; Vice Chairman of our Company and our Bank.

  1998*

       

Stephen F. Hutchinson

69

President, The Hutchinson Company, Inc. (real estate).

2005

       

Directors whose terms of office

will continue until the Annual Meeting of Shareholders in 2016:

       

L. Wayne Pearson

68

Chairman, Chief Executive Officer, and President of our Company and our Bank since June, 1998.

  1998*

       

Robert M. Scott

72

Treasurer, Secretary and Executive Vice President of our Company and our Bank since November, 2011; Chief Financial Officer of our Company and our Bank from June, 1998 until May, 2006; Secretary of our Company and our Bank since June, 1998.

  1998*

   

 

 

Director whose term of office will continue

until the Annual Meeting of Shareholders in 2017:

       

James P. Smith, CLU, ChFC

61

President and Chief Executive Officer, Atlantic Coast Advisory Group (insurance sales) since 2004; Member of MUSC Children’s Hospital Fund Raising Advisory Board, 2008.

  1998*

 

*Includes membership on the Board of Directors of our Bank prior to organization of our Company as a holding company for our Bank in 1999.

 

None of the directorS nor any of the principal executive officers are related by blood, marriage or adoption in the degree of first cousin or closer.

 

The Nominating Committee believes the combined business and professional experience of the Company’s directors, and their various areas of expertise make them a useful resource to management and qualify them for service on the Board. Most of our Board members have served on the Board since our organization, and Mr. Pearson has been our Chief Executive Officer and Chairman since our organization. During their tenures, these directors have gained considerable institutional knowledge about the Company and its operations, which has made them effective board members. Because the Company’s operations are complex and highly regulated, continuity of service and this development of institutional knowledge help make the Board more efficient and more effective at developing long-range plans than it would be if there were frequent turnover in Board membership. When Board members retire from the Board, the Nominating Committee seeks out replacements who it believes will make significant contributions to the Board for a variety of reasons, including among others, business and financial experience and expertise, business and government contacts, relationship skills, knowledge of the Company, and diversity.

 

 
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Mr. Pearson was an organizer of our Company and our Bank, and has served as the president and Chief Executive Officer and Chairman of the Board of Directors of our Company and our Bank since that time. He has over 40 years’ experience in banking and has significant banking contacts throughout the state of South Carolina.

 

Mr. Scott was also an organizer of our Company and our Bank, and has served as a director of each since that time. He also served as the Chief Financial Officer of the Company and the Bank from the Company’s organization through May 2006. In November 2011, he rejoined the Company and the Bank as Treasurer and Executive Vice-President. He has over 40 years’ experience in banking and has significant contacts within the industry.

 

Mr. Coates, who is currently our Vice Chairman, was also an organizer of our Company and our Bank, and has served as a director of each since that time. He has been an attorney in the state of South Carolina for over 30 years. His legal experience and insights are a valuable resource to our Board. Additionally, during his many years of legal practice, he has developed significant contacts throughout the state and utilizes information gained from those contacts to provide guidance to the Board regarding economic conditions beyond our direct service area.

 

Mr. Smith was also an organizer of our Company and our Bank, and has served as a director of each since that time. He has over 30 years’ experience in the financial services industry, most recently as the President and Chief Executive Officer of Atlantic Coast Advisory Group, an insurance brokerage firm. He uses his in depth knowledge of financial risk management tools to provide guidance to us on matters involving risk and risk management.

 

Mr. Hutchinson has served as a member of our Board of Directors since 2005, and is also a member of our Bank’s Board of Directors. Prior to his election to our Board of Directors, he served on the advisory board of our Summerville region. He has over 30 years’ experience in the real estate development industry in the greater Charleston area. He provides the Board with insights into the real estate market in the area, which we use in developing our long range strategy, as well as in understanding individual loans requiring board approval.

 

Mr. Baker has served as a member of our Board of Directors since 2005, and is also a member of our Bank’s Board of Directors. He has over 30 years’ experience in the automobile dealership industry. In that time he has developed extensive knowledge of financing, as well as the skills required to develop and implement a successful long range business and marketing strategy for an organization. As a member of our Board, he translates this knowledge and skill set to the financial services industry in providing guidance to the Board on long range strategy and short term implementation of that strategy.

 

Executive Officers

 

Our executive officers are L. Wayne Pearson, Robert A. Daniel, Jr., Robert M. Scott, William B. Seabrook, William R. Billings, and William C. Heslop. Messrs. Pearson and Scott are directors and information about their ages and business experience is set forth above. Information about Messrs. Daniel, Seabrook, Billings, and Heslop is set forth below.

 

 
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Name

Age

Business Experience During Past Five Years

 

Robert A. Daniel, Jr.

65

Executive Vice President of our Company and our Bank since 2005; Chief Lending Officer of our Bank since 1998; Senior Vice President of our Bank from 1999 to 2005.

     

William B. Seabrook

59

Executive Vice President of our Company and our Bank since 2005, and Chief Operating Officer of our Company since May, 2009; Head of Retail Banking for our Bank since 2004; Senior Vice President of our Bank from 2004 to 2005; correspondent banker with FTN Financial, a division of First Tennessee Bank from 1997 to 2004.

     

William R. Billings

56

Executive Vice President of our Bank since May 2010, and Senior Credit Officer of our Bank since November 2006; Senior Vice President of our Bank from November 2006 until May 2010; Senior Vice President of Wachovia Wealth Management from 2001-2006; Senior Vice President and Consumer Bank Director of Wachovia from 1998-2001; Certified Financial Planner since 2006.

     

William C. Heslop

40

Senior Vice President and Chief Financial Officer of our Company and our Bank since May, 2006; certified public accountant with Elliott Davis, LLC from January, 2003 to April, 2006.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

As required by Section 16(a) of the Securities Exchange Act of 1934, our directors, executive officers and certain individuals are required to report periodically their ownership of our common stock and any changes in ownership to the Securities and Exchange Commission. Based on a review of Section 16(a) reports available to us and any representations made to us, our directors and executive officers timely filed all required reports for 2015.

 

Code of Ethics

 

The Company has adopted a code of ethics (as defined by 17 C.F.R. 229.406) that applies to its principal executive officer and principal financial/accounting officer. The Company will provide a copy of the code of ethics, free of charge, to any person upon written request to William C. Heslop, Senior Vice President, Southcoast Financial Corporation, 534 Johnnie Dodds Boulevard, Mt. Pleasant, South Carolina 29464.

 

Audit Committee

 

We have a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The members of the Audit Committee, all of whom are independent under the NASDAQ rules are William A. Coates, Tommy B. Baker and Stephen F. Hutchinson.

  

 
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Audit Committee Financial Expert

 

The Company’s board of directors has determined that the Company does not have an “audit committee financial expert,” as that term is defined by Item 407(d)(5) of Regulation S-K promulgated by the Securities and Exchange Commission, serving on its audit committee. The Company’s audit committee is a committee of directors who are independent of the Company and its management. After reviewing the experience and training of all of the Company’s independent directors, the board of directors has concluded that no independent director meets the SEC’s very demanding definition of an “audit committee financial expert.” Therefore, it would be necessary to find a qualified individual willing to serve as both a director and member of the audit committee and have that person elected as a director by the shareholders in order to have an “audit committee financial expert” serving on the Company’s audit committee. The Company’s audit committee is, however, authorized to use consultants to provide financial accounting expertise in any instance where members of the committee believe such assistance would be useful. Accordingly, the Company does not believe that it needs to have an “audit committee financial expert” on its audit committee.

 

Item 11.

Executive Compensation.

 

 

MANAGEMENT COMPENSATION

 

Overview of Executive Compensation

 

Our Compensation Committee administers our executive officer compensation program. (As used in this discussion, “named executive officers” refers specifically to our Chief Executive Officer, Mr. Pearson, and our two other next most highly compensated executive officers, Messrs. Scott and Seabrook, as shown in the Summary Compensation Table, and “executive officers” refers generally to all of our executive officers.) The Committee has historically followed an informal policy of providing our executive officers with a total compensation package consisting of salary, bonuses, insurance and other benefits, and, occasionally, stock options. The Committee’s objectives in setting executive compensation are:

 

 

to set salaries and benefits and, from time to time, award options, at competitive levels designed to encourage our executive officers to perform at their highest levels in order to increase earnings and value to shareholders;

 

where appropriate, to award bonuses and increase salaries to reward our executive officers for performance; and

 

to retain our key executives.

 

Compensation is designed to reward our individual executive officers both for their personal performance and for performance of our Company with respect to growth in assets and earnings, expansion and increases in shareholder value. Base salary and bonus are designed to be commensurate with each executive officer’s scope of responsibilities, leadership, and management experience and effectiveness, and to reward annual achievements.

 

The Committee has not historically set specific advance goals for personal or corporate performance, and the Committee does not apply rigid formulas or necessarily react to short-term changes in business performance in determining the mix or amount of compensation elements. The Committee makes its decisions about the amounts of the various types of compensation, and allocations between long-term and current compensation, allocations between cash and non-cash compensation, and allocations among various forms of compensation, in its discretion based on the Committee’s subjective assessment of how these amounts and allocations will best meet the Committee’s overall compensation goals outlined above.

 

Components of 2015 Executive Compensation

 

Minimum base salaries and certain additional benefits are set forth in employment agreements with our named executive officers. During 2015, executive compensation consisted primarily of base salary, bonuses and retirement benefits. In 2015, the Compensation Committee awarded five percent salary increases to each of our named executive officers, with the exception of Mr. Pearson, who did not receive an increase, and to certain other executive officers. In 2015, the Committee also awarded bonuses to Messrs. Pearson, Scott and Seabrook and certain other executive officers based on their commitments of substantial additional time and effort in successfully negotiating the proposed merger transaction between us and BNC Bancorp, and in overseeing and participating in the extensive due diligence activities relating to the transaction, in addition to discharging their regular duties. Additionally in 2015, the Committee approved transfer to Mr. Pearson of title to the Bank-owned vehicle assigned for his use, which had an estimated market value at the time of transfer of $40,000. We have not awarded executive officers any short or long-term incentive compensation or equity awards since 2008, and did not make any such awards in 2015.We also provide various additional benefits to executive officers, including health, life and disability insurance plans, split dollar insurance, employment and change of control arrangements, and perquisites. A more detailed discussion of each of these components of executive compensation, the reasons for awarding such types of compensation, the considerations in setting the amounts of each component of compensation, the amounts actually awarded for the periods indicated, and various other related matters is set forth in the sections and tables that follow.

 

 
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Factors Considered in Setting Compensation

 

In setting compensation the Compensation Committee considers each executive’s knowledge, skills, scope of authority and responsibilities, job performance and tenure with us as an executive officer, as well as our perception of the fairness of the compensation paid to each executive in relation to what we pay our other executive officers, and the business and financial performance of our Company. The Committee also considers recommendations from our Chief Executive Officer in setting his compensation and compensation for the other executive officers.

 

Although the Compensation Committee considers competitive market compensation paid by other financial institutions in South Carolina and the southeast derived from proxy statements and publicly available compilations prepared by regional investment banking firms, the Committee does not attempt to maintain a target percentile within a peer group.

 

We review our compensation program and levels of compensation paid to all of our executive officers annually and may make adjustments based on the foregoing factors as well as other subjective factors.

 

Timing of Executive Compensation Decisions

 

Annual salary reviews and adjustments and bonus are routinely made in January of each year at the first regularly scheduled Compensation Committee and Board meetings. Compensation determinations may also be made at other times during the year, especially in the case of newly hired executives or promotions of existing employees that could not be deferred until the next scheduled meeting. Board and Committee meetings are generally scheduled well in advance of the meeting dates, and these scheduling decisions are made without regard to anticipated earnings or other major announcements. We do, however, routinely release earnings after our regular Board meetings.

 

Base Salaries and Bonuses

 

The Compensation Committee believes it is appropriate to set base salaries at a reasonable level that will provide executive officers with a predictable income base on which to structure their personal budgets. The employment agreements with each of the named executive officers and our other executive officers set minimum thresholds for base salaries, but the Compensation Committee may set annual base salaries in excess of those minimum thresholds. In setting base salaries, the Committee considers the scope of our executive officers’ responsibilities, their performance, and the period over which they have performed such responsibilities, as well as the overall condition of our Company, its level of success in recent years and its goals and budget for the current year. The Committee then makes a subjective determination of the salary level for each executive officer. Salaries are reviewed annually, but are not adjusted automatically. For the past several years, including 2015, the Committee considered generally the matters discussed below in setting salaries for each individual executive officer.

 

 
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In setting the salary for Mr. Pearson, our Chief Executive Officer, the Committee has taken note of the regulatory changes that are continuing to increase the complexity and challenges of operating our business, and of Mr. Pearson’s continued personal leadership and business skills that are critical to us, particularly during the past several years of difficult local and national economic conditions. The Committee also has considered information it had regarding salary levels of other chief executive officers of financial institutions in South Carolina and the southeast, and set a salary level that the Committee believed was fair to Mr. Pearson and to our Company.

 

In setting salaries for our other named executive officers, the Committee has taken into consideration the recommendations of our Chief Executive Officer and the following contributions. For Mr. Scott, the Committee has considered his long-term experience as our previous Chief Financial Officer and as a banker in general, and his extensive knowledge of our business and the business of banking generally, as well as the fact that he agreed to come out of retirement to help us work through the difficult economic environment of the past several years. For Mr. Seabrook, our Chief Operating Officer, the Committee has considered the role he has played in growth of our branches in loans, deposits and profitability, his responsibilities in connection with personnel decisions, and his role as a loan officer.

 

As noted above, In 2015, the Compensation Committee awarded five percent salary increases to each of our named executive officers, with the exception of Mr. Pearson, who did not receive an increase, and to certain other executive officers.

 

The Compensation Committee sets bonuses, if any, for executive officers taking into account our overall success, increase in market share, performance relative to budget and the individual executive’s performance and contribution to our success. As noted above, in 2015, the Committee awarded bonuses to each of Southcoast’s named executive officers based on their commitments of substantial additional time and effort in successfully negotiating the proposed merger transaction between us and BNC Corporation, and in overseeing and participating in the extensive due diligence activities relating to the transaction, in addition to discharging their regular duties.

 

Stock Options

 

Stock options have been awarded from time to time, and generally have been set by the Committee at levels believed to be competitive with other financial institutions of similar size and to advance our goal of retaining key executives, as well as levels believed to appropriately align the interests of management with the interests of shareholders. Because options are granted with exercise prices set at fair market value of our common stock on the date of grant, executives can only benefit from the options if the price of our stock increases. The Committee does not award options every year, and has not awarded options since 2004.

 

Other Benefits

 

We provide our executive officers with medical and dental, life and disability insurance benefits, and we make contributions to our 401(k) plan on their behalf on the same basis as contributions are made for all other employees.

 

We also pay country club dues for each of our named executive officers and provide Messrs. Pearson and Seabrook with an automobile allowance. We consider the club dues to be directly and integrally related to performance of our named executive officers’ duties. In addition, we encourage, and pay for our named executives and their spouses, to attend banking conventions and seminars. The Compensation Committee has determined that these benefits play an important role in our named executive officers’ business development activities on behalf of our Company. The Compensation Committee has also determined that providing such benefits helps to retain key executives and is an important factor in keeping our executive compensation packages competitive in our market area.

 

All of the foregoing benefits awarded to our executives in 2015 were set at levels believed to be competitive with other community financial institutions in South Carolina.

 

Employment Agreements, Split Dollar Life Insurance, and Salary Continuation Agreement

 

We have entered into employment agreements with Messrs. Pearson, Scott and Seabrook. These agreements are described under “ -- Employment Agreements and Potential Payments upon Termination of Employment or Change of Control.” As discussed in that section, the employment agreements provide, among other things, for payments to Messrs. Pearson, Scott and Seabrook upon termination of their employment other than for cause or upon a change of control of our Company. The events set forth as triggering events for the payments were selected because they are events similar to those provided for in many employment agreements for executive officers of financial institutions throughout South Carolina. It has become increasingly common in South Carolina for community financial institutions to provide for such payments under such conditions. We believe these arrangements are an important factor in attracting and retaining our named executive officers by assuring them financial and employment status protections in the event we terminate their employment for our own business purposes without cause, or control of our Company changes. We believe such assurances of financial and employment protections help free executives from personal concerns over their futures, and, thereby, can help to align their interests more closely with those of shareholders, particularly in negotiating transactions that could result in a change of control.

 

 
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We have also entered into agreements relating to split dollar life insurance with Mr. Seabrook, and with our non-employee directors, Messrs. Coates, Hutchinson, and Smith. Although we had also previously entered into split dollar agreements with Messrs. Scott and Baker, their agreements have terminated as a result of their attaining age 70. The agreement with Mr. Seabrook is described under “ -- Split Dollar Life Insurance/Endorsement Split Dollar Agreement.” Also discussed in that section is the termination of a split dollar life insurance agreement that we had previously entered into with Mr. Pearson. The agreements with our non-employee directors are described under “—Director Split Dollar Agreements.” These agreements provide benefits to us and to the executives’ and directors’ beneficiaries upon their deaths. We believe this type of agreement is an important factor in retaining our executive officers and directors because they are required to be employed by us, or serving on our Board, at death or disability or a change in control, or remain employed by us, or serving on our Board, until retirement, for their beneficiaries to receive benefits under the policies without having to make payments for such benefits.

 

Additionally, in 2008 we entered into a salary continuation agreement with our Chief Executive Officer, Mr. Pearson. This agreement is described under “- Salary Continuation Agreement.” We believe that this salary continuation agreement is important to provide our Chief Executive Officer with a level of retirement security appropriate to the level of benefits he has regularly conferred on the Company and the Bank since the organization of the Bank in 1998 and is expected to continue to confer in the future.

 

Tax and Accounting Considerations

 

We expense salary, bonus and benefit costs as they are incurred for tax and accounting purposes. Salary, bonus and some benefit payments are taxable to the recipients as ordinary income. The tax and accounting treatment of the various elements of compensation, while important and taken into consideration, is not a major factor in our decision making with respect to compensation.

 

Security Ownership Guidelines and Hedging

 

We do not have any formal security ownership guidelines for our executive officers, but most of our executive officers own a significant number of shares. We do not have any policies regarding our executive officers’ hedging the economic risk of ownership of our shares.

 

Financial Restatement

 

The Board of Directors does not have a policy with respect to adjusting retroactively any cash or equity based incentive compensation paid to our executive officers where payment was conditioned on achievement of certain financial results that were subsequently restated or otherwise adjusted in a manner that would reduce the size of an award or payment, or with respect to recovery of any amount determined to have been inappropriately received by an individual executive. The Board will be required to adopt such a policy after the Nasdaq adopts the related listing standards in accordance with regulations that are required to be adopted by the Securities and Exchange Commission (“SEC”) pursuant to the Dodd-Frank Act. Although the SEC has proposed such regulations, final regulations and Nasdaq listing standards have not yet been adopted. Until the Board adopts such a formal policy, if such a restatement were ever to occur, the Board would expect to address recovery of any such compensation paid to executive officers on a case-by-case basis in light of all of the relevant circumstances.

 

Non-binding Shareholder Advisory Votes on Executive Compensation and Frequency of Votes on Executive Compensation

 

Pursuant to the requirements of Section 14A of the Securities Exchange Act of 1934 and related SEC regulations, at our 2015 annual meeting of shareholders, we submitted to our shareholders a non-binding advisory vote on approval of executive compensation.  Of the total shares voted, 91% voted in favor of the proposal. However, the results of the advisory vote did not affect the Compensation Committee’s decisions relating to executive compensation decisions and policies.

 

 
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Also pursuant to the requirements of Section 14A of the Securities Exchange Act of 1934 and related SEC regulations, at our 2015 annual meeting of shareholders, we submitted to our shareholders a non-binding advisory vote on whether to hold the non-binding advisory vote on executive compensation every year, every two years, or every three years. The Committee and the Board took into consideration that, of the shares voting on the non-binding advisory vote on frequency of the vote on executive compensation, more shares voted in favor of a one year frequency than on either of the other frequency alternatives. In light of this vote, the Board has set the current frequency of the non-binding advisory vote on executive compensation at every year, to remain in effect until the next non-binding advisory vote on frequency of the vote on executive compensation.  Therefore, at the 2015 Annual Meeting, shareholders were again given the opportunity to vote on a non-binding advisory resolution relating to executive compensation. If the merger with BNC Bancorp is not completed, the next non-binding advisory vote on executive compensation will be at the 2016 annual meeting, and the next vote on a non-binding advisory proposal relating to the frequency of the vote on executive compensation will be at the 2019 annual meeting.

 

Summary of 2015 Named Executive Officer Compensation

 

The following table sets forth for the years ended December 31, 2015 and 2014 information about compensation awarded to, earned by or paid to our Chief Executive Officer and our two next most highly compensated executive officers. Further information about each component of compensation is included in the discussion on the foregoing pages.

 

Summary Compensation Table

 

Name and Principal Position

 

Year

 

Salary

($)

   

Bonus

($)

   

All Other

Compensation (1)

($)

   

Total

($)

 

L. Wayne Pearson

 

2015

  $ 395,000     $ 60,950     $ 482,495     $ 938,445  

President and Chief Executive Officer

 

2014

    395,000     $ 39,500       798,825       1,233,325  
                                     

Robert M. Scott

 

2015

    252,000       39,500       88,579       380,079  
                                     

Executive Vice President, Secretary and Treasurer

 

2014

    240,000       24,000       51,975       315,975  
                                     

William B. Seabrook

 

2015

    273,000       42,650       56,745       372,395  

Executive Vice President and Chief Operating Officer

 

2014

    260,000       26,000       55,736       341,736  

 

 

(1)

Includes our 2015 contributions to the Bank’s 401(k) Plan on behalf of the named persons, premiums for medical and dental insurance, disability insurance and life insurance, split dollar life insurance, amount accrued for the salary continuation agreement, holding company and bank directors’ fees, and automobile allowances in the amounts shown below for each person. Does not include club dues, which we do not consider to be perquisites or personal benefits because we deem them to be directly and integrally related to performance of our executives’ duties.

  

 
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401(k)

   

Medical

and

Dental

   

Disability

   

Life and Split

Dollar

Insurance

   

Salary

Continuation

Agreement(b)

   

Directors’ Fees

   

Automobile

Allowance

and

Transfer(c)

 
                                                         

Mr. Pearson

  $ 10,600     $ 8,732     $ 247     $ 122,278 (a)   $ 252,583     $ 34,375     $ 53,680  

Mr. Scott

    -     $ 339     $ 247     $ 53,618       -     $ 34,375       -  

Mr. Seabrook

  $ 10,600     $ 4,061     $ 247     $ 35,817       -       -     $ 6,000  

 

(a) Includes amount paid to Mr. Pearson pursuant to the Split Dollar Life Insurance Termination Agreement entered into in August 2014 for him to use to timely pay the annual premium on the life insurance policy transferred to him pursuant to such agreement. See “—Endorsement Split Dollar Insurance Agreements.”

 

(b) Amount accrued by the Bank with respect to retirement payments to be made to Mr. Pearson under our agreement with him beginning at the normal retirement age under the agreement (age 70.5). See “--Retirement and Nonqualified Deferred Compensation Plan.” The Bank amended the agreement in 2009, at Mr. Pearson’s request, to raise the normal retirement age under the agreement to age 70.5. The change substantially reduced the amount the Bank will be required to accrue annually going forward.

 

(c) For Mr. Pearson, in addition to automobile allowance, includes transfer of title to the Bank-owned vehicle previously assigned for his use, which had an estimated market value at the time of transfer of $40,000.

 

Employment Agreements and Potential Payments upon Termination of Employment or Change of Control

 

We are currently party to employment agreements with Messrs. Pearson, Seabrook and Scott. The employment agreements are for terms of one year, with automatic one year extensions at each annual anniversary date in the case of Messrs. Scott and Seabrook, and three years, with automatic one day extensions at the end of each day in the case of Mr. Pearson, unless the employee is terminated or either party gives written notice that the term will not be extended. The employment agreements provide for minimum annual base salaries of $333,505, $225,000 and $231,525 for Messrs. Pearson, Scott and Seabrook, respectively. In addition to salary, the employment agreements provide for each officer to participate in any retirement or other employee benefit plans applicable to all employees or to executive officers, and to receive life, health and disability insurance benefits, other unspecified benefits provided under plans applicable to senior management officers and appropriate to their positions, and, in the case of Messrs. Pearson and Scott, salary continuation if termination occurs because of disability. The employment agreement with Mr. Scott also provides that, if there has been a change of control of the Company or the Bank and, within 24 months thereafter, he is terminated involuntarily and without cause or resigns because his position has been materially diminished or he is required to relocate out of South Carolina without his prior consent, he will receive a lump sum payment equal to three times his: (i) annual salary, plus the average of any bonus and other non-equity compensation paid for the three years immediately preceding the date of termination, and (ii) benefits such as life, health, dental and disability insurance, and pre-tax retirement plan employer contributions. Such payments may not, however, exceed the amount which we may deduct for federal income tax purposes. Mr. Pearson’s employment agreement also provides that, if there has been a change of control of us or the Bank and, within 24 months thereafter, Mr. Pearson’s base compensation or his position has been materially diminished or he is required to relocate out of Mt. Pleasant, South Carolina without his prior consent or if we or the Bank materially breach the agreement in any way, he may terminate the employment agreement and receive a lump sum payment equal to three times his annual salary, as well as benefits for a period of three years after termination. Mr. Pearson would also be entitled to a lump sum payment equal to three times his annual salary, as well as benefits for a period of three years after termination, if he is terminated by us without cause within 24 months after a change in control. In contrast to the employment contracts of our other executives, the contract with Mr. Pearson does not require that his change-in-control benefits be reduced to avoid application of Internal Revenue Code section 280G and section 4999 excess parachute payment excise taxes and loss of employer deductibility. As amended in the fourth quarter of 2015, Mr. Seabrook’s employment agreement provides that when a change in control occurs, he is entitled to a lump-sum payment equal to three times the sum of salary and average bonus. The benefit is not contingent upon employment termination after a change in control, but if employment termination occurs, Mr. Seabrook would also potentially be entitled for the remaining contract term to continued life, health, dental, and disability insurance benefits and employer pre-tax retirement plan contributions.

  

 
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The employment agreements with Messrs. Pearson and Scott provide that we will provide each of them with disability insurance in an amount equal at all times to at least one-half of his annual base salary. If the executive officer’s employment terminates because of disability, the agreements provide that we will pay him his full salary then in effect and continue all benefits then in effect for a period of one year from the date of termination.

 

We may terminate an officer under the terms of the employment agreements for cause, which for Messrs. Scott and Seabrook includes, among other grounds for termination: his breach of any material provision of the employment agreement; his engaging in misconduct (criminal, immoral or otherwise) that is materially injurious to us or the Bank; his failure to substantially perform his duties under the employment agreement after a demand for substantial performance is given to him; his failure to comply with provisions of law and regulations that is materially injurious to the Bank; his conviction of a felony or any crime of moral turpitude; his commission in the course of his employment of an act of fraud, embezzlement, theft or dishonesty, or any other illegal act or practice, which would constitute a crime, (whether or not resulting in criminal prosecution or conviction), or any act or practice that results in his becoming ineligible for coverage under the Bank’s banker’s blanket bond; or his being removed from office or prohibited from being affiliated with the Bank by the Federal Deposit Insurance Corporation. Under Mr. Pearson’s employment agreement, cause includes, among other grounds for termination: his breach of any material provision of the employment agreement; his engaging in willful misconduct, criminal, immoral or otherwise, that is materially injurious to us or the Bank; his failure to comply with the clear provisions of law and regulations applicable to us or the Bank that is materially injurious to us or the Bank; his conviction of a felony; his commission in the course of his employment of an act of fraud, embezzlement, theft or proven dishonesty, or any other illegal act or practice, which would constitute a felony, (whether or not resulting in criminal prosecution or conviction), or any act or practice that results in his becoming ineligible for coverage under the Bank’s banker’s blanket bond; or his being removed from office or prohibited from being affiliated with the Bank by the FDIC. Mr. Pearson may be terminated with cause solely by board action, if at least two-thirds of the board, excluding Mr. Pearson, votes in favor of termination.

 

We may also terminate the officer other than for cause in our discretion or that of the Bank, but if we do so we must pay him the full annual compensation and other benefits provided for in the employment agreement over the remaining term of the employment agreement, in the case of Mr. Pearson, or for one year, in the case of Messrs. Scott and Seabrook.

 

If we terminate an officer other than for cause or if an officer resigns for good reason after a change of control, his outstanding stock options and stock appreciation rights, and any and all rights under performance stock award plans, restricted stock plans and any other stock option, or incentive stock plans shall become immediately and fully exercisable for a period of 60 days following the last payment required by the agreement to be made by us or the Bank to the officer, except that no such option or right shall be exercisable after the termination date of such option or right. The executives currently have no unvested equity awards.

 

The employment agreements do not require the executive officers to seek other employment in mitigation of the amounts payable or arrangements made under any provision of the employment agreements. Nevertheless, if an executive officer obtains any such other employment, our and the Bank’s obligations to make the payments and provide the benefits required to be paid and provided under the employment agreements would be reduced by an amount equal to the payments or benefits received from such other employment, and the executive officer would be required to promptly notify us or the Bank of his employment and receipts therefrom. This mitigation provision would not apply to Mr. Pearson if he terminated his employment for “good reason” following a change of control.

  

 
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The employment agreements require the officers to maintain the confidentiality of information obtained from us and the Bank during employment with us and the Bank and for so long thereafter as we, in our sole opinion, deem that it remains proprietary and confidential, and prohibit each officer from competing with us or the Bank or soliciting our customers for a period of twelve months after termination of employment by the officer for other than “good reason” or for the period during which payments are being made to him pursuant to the employment agreement, whichever is longer.

 

The foregoing description is a summary of the terms of the employment agreements with Messrs. Pearson, Scott and Seabrook, and is qualified in its entirety by reference to the actual text of these agreements, which are filed with the SEC. The foregoing summary does not create any legal or equitable rights in any person.

 

Split Dollar Life Insurance/Endorsement Split Dollar Agreements

 

We are currently party to a December 29, 2008 split dollar agreement relating to split dollar life insurance with Mr. Seabrook. We are the sole owner of this life insurance policy and are required to maintain the policy in full force and effect and pay any premiums due on the policies. The split dollar agreement provides that, if Mr. Seabrook’s death occurs before the earlier of the date of his termination of employment with us or the date that is six months after Mr. Seabrook attains age 70, Mr. Seabrook’s beneficiary will be entitled to the net death proceeds under the life insurance policy. Mr. Seabrook’s interest in the life insurance policy will be extinguished at the earlier of the date of his termination of employment or six months after the date on which he attains age 70, and we will be entitled to any remaining proceeds of the life insurance policy, provided a change in control has not occurred. In the event of a change in control prior to the termination of Mr. Seabrook’s employment, we are required to transfer to him ownership of the life insurance policy.

 

In 2008, we had also entered into a split dollar agreement with Mr. Pearson with the same terms as those set forth above for Mr. Seabrook. However, on August 11, 2014, we entered into a split dollar termination agreement with Mr. Pearson, which provided for: (i) termination of the split dollar agreement, and (ii) our transfer to Mr. Pearson of the rights to the related life insurance policy and the proceeds therefrom. In consideration of transfer of the life insurance policy to Mr. Pearson, Mr. Pearson paid us $271,385. The split dollar termination agreement further provides that, as long as the life insurance policy is in effect and outstanding, we will make an annual payment to Mr. Pearson of $120,000.00, which he will use to timely pay the annual premium for such life insurance policy. If the annual premium for the life insurance policy is reduced for any reason, the annual payment to Mr. Pearson will be reduced by the same amount. The annual payments to Mr. Pearson will terminate upon the earliest to happen of: (i) his separation from service with us, as defined in the split dollar agreement; (ii) a change in control; or (iii) Mr. Pearson’s death. We had also entered into a split dollar agreement with Mr. Scott, but his agreement has terminated as a result of his reaching age 70.

 

The foregoing description is a summary of the terms of the Endorsement Split Dollar Agreement with Mr. Seabrook and the Termination Agreement with Mr. Pearson, and is qualified in its entirety by reference to the actual text of these agreements, which are filed with the Securities and Exchange Commission. The foregoing summary does not create any legal or equitable rights in any person.

 

Salary Continuation Agreement

 

In 2008, the Bank entered into a salary continuation agreement with Mr. Pearson that provides payments in connection with retirement. This agreement was amended in March 2009 to change the normal retirement date from age 65 to age 70.5. Under the terms of the salary continuation agreement, Mr. Pearson will receive an annual retirement benefit of $287,730 beginning at age 70.5, if Mr. Pearson is still employed with the Bank at such time. The benefit will be paid in monthly installments for fifteen years beginning the month after Mr. Pearson attains age 70.5. If Mr. Pearson’s employment with the Bank terminates prior to his reaching age 70.5, other than as a result of a termination by the Bank for cause as defined in the salary continuation agreement, Mr. Pearson will receive the following applicable benefit amount under the salary continuation agreement, with monthly payments beginning on the later of the seventh month after his termination or the month after he attains age 70.5: $246,153 if the termination is in 2015; $262,393 if the termination is in 2016; and $278,671 if the termination is in 2017. If a change in control occurs while Mr. Pearson is employed by us, he will be entitled to the $287,730 annual retirement benefit at age 70.5 regardless of when termination occurs. The salary continuation agreement also provides a death benefit to Mr. Pearson’s beneficiary equal to the liability accrual balance existing at the time of his death in lieu of any unpaid benefits under the salary continuation agreement. The death benefit is payable in a lump sum. No benefits are payable under the salary continuation agreement if Mr. Pearson is terminated for cause, or if he makes any material misstatement of fact on any application or resume provided to us or the Bank or on any application for benefits provided by the Bank, or if he is removed from office or barred from affiliation with the Bank by the FDIC, or if the Bank is in default or in danger of default (as defined in the Federal Deposit Insurance Act).

  

 
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Our obligations under the salary continuation agreement are unfunded and unsecured.

 

The foregoing is a summary of the salary continuation agreement and is qualified in its entirety by reference to the actual text of the salary continuation agreement, which is filed with the SEC. The foregoing summary does not create any legal or equitable rights in any person.

 

2015 Grants of Plan-Based Awards

 

We did not grant any stock options or other equity-based awards in 2015, and we do not currently have any equity or non-equity incentive plans under which awards were granted in 2015.

 

Outstanding Equity Awards at 2015 Fiscal Year-End

 

None of our executive officers held any stock options at the end of 2015. We have not granted any other types of equity-based awards.

 

2015 Option Exercises and Stock Vested

 

No stock options were exercised by our executive officers during 2015. No stock or other equity-based awards vested in 2015.

 

Director Compensation

 

Set forth in the table below is information about compensation we paid to our outside directors for their service to the Company and the Bank in 2015. We pay our directors an annual retainer of $15,000 plus an additional $2,500 for each meeting of the Board of Directors attended. We do not pay additional fees for attendance at committee meetings. All of our directors are also directors of our Bank. The Bank pays its directors $625 for each monthly meeting of the Bank’s board of directors attended. Information about directors’ fees and other compensation paid to Messrs. Pearson and Scott is set forth in the Summary Compensation table.

 

2015 Director Compensation

 

Name

 

Fees Earned

Or Paid in Cash ($)

   

All other

Compensation ($)

   

Total ($)

 

Tommy B. Baker

  $ 33,750       -     $ 33,750  

William A. Coates

  $ 34,375       -     $ 34,375  

Stephen F. Hutchinson

  $ 34,375       -     $ 34,375  

James P. Smith

  $ 34,375       -     $ 34,375  

 

Director Endorsement Split Dollar Agreements

 

We are currently a party to Endorsement Split Dollar Agreements with Messrs. Coates, Hutchinson and Smith. We are the sole owner of these life insurance policies and are required to maintain the policies in full force and effect and pay any premiums due on the policies. The agreements provide that if the director’s death occurs (a) before the earlier of the date of his separation from service with us or the date on which the director attains age 70, or (b) after a change in control that occurs before the director’s separation from service with us, the director’s beneficiary will be entitled to the lesser of $250,000 or the total death proceeds under the policies. The director’s interest in the policies will be extinguished at the earlier of the date of his separation from service or the date on which he attains age 70, and we will be entitled to any remaining proceeds of the policies. In the event of a change in control prior to the director’s separation from service, the director’s beneficiary will be entitled to the director’s interest in the policy at his death. If they had died, or a change of control had occurred, on December 31, 2015, the benefits payable to each director’s beneficiary upon the director’s death would have been $250,000. We had also entered into a split dollar agreement with Mr. Baker, but the agreement terminated as a result of his attaining age 70.

  

 
100

 

 

The foregoing description is a summary of the terms of the endorsement split dollar agreements with our directors and is qualified in its entirety by reference to the actual text of the agreements, which are filed with the Securities and Exchange Commission. The foregoing summary does not create any legal or equitable rights in any person.

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

 

 

The following table shows information as of December 31, 2015, about persons known to us to be the beneficial owners of more than 5% of our common shares. This information was obtained from Schedules 13G filed with the Securities and Exchange Commission by the entities named below, and we have not independently verified it.

 

Title of Class

 

Name and Address of Beneficial

Owner

 

 

Number of Shares

 

   

Percent

 of

Class

 

No Par Value Common

Context BH Capital Management, LP

401 City Avenue, Suite 815

Bala Cynwyd, Pennsylvania 19004

    624,504 (1)     8.8  
                   
 

RMB Capital Holdings, LLC

RMB Capital Management, LLC

Iron Road Capital Partners, LLC

RMB Mendon Managers, LLC

115 LaSalle Street

34th Foor

Chicago, Illinois 60603

    500,474 (2)     7.05  

________________

 

(1)

In its most recently filed Schedule 13G, Context BH Capital Management, LP reported sole voting power and dispositive power with respect to all 624,504 shares.

(2)

In their most recently jointly filed Schedule 13G, RMB Capital Holdings, LLC and RMB Capital Management, LLC reported shared voting and dispositive power with respect to all 500,474 shares; Iron Road Capital Partners, LLC reported shared voting and dispositive power with respect to 48,191 shares; and RMB Mendon Managers, LLC reported shared voting and dispositive power with respect to 452,283 shares.

  

 
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SECURITY OWNERSHIP OF OUR MANAGEMENT

 

The table below shows at February 29, 2016, the number and percentage of shares of our common stock owned by each of our directors, director nominees and each of our executive officers.

 

Name

 

Amount and Nature

Of Beneficial Ownership

   

% of Class

 
                 

Tommy B. Baker

    164,838       2.32%  

William A. Coates

    134,483       1.90%  

Stephen F. Hutchinson

    33,913       *  

L. Wayne Pearson (1)

    307,219       4.32%  

Robert M. Scott

    135,933       1.92%  

James P. Smith (2)

    119,815       1.69%  

Robert A. Daniel, Jr.

    77,182       1.09%  

William C. Heslop

    20,472       *  

William B. Seabrook

    78,325       1.10%  

William R. Billings

    84,940       1.20%  
                 

All Directors and executive officers as a group (10 persons)

    1,157,120       16.29%  

 

*Less than one percent.                

 

Except as noted, to the knowledge of our management, all shares are owned directly with sole voting power.

 

(1)

Includes 51,803 shares owned by Mr. Pearson’s wife, as to which he disclaims beneficial ownership.

(2)

Of the total shares reported, 33,715 are pledged as collateral.

 

Equity Compensation Plan Information

 

As of December 31, 2015 the Company did not have any compensation plans (including individual compensation arrangements) under which equity securities of the Company were authorized for issuance. 

  

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

  

Certain Relationships and Related Transactions

 

Our Bank, in the ordinary course of its business, makes loans to and has other transactions with our directors, officers, principal shareholders, and their associates. Loans, if made, are made on substantially the same terms, including rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than the normal risk of collectability or present other unfavorable features. Our Bank expects to continue to enter into transactions in the ordinary course of business on similar terms with directors, officers, principal stockholders, and their associates. The aggregate dollar amount of such loans outstanding at December 31, 2015 was $1,506,063. None of such loans are classified as nonaccrual, past due, restructured or problem loans. During 2015, there were not any new loans and repayments totaled $80,148.

 

From time to time we may also enter into other types of business transactions or arrangements for services with our directors, officers, principal shareholders or their associates. These types of transactions or services might include, among others, purchases of insurance, purchases or leases of automobiles, and legal services. We only enter into such arrangements if we determine that the prices or rates offered are comparable to those available to us from unaffiliated third parties. Our Board approves such transactions on a case by case basis. We do not have formal policies or procedures with respect to such approvals.

 

 
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Director Independence

 

We are required by the Nasdaq Rules to have a majority of independent directors. Our Board of Directors has determined that none of Tommy B. Baker, William A. Coates, Stephen F. Hutchinson or James P. Smith has a relationship that, in the opinion of our Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and that each is independent under these rules. Additionally, all of the members of each of our Nominating, Audit, and Compensation Committees are also independent under the Nasdaq Rules.

 

As disclosed under “Certain Relationships and Related Transactions,” in Item 13 above, some of our independent directors and some of their affiliates have loan and deposit relationships with our Bank. These relationships are not considered by our Board to compromise their independence.

 

Item 14.

Principal Accountant Fees and Services.

 

Fees Paid to Independent Auditors

 

For the year ended December 31, 2015, Crowe Horvath LLP served as our independent registered public accounting firm, and the Audit Committee has appointed Crowe Horvath LLP to continue to serve as our independent registered public accounting firm for the year ended December 31, 2016. Set forth below is information about fees billed by Crowe Horvath LLP for audit services rendered in connection with the consolidated financial statements and reports for the years ended December 31, 2015 and 2014, and for other services rendered on our behalf during 2015 and 2014, as well as all out-of- pocket expenses incurred in connection with these services, which have been billed to us.

 

   

Year Ended

December 31, 2015

   

Year Ended

December 31, 2014

 

Audit Fees

  $ 133,000     $ 127,000  

Audit Related Fees

    12,108       12,471  

Tax Fees

    19,984       15,225  

All Other Fees

    19,845       7,325  

Total

  $ 184,937     $ 162,021  

 

Audit Fees. Audit fees include fees billed for professional services rendered for the audit of our consolidated financial statements and review of the interim condensed consolidated financial statements included in quarterly reports, and services that are normally provided by our independent auditor in connection with statutory and regulatory filings or engagements, and attest services, except those not required by statute or regulation.

 

Tax Fees. Tax fees include fees for tax compliance/ preparation and other tax services. Tax compliance/ preparation fees include fees billed for professional services related to federal and state tax compliance. Other tax services include fees billed for other miscellaneous tax consulting and planning.

 

All Other Fees. All other fees in 2015 and 2014 relate to accounting fees and financial reporting issues that are outside the scope of our regular audit fees.

 

In making its decision to appoint Crowe Horvath LLP, as our independent auditors for the fiscal year ending December 31, 2015, our Audit Committee considered whether services other than audit and audit-related services provided by that firm are compatible with maintaining the firm’s independence.

 

Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors

 

Our Audit Committee pre-approves all audit and permitted non-audit services (including the fees and terms thereof) provided by the independent auditors, subject to limited exceptions for non-audit services described in Section 10A of the Securities Exchange Act of 1934, which are approved by the Audit Committee prior to completion of the audit. The Committee may delegate to one or more designated members of the Committee the authority to pre-approve audit and permissible non-audit services, provided such pre-approval decision is presented to the full Committee at its next scheduled meeting.

 

General pre-approval of certain audit, audit-related and tax services is granted by the Audit Committee at the first quarter Committee meeting. The Committee subsequently reviews fees paid. Specific pre-approval is required for all other services. During 2015, all audit and permitted non-audit services were pre-approved by the Committee.

 

 
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PART IV

 

Item 15.

Exhibits and Financial Statement Schedules

 

(a)(1)

 -

Report of Independent Registered Public Accounting Firm

 

 -

Consolidated Balance Sheets

 

 -

Consolidated Statements of Operations

 

 -

Consolidated Statements of Shareholders’ Equity

 

 -

Consolidated Statements of Comprehensive Income (Loss)

 

 -

Consolidated Statements of Cash Flows

 

 -

Notes to Consolidated Financial Statements

(2)

 

Financial Statement Schedules – None

(3)

 

Exhibits – Please see Exhibit Index for a list of exhibits

 

 
104

 

 

SIGNATURE

 

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

 

 

   

Southcoast Financial Corporation

     
     

March 24, 2016

By:

/s/L. Wayne Pearson

   

L. Wayne Pearson

   

Chairman and Chief Executive Officer

     
     
 

By

/s/William C. Heslop

   

William C. Heslop

   

Senior Vice President and Chief Financial Officer

   

(Principal Financial and Principal

   

Accounting Officer)

 

 

Pursuant to the Requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

 

Signature

Title

Date

     

/s/Tommy B. Baker

   

Tommy B. Baker

Director

March 24, 2016

   

 

/s/William A. Coates

 

 

William A. Coates

Director

March 24, 2016

   

 

/s/Stephen F. Hutchinson

 

 

Stephen F. Hutchinson

Director

March 24, 2016

   

 

/s/L. Wayne Pearson

 

 

L. Wayne Pearson

Chairman, Chief Executive

Officer, Director

March 24, 2016

   

 

/s/Robert M. Scott

 

 

Robert M. Scott

Director

March 24, 2016

   

 

/s/James P. Smith

 

 

James P. Smith

Director

March 24, 2016

 

 
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EXHIBIT INDEX

 

Exhibit No.

Description

3.1

Articles of Incorporation of Registrant (incorporated by reference to exhibits to Form 10-SB filed April 30, 1999)

3.2

Bylaws of Registrant, as amended September 13, 2007 (incorporated by reference to exhibit to Form 8-K filed September 14, 2007)

4.1

Form of Common Stock Certificate (incorporated by reference to exhibits to Form 10-KSB for the year ended December 31, 2000)

10.1

Form of Amended and Restated Employment Agreements, dated as of December 29, 2008, between the Company and each of Robert A. Daniel, Jr., William C. Heslop and William B. Seabrook (incorporated by reference to exhibits to Form 8-K, filed January 5, 2009)

10.2

Form of Endorsement Split Dollar Agreement, dated as of December 29, 2008, between Southcoast Community Bank and each of Robert A. Daniel, Jr., William B. Seabrook, and William C. Heslop (incorporated by reference to exhibits to Form 8-K, filed January 5, 2009)

10.3

Junior Subordinated Indenture between Registrant and Wilmington Trust Company dated as of August 5, 2005 (incorporated by reference to exhibits to Form S-1 (Registration Statement No. 333-128247), filed August 12, 2005)

10.4

Guarantee Agreement between Registrant and Wilmington Trust Company, dated as of August 5, 2005 (incorporated by reference to exhibits to Form S-1 (Registration Statement No. 333-128247), filed August 12, 2005)

10.5

Placement Agreement among Registrant, Southcoast Capital Trust III and Credit Suisse First Boston LLC dated as of August 5, 2005 (incorporated by reference to exhibits to Form S-1 (Registration Statement No. 333-128247), filed August 12, 2005)

10.6

Form of Endorsement Split Dollar Agreements between the Company and each of William A. Coates, Stephen F. Hutchinson and James P. Smith, dated December 13, 2007 (incorporated by reference to exhibit to Form 8-K filed December 19, 2007)

10.7

Form of Letter Agreement, dated November 3, 2015, amending Endorsement Split Dollar Agreements, dated December 13, 2007, between the Company and each of William A. Coates, Stephen F. Hutchinson and James P. Smith (incorporated by reference to exhibit to Form 8-K filed November 5, 2015)

10.8

Amended and Restated Employment Agreement, dated as of August 14, 2008, among Southcoast Financial Corporation, Southcoast Community Bank and L. Wayne Pearson (incorporated by reference to exhibits to Form 8-K filed August 20, 2008)

10.9

Amendment, dated August 14, 2015, to Amended and Restated Employment Agreement, dated as of August 14, 2008, among Southcoast Financial Corporation, Southcoast Community Bank and L. Wayne Pearson (incorporated by reference to exhibit to Form 8-K filed November 5, 2015)

10.10

Amended Salary Continuation Agreement between Southcoast Community Bank and L. Wayne Pearson (incorporated by reference to exhibits to Form 8-K filed April 3, 2009)

10.11

Split Dollar Termination Agreement, dated as of August 11, 2014, between Southcoast Financial Corporation and L. Wayne Pearson (incorporated by reference to Form 8-K filed August 14, 2014)

10.12

Employment Agreement, dated as of February 9, 2015, between Southcoast Financial Corporation and Robert M. Scott (incorporated by reference to exhibits to Form 10-K for the year ended December 31, 2014)

10.13

Amendment, dated November 3, 2015, to Amended and Restated Employment Agreement, dated as of December 29, 2008, between the Company and William B. Seabrook (incorporated by reference to exhibit to Form 8-K filed November 5, 2015)

21

Subsidiaries of Registrant (incorporated by reference to exhibits to Form 10-K for the year ended December 31, 2007)

23

Consent of Crowe Horwath LLC

31.1

13a-14(a)/15d-14(a) Certifications of Chief Executive Officer

31.2

13a-14(a)/15d-14(a) Certifications of Chief Financial Officer

32

Section 1350 Certifications

101

The following materials from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2015, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at December 31, 2015 and 2014, (ii) Consolidated Statements of Income for the years ended December 31, 2015 and 2014, (iii) Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2015 and 2014, (iv) Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2015 and 2014, (v) Consolidated Statements of Cash Flows for the years ended December 31, 2015 and 2014, and (vi) Notes to Consolidated Financial Statements.

 

 

105