UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(MARK ONE)

 

x

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

For the Quarterly Period ended March 31, 2016

 

OR

 

o

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

 

For the Transition Period from _________to_________

 

Commission File No. 001-33065

 

TIDELANDS BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

South Carolina	02-0570232
(State or other jurisdiction	(I.R.S. Employer
of incorporation)	Identification No.)

875 Lowcountry Blvd.

Mount Pleasant, South Carolina 29464

(Address of principal executive offices)

 

(843) 388-8433

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

 

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

 

	Large accelerated filer o	Accelerated filer o
	Non-accelerated o (do not check if smaller reporting company)	Smaller reporting company x

 

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

Yes o No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 4,277,176 shares of common stock, $.01 par value per share, were issued and outstanding as of May 11, 2016.

Index

 

		Page No.
Cautionary Note Regarding Forward-Looking Statements		3
PART I - FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets –
	March 31, 2016 (Unaudited) and December 31, 2015 (Audited)	5
	Consolidated Statements of Operations and Comprehensive Income –
	Three months ended March 31, 2016 and 2015 (Unaudited)	6
	Consolidated Statements of Changes in Shareholders’ Equity –
	Three months ended March 31, 2016 and 2015 (Unaudited)	7
	Consolidated Statements of Cash Flows –
	Three months ended March 31, 2016 and 2015 (Unaudited)	8
	Notes to Consolidated Financial Statements	9-34
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	35-55
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	55
Item 4.	Controls and Procedures	55
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	56
Item 3.	Defaults Upon Senior Securities	56
Item 6.	Exhibits	56

 

This statement has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation.

Cautionary Note Regarding Forward-Looking Statements

 

This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of the words “may,” “should,” “predict,” “project,” “potential,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions. These forward-looking statements include statements the completion of our merger with United Community Banks, Inc., including the timing thereof and the ability to consummate the merger, what will happen if we are unable to complete the merger or continue as a going concern, our ability to develop strategies to eliminate uncertainty related to liquidity, capital and profitability, our expectation regarding economic growth in our markets, our belief that the diversity of economic activity in our markets will mitigate economic volatility and reduce our risk of loss, the effectiveness of our credit administration and risk management programs, our expectations related to our loan portfolio, including expectations related to our nonperforming assets, our expectation that a significant portion of unfunded commitments related to consumer equity lines of credit will not be funded, our belief that the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, as well as statements related to the anticipated effects on results of operations and financial condition from expected developments or events. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those projected in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. Potential risks and uncertainties include, but are not limited to those described below and those described under Item 1A - “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015:

 

●

the risk that our shareholders do not approve the merger;

●

the occurrence of any event, change or other circumstances that could give rise to the termination of the merger agreement;

●

the failure to satisfy each of the conditions to the consummation of the merger, including but not limited to, the risk that a governmental entity may prohibit, delay or refuse to grant approval for the consummation of the merger on acceptable terms, or at all;

●

the outcome of any potential legal proceedings related to the merger;

●

diversion of management time on merger-related issues;

●

the reaction of the companies’ customers to the merger transaction;

●

our ability to pay the interest in arrears on the outstanding junior subordinated debentures, which failure to pay could result in the holders of the junior subordinated debentures pursuing certain legal rights against the Company, including, but not limited to, forcing the Company into bankruptcy;

●

our efforts to raise capital or find a merger partner may not be successful;

●

our ability to achieve compliance with our Consent Order and potential regulatory actions if we fail to achieve compliance;

●

general economic conditions (both generally and in our markets) may be less favorable than expected, resulting in, among other things, a continued deterioration in credit quality, a further reduction in demand for credit and/or a further decline in real estate values;

●

a general decline in the real estate and lending market, particularly in our market areas, could negatively affect our financial results;

●

the results of our most recent external, independent review of our credit risk assets may not accurately predict the adverse effects on our financial condition if the economy were to deteriorate;

●

our ability to maintain appropriate levels of capital, including the potential that the regulatory agencies may require higher levels of capital above the standard regulatory-mandated minimums;

●

our ability to complete the sale of our Other Real Estate Owned properties, specifically at values equal to or above the currently recorded loan balances which could result in additional write downs;

●

the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

●

increased funding costs due to market illiquidity, increased competition for funding, and /or increased regulatory requirements with regard to funding;

●

changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board;

●

legislative or regulatory changes, including changes in accounting standards and compliance requirements, may adversely affect the businesses in which we are engaged;

 

See accompanying notes to the consolidated financial statements.

●

competitive pressures among depository and other financial institutions may increase significantly;

●

changes in the interest rate environment may reduce margins or the volumes or values of the loans we make;

●

competitors may have greater financial resources and develop products that enable those competitors to compete more successfully than we can;

●

our ability to attract and retain key personnel can be affected by the increased competition for experienced employees in the banking industry;

●

adverse changes may occur in the bond and equity markets;

●

war or terrorist activities may cause further deterioration in the economy or cause instability in credit markets;

●

economic, governmental or other factors may prevent the projected population, residential and commercial growth in the markets in which we operate; and

●

we will or may continue to face the risk factors discussed from time to time in the periodic reports we file with the SEC.

 

We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements whether as a result of new information, future events, or otherwise.

 

See accompanying notes to the consolidated financial statements.

Item 1. Financial Statements

 

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Balance Sheets

 

		March 31,				December 31,
		2016				2015
		(Unaudited)				(Audited)
Assets:
Cash and cash equivalents:
Cash and due from banks		$	4,605,838			$	5,733,049
Interest bearing balances			11,437,009				8,155,490
Total cash and cash equivalents			16,042,847				13,888,539
Securities available-for-sale			69,401,649				72,854,275
Securities held-to-maturity			5,245,348				5,254,558
Nonmarketable equity securities			1,077,350				895,950
Total securities			75,724,347				79,004,783
Mortgage loans held for sale			255,000				704,250
Loans receivable			325,044,893				324,211,251
Less allowance for loan losses			3,834,565				4,045,227
Loans, net			321,210,328				320,166,024
Premises, furniture and equipment, net			19,466,431				19,734,679
Accrued interest receivable			1,159,968				1,145,963
Bank owned life insurance (BOLI)			16,812,868				16,709,143
Other real estate owned			11,886,940				12,752,533
Other assets			1,655,802				2,128,829
Total assets		$	464,214,531			$	466,234,743
Liabilities:
Deposits:
Noninterest-bearing transaction accounts		$	33,432,408			$	34,104,265
Interest-bearing transaction accounts			36,697,429				37,022,130
Savings and money market accounts			103,467,525				105,963,416
Time deposits $100,000 and over			153,817,020				154,672,973
Other time deposits			85,877,822				88,747,198
Total deposits			413,292,204				420,509,982
Securities sold under agreements to repurchase			10,000,000				10,000,000
Advances from Federal Home Loan Bank			14,000,000				9,000,000
Junior subordinated debentures			14,434,000				14,434,000
Accrued interest payable			3,686,368				3,565,369
Other liabilities			7,265,173				6,778,562
Total liabilities			462,677,745				464,287,913
Commitments and contingencies-Note 6,14, and 19
Shareholders’ equity:
Preferred stock, $.01 par value and liquidation value per share of $1,000, 10,000,000 shares authorized, 14,448 issued and outstanding			14,448,000				14,448,000
Common stock, $.01 par value, 75,000,000 shares authorized; 4,277,176 shares issued and outstanding			42,772				42,772
Common stock-warrant, 571,821 shares outstanding			1,112,248				1,112,248
Capital surplus			41,550,104				41,550,104
Retained deficit			(55,070,448	)			(54,201,346	)
Accumulated other comprehensive loss			(545,890	)			(1,004,948	)
Total shareholders’ equity			1,536,786				1,946,830
Total liabilities and shareholders’ equity		$	464,214,531			$	466,234,743

 

See accompanying notes to the consolidated financial statements.

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Statements of Operations and Comprehensive Income

For the three months ended March 31, 2016 and 2015

(Unaudited)

 

		2016				2015
Interest income:
Loans, including fees		$	3,878,635			$	3,823,679
Securities available-for-sale, taxable			344,678				355,977
Interest bearing deposits			11,393				9,522
Other interest income			9,782				8,997
Total interest income			4,244,488				4,198,175
Interest expense:
Time deposits $100,000 and over			509,387				544,693
Other deposits			367,842				406,831
Other borrowings			335,692				289,509
Total interest expense			1,212,921				1,241,033
Net interest income			3,031,567				2,957,142
Provision for loan losses			—				—
Net interest income after provision for loan losses			3,031,567				2,957,142
Noninterest income:
Service charges on deposit accounts			10,132				9,503
Residential mortgage origination income			37,970				48,200
Gain on sale of securities available-for-sale			—				6,053
Loss on sale and disposal of other assets			(2,234	)			(1,701	)
Other service fees and commissions			157,241				143,771
Increase in cash surrender value of BOLI			103,724				105,191
Other			2,603				4,586
Total noninterest income			309,436				315,603
Noninterest expense:
Salaries and employee benefits			1,689,076				1,636,353
Net occupancy			411,269				448,652
Furniture and equipment			164,019				177,084
Other real estate owned expense, net			340,978				128,924
Other operating			1,155,369				1,197,644
Total noninterest expense			3,760,711				3,588,677
Loss before income taxes			(419,708	)			(315,932	)
Income tax expense			—				—
Net loss		$	(419,708	)		$	(315,932	)
Preferred dividends accrued			449,394				413,532
Net loss available to common shareholders		$	(869,102	)		$	(729,464	)
Comprehensive Income:
Net loss		$	(419,708	)		$	(315,932	)
Unrealized gain on securities available for sale			740,415				887,595
Reclassification adjustment for realized gain on securities			—				(6,053	)
Tax effect			(281,357	)			(334,986	)
Comprehensive income		$	39,350			$	230,624
Basic loss per common share		$	(.20	)		$	(.17	)
Diluted loss per common share		$	(.20	)		$	(.17	)
Weighted average common shares outstanding
Basic			4,277,176				4,220,991
Diluted			4,277,176				4,220,991

 

See accompanying notes to the consolidated financial statements.

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

For the three months ended March 31, 2016 and 2015

(Unaudited)

 

		Preferred Stock								Common Stock				Common Stock								Capital				Retained Earnings				Accumulated other Comprehensive
		Shares				Amount				Warrants				Shares				Amount				Surplus				(deficit)				income				Total
Balance, December 31, 2014			14,448			$	14,448,000			$	1,112,248				4,277,176			$	42,772			$	41,550,104			$	(50,680,789	)		$	(1,131,646	)		$	5,340,689
Preferred stock, dividend accrued																											(413,532	)							(413,532	)
Net loss																											(315,932	)							(315,932	)
Other comprehensive income																															546,556				546,556
Balance, March 31, 2015			14,448			$	14,448,000			$	1,112,248				4,277,176			$	42,772			$	41,550,104			$	(51,410,253	)		$	(585,090	)		$	5,157,781
Balance, December 31, 2015			14,448			$	14,448,000			$	1,112,248				4,277,176			$	42,772			$	41,550,104			$	(54,201,346	)		$	(1,004,948	)		$	1,946,830
Preferred stock, dividend accrued																											(449,394	)							(449,394	)
Net loss																											(419,708	)							(419,708	)
Other comprehensive income																															459,058				459,058
Balance, March 31, 2016			14,448			$	14,448,000			$	1,112,248				4,277,176			$	42,772			$	41,550,104			$	(55,070,448	)		$	(545,890	)		$	1,536,786

 

See accompanying notes to the consolidated financial statements.

Tidelands Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows

For the three months ended March 31, 2016 and 2015

 

		2016				2015
Cash flows from operating activities:
Net loss		$	(419,708	)		$	(315,932	)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
Provision for loan losses			—				—
Depreciation and amortization of premises, furniture and equipment			296,103				306,224
Discount accretion and premium amortization, net			67,500				90,044
Proceeds from sale of residential mortgages held-for-sale			2,142,980				2,869,690
Disbursements for residential mortgages held-for-sale			(1,693,730	)			(3,286,690	)
Increase in accrued interest receivable			(14,005	)			(11,946	)
Increase in accrued interest payable			120,999				139,046
Increase in cash surrender value of life insurance			(103,724	)			(105,191	)
Loss from sale and disposal of other assets			2,234				1,701
Gain from sale of real estate and other assets			(152,591	)			(15,709	)
Gain from sale of securities available-for-sale			—				(6,053	)
Decrease in carrying value of other real estate			384,471				—
Decrease in other assets			191,669				37,872
Decrease in other liabilities			37,217				(453,596	)
Net cash provided (used) by operating activities			859,415				(750,540	)
Cash flows from investing activities:
Purchases of securities available-for-sale			—				(6,006,885	)
Proceeds from sales of securities available-for-sale			—				7,227,111
Proceeds from calls, maturities, and paydowns of securities available-for-sale			4,134,751				2,439,744
Proceeds from payments of non-marketable equity securities			—				9,100
Purchase of non-marketable equity securities			(181,400	)			—
Net increase in loans receivable			(1,125,711	)			(2,876,483	)
Proceeds from sale of other real estate owned			715,119				619,606
Purchase of premises, furniture and equipment, net			(30,089	)			(66,056	)
Net cash provided by investing activities			3,512,670				1,346,137
Cash flows from financing activities:
Net increase (decrease) in demand deposits, interest-bearing transaction accounts and savings accounts			(3,492,449	)			1,438,017
Net decrease in certificates of deposit and other time deposits			(3,725,328	)			(277,449	)
Increase in FHLB advances			5,000,000				—
Net cash (used) provided by financing activities			(2,217,777	)			1,160,568
Net increase in cash and cash equivalents			2,154,308				1,756,165
Cash and cash equivalents, beginning of period			13,888,539				21,285,269
Cash and cash equivalents, end of period		$	16,042,847			$	23,041,434
Supplemental cash flow information:
Interest paid on deposits and borrowed funds		$	1,091,922			$	1,101,988
Transfer of loans to foreclosed assets		$	81,407			$	303,550
Preferred stock-dividends accrued		$	449,394			$	413,532
Change in unrealized loss on securities available-for-sale		$	704,415			$	881,542

 

See accompanying notes to the consolidated financial statements.

NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying consolidated financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they are condensed and omit disclosures, which would substantially duplicate those contained in the most recent annual report on Form 10-K. The financial statements, as of March 31, 2016 and for the interim periods ended March 31, 2016 and 2015, are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation. Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The financial information as of December 31, 2015 has been derived from the audited financial statements as of that date. For further information, refer to the financial statements and the notes included in the Company’s 2015 Annual Report on Form 10-K.

 

In preparing these financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users, or filed with the Securities and Exchange Commission. In conjunction with applicable accounting standards, all material subsequent events have been either recognized in the financial statements or disclosed in the notes to the financial statements.

 

As discussed in note 22, Subsequent Events, on April 4, 2016, Tidelands Bancshares, Inc. (the “Company”) entered into an Agreement and Plan of Merger (the “merger agreement”) with United Community Banks, Inc. (“United”). Under the merger agreement, the Company will merge with and into United and Tidelands Bank (the “Bank”) will merge with and into United’s wholly-owned subsidiary bank, United Community Bank. In connection with the merger, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing the Company into involuntary bankruptcy. The merger agreement provides that, at the effective time of the merger, United will assume all of the Company’s obligations relating to its outstanding trust preferred securities. The assumption is conditioned on United’s payment of all amounts required to bring current the payment of interest (including deferred interest) on the trust preferred securities.

 

Organization - Tidelands Bancshares, Inc. was incorporated on January 31, 2002 to serve as a bank holding company for its subsidiary, Tidelands Bank. The Company operated as a development stage company from January 31, 2002 to October 5, 2003. Tidelands Bank commenced business on October 6, 2003. The principal business activity of the Bank is to provide banking services to domestic markets, principally in Charleston, Dorchester, Berkeley, Horry, Georgetown, Beaufort and Jasper counties in South Carolina. The Bank is a state-chartered commercial bank, and its deposits are insured by the Federal Deposit Insurance Corporation. The consolidated financial statements include the accounts of the parent company and its wholly-owned subsidiary after elimination of all significant intercompany balances and transactions. The Company formed Tidelands Statutory Trust I and Tidelands Statutory Trust II on February 22, 2006 and June 20, 2008, respectively, for the purpose of issuing trust preferred securities. In accordance with current accounting guidance, the Trusts are not consolidated in these financial statements. As further discussed in Note 18, on December 19, 2008, as part of the Capital Purchase Program established by the U.S. Department of the Treasury under the Emergency Economic Stabilization Act of 2008, the Company issued 14,448 preferred shares and a common stock warrant to purchase 571,821 shares in return for $14.4 million in cash, to the U.S. Department of Treasury.

 

Management’s 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 at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans, including valuation allowances for impaired loans, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.

 

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for losses on loans and valuation of foreclosed real estate. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for losses on loans and valuation of foreclosed real estate may change materially in the near term.

Consent Order – The Bank is under a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”). See note 2.

 

Trust Preferred Securities – The Company has issued trust preferred securities. See note 11.

 

Concentrations of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks.

 

The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily in the Charleston metropolitan area (which includes Charleston, Dorchester, and Berkeley counties), Horry, Georgetown, Jasper and Beaufort counties, and additional markets along the South Carolina coast. The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions.

 

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. 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 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.

 

The Company’s investment portfolio consists principally of obligations of the United States and its agencies or its corporations. In the opinion of management, there is no concentration of credit risk in its investment portfolio. The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant.

 

Securities Available-for-Sale - Securities available-for-sale are carried at amortized cost and adjusted to estimated market value by recognizing the aggregate unrealized gains or losses in a valuation account. Aggregate market valuation adjustments are recorded in shareholders’ equity net of deferred income taxes. Reductions in market value considered by management to be other than temporary are reported as a realized loss and a reduction in the cost basis of the security. The adjusted cost basis of investments available-for-sale is determined by specific identification and is used in computing the gain or loss upon sale.

 

Nonmarketable Equity Securities - Nonmarketable equity securities include the cost of the Company’s investment in the stock of the Federal Home Loan Bank and stock in community bank holding companies. The Federal Home Loan Bank stock has no quoted market value and no ready market exists. Investment in the Federal Home Loan Bank is a condition of borrowing from the Federal Home Loan Bank, and the stock is pledged to collateralize such borrowings. Dividends received on this stock are included as interest income.

 

Loans Held for Sale – Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

 

Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

 

Loans held for sale, for which the fair value option has been elected, are recorded at fair value as of each balance sheet date. The fair value includes the servicing value of the loans as well as any accrued interest.

 

Loans Receivable - Loans are stated at their unpaid principal balance. Interest income on loans is computed based upon the unpaid principal balance. Interest income is recorded in the period earned.

 

The accrual of interest income is generally discontinued when a loan becomes contractually 90 days past due as to principal or interest. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral exceeds the principal balance and accrued interest. A payment of interest on a loan that is classified as nonaccrual is applied against the principal balance. Nonaccrual loans may be restored to performing status when all principal and interest has been kept current for six months and full repayment of the remaining contractual principal and interest is expected.

Loan origination and commitment fees are deferred and amortized to income over the contractual life of the related loans or commitments, adjusted for prepayments, using the straight-line method, which approximates the interest method.

 

Loans are defined as impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans are subject to these criteria except for smaller balance homogeneous loans that are collectively evaluated for impairment and loans measured at fair value or at the lower of cost or fair value. The Company considers its consumer installment portfolio, credit card loans, and home equity lines as such exceptions.

 

Impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral, less estimated costs to sell, if the loan is collateral dependent. When management determines that a loan is impaired, the difference between the Company’s investment in the related loan and the present value of the expected future cash flows, or the fair value of the collateral, less estimated costs to sell, is generally charged off with a corresponding entry to the allowance for loan losses. The accrual of interest is discontinued on an impaired loan when management determines the borrower may be unable to meet payments as they become due.

 

Troubled Debt Restructurings (“TDRs”) – The Company designates loan modifications as TDRs when, for economic or legal reasons related to the borrower’s financial difficulties, it grants a concession to the borrower that it would not otherwise consider. Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of modification are initially classified as accruing TDRs at the date of modification, if the note is reasonably assured of repayment and performance is in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the modification date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is well documented credit evaluation of the borrower’s financial condition,, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated repayment performance in accordance with the modified terms for a reasonable period of time (a minimum of six months).

 

Allowance for Loan Losses - An allowance for loan losses is maintained at a level deemed appropriate by management to provide adequately for known and inherent losses in the loan portfolio. The Company’s judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which the Company believes to be reasonable, but which may or may not prove to be accurate. The Company’s determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of the Company’s overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, the Company’s historical loan loss experience, and a review of specific problem loans. The Company also considers subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons. Loans which are deemed to be uncollectible are charged off and deducted from the allowance. During the second quarter of 2015, the Company began using 12 quarters to measure historical losses rather than a 6 quarter period as used previously. The Company believes that the longer period used to determine historical losses captures a longer economic cycle, including periods of economic uncertainty that are unlike those the Company has experienced in the past three years. The Company also believes that using 12 quarters to measure historical losses is more indicative of the expected losses and risks inherent in the portfolio. The provision for loan losses and recoveries of loans previously charged off are added to the allowance. Our analysis in accordance with generally accepted accounting principles (“GAAP”) indicates that the level of the allowance for loan losses is appropriate to cover estimated credit losses on individually evaluated loans as well as estimated credit losses inherent in the remainder of the portfolio.

 

Premises, Furniture and Equipment - Premises, furniture and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed by the straight-line method, based on the estimated useful lives for furniture and equipment of five to 10 years and buildings of 40 years. Leasehold improvements are amortized over the life of the leases, which range up to 40 years. The cost of assets sold or otherwise disposed of and the related allowance for depreciation are eliminated from the accounts and the resulting gains or losses are reflected in the income statement when incurred. Maintenance and repairs are charged to current expense. The costs of major renewals and improvements are capitalized.

 

Other Real Estate Owned - Other real estate is acquired through, or in lieu of, foreclosure and is held for sale. It is initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations are included within noninterest expense as part of other operating expense.

Securities Sold Under Agreements to Repurchase - The Bank enters into sales of securities under agreements to repurchase. Fixed-coupon repurchase agreements are treated as financing, with the obligation to repurchase securities sold being reflected as a liability and the securities underlying the agreements remaining as assets.

 

Income Taxes - Income taxes are the sum of amounts currently payable to taxing authorities and the net changes in income taxes payable or refundable in future years. Income taxes deferred to future years are determined utilizing a liability approach. This method gives consideration to the future tax consequences associated with differences between financial accounting and tax bases of certain assets and liabilities which are principally the allowance for loan losses, depreciable premises and equipment, and the net operating loss carry forward. Deferred tax assets are reduced by a valuation allowance, if based on the weight of evidence available; it is more likely than not that some portion or all of a deferred tax asset will not be realized. The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded.

 

Retirement Plan - The Company has a 401(k) profit sharing plan, which provides retirement benefits to substantially all officers and employees who meet certain age and service requirements. The plan includes a “salary reduction” feature pursuant to Section 401(k) of the Internal Revenue Code. Additionally, the Company maintains supplemental retirement plans for certain highly compensated employees designed to offset the impact of regulatory limits on benefits under qualified pension plans. There are supplemental retirement plans in place for certain current employees. Effective June 30, 2010, the executive officers agreed to cease further benefit accrual under the contracts and will only be entitled to receive benefits accrued through June 30, 2010.

 

Bank Owned Life Insurance - Bank owned life insurance (“BOLI”) represents life insurance on the lives of certain current and former employees who have provided positive consent allowing the Bank to be the beneficiary of such policies. The Bank purchases BOLI in order to use its earnings to help offset the costs of the Bank’s benefit expenses including pre- and post-retirement employee benefits. Increases in the cash surrender value (“CSV”) of the policies, as well as death benefits received net of any CSV, are recorded in other non-interest income, and are not subject to income taxes. The CSV of the policies are recorded as assets of the Bank. Any amounts owed to employees from policy benefits are recorded as liabilities of the Bank. The Company reviews the financial strength of the insurance carriers prior to the purchase of BOLI and annually thereafter. The Bank is currently not in compliance with Company policy that BOLI with any individual carrier is limited to 15% of tier one capital and BOLI in total is limited to 25% of tier one capital.

 

Employee Stock Ownership Plan - The Company established the Tidelands Bancshares, Inc. Employee Stock Ownership Plan (“ESOP”) for the exclusive benefit of all eligible employees and their beneficiaries subject to authority to amend, from time to time, or terminate, the ESOP. The ESOP is primarily designed to invest in common stock of the Company and is permitted to purchase Company common stock with contributions to the ESOP made by the Company. Also, the ESOP is permitted to borrow money and use the loan proceeds to purchase Company common stock. The money and Company common stock in the ESOP is intended to grow tax free until retirement, death, permanent disability or other severance of employment with the Company. When an employee retires, he/she will receive the value of the accounts that have been set up for the contributions to the ESOP. An employee may also be eligible for benefits in the event of death, permanent disability or other severance from employment with the Company. The employee must pay taxes when the money is paid following one of these events or any other distributable event described in the ESOP.

 

Earnings (Loss) Per Common Share - Basic earnings (loss) per common share represent income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Dilutive earnings (loss) per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options and warrants and are determined using the treasury stock method. Weighted average shares outstanding are reduced for shares encumbered by the ESOP borrowings.

 

Comprehensive Income (Loss) - Accounting principles generally require that recognized income, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income (loss) are components of comprehensive income (loss).

 

Statements of Cash Flows - For purposes of reporting cash flows in the consolidated financial statements, the Company considers certain highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.

Changes in the valuation account of securities available-for-sale, including the deferred tax effects, are considered noncash transactions for purposes of the statement of cash flows and are presented in detail in the notes to the consolidated financial statements.

 

Off-Balance Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. These financial instruments are recorded in the financial statements when they become payable by the customer.

 

Recently Issued Accounting Pronouncements - The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by the Company.

 

In January 2014, the FASB amended the Receivables topic of the Accounting Standards Codification. The amendments are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to other real estate owned (“OREO”). In addition, the amendments require a creditor to reclassify a collateralized consumer mortgage loan to OREO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The amendments will be effective for the Company for annual periods, and interim periods within those annual periods beginning after December 15, 2014, with early implementation of the guidance permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company will apply the amendments using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

 

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

 

In June 2014, the FASB issued guidance which makes limited amendments to the guidance on accounting for certain repurchase agreements. The new guidance (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. The amendments will be effective for the Company for the first interim or annual period beginning after December 15, 2014. The Company will apply the guidance by making a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

 

In August 2014, the FASB issued guidance that is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. In connection with preparing financial statements, management will need to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the organization’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will be effective for the Company for annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

 

In January 2015, the FASB issued guidance that eliminated the concept of extraordinary items from U.S. GAAP. Existing U.S. GAAP required that an entity separately classify, present, and disclose extraordinary events and transactions. The amendments will eliminate the requirements for reporting entities to consider whether an underlying event or transaction is extraordinary, however, the presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and will be expanded to include items that are both unusual in nature and infrequently occurring. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The amendments may be applied either prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. As a result of the deferral, the guidance in ASU 2014-09 will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2015, the FASB issued amendments to the Interest topic of the ASC to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements. 

 

In February 2016, the FASB issued new guidance to change accounting for leases that will generally require most leases to be recognized on the balance sheet. The new lease standard only contains targeted changes to accounting by lessors, however, lessees will be required to recognize most leases in their balance sheets as lease liabilities for lease payments and right-of-use assets representing the lessee’s rights to use the underlying assets for the lease terms for lease arrangements longer than 12 months. Under this approach, a lessee will account for most existing capital/finance leases as Type A leases and most existing operating leases as Type B leases. Type A and Type B leases have unique accounting and disclosure requirements. Existing sale-leaseback guidance, including guidance for real estate, will be replaced with a new model applicable to both lessees and lessors. The new guidance will be effective for fiscal years beginning after December 15, 2018. Early adoption is permitted for all companies and organizations. Management is currently analyzing the impact of the adoption of this guidance on the Company’s consolidated financial statements, including assessing changes that might be necessary to information technology systems, processes and internal controls to capture new data and address changes in financial reporting.

 

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements. 

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Risks and Uncertainties - In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets. Credit risk is the risk of default on the loan portfolio that results from borrower’s inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

 

The Company is subject to the regulations of various governmental agencies. These regulations can and do change significantly from period to period. Periodic examinations by the regulatory agencies may subject the Company to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.

 

Reclassifications - Certain captions and amounts in the 2015 financial statements were reclassified to conform to the 2016 presentation. These reclassifications had no effect on shareholders’ equity or results of operations as previously presented.

 

NOTE 2 – OTHER CONSIDERATIONS AND REGULATORY MATTERS

 

Other Considerations

 

The effects of the current economic environment are being felt across many industries, with financial services and residential real estate being particularly hard hit. The Bank, with a loan portfolio consisting of a concentration in commercial real estate loans, has seen a decline in the value of the collateral securing its portfolio as well as rapid deterioration in its borrowers’ cash flows and ability to repay their outstanding loans to the Bank. As a result, the Bank’s level of nonperforming assets increased substantially during 2010 and 2011. However, since 2012, the Bank’s nonperforming assets have begun to stabilize. The Bank’s nonperforming assets at March 31, 2016 were $19.2 million, $20.5 million at December 31, 2015 and $24.4 million at December 31, 2014. As a percentage of total assets, nonperforming assets were 4.13% as of March 31, 2016, 4.39% as of December 31, 2015 and 5.12% as of December 31, 2014. As a percentage of total loans, nonperforming loans were 2.24% as of March 31, 2016, 2.38% as of December 31, 2015 and 2.15% as of December 31, 2014.

 

The Company and the Bank operate in a highly regulated industry and must plan for the liquidity needs of each entity separately. A variety of sources of liquidity have historically been available to the Bank to meet its short-term and long-term funding needs. Although a number of these sources have been limited following execution of the Consent Order, management has prepared forecasts of these sources of funds and the Bank’s projected uses of funds during 2016 in an effort to ensure that the sources available are sufficient to meet the Bank’s projected liquidity needs for this period.

Prior to the recent economic downturn, the Company, if needed, would have relied on dividends from the Bank as its primary source of liquidity. Currently, however, the Company has no available sources of liquidity. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company to meet its obligations, including paying dividends. In addition, the terms of the Consent Order described below further limits the Bank’s ability to pay dividends to the Company to satisfy its funding needs. Management believes the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, but if the Bank is unable to meet its liquidity needs, then the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed conservator or receiver. As discussed in Note 22, Subsequent Events, on April 4, 2016, the Company entered into a merger agreement with United. Under the merger agreement, the Bank will merge with and into United’s wholly-owned subsidiary bank, United Community Bank.

 

As permitted by the indentures, the Company began deferring interest payments on its trust preferred securities in December 2010 and was allowed to defer such payments for up to 20 consecutive quarterly periods, although interest continued to accrue and compounded quarterly. All of the deferred interest, including interest accrued on such deferred interest, became due and payable on December 30, 2015. The Company failed to pay the deferred and compounded interest at the end of the deferral period, and on March 8, 2016, the Company received notices of default from Wilmington Trust Company, in its capacity as Trustee, relating to the trust preferred securities declaring the entire principal and unpaid interest amounts of the trust preferred securities immediately due and payable. The aggregate principal amount of these trust preferred securities plus accrued interest totaled $18.3 million at March 31, 2016.

 

In connection with the proposed merger with United, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing the Company into involuntary bankruptcy. The merger agreement provides that, at the effective time of the merger, United will assume all of the Company’s obligations relating to its outstanding trust preferred securities. The assumption is conditioned on United’s payment of all amounts required to bring current the payment of interest (including deferred interest) on the trust preferred securities.

 

The merger is subject to required regulatory approvals, approval of the Company’s common shareholders and other customary closing conditions. If the merger does not close, the Company will need to raise substantial additional capital to pay all interest accrued on its trust preferred securities and to increase the Bank’s capital levels to meet the standards set forth by the FDIC in the Consent Order. Receivership by the FDIC is based on the Bank’s capital ratios rather than those of the Company. As of March 31, 2016, the Bank is categorized as “adequately capitalized.”

 

If the merger does not close, there can be no assurances that the Company or the Bank will be able to raise additional capital. An equity financing transaction by the Company would result in substantial dilution to the Company’s current shareholders and could adversely affect the market price of the Company’s common stock. Likewise, an equity financing transaction by the Bank would result in substantial dilution to the Company’s ownership interest in the Bank. It is difficult to predict if these efforts will be successful, either on a short-term or long-term basis. Should these efforts be unsuccessful, the Company would be unable to realize its assets and discharge its liabilities in the normal course of business.

 

Regulatory Matters

 

Written Agreement with the Federal Reserve Bank of Richmond

 

As reported in the Form 8-K filed on March 22, 2011, the Company entered into a written agreement (the “FRB Written Agreement”) with the Federal Reserve Bank of Richmond (“FRB”) on March 18, 2011. The FRB Written Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. The Bank’s lending and deposit operations continue to be conducted in the usual and customary manner, and all other products, services and hours of operation remain the same. All Bank deposits will remain insured by the FDIC to the maximum extent allowed by law.

 

Consent Order with FDIC and South Carolina State Board of Financial Institutions

 

In addition to the foregoing, on June 1, 2010, the FDIC and the South Carolina State Board of Financial Institutions (the “State Board”) conducted their annual joint examination of the Bank. As a result of the examination, the Bank entered into a Consent Order, effective December 28, 2010 (the “Consent Order”), with the FDIC and the State Board. Based on information included in the FDIC’s report, the Bank’s credit risk rating at the FHLB has been negatively impacted, resulting in reduced borrowing capacity. This action also restricts the Bank’s ability to accept, renew, or roll over brokered deposits. In addition, the Bank’s ability to borrow funds from the Federal Reserve Bank Discount Window as a source of short-term liquidity is not guaranteed. The Federal Reserve Discount Window borrowing capacity has been curtailed to only overnight terms, contingent upon credit approval for each transaction.

The Consent Order requires the Bank to, among other things, take the following actions: establish a board committee to monitor and coordinate compliance with the Consent Order; ensure that the Bank has competent management in place; develop an independent assessment of the Bank’s management and staffing needs; achieve Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets within 150 days and establish a capital plan that includes a contingency plan to sell or merge the Bank; implement a plan addressing liquidity, contingency funding, and asset liability management; implement a program designed to reduce the Bank’s exposure in problem assets; develop a three year strategic plan; adopt an effective internal loan review and grading system; adopt a plan to reduce concentrations of credit; implement a policy to ensure the adequacy of the Bank’s allowance for loan and lease losses; implement a written plan to improve and sustain the Bank’s earnings; revise, adopt and implement a written asset/liability management policy to provide effective guidance and control over the Bank’s funds management activities; develop a written policy for managing interest rate risk; not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval; not accept, renew, or rollover any brokered deposits unless it is in compliance with regulatory requirements and adopt a plan to eliminate reliance on brokered deposits; limit asset growth to 10% per year; adopt an employee compensation plan after undertaking an independent review of compensation paid to all the Bank’s senior executive officers; and address various violations of law and regulation cited by the FDIC.

 

The Company intends to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order. Under the proposed merger agreement with United, the Bank will merge with and into United’s wholly-owned subsidiary bank, United Community Bank. If the merger does not close, there can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of the Bnak’s compliance will be made by the FDIC and the State Board. Failure to meet the requirements of the Consent Order could result in additional regulatory requirements, which could ultimately lead to the Bank being taken into receivership by the FDIC. As of March 31, 2016, the Bank is not in compliance with all the provisions outlined in the Consent Order.

 

NOTE 3 - FAIR VALUE MEASUREMENTS

 

The current accounting literature requires the disclosure of fair value information for financial instruments, whether or not they are recognized in the consolidated balance sheets, when it is practical to estimate the fair value. The guidance defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment, accrued interest receivable and payable, and other assets and liabilities.

 

The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

 

The Company has used management’s best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented.

 

The following methods and assumptions were used to estimate the fair value of significant financial instruments:

 

Cash and Due from Banks and Interest Bearing Balances- The carrying amount for cash and due from banks is a reasonable estimate of fair value.

 

Federal Funds Sold - Federal funds sold are for a term of one day, and the carrying amount approximates the fair value.

Securities Held-to-Maturity - Investment securities held-to-maturity are recorded at amortized cost on a recurring basis. Fair value measurement is based upon quoted prices, if available.

 

Securities Available-for-sale - Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. 

 

With respect to securities available-for-sale, Level 1 includes those securities traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

 

Nonmarketable Equity Securities - The carrying amount for nonmarketable equity securities approximates the fair value since no readily available market exists for these securities.

 

Loans Receivable - For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk, fair values are based on the carrying amounts. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. 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. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans.

 

Deposits - The fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date. The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities.

 

Securities Sold Under Agreements to Repurchase - These repurchase agreements have a fixed rate. Due to the minor change in interest rates, management estimated the fair value using a discounted cash flow calculation that applies the Company’s current borrowing rate for the securities sold under agreements to repurchase.

 

Advances from Federal Home Loan Bank - The fair values of fixed rate borrowings are estimated using a discounted cash flow calculation that applies the Company’s current borrowing rate from the Federal Home Loan Bank. The carrying amounts of variable rate borrowings are reasonable estimates of fair value because they can be repriced frequently.

 

Junior Subordinated Debentures - The Company is unable to determine value based on the significant unobservable inputs required in the calculation. Refer to Note 11 for further information.

 

Off-Balance Sheet Financial 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.

 

Assets and liabilities that are carried at fair value are classified in one of the following three categories based on a hierarchy for ranking the quality and reliability of the information used to determine fair value.

 

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 market based inputs or unobservable inputs that are corroborated by market data. 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 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. This category generally includes certain derivative contracts and impaired loans.

Level 3 —

Unobservable inputs that are not corroborated by market data. Observable 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, 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 instruments, retained residual interests in securitizations, residential mortgage servicing rights, and highly-structured or long-term derivative contracts.

 

In determining appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to fair value disclosures. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3. Following is a description of valuation methodologies used for assets received of fair value on a recurring and nonrecurring basis.

 

The carrying values and estimated fair values of the Company’s financial instruments are as follows:

 

		March 31, 2016
		Carrying Amount				Estimated Fair Value				Level 1				Level 2				Level 3
Financial Assets:
Cash and due from banks		$	4,605,838			$	4,605,838			$	4,605,838			$	—			$	—
Interest bearing balances			11,437,009				11,437,009				11,437,009				—				—
Securities available-for-sale			69,401,649				69,401,649				4,493,047				64,908,602				—
Securities held-to-maturity			5,245,348				5,297,850				—				5,297,850				—
Nonmarketable equity securities			1,077,350				1,077,350				—				—				1,077,350
Mortgage loans held for sale			255,000				255,000				—				255,000				—
Loans receivable			325,044,893				323,546,787				—				308,783,665				14,763,122
Financial Liabilities:
Demand deposit, interest-bearing transaction, and savings accounts		$	173,597,362			$	173,597,362			$	—			$	173,597,362			$	—
Certificates of deposit and other time deposits			239,694,842				238,927,000				—				238,927,000				—
Securities sold under agreements to repurchase			10,000,000				10,240,000				—				10,240,000				—
Advances from Federal Home Loan Bank			14,000,000				14,151,000				—				14,151,000				—
Junior subordinated debentures			14,434,000	(1)			N/A	(1)			—				—				N/A	(1)

 

		December 31, 2015
		Carrying Amount				Estimated Fair Value				Level 1				Level 2				Level 3
Financial Assets:
Cash and due from banks		$	5,733,049			$	5,733,049			$	5,733,049			$	—			$	—
Interest bearing balances			8,155,490				8,155,490				8,155,490				—				—
Securities available-for-sale			72,854,275				72,854,275				4,474,688				68,379,587				—
Securities held-to-maturity			5,254,558				5,221,623				—				5,221,623				—
Nonmarketable equity securities			895,950				895,950				—				—				895,950
Mortgage loans held for sale			704,250				704,250				—				704,250				—
Loans receivable			324,211,251				321,959,119				—				306,355,758				15,603,361
Financial Liabilities:
Demand deposit, interest-bearing transaction, and savings accounts		$	177,089,811			$	177,089,811			$	—			$	177,089,811			$	—
Certificates of deposit and other time deposits			243,420,171				242,259,000				—				242,259,000				—
Securities sold under agreements to repurchase			10,000,000				10,328,000				—				10,328,000				—
Advances from Federal Home Loan Bank			9,000,000				9,163,000				—				9,163,000				—
Junior subordinated debentures			14,434,000	(1)			N/A	(1)			—				—				N/A	(1)

 

(1)

The Company is unable to determine value based on the significant unobservable inputs required in the calculation. Refer to Note 11 for further information.

		March 31, 2016								December 31, 2015
		Notional Amount				Estimated Fair Value				Notional Amount				Estimated Fair Value
Off-Balance Sheet Financial Instruments:
Commitments to extend credit		$	21,728,953			$	—			$	19,112,618			$	—
Letters of credit			479,776				—				501,751				—

 

Fair value measurement on Investment Securities, Loans, Mortgage Loans held for Sale and Other Real Estate are presented below.

 

Investment Securities

 

Measurement is on a recurring basis upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. Level 1 securities include those traded on an active exchange or by dealers or brokers in active over-the-counter markets. Level 2 securities include securities issued by government sponsored enterprises, municipal enterprises, and mortgage-backed securities issued by government sponsored enterprises. Generally these fair values are priced from established pricing models.

 

Loans

 

Loans that are considered impaired are recorded at fair value on a non-recurring basis. Once a loan is considered impaired, the fair value is measured using one of several methods, including collateral liquidation value, market value of similar debt and discounted cash flows. Those impaired loans not requiring a specific charge against allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investment in the loan. When the Company records the fair value based on a current appraisal, the fair value measurement is considered a non-recurring Level 3 measurement.

 

Mortgage Loans Held for Sale

 

Mortgage loans held for sale are carried at the lower of cost of market value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans held for sale is non-recurring Level 2.

 

Other Real Estate Owned (OREO)

 

Other real estate owned is adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, other real estate owned is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the other real estate owned as non-recurring Level 3.

 

Assets measured at fair value on a recurring basis are as follows as of March 31, 2016 and December 31, 2015:

 

Available-for-sale: March 31, 2016		Quoted market price in active markets  (Level 1)				Significant other observable inputs  (Level 2)				Significant unobservable inputs  (Level 3)
US Treasuries		$	4,493,047			$	—			$	—
Government sponsored enterprises			—				11,850,987				—
Mortgage-backed securities			—				42,970,270				—
SBA loan pools			—				10,087,345				—
Mortgage loans held-for-sale			—				255,000				—
Total		$	4,493,047			$	65,163,602			$	—
December 31, 2015
US Treasuries		$	4,474,688			$	—			$	—
Government sponsored enterprises			—				13,773,797				—
Mortgage-backed securities			—				44,445,132				—
SBA loan pools			—				10,160,658				—
Mortgage loans held-for-sale			—				704,250				—
Total		$	4,474,688			$	69,083,837			$	—

Held-to-maturity: March 31, 2016		Quoted market price in active markets  (Level 1)				Significant other observable inputs  (Level 2)				Significant  unobservable inputs  (Level 3)
Government sponsored enterprises		$	—			$	3,073,989			$	—
Mortgage-backed securities			—				1,213,203				—
SBA loan pools			—				1,010,658				—
Total		$	—			$	5,297,850			$	—
December 31, 2015
Government sponsored enterprises		$	—			$	3,016,363			$	—
Mortgage-backed securities			—				1,202,437				—
SBA loan pools			—				1,002,823				—
Total		$	—			$	5,221,623			$	—

 

March 31, 2016		Quoted market price in active markets  (Level 1)				Significant other observable inputs  (Level 2)				Significant unobservable inputs  (Level 3)
Impaired loans		$	—			$	—			$	14,763,122
Other real estate owned			—				—				11,886,940
Total		$	—			$	—			$	26,650,062
December 31, 2015
Impaired loans		$	—			$	—			$	15,603,361
Other real estate owned			—				—				12,752,533
Total		$	—			$	—			$	28,355,894

 

For Level 3 assets measured at fair value on a non-recurring basis as of March 31, 2016 and December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

 

March 31, 2016

December 31, 2015

Valuation Technique

Significant Observable Inputs

Significant Unobservable Inputs

Other real estate owned

$

11,886,940

$

12,752,533

Appraisal Value/Comparison Sales/Other Estimates

Appraisals and or sales of comparable properties

Appraisals discounted 7% for sales commissions and other holding costs

Impaired loans

$

14,763,122

$

15,603,361

Appraisal Value/Comparison Sales/Discounted Cash Flows

Appraisals, sales of comparable properties and or discounted cash flows

Appraisals discounted 2% to 12% for sales commissions and other holding costs

 

NOTE 4 - CASH AND DUE FROM BANKS

 

The Company maintains cash balances on hand in order to meet reserve requirements determined by the Federal Reserve. At March 31, 2016, the Bank had $321,000 on hand with the Federal Reserve Bank to meet this requirement. At March 31, 2016, the Bank had $1.4 million in actual currency and cash on hand, $3.2 million in due from non-interest bearing balances and $11.4 million in due from interest bearing balances.

NOTE 5 - INVESTMENT SECURITIES

 

The amortized cost and estimated fair values of securities available-for-sale were:

 

Available-for-sale:

 

		Amortized				Gross Unrealized								Estimated
March 31, 2016		Cost				Gains				Losses				Fair Value
US Treasuries		$	4,477,057			$	15,990			$	—			$	4,493,047
Government-sponsored enterprises			11,815,595				35,392				—				11,850,987
Mortgage-backed securities			43,845,003				21,579				896,312				42,970,270
SBA loan pools			10,144,463				9,859				66,977				10,087,345
Total		$	70,282,118			$	82,820			$	963,289			$	69,401,649
December 31, 2015
US Treasuries		$	4,473,861			$	2,164			$	1,337			$	4,474,688
Government-sponsored enterprises			13,814,519				2,740				43,462				13,773,797
Mortgage-backed securities			45,815,211				17,161				1,387,240				44,445,132
SBA loan pools			10,371,569				—				210,911				10,160,658
Total		$	74,475,160			$	22,065			$	1,642,950			$	72,854,275

 

Held-to-Maturity:
		Amortized				Gross Unrealized								Estimated
March 31, 2016		Cost				Gains				Losses				Fair Value
Government-sponsored enterprises		$	3,010,307			$	63,681			$	—			$	3,073,988
Mortgage-backed securities			1,230,434				—				17,231				1,213,203
SBA loan pools			1,004,607				6,052				—				1,010,659
Total		$	5,245,348			$	69,733			$	17,231			$	5,297,850
December 31, 2015
Government-sponsored enterprises		$	3,011,148			$	7,750			$	2,535			$	3,016,363
Mortgage-backed securities			1,237,308				—				34,871				1,202,437
SBA loan pools			1,006,102				—				3,279				1,002,823
Total		$	5,254,558			$	7,750			$	40,685			$	5,221,623

 

The amortized cost and estimated fair values of investment securities at March 31, 2016, by contractual maturity dates are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty. Mortgage-backed securities are presented as a separate line item since pay downs are expected before contractual maturity dates.

 

		Available-For-Sale								Held-to-Maturity
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Due within one year		$	—			$	—			$	—			$	—
Due after one year through five years			14,472,653				14,523,436				—				—
Due after five years through ten years			912,337				915,903				3,009,210				3,066,523
Due after ten years			11,052,125				10,992,040				1,005,704				1,018,124
Subtotal			26,437,115				26,431,379				4,014,914				4,084,647
Mortgage-backed securities			43,845,003				42,970,270				1,230,434				1,213,203
Total Securities		$	70,282,118			$	69,401,649			$	5,245,348			$	5,297,850

 

At March 31, 2016 and December 31, 2015, investment securities with market values of $17,445,685 and $17,690,070 respectively, were pledged as collateral for securities sold under agreements to repurchase and a fed funds line. Gross proceeds from the sale of investment securities totaled $0 and $7,227,111 for the periods ended March 31, 2016 and December 31, 2015, respectively. There were no sales of securities for the period ended March 31, 2016. There were gross realized losses of $32,118 resulting in a net realized loss of $32,118 for the year ended December 31, 2015. There were no proceeds from the sale of investment securities for the three months ended March 31, 2016, resulting in no realized gains or losses on the sale of investment securities for the three months ended March 31, 2016. There were gross realized gains on the sale of investment securities of $17,654 with gross realized losses of $11,601 resulting in a net realized gain of $6,053 for the year ended December 31, 2015. The cost of investments sold is determined using the specific identification method.

For investments where fair value is less than amortized cost the following table shows 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 March 31, 2016 and December 31, 2015:

 

		Less than
Available-for-sale:		Twelve months								Twelve months or more								Total
						Unrealized								Unrealized								Unrealized
March 31, 2016		Fair value				losses				Fair value				losses				Fair value				losses
US Treasuries		$	—			$	—			$	—			$	—			$	—			$	—
Government-sponsored enterprises			—				—				—				—				—				—
Mortgage-backed securities			3,827,598				22,152				36,122,949				874,159				39,950,947				896,311
SBA loan pools			3,417,477				10,863				4,500,519				56,115				7,917,996				66,978
Total		$	7,245,075			$	33,015			$	40,623,468			$	930,274			$	47,868,543			$	963,289

 

		Less than Twelve months								Twelve months or more								Total
December 31, 2015		Fair value				Unrealized losses				Fair value				Unrealized losses				Fair value				Unrealized losses
US Treasuries		$	1,495,313			$	1,337			$	—			$	—			$	1,495,313			$	1,337
Government-sponsored enterprises			12,782,240				43,462				—				—				12,782,240				43,462
Mortgage-backed securities			5,079,922				42,448				37,421,026				1,344,792				42,500,948				1,387,240
SBA loan pools			2,158,767				14,042				8,001,891				196,869				10,160,658				210,911
Total		$	21,516,242			$	101,289			$	45,422,917			$	1,541,661			$	66,939,159			$	1,642,950

 

Held-to-maturity:		Less than Twelve months								Twelve months or more								Total
March 31, 2016		Estimated Fair Value				Unrealized losses				Estimated Fair Value				Unrealized losses				Estimated Fair Value				Unrealized losses
Government-sponsored enterprises		$	—			$	—			$	—			$	—			$	—			$	—
Mortgage-backed securities			1,213,203				17,231				—				—				1,213,203				17,231
SBA loan pools			—				—				—				—				—				—
Total		$	1,213,203			$	17,231			$	—			$	—			$	1,213,203			$	17,231

 

		Less than Twelve months								Twelve months or more								Total
December 31, 2015		Fair value				Unrealized losses				Fair value				Unrealized losses				Fair value				Unrealized losses
Government-sponsored enterprises		$	1,003,816			$	2,535			$	—			$	—			$	1,003,816			$	2,535
Mortgage-backed securities			1,202,437				34,871				—				—				1,202,437				34,871
SBA loan pools			1,002,823				3,279				—				—				1,002,823			$	3,279
Total		$	3,209,076			$	40,685			$	—			$	—			$	3,209,076			$	40,685

 

Securities classified as available-for-sale are recorded at fair market value. Of the securities in an unrealized loss position, there were thirty-three securities in a continuous loss position for 12 months or more at March 31, 2016 and there were thirty-nine securities in a continuous loss position for 12 months or more at December 31, 2015. 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 Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.

 

Nonmarketable equity securities include the fair value of stock in community bank holding companies of $63,150 at March 31, 2016 and December 31, 2015, respectively, and the Federal Home Loan Bank stock which has no quoted market value and no ready market exists. Investment in the Federal Home Loan Bank is a condition of borrowing from the Federal Home Loan Bank, and the stock is pledged to collateralize such borrowings. At March 31, 2016 and December 31, 2015, the Company’s investment in Federal Home Loan Bank stock was $1,014,200 and $832,800, respectively.

 

The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”). Factors considered in the review include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospects of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or a portion may be recognized in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

NOTE 6 - LOANS RECEIVABLE

 

Major classifications of loans receivable are summarized as follows for the periods ended March 31, 2016 and December 31, 2015:

 

		2016				2015
Real estate - construction		$	42,484,064			$	42,696,168
Real estate - mortgage			251,756,680				253,617,224
Commercial and industrial			26,219,650				23,977,848
Consumer and other			4,740,074				4,058,626
Total loans receivable, gross			325,200,468				324,349,866
Deferred origination fees			(155,575	)			(138,615	)
Total loans receivable, net of deferred origination fees			325,044,893				324,211,251
Less allowance for loan losses			3,834,565				4,045,227
Total loans receivable, net of allowance for loan loss		$	321,210,328			$	320,166,024

 

The composition of gross loans by rate type is as follows for the periods ended March 31, 2016 and December 31, 2015:

 

		2016				2015
Variable rate loans		$	91,518,255			$	91,607,108
Fixed rate loans			233,526,638				232,604,143
Total gross loans		$	325,044,893			$	324,211,251

 

The following is an analysis of our loan portfolio by credit quality indicators at March 31, 2016 and December 31, 2015:

 

		Commercial and Industrial								Commercial Real Estate								Commercial Real Estate Construction
		2016				2015				2016				2015				2016				2015
Grade:
Pass		$	25,093,752			$	23,018,548			$	139,926,807			$	136,343,608			$	16,073,250			$	14,911,423
Special Mention			200,190				356,774				12,431,588				13,606,093				—				—
Substandard			925,708				602,526				4,027,671				4,011,084				—				—
Doubtful			—				—				—				—				—				—
Loss			—				—				—				—				—				—
Total		$	26,219,650			$	23,977,848			$	156,386,066			$	153,960,785			$	16,073,250			$	14,911,423

 

		Residential Real Estate								Real Estate Residential Construction								Consumer and Other
		2016				2015				2016				2015				2016				2015
Grade:
Pass		$	89,540,161			$	92,286,019			$	22,110,342			$	23,484,405			$	4,654,879			$	3,971,129
Special Mention			1,708,859				2,417,580				3,138,281				3,121,147				85,195				87,497
Substandard			4,121,594				4,952,840				1,162,191				1,179,193				—				—
Doubtful			—				—				—				—				—				—
Loss			—				—				—				—				—				—
Total		$	95,370,614			$	99,656,439			$	26,410,814			$	27,784,745			$	4,740,074			$	4,058,626

 

Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The following definitions are utilized for risk ratings, which are consistent with the definitions used in supervisory guidance:

 

Special Mention - Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

 

The following is an aging analysis of our loan portfolio at March 31, 2016 and December 31, 2015:

  

		Commercial and Industrial				Commercial Real Estate				Commercial Real Estate Construction				Residential Real Estate				Residential Real Estate Construction				Consumer and Other				Total
March 31, 2016
Accruing Loans Paid Current		$	25,446,185			$	153,800,732			$	16,073,250			$	90,219,218			$	25,248,622			$	4,740,074			$	315,528,081
Accruing Loans Past Due:
30-59 Days			307,493				—				—				735,192				—				—				1,042,685
60-89 Days			—				65,647				—				1,289,001				—				—				1,354,648
Total Loans Past Due			307,493				65,647				—				2,024,193				—				—				2,397,333
Loans Receivable on Nonaccrual Status		$	465,972			$	2,519,687			$	—			$	3,127,203			$	1,162,192			$	—			$	7,275,054
Total Loans Receivable		$	26,219,650			$	156,386,066			$	16,073,250			$	95,370,614			$	26,410,814			$	4,740,074			$	325,200,468
December 31, 2015
Accruing Loans Paid Current		$	23,349,423			$	151,472,170			$	14,911,423			$	94,347,976			$	26,605,552			$	4,058,626			$	314,745,170
Accruing Loans Past Due:
30-59 Days			102,676				—				—				1,527,207				—				—				1,629,883
60-89 Days			130,749				—				—				120,323				—				—				251,072
Total Loans Past Due			233,425				—				—				1,647,530				—				—				1,880,955
Loans Receivable on Nonaccrual Status		$	395,000			$	2,488,615			$	—			$	3,660,933			$	1,179,193			$	—			$	7,723,741
Total Loans Receivable		$	23,977,848			$	153,960,785			$	14,911,423			$	99,656,439			$	27,784,745			$	4,058,626			$	324,349,866

 

The following is a summary of information pertaining to impaired and nonaccrual loans at March 31, 2016 and December 31, 2015:

 

		2016				2015
Impaired loans without a valuation allowance		$	11,876,877			$	12,869,116
Impaired loans with a valuation allowance			4,284,458				3,988,875
Total impaired loans		$	16,161,335			$	16,857,991
Valuation allowance related to impaired loans		$	1,398,213			$	1,254,631
Average of impaired loans during the period		$	17,667,222			$	18,363,879
Total nonaccrual loans		$	7,275,054			$	7,723,741
Total Loans past due 90 days and still accruing		$	—			$	—
Total loans considered impaired which are classified as troubled debt restructurings		$	11,306,725			$	11,810,645

The following is an analysis of our impaired loan portfolio detailing the related allowance recorded at March 31, 2016 and December 31, 2015:

 

March 31, 2016		Commercial and Industrial				Commercial Real Estate				Commercial Real Estate Construction				Residential Real Estate				Residential Real Estate Construction				Consumer and Other				Total
With no related allowance recorded:
Recorded Investment		$	—			$	6,981,711			$	—			$	3,925,400			$	969,766			$	—			$	11,876,877
Unpaid Principal Balance			—				7,500,707				—				4,511,707				1,099,766				—				13,112,180
Related Allowance			—				—				—				—				—				—				—
With an allowance recorded:
Recorded Investment		$	465,972			$	2,469,930			$	—			$	1,156,130			$	192,426			$	—			$	4,284,458
Unpaid Principal Balance			465,972				2,740,514				—				1,156,130				192,426				—				4,555,042
Related Allowance			295,972				538,117				—				489,199				74,925				—				1,398,213
Total:
Recorded Investment		$	465,972			$	9,451,641			$	—			$	5,081,530			$	1,162,192			$	—			$	16,161,335
Unpaid Principal Balance			465,972				10,241,221				—				5,667,837				1,292,192				—				17,667,222
Related Allowance			295,972				538,117				—				489,199				74,925				—				1,398,213
December 31, 2015
With no related allowance recorded:
Recorded Investment		$	395,000			$	7,025,383			$	—			$	4,461,966			$	986,767			$	—			$	12,869,116
Unpaid Principal Balance			395,000				7,544,378				—				5,048,273				1,116,768				—				14,104,419
Related Allowance			—				—				—				—				—				—				—
With an allowance recorded:
Recorded Investment		$	—			$	2,434,464			$	—			$	1,361,986			$	192,425			$	—			$	3,988,875
Unpaid Principal Balance			—				2,705,049				—				1,361,986				192,425				—				4,259,460
Related Allowance			—				484,653				—				695,053				74,925				—				1,254,631
Total:
Recorded Investment		$	395,000			$	9,459,847			$	—			$	5,823,952			$	1,179,192			$	—			$	16,857,991
Unpaid Principal Balance			395,000				10,249,427				—				6,410,259				1,309,193				—				18,363,879
Related Allowance			—				484,653				—				695,053				74,925				—				1,254,631

 

The following is an analysis of our impaired loan portfolio detailing average recorded investment and interest income recognized on impaired loans for the three months ended March 31, 2016 and 2015, respectively.

 

For the Three Months Ended		Commercial and Industrial				Commercial Real Estate				Commercial Real Estate Construction				Residential Real Estate				Residential Real Estate Construction				Consumer and Other				Total
March 31, 2016
With no related allowance recorded:
Average Recorded Investment		$	—			$	7,521,877			$	—			$	4,566,432			$	1,107,998			$	—			$	13,196,307
Interest Income Recognized			—				49,832				—				11,996				—				—				61,828
With an allowance recorded:
Average Recorded Investment		$	467,346			$	2,739,669			$	—			$	1,159,032			$	192,425			$	—			$	4,558,472
Interest Income Recognized			371				7,918				—				12,645				—				—				20,934
March 31, 2015
With no related allowance recorded:
Average Recorded Investment		$	1,195,988			$	6,987,478			$	—			$	4,389,872			$	1,537,559			$	—			$	14,110,897
Interest Income Recognized			23,890				52,473				—				39,762				—				—				116,125
With an allowance recorded:
Average Recorded Investment		$	4,840,000			$	3,970,930			$	—			$	2,436,238			$	1,364,926			$	—			$	12,612,094
Interest Income Recognized			54,450				15,936				—				20,107				8,995				—				99,488

The following is a summary of information pertaining to our allowance for loan losses at March 31, 2016 and December 31, 2015:

 

March 31, 2016		Commercial and Industrial				Commercial Real Estate				Commercial Real Estate Construction				Residential Real Estate				Residential Real Estate Construction				Consumer and Other				Unallocated				Total
Allowance for  loan losses:
Beginning Balance		$	172,096			$	1,252,596			$	50,699			$	1,524,430			$	373,285			$	13,837			$	658,284			$	4,045,227
Charge-offs			(13,837	)			—				—				(247,429	)			—				—				—				(261,266	)
Recoveries			27,005				6,400				—				16,993				—				206				—				50,604
Provision			250,314				(22,492	)			5,557				(79,991	)			(57,317	)			727				(96,797	)			—
Ending Balance		$	435,578			$	1,236,503			$	56,256			$	1,214,003			$	315,968			$	14,770			$	561,487			$	3,834,565
Individually evaluated for impairment			295,972				538,117				—				489,199				74,925				—				—				1,398,213
Collectively evaluated for impairment			139,606				698,386				56,256				724,804				241,043				14,770				561,487				2,436,352
Loans Receivable:
Ending Balance		$	26,219,650			$	156,386,066			$	16,073,250			$	95,370,614			$	26,410,814			$	4,740,074			$	—			$	325,200,468
Individually evaluated for impairment			465,972				9,451,641				—				5,081,530				1,162,192				—				—				16,161,335
Collectively evaluated for impairment			25,753,678				146,934,425				16,073,250				90,289,084				25,248,622				4,740,074				—				309,039,133

 

December 31, 2015		Commercial and Industrial				Commercial Real Estate				Commercial Real Estate Construction				Residential Real Estate				Residential Real Estate Construction				Consumer and Other				Unallocated				Total
Allowance for loan losses:
Beginning Balance		$	546,588			$	1,311,805			$	73,911			$	921,649			$	1,082,036			$	93,165			$	720,383			$	4,749,537
Charge-offs			(636,997	)			(1,189,302	)			—				(610,019	)			(290,826	)			(764	)			—				(2,727,908	)
Recoveries			25,161				123,611				—				100,179				598,961				686				—				848,598
Provision			237,344				1,006,482				(23,212	)			1,112,621				(1,016,886	)			(79,250	)			(62,099	)			1,175,000
Ending Balance		$	172,096			$	1,252,596			$	50,699			$	1,524,430			$	373,285			$	13,837			$	658,284			$	4,045,227
Individually evaluated for impairment			—				484,653				—				695,053				74,925				—				—				1,254,631
Collectively evaluated for impairment			209,141				767,943				50,699				831,341				259,351				13,837				658,284				2,790,596
Loans Receivable:
Ending Balance		$	23,977,848			$	153,960,785			$	14,911,423			$	99,656,439			$	27,784,745			$	4,058,626			$	—			$	324,349,866
Individually evaluated for impairment			395,000				9,459,847				—				5,823,951				1,179,193				—				—				16,857,991
Collectively evaluated for impairment			23,582,848				144,500,938				14,911,423				93,832,488				26,605,552				4,058,626				—				307,491,875

 

The allowance for loan losses, as a percent of loans, net of deferred fees, was 1.18% and 1.25% for periods ended March 31, 2016 and December 31, 2015, respectively. At March 31, 2016, the Bank had 23 loans totaling $7,310,516 or 2.25% of gross loans, in nonaccrual status, of which $2,954,253 were deemed to be troubled debt restructurings. There were nine loans totaling $8,407,005 deemed to be troubled debt restructurings not in nonaccrual status at March 31, 2016. At December 31, 2015, the Bank had 19 loans totaling $7,723,741 or 2.38% of gross loans, in nonaccrual status, of which $3,360,185 were deemed to be troubled debt restructurings. There were nine loans totaling $8,450,460 deemed troubled debt restructurings in accruing status at December 31, 2015. There were no loans contractually past due 90 days or more and still accruing interest at March 31, 2016 or December 31, 2015. Our analysis under generally accepted accounting principles indicates that the level of the allowance for loan losses is appropriate to cover estimated credit losses on individually evaluated loans as well as estimated credit losses inherent in the remainder of the portfolio. We do not recognize interest income on loans that are in nonaccrual status. At March 31, 2016 and December 31, 2015, the Bank had $18,000 reserved for off-balance sheet credit exposure related to unfunded commitments included in other liabilities on our consolidated balance sheet.

 

At March 31, 2016, loans totaling $24.6 million were pledged as collateral at the Federal Home Loan Bank, and no loans were required to be pledged to maintain a line of credit with the Federal Reserve Bank.

The troubled debt restructurings (“TDR’s”) amounted to $11,306,725 at March 31, 2016. The accruing TDR’s were $8,406,210 and the non-accruing TDR’s were $2,900,515 at March 31, 2016. The TDR’s amounted to $12,082,331 at March 31, 2015. The accruing TDR’s were $7,572,466 and the non-accruing TDR’s were $4,509,865 at March 31, 2015.

 

During the three months ended March 31, 2016, the Bank did not modify any loans that were considered to be troubled debt restructurings.

 

The Bank did not have any troubled debt restructurings that subsequently defaulted during the three months ended March 31, 2016.

 

The following chart represents the troubled debt restructurings that subsequently defaulted during the three months ended March 31, 2015.

 

		For the three months ended March 31, 2015
		Number of Contracts				Recorded Investment
Troubled Debt Restructurings
That Subsequently Defaulted During the Period:
Commercial Real Estate			1			$	1,172,501
Totals			1			$	1,172,501

 

No loans that were determined to be troubled debt restructurings during the three months ended March 31, 2016, subsequently defaulted. During the three months ended March 31, 2015, one loan that had previously been restructured went into default.

 

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by performing the usual process for all loans in determining the allowance for loan loss.

 

NOTE 7 - OTHER REAL ESTATE OWNED

 

Transactions in other real estate owned for the three months ended March 31, 2016 and the year ended December 31, 2015 are summarized below:

 

		2016				2015
Balance, beginning of year		$	12,752,533			$	17,518,665
Additions			81,407				1,752,347
Sales			(562,529	)			(6,463,682	)
Write-downs			(384,471	)			(54,797	)
Balance, end of period		$	11,886,940			$	12,752,533

 

NOTE 8 - PREMISES, FURNITURE AND EQUIPMENT

 

Premises, furniture and equipment consist of the following at March 31, 2016 and December 31, 2015:

 

		2016				2015
Land and land improvements		$	3,434,431			$	3,434,431
Building and leasehold improvements			18,668,886				18,668,886
Furniture and equipment			4,068,147				4,076,245
Software			657,630				663,066
Construction in progress			89,942				80,750
Total			26,919,036				26,923,378
Less, accumulated depreciation			7,452,605				7,188,699
Premises, furniture and equipment, net		$	19,466,431			$	19,734,679

 

Depreciation expense for the three months ended March 31, 2016 and 2015 amounted to $296,103 and $306,224, respectively. Construction in progress is related to financial reporting software upgrades. For the three months ended March 31, 2016 the Bank capitalized $0 in interest related to this in progress item. The expected costs to complete the in progress item are $15,000.

NOTE 9 - DEPOSITS

 

At March 31, 2016, the scheduled maturities of certificates of deposit were as follows:

 

Maturing:		Amount
Remaining through 2016		$	139,296,635
2017			81,085,152
2018			14,488,477
2019			1,760,834
2020			2,075,033
Thereafter			988,711
Total		$	239,694,842

 

 

The Bank had no wholesale deposits for the periods ended March 31, 2016 and December 31, 2015. For the period ended March 31, 2016, the Bank had $25.5 million in certificates of deposits greater than $250,000.

 

Overdraft deposit accounts are reclassified to consumer loans and are included in gross loans. At March 31, 2016 and December 31, 2015, overdraft deposits were $8,746 and $4,375, respectively.

 

NOTE 10 - SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

 

The Bank has entered into sales of securities under an agreement to repurchase. This obligation to repurchase securities sold is reflected as a liability on the consolidated balance sheet as one obligation totaling $10.0 million at March 31, 2016. On November 14, 2007, the Bank borrowed $10.0 million under a nine-year repurchase agreement at a fixed rate of 4.40%. This repurchase agreement requires quarterly interest only payments with principal and interest due on maturity. The dollar amounts of securities underlying the agreements are book entry securities. Available-for-sale securities with fair values of $10,501,417 and $10,715,693 at March 31, 2016 and December 31, 2015, respectively, are used as collateral for the agreement.

 

Securities sold under repurchase agreements are summarized as follows for the periods ended March 31, 2016 and December 31, 2015:

 

		2016				2015
Amount outstanding at period end		$	10,000,000			$	10,000,000
Average amount outstanding during the period			10,000,000				10,000,000
Maximum outstanding at any month-end			10,000,000				10,000,000
Weighted average rate paid at period-end			4.40	%			4.40	%
Weighted average rate paid during the period			4.47	%			4.46	%

 

NOTE 11 - JUNIOR SUBORDINATED DEBENTURES

 

On February 22, 2006, Tidelands Statutory Trust (the “Trust I”), a non-consolidated subsidiary of the Company, issued and sold floating rate capital securities of the trust (the “Trust I Securities”), generating proceeds of $8.0 million. The Trust I loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 capital under Federal Reserve Board guidelines.

 

The Trust I Securities in the transaction accrue and pay distributions quarterly at a rate per annum equal to the three-month LIBOR plus 1.38%, which was 1.983% at March 31, 2016. The distribution rate payable on the Trust I 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 Trust I Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of March 30, 2036.

 

The Trust I Securities mature or are mandatorily redeemable upon maturity on March 30, 2036 or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Trust I Securities in whole or in part, on or after March 30, 2011. The Company may also redeem the Trust I Securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium.

 

On June 20, 2008, Tidelands Statutory Trust II (the “Trust II”), a non-consolidated subsidiary of the Company, issued and sold floating rate capital securities of the trust (the “Trust II Securities”), generating proceeds of $6.0 million. The Trust II loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 Capital under Federal Reserve Board guidelines.

The Trust II Securities accrue and pay distributions quarterly at a rate equal to (i) 9.425% fixed for the first 5 years, and (ii) the three-month LIBOR rate plus 5.075%, which was 5.678% at the period ended March 31, 2016. The distribution rate payable on the Trust II 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 Trust II Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of June 30, 2038.

 

The Trust II Securities mature or are mandatorily redeemable upon maturity on June 30, 2038 or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Trust II Securities in whole or in part, on or after June 30, 2013. The Company may also redeem the Trust II Securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium. The Trust I Securities and Trust II Securities are collectively referred to as the trust preferred securities.

 

As permitted by the indentures, the Company began deferring interest payments on its trust preferred securities in December 2010 and was allowed to defer such payments for up to 20 consecutive quarterly periods, although interest continued to accrue and compounded quarterly. All of the deferred interest, including interest accrued on such deferred interest, became due and payable on December 30, 2015. The Company failed to pay the deferred and compounded interest at the end of the deferral period and on March 8, 2016, the Company received notices of default from Wilmington Trust Company, in its capacity as Trustee, relating to the trust preferred securities declaring the entire principal and unpaid interest amounts of the trust preferred securities immediately due and payable. The aggregate principal amount of these trust preferred securities plus accrued interest totaled $3.1 million at March 31, 2016.

 

In connection with the merger, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing the Company into involuntary bankruptcy. The merger agreement provides that, at the effective time of the merger, United will assume all of the Company’s obligations relating to its outstanding trust preferred securities. The assumption is conditioned on United’s payment of all amounts required to bring current the payment of interest (including deferred interest) on the trust preferred securities.

 

The merger is subject to required regulatory approvals, approval of the Company’s common shareholders and other customary closing conditions. If the merger does not close, the Company will need to raise substantial additional capital to pay all interest accrued on its trust preferred securities. In addition, as described in Note 16 below, on March 18, 2011, the Company entered into an agreement with the Federal Reserve Bank of Richmond (“FRB”) which, among other things, prohibits the Company making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior approval of the FRB.

 

Note 12 – ADVANCES FROM FEDERAL HOME LOAN BANK

 

At March 31, 2016, advances from the Federal Home Loan Bank (“FHLB”) totaled $14.0 million. On September 21, 2007, the Bank borrowed $9.0 million under a 10-year convertible advance at a fixed rate of 3.96%. The advance is collateralized by pledged FHLB stock and certain loans. On March 18, 2016, the bank borrowed $5 million under a one month fixed rate of 0.40%. At March 31, 2016, loans totaling $24.6 million were pledged as collateral at the Federal Home Loan Bank.

 

FHLB advances are summarized as follows for the periods ended March 31, 2016 and December 31, 2015:

  

		2016				2015
Amount outstanding at period end		$	14,000,000			$	9,000,000
Average amount outstanding during the period			10,358,242				9,000,000
Maximum outstanding at any month-end			14,000,000				9,000,000
Weighted average rate at period-end			2.69	%			3.96	%
Weighted average rate during the period			3.55	%			4.01	%

NOTE 13 - OTHER OPERATING EXPENSES

 

Other operating expenses for the three months ended March 31, 2016 and 2015 are summarized below:

 

		2016				2015
Professional fees		$	278,939			$	273,111
Telephone expenses			39,714				51,181
Office supplies, stationery, and printing			28,986				27,633
Insurance			112,049				102,924
Postage			6,665				2,666
Data processing			196,062				186,887
Advertising and marketing			35,222				61,083
FDIC Insurance			256,474				265,489
Other loan related expenses			69,918				107,959
Other			131,340				118,726
Total		$	1,155,369			$	1,197,664

 

NOTE 14 - COMMITMENTS AND CONTINGENCIES

 

From time to time, we are involved in routine legal matters incidental to our business. In the opinion of management, the ultimate resolution of such matters will not have a material adverse effect on our financial position, results of operations or liquidity.

 

NOTE 15 –LOSS PER COMMON SHARE

 

Basic loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding. Diluted loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding and dilutive common share equivalents using the treasury stock method. Potentially dilutive common share equivalents include common shares issuable upon the exercise of outstanding stock options and warrants.

 

For the period ended March 31, 2016 and 2015, there were no stock options outstanding. At March 31, 2016 and 2015, there were 571,821 warrant shares outstanding that were anti-dilutive. Warrants are considered anti-dilutive because the exercise price exceeded the average market price for the period.

 

Basic and diluted loss per share is computed below for the three months ended March 31, 2016 and 2015:

 

		2016				2015
Basic loss per common share computation:
Net loss available to common shareholders		$	(869,102	)		$	(729,464	)
Average common shares outstanding - basic			4,277,176				4,220,991
Basic net loss per common share		$	(.20	)		$	(.17	)
Diluted loss per common share computation:
Net loss available to common shareholders		$	(869,102	)		$	(729,464	)
Average common shares outstanding - basic			4,277,176				4,220,991
Incremental shares from assumed conversions:
Stock options and warrants			—				—
Average common shares outstanding - diluted			4,277,176				4,220,991
Diluted loss per common share		$	(.20	)		$	(.17	)

NOTE 16 - REGULATORY MATTERS

 

Regulatory Capital Requirements

 

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

 

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1250%. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets. Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. 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.

 

In July 2013, the federal bank regulatory agencies issued a final rule that has revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with certain standards that were developed by the Basel Committee on Banking Supervision (“Basel III”) and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The final rule applies to all depository institutions, such as the Bank, top-tier bank holding companies with total consolidated assets of $1 billion or more, and top-tier savings and loan holding companies, which we refer to below as “covered” banking organizations. Bank holding companies with less than $1 billion million in total consolidated assets, such as the Company, are not subject to the final rule.

 

As noted above, beginning on January 1, 2015, the Bank became subject to the provisions of Basel III, which revises Prompt Corrective Action (“PCA”) capital category thresholds to reflect new capital ratio requirements and introduces a Common Equity Tier 1 (“CET1”) ratio as a new PCA capital category threshold. Under the new rules, the minimum capital requirements for the Bank are now (i) a CET1 ratio of 4.5%, (ii) a Tier 1 risk-based capital ratio (CET1 plus Additional Tier 1 capital) of 6% (up from 4%) and (iii) a total risk-based capital ratio of 8% (which is unchanged from the prior requirement). The Bank is also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio. Under the revised PCA requirements, our leverage ratio will remain at the 4% level previously required. Beginning in 2016, a capital conservation buffer will phase in over three years, ultimately resulting in a requirement of 2.5% on top of the CET1, Tier 1 and total capital requirements, resulting in a required CET1 ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%.

 

Effective January 1, 2015, to be considered “well-capitalized” a bank is required to maintain a leverage capital ratio of at least 5%, a CET1 ratio of at least 6.5%, a Tier 1 risk-based capital ratio of at least 8%, and a total risk-based capital ratio of at least 10%. In addition, an institution (such as the Bank) cannot be considered well-capitalized if it is subject to any order or written directive to meet and maintain a specific capital level for any capital measure (such as the Consent Order). Under the Consent Order, the Bank must obtain and maintain a minimum amount of $35,821,000 in total capital in order to maintain a total risk-based capital ratio of 10% and $37,092,000 of Tier 1 capital in order to maintain a minimum leverage capital ratio of 8%. As of March 31, 2016, the Bank was deemed “adequately capitalized” and is not in compliance with the capital requirements of the Consent Order. As a result, we have been pursuing a plan to increase our capital ratios in order to strengthen our balance sheet and satisfy the commitments required under the Consent Order. However, if we continue to fail to meet the capital requirements in the Consent Order in a timely manner, then this would result in additional regulatory actions, which could ultimately lead to the Bank being taken into receivership by the FDIC. As of March 31, 2016 the Company was categorized as “critically undercapitalized.”

The following table summarizes the capital amounts and ratios of the Company and the regulatory minimum requirements at March 31, 2016 and December 31, 2015:

 

		Actual								For Capital Adequacy Purposes								To Be Well- Capitalized Under Prompt Corrective Action Provisions
Tidelands Bancshares, Inc.		Amount				Ratio				Amount				Ratio				Amount		Ratio
March 31, 2016
Common Equity Tier 1 (to risk-weighted assets)		$	(12,365,000	)			(3.45	%)		$	16,123,000				4.50	%		N/A		N/A
Total capital (to risk-weighted assets)			5,554,000				1.55	%			28,662,000				8.00	%		N/A		N/A
Tier 1 capital (to risk-weighted assets)			2,777,000				0.78	%			21,497,000				6.00	%		N/A		N/A
Tier 1 capital (to average assets)			2,777,000				0.60	%			18,566,000				4.00	%		N/A		N/A
December 31, 2015
Common Equity Tier 1 (to risk-weighted assets)		$	(11,496,000	)			(3.22	%)		$	16,093,000				4.50	%		N/A		N/A
Total capital (to risk-weighted assets)			7,871,000				2.20	%			28,610,000				8.00	%		N/A		N/A
Tier 1 capital (to risk-weighted assets)			3,936,000				1.10	%			21,457,000				6.00	%		N/A		N/A
Tier 1 capital (to average assets)			3,936,000				0.84	%			18,809,000				4.00	%		N/A		N/A

 

The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at March 31, 2016 and December 31, 2015:

 

		Actual								For Capital Adequacy Purposes								To Be Well- Capitalized Under Prompt Corrective Action Provisions
Tidelands Bank		Amount				Ratio				Amount				Ratio				Amount				Ratio
March 31, 2016
Common Equity Tier 1 (to risk-weighted assets)		$	25,428,000				7.10	%		$	16,119,000				4.50	%		$	21,493,000				6.00	%
Total capital (to risk-weighted assets)			29,281,000				8.17	%			28,657,000				8.00	%			35,821,000				10.00	%
Tier 1 capital (to risk-weighted assets)			25,428,000				7.10	%			21,493,000				6.00	%			28,657,000				8.00	%
Tier 1 capital (to average assets)			25,428,000				5.48	%			18,546,000				4.00	%			23,183,000				5.00	%
December 31, 2015
Common Equity Tier 1 (to risk-weighted assets)		$	25,715,000				7.19	%		$	16,090,000				4.50	%		$	21,453,000				6.00	%
Total capital (to risk-weighted assets)			29,778,000				8.33	%			28,604,000				8.00	%			35,755,000				10.00	%
Tier 1 capital (to risk-weighted assets)			25,715,000				7.19	%			21,453,000				6.00	%			28,604,000				8.00	%
Tier 1 capital (to average assets)			25,715,000				5.47	%			18,789,000				4.00	%			23,486,000				5.00	%

 

NOTE 17 - UNUSED LINES OF CREDIT

 

As of March 31, 2016, the Bank had a line of credit with Alostar Bank of Commerce of $6.0 million, Raymond James of $5.0 million, and $132,000 with the Federal Reserve Bank. These credit lines are currently secured by $6.5 million, $0, and $420,000, respectively in bonds as of March 31, 2016. The Raymond James line of credit is required to be secured by bonds prior to any disbursements. A line of credit is also available from the FHLB with a remaining credit availability of $55.5 million and an excess lendable collateral value of approximately $5.1 million at March 31, 2016.

 

NOTE 18 - SHAREHOLDERS’ EQUITY

 

Preferred Stock - In December 2008, in connection with the Troubled Asset Relief Program (the “TARP”) Capital Purchase Program (the “CPP”), established as part of the Emergency Economic Stabilization Act of 2008 (the “EESA”), the Company issued to the U.S. Treasury 14,448 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series T (the “Series T Preferred Stock”), having a liquidation preference of $1,000 per share. The Series T Preferred Stock qualifies as Tier 1 capital under Federal Reserve Board guidelines and was entitled to cumulative dividends at a rate of 5% per annum for the first five years, and beginning with the May 15, 2014 dividend date, is now entitled to a cumulative dividend at a rate of 9% per annum. We must consult with the Federal Reserve before we may redeem the Series T Preferred Stock. The Series T Preferred Stock has a call feature after three years.

 

In connection with the sale of the Series T Preferred Stock, the Company also issued to the U.S. Treasury a ten-year warrant to purchase up to 571,821 shares of the Company’s common stock (the “Warrants”), par value $0.01 per share at an initial exercise price of $3.79 per share. Please see the Form 8-K we filed with the SEC on December 19, 2008, for additional information about the Series T Preferred Stock and the Warrants.

 

As required under the TARP CPP, dividend payments on and repurchase of the Company’s common stock are subject to certain restrictions. For as long as the Series T Preferred Stock is outstanding, no dividends may be declared or paid on the Company’s common stock until all accrued and unpaid dividends on the Series T Preferred Stock are fully paid.

The Series T Preferred Stock and Warrants were sold to the U.S. Treasury for an aggregate purchase price of $14,448,000 in cash. The purchase price was allocated between the Series T Preferred Stock and the Warrants based upon the relative fair values of each to arrive at the amounts recorded by the Company. This resulted in the Series T Preferred Stock being issued at a discount which was amortized on a level yield basis and charged to retained earnings over the assumed life of five years.

 

The Company began deferring dividend payments on the Series T Preferred Stock beginning with the payment date of November 15, 2010. Although the Company may defer dividend payments, the dividend is a cumulative dividend and failure to pay dividends for six dividend periods triggered board appointment rights for the holder of the Series T Preferred Stock. The Treasury has appointed an observer to the Board. The Company deferred its 21st dividend payment in February 2016. As of March 31, 2016, the amount of cumulative unpaid dividends is $6,091,462.

 

In connection with the merger, the U.S. Treasury, by letter dated March 21, 2016, has confirmed that it is willing to consent to the redemption of all of the outstanding shares of the Company’s Series T Preferred Stock and Warrants that were issued to the Treasury under the CPP, plus unpaid dividends, for $9.0 million in the aggregate. Such redemption will take place immediately after the close of the merger.

 

Restrictions on Dividends - A South Carolina state bank may not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. The Bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the State Board, provided that the Bank received a composite rating of one or two at the last federal or state regulatory examination. The Bank must obtain approval from the State Board prior to the payment of any other cash dividends. In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. As described above on December 28, 2010, the Bank entered into the Consent Order with the FDIC and the State Board which, among other things, prohibits the Bank from declaring or paying any dividends or making any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities.

 

As described above, on March 18, 2011, the Company entered into the FRB Written Agreement with the FRB which, among other things, prohibits the Company’s declaring or paying any dividends or directly or indirectly take dividends or any other form of payment representing a reduction in capital from the Bank without the prior approval of the FRB.

 

Further, as a result of the Company’s deferral of dividend payments on its Series T Preferred Stock issued to the U.S. Treasury pursuant to the CPP and deferral of interest payments on its junior subordinated debentures, the Company is prohibited from paying any dividends on its common stock until all deferred payments have been made in full.

 

NOTE 19 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by the other party to the instrument is represented by the contractual notional amount of the instrument. Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments to extend credit as it does for on-balance-sheet instruments. Standby letters of credit are conditional commitments issued to guarantee a customer’s performance to a third party and have essentially the same credit risk as other lending facilities. At March 31, 2016, the Bank had $18,000 reserved for off-balance sheet credit exposure related to unfunded commitments, which is included in other liabilities on our consolidated balance sheet.

 

Collateral held for commitments to extend credit and letters of credit varies but may include accounts receivable, inventory, property, plant, equipment and income-producing commercial properties.

 

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2016.

 

		Amount
Commitments to extend credit		$	21,728,953
Standby letters of credit			479,776
Total		$	22,208,729

NOTE 20 - EMPLOYEE STOCK OWNERSHIP PLAN

 

On May 17, 2007, the Company announced the formation of the Tidelands Bancshares, Inc. Employee Stock Ownership Plan (“ESOP”), a non-contributory plan, for its employees. The ESOP will purchase shares of the Company’s common stock on the open market from time to time with funds borrowed from a loan from a third party lender. All employees of the Company meeting certain tenure requirements are entitled to participate in the ESOP. There was no compensation expense related to the ESOP for the three months ended March 31, 2016 and 2015.

 

During 2014, all shares available were allocated to all eligible participants.

 

NOTE 21 – RETIREMENT PLAN

 

The Company has a 401(k) profit sharing plan, which provides retirement benefits to a majority of officers and employees who meet certain age and service requirements. The plan includes a “salary reduction” feature pursuant to Section 401(k) of the Internal Revenue Code. Expenses charged to earnings for the 401(k) profit sharing plan were $26,661 and $23,939, for the three months ended March 31, 2016 and 2015, respectively.

 

The Bank has a Supplemental Executive Retirement Plan (Supplemental Plan). This plan provides an annual post-retirement cash payment beginning after a chosen retirement date for certain officers of the Bank. The officers will receive an annual payment from the Bank equal to the promised benefits. In connection with this plan, life insurance contracts were purchased on the officers. Effective June 30, 2010, the executive officers agreed to cease further benefit accrual under the contracts and will only be entitled to receive benefits accrued through June 30, 2010. As a result, there was no expense related to the plan for the three months ended March 31, 2016 and 2015.

 

As of March 31, 2016, total benefits expected to be paid in future periods equal $731,291, such payments commenced during 2012 in the amount of $2,239. Total benefits expected to be paid between the years 2016 and 2021 equal $273,935 with $457,356 remaining in the years thereafter.

 

NOTE 22 – SUBSEQUENT EVENTS

 

On April 4, 2016, the Company entered into an merger agreement United. Under the merger agreement, the Company will merge with and into United and the Bank will merge with and into United’s wholly-owned subsidiary bank, United Community Bank.

 

In the merger, the Company’s common shareholders will receive $0.52 in cash for each share of the Company’s common stock, or approximately $2.2 million in the aggregate. Additionally, the U.S. Treasury, by letter dated March 21, 2016, has confirmed that it is willing to consent to the redemption of all of the outstanding shares of the Company’s Series T Preferred Stock and Warrants that were issued to the Treasury under the CPP, plus unpaid dividends, for $9.0 million in the aggregate. Such redemption will take place immediately after the close of the merger.

 

In addition, in connection with the merger, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments. The assumption is conditioned on United’s payment of all amounts required to bring current the payment of interest (including deferred interest) on the trust preferred securities.

 

The merger agreement has been unanimously approved by the boards of directors of each of the Company and United. The closing of the merger is subject to the required approval of the Company’s common shareholders, requisite regulatory approvals and other customary closing conditions.

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

 

The following is a discussion of our financial condition as of March 31, 2016 compared to December 31, 2015 and the results of operations for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. These comments should be read in conjunction with our consolidated financial statements and accompanying footnotes appearing in this report and in conjunction with the financial statements and related notes and disclosures in our 2015 Annual Report on Form 10-K.

 

Overview

 

We are a South Carolina corporation organized in 2002 to serve as the holding company for Tidelands Bank (the “Bank”), a state-chartered banking association under the laws of South Carolina headquartered in Mount Pleasant, South Carolina. The Bank commenced operations in October 2003 through our main office located in Mount Pleasant, South Carolina. On April 23, 2007, we opened a permanent full service banking facility in our Summerville, South Carolina location. We opened a permanent facility for our full service branch in Myrtle Beach, South Carolina on June 7, 2007. In addition, we opened a new full service branch office in the Park West area of Mount Pleasant, South Carolina on May 14, 2007, and converted the loan production office in the West Ashley area of Charleston, South Carolina to a full service branch on July 2, 2007. The Bluffton, South Carolina loan production office opened as a full service banking facility on May 21, 2008. On July 23, 2008, we opened a permanent full service banking facility in Murrells Inlet, South Carolina. We plan to focus our efforts at these branch locations on obtaining lower cost deposits that are less affected by rising rates.

 

Like most community banks, we derive most of our income from interest we receive on our loans and investments. In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities. There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a detailed discussion of this process.

 

We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

 

Critical Accounting Policies

 

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our unaudited consolidated financial statements as of March 31, 2016 and our audited consolidated financial statements included in our 2015 Annual Report on Form 10-K.

 

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

We believe other real estate is a critical accounting policy that requires significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our other real estate include judgments about the estimated value of the property, the impact of current events, and conditions and other factors impacting the value. Under different conditions or using different assumptions, the actual value of other real estate determined by us may be different from management’s estimates provided in our consolidated financial statements.

 

Proposed Merger With United Community Bank, Inc.

 

On April 4, 2016, the Company entered into an Agreement and Plan of Merger (the “merger agreement”) with United Community Banks, Inc. (“United”). Under the merger agreement, the Company will merge with and into United and the Bank will merge with and into United’s wholly-owned subsidiary bank, United Community Bank.

 

In the merger, the Company’s common shareholders will receive $0.52 in cash for each share of the Company’s common stock, or approximately $2.2 million in the aggregate. Additionally, the United States Department of Treasury (the “Treasury”), by letter dated March 21, 2016, has confirmed that it is willing to consent to the redemption of all of the outstanding shares of the Company’s fixed-rate cumulative preferred stock (the “Series T Preferred Stock”) and Warrants to purchase the Company’s common stock that were issued to the Treasury under the Treasury’s Capital Purchase Program, plus unpaid dividends, for $9.0 million in the aggregate. Such redemption will take place immediately after the close of the merger.

 

In addition, in connection with the merger, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing the Company into involuntary bankruptcy. The assumption is conditioned on United’s payment of all amounts required to bring current the payment of interest (including deferred interest) on the trust preferred securities.

 

The merger agreement has been unanimously approved by the boards of directors of each of the Company and United. The closing of the merger is subject to the required approval of the Company’s common shareholders, requisite regulatory approvals and other customary closing conditions.

 

Financial and Regulatory Developments

 

I.

Federal Reserve Board

 

As reported in our Current Report on Form 8-K filed on March 22, 2011, the Company entered into a written agreement (the “FRB Agreement”) with the Federal Reserve Bank of Richmond (“FRB”) on March 18, 2011. The FRB Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank. The Bank’s lending and deposit operations continue to be conducted in the usual and customary manner, and all other products, services and hours of operation remain the same. All Bank deposits will remain insured by the FDIC to the maximum extent allowed by law.

 

Pursuant to the FRB Agreement, the Company agreed to seek the prior written approval of the FRB before (i) declaring or paying any dividends, (ii) directly or indirectly taking dividends or any other form of payment representing a reduction in capital from the Bank, (iii) directly or indirectly making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities, (iv) directly or indirectly incurring, increasing or guaranteeing any debt, or (v) directly or indirectly purchasing or redeeming any shares of its stock.

 

Pursuant to its plans to preserve capital and to inject more capital into the Bank, the Company has no plans to undertake any of the foregoing activities.

The Company submitted, and the FRB approved, a written plan designed to maintain sufficient capital at the Company on a consolidated basis. Although the FRB Agreement does not contain specific target capital ratios or specific timelines, the plan must address the Company’s and Bank’s current and future capital requirements, the adequacy of the Bank’s capital, the source and timing of additional funds to satisfy the Company’s and the Bank’s future capital requirements, and supervisory requests for additional capital at the Bank or the supervisory action imposed on the Bank.

 

The Company also agreed to comply with certain notice provisions set forth in the Federal Deposit Insurance Act and Board of Governors’ Regulations in appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position. The Company is also required to comply with certain restrictions on indemnification and severance payments pursuant to the Federal Deposit Insurance Act and FDIC regulations. The Company is providing quarterly progress reports to the FRB on all provisions of the FRB Agreement.

 

II.

FDIC and South Carolina State Board

 

On June 1, 2010, the FDIC and the State Board conducted their annual joint examination of the Bank. As a result of the examination, the Bank entered into a Consent Order, effective December 28, 2010 (the “Consent Order”), with the FDIC and the State Board. The Consent Order requires the Bank to, among other things, take the following actions:

 

●

Establish, within 60 days from the effective date of the Consent Order, a board committee to monitor compliance with the Consent Order, consisting of at least four members of the board, three of whom shall not be officers of the Bank. This requirement has been completed by the Bank.

 

●

Develop, within 60 days from the effective date of the Consent Order, a written management plan that addresses specific areas in the Joint Report of Examinations dated as of June 1, 2010. This requirement has been completed by the Bank.

 

●

Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers and provide prior notification and approval for any new directors or senior executive officers. This requirement has been completed by the Bank.

 

●

Achieve and maintain, within 150 days from the effective date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. The Bank is not in compliance with this requirement.

 

●

Establish, within 60 days from the effective date of the Consent Order, a written capital plan to include a contingency plan in the event the Bank fails to maintain minimums, submit an acceptable capital plan as required by the Consent Order, or implement or adhere to the capital plan to which supervisory authorities have taken no objections. Such contingency plan must include a plan to sell or merge the Bank. The Bank must implement the contingency plan upon written notice from the Regional Director. This requirement has been completed by the Bank.

 

●

Adopt and implement, within 60 days from the effective date of the Consent Order, a written plan addressing liquidity, contingency funding, and asset /liability management. This requirement has been completed by the Bank.

 

●

Eliminate, within 30 days from the effective date of the Consent Order, by charge-off or collection, all assets or portions of assets classified “Loss,” and during the Consent Order, within 30 days of receipt of any Report of Examination, eliminate by collection, charge-off, or other proper entry, the remaining balance of any assets classified as “Loss” and 50% of those assets classified “Doubtful”. This requirement has been completed by the Bank. The Bank is in compliance with this continuing requirement.

 

●

Submit, within 60 days from the effective date of the Consent Order, a written plan to reduce the Bank’s risk exposure in relationships with assets in excess of $500,000 criticized as “Substandard” in the Report of Examination. The plan must require a reduction in the aggregate balance of assets criticized as “Substandard” in accordance with the following schedule: (i) within 180 days, a reduction of 25% in the balance of assets criticized “Substandard; (ii) within 360 days, a reduction of 45% in the balance of assets criticized “Substandard; (iii) within 540 days, a reduction of 60% in the balance of assets criticized “Substandard; and (iv) within 720 days, a reduction of 70% in the balance of assets criticized “Substandard.” The Bank is in compliance with this ongoing requirement.

●

Not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, “Loss,” and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or in part, “Substandard,” and is uncollected, unless the Bank’s board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank. The Bank is in compliance with this requirement.

 

●

Prepare and submit, within 90 days from the effective date of the Order, a plan consisting of long term goals designed to improve the condition of the Bank and its viability, and strategies for achieving those goals. The plan must cover minimum of three years and provide specific objectives for asset growth, market focus, earnings projections, capital needs, and liquidity position. The Bank is in compliance with this requirement.

 

●

Adopt, within 60 days from the effective date of the Consent Order, an effective internal loan review and grading system to provide for the periodic review of the Bank’s loan portfolio in order to identify and categorize the Bank’s loans, and other extensions of credit which are carried on the Bank’s books as loans, on the basis of credit quality. This requirement has been completed by the Bank.

 

●

Perform, within 60 days from the effective date of the Consent Order, a risk segmentation analysis with respect to the Bank’s concentrations of credit and develop a written plan to reduce any segment of the portfolio which the supervisory authorities deem to be an undue concentration of credit in relation to Tier 1 capital. The Bank is working to reduce concentrations within required thresholds.

 

●

Review and establish, within 60 days from the effective date of the Consent Order, a policy to ensure the adequacy of the Bank’s allowance for loan and lease losses, which must provide for a review of the Bank’s allowance for loan and lease losses at least once each calendar quarter. This requirement has been completed by the Bank.

 

●

Formulate and implement, within 60 days from the effective date of the Consent Order, a written plan to improve and sustain Bank earnings, which shall include (i) goals and strategies for improving and sustaining earnings; (ii) major areas and means by which to improve operating performance; (iii) realistic and comprehensive budget; (iv) budget review process to monitor income and expenses to compare with budgetary projections; (v) operating assumptions forming the basis for, and adequately support, major projected income and expense components; and (vi) coordination of the Bank’s loan, investment, and operating policies and budget and profit planning with the funds management policy. The written plan must be evaluated at the end of each calendar quarter and record results and any actions taken by the Board in minutes. The Bank is in compliance with this ongoing requirement.

 

●

Revise, adopt and implement, within 60 days of the effective date of the Consent Order, the Bank’s written asset/liability management policy to provide effective guidance and control over the Bank’s funds management activities, which shall also address all items of criticism set forth in the Joint Report of Examinations in June 2010. This requirement has been completed by the Bank.

 

●

Develop and implement, within 60 days of the effective date of the Consent Order, a written policy for managing interest rate risk in a manner that is appropriate to the size of the Bank and the complexity of its assets. The policy shall comply with the Joint Inter-Agency Policy Statement on Interest Rate Risk. This requirement has been completed by the Bank.

 

●

Eliminate or correct, within 30 days from the effective date of the Consent Order, all violations of law and regulation or contraventions of FDIC guidelines and statements of policy described in the Joint Report of Examinations in June 2010. This requirement has been completed by the Bank.

 

●

Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities. The Bank is in compliance with this ongoing requirement.

 

●

Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b), and, within 60 days of the effective date of the Consent Order, submit a written plan to the supervisory authorities for eliminating reliance on brokered deposits. This requirement has been completed by the Bank.

 

●

Limit asset growth to 10% per annum. The Bank is in compliance with this ongoing requirement.

●

Adopt, within 60 days of the effective date of the Consent Order, an employee compensation plan after undertaking an independent review of compensation paid to all the Bank’s senior executive officers, as defined at Section 301.101(b) of the FDIC Rules and Regulations. This requirement has been completed by the Bank.

 

●

Furnish, within 30 days from the end of the first quarter following the effective date of the Consent Order, and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order. The Bank is in compliance with this ongoing requirement.

 

We have taken actions to comply with the requirements of both the FRB Agreement and the Consent Order. All of the requirements of the consent order except for the following two have been completed: (1) capital levels are below the thresholds of 10% for Total Risk-Based Capital and 8% for Tier 1 Leverage Capital and (2) credit concentrations within the portfolio continue to decrease, but remain elevated.

 

The Bank presents monthly updates to the Board of Directors regarding compliance with the FRB Agreement and the Consent Order, and quarterly updates to the regulators on all provisions. We continue to focus our efforts on meeting the objectives in these two documents designed to improve the Bank’s financial condition and enable the Bank to meet regulatory requirements.

 

The determination of our compliance with the regulatory requirements will be made by the FDIC and the South Carolina State Board. Failure to comply with the requirements could result in additional regulatory pressures and, if the Bank is unable to comply, could ultimately lead to further action by the FDIC including the Bank being taken into receivership by the FDIC.

Results of Operations

 

Income Statement Review

 

Summary

 

Three months ended March 31, 2016 and 2015

 

Our net loss available to common shareholders was approximately $869,000 for the three months ended March 31, 2016, compared to a net loss available to common shareholders of $729,000 for the three months ended March 31, 2015. The pre-tax net loss for the three months ended March 31, 2016 was $420,000 compared to $316,000 for the three months ended March 31, 2015. We recorded no provisions for loan losses for the three months ended March 31, 2016 and 2015. For both the three months ended March 31, 2016 and 2015, there was no income tax expense or benefit.

 

In comparing the three months ended March 31, 2016 and 2015, the increase in pre-tax net loss from $316,000 to $420,000 resulted primarily from an increase of $172,000 in noninterest expense offset by an increase of $74,000 in net interest income. The increase in net interest income is a result of an increase in yield on interest earning assets and a decrease in yield on interest bearing liabilities.

 

Net Interest Income

 

Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. The growth in our loan portfolio has historically been the primary driver of the increase in net interest income. During the three months ended March 31, 2016, our loan portfolio decreased $166,000 from the year-end balance. We anticipate any growth in loans will drive growth in assets and growth in net interest income.

 

Our loans typically provide higher interest yields than other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio. This strategy resulted in a significant portion of our assets being in higher earning loans rather than in lower yielding investments. At March 31, 2016, loans represented 70.0% of total assets, while securities and interest bearing balances represented 18.8% of total assets. While we focus on increasing the size of our loan portfolio, we also anticipate managing the size of the investment portfolio as investment yields become more attractive.

 

At March 31, 2016, retail deposits represented $413.3 million, or 91.5% of total funding, which includes total deposits plus borrowings. Borrowings represented $38.4 million, or 8.5% of total funding, and we had no wholesale deposits. We plan to continue to offer competitive rates on our retail deposit accounts, including investment checking, money market accounts, savings accounts and time deposits. Our goal is to maintain a higher percentage of assets being funded by retail deposits and to increase the percentage of low-cost transaction accounts to total deposits. No assurance can be given that these objectives will be achieved. We operate seven full service banking offices located along the South Carolina coast. We anticipate that our full service banking offices will assist us in meeting these objectives. We believe these strategies will provide us with additional customers and a lower alternative cost of funding.

 

In addition to the growth in both assets and liabilities, and the timing of the repricing of our assets and liabilities, net interest income is also affected by the ratio of interest-earning assets to interest-bearing liabilities and the changes in interest rates earned on our assets and interest rates paid on our liabilities. For the three months ended March 31, 2016, average interest-bearing liabilities exceeded average interest-earning assets by $8.4 million compared to $15.9 million for the three months ended March 31, 2015.

 

Net interest margin increased to 2.97% for the three months ended March 31, 2016, as a result of the Bank’s higher yield on interest earning assets and lower yield and volume of interest bearing liabilities. Net interest margin for the three months ended March 31, 2015 was 2.89%.

Three Months Ended March 31, 2016 and 2015

 

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. All investments were owned at an original maturity of over one year.

 

Average Balances, Income and Expenses, and Rates

 

		For the Three Months Ended  March 31, 2016												For the Three Months Ended  March 31, 2015
		Average  Balance				Income/  Expense				Yield/  Rate(1)				Average  Balance				Income/  Expense				Yield/  Rate(1)
		(dollars in thousands)
Earning assets:
Interest bearing balances		$	7,772			$	21				1.10	%		$	15,842			$	18				0.47	%
Taxable investment securities			77,982				345				1.78	%			79,993				356				1.80	%
Loans receivable(2)			324,732				3,879				4.80	%			319,330				3,824				4.86	%
Total earning assets			410,486				4,245				4.16	%			415,165				4,198				4.10	%
Nonearning assets:
Cash and due from banks			5,150												3,417
Mortgages held for sale			169												201
Premises and equipment, net			19,629												20,664
Other assets			32,675												37,041
Allowance for loan losses			(3,960	)											(4,763	)
Total nonearning assets			53,663												56,560
Total assets		$	464,149											$	471,725
Interest-bearing liabilities:
Interest bearing transaction accounts		$	36,270				10				0.11	%		$	35,433				16				0.19	%
Savings & money market			106,408				83				0.31	%			101,226				93				0.38	%
Time deposits less than $100,000			87,604				275				1.26	%			96,555				297				1.25	%
Time deposits greater than $100,000			153,794				509				1.33	%			164,385				545				1.34	%
Securities sold under repurchase agreement			10,000				111				4.47	%			10,000				110				4.46	%
Advances from FHLB			10,358				92				3.55	%			9,000				89				4.01	%
Junior subordinated debentures			14,434				133				3.71	%			14,434				91				2.54	%
ESOP borrowings			—				—				0.00	%			—				—				0.00	%
Total interest-bearing liabilities			418,868				1,213				1.16	%			431,033				1,241				1.17	%
Noninterest-bearing liabilities:
Demand deposits			32,039												26,246
Other liabilities			11,022												8,902
Shareholders’ equity			2,220												5,544
Total liabilities and shareholders’ equity		$	464,149											$	471,725
Net interest income						$	3,032											$	2,957
Net interest spread											2.99	%											2.93	%
Net interest margin											2.97	%											2.89	%

 

(1)

Annualized for the three month period.

 

(2)

Includes nonaccruing loans

During the three months ended March 31, 2016, the net interest spread and net interest margin increased in comparison to the previous period in 2015. Our net interest spread was 2.99% and 2.93% for the three months ended March 31, 2016 and 2015, respectively. This increase in net interest spread was due to the yield on average earning assets increasing by 0.06% and by the average rate on total funding decreasing by 0.01%. Our net interest margin for the three months ended March 31, 2016 was 2.97% compared to 2.89% for the three months ended March 31, 2015. During the first quarter of 2016, interest-earning assets averaged $410.5 million, compared to $415.2 million in the same quarter of 2015. During the same periods, average interest-bearing liabilities were $418.9 million and $431.0 million, respectively.

 

Interest income for the three months ended March 31, 2016 was $4.2 million, consisting of $3.9 million on loans, $345,000 on investments, and $11,000 on interest bearing deposits. Interest income for the three months ended March 31, 2015 was $4.2 million, consisting of $3.8 million on loans, $356,000 on investments, and $10,000 on interest bearing deposits. Interest and fees on loans represented 91.4% and 91.1% of total interest income for the three months ended March 31, 2016 and 2015, respectively. Income from investments and interest bearing deposits represented 8.4% and 8.7% of total interest income for the three months ended March 31, 2016 and 2015, respectively. The higher percentage of interest income from loans relates to our strategy to maintain a significant portion of our assets in higher earning loans compared to lower yielding investments. Average loans represented 72.3% and 76.9% of average interest-earning assets for the three months ended March 31, 2016 and 2015, respectively.

 

Interest expense for the three months ended March 31, 2016 was $1.2 million, consisting of $877,000 related to deposits, $111,000 related to securities sold under repurchase agreements, $133,000 related to junior subordinated debentures, and $92,000 related to FHLB advances. Interest expense for the three months ended March 31, 2015 was $1.2 million, consisting of $953,000 related to deposits, $110,000 related to securities sold under repurchase agreements, $91,000 related to junior subordinated debentures, and $89,000 related to FHLB advances. Interest expense on deposits for the three months ended March 31, 2016 and 2015 represented 72.3% and 76.7%, respectively, of total interest expense, while interest expense on other liabilities represented 27.7% and 23.3%, respectively, of total interest expense for the three months ended March 31, 2016 and 2015, respectively. During the three months ended March 31, 2016, average interest-bearing liabilities were lower than the comparable period ended March 31, 2015 by $12.2 million.

 

Rate/Volume Analysis

 

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following table sets forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

 

		Three Months Ended  March 31, 2016 vs. March 31, 2015																Three Months Ended  March 31, 2015 vs. March 31, 2014
		Increase (Decrease) Due to																Increase (Decrease) Due to
		Volume				Rate				Rate/ Volume				Total				Volume				Rate				Rate/ Volume				Total
		(dollars in thousands)
Interest income
Loans		$	(10	)		$	24			$	(12	)		$	2			$	(129	)		$	6			$	—			$	(123	)
Taxable investment securities			(9	)			(5	)			—				(14	)			(12	)			(74	)			2				(84	)
Interest bearing balances			65				(43	)			(1	)			21				7				(5	)			(2	)			—
Total interest income			46				(24	)			(13	)			9				(134	)			(73	)			—				(207	)
Interest expense
Deposits			(17	)			(58	)			1				(74	)			(16	)			10				—				(6	)
Junior subordinated debentures			—				42				—				42				—				(25	)			—				(25	)
Advances from FHLB			13				(9	)			(1	)			3				(27	)			38				(12	)			(1	)
Securities sold under repurchase  agreements			—				1				—				1				—				—				—				—
ESOP borrowings			—				—				—				—				—				—				—				—
Total interest expense			(4	)			(24	)			—				(28	)			(43	)			23				(12	)			(32	)
Net interest income		$	50			$	—			$	(13	)		$	37			$	(91	)		$	(96	)		$	12			$	(175	)

Provision for Loan Losses

 

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of operations. We review our loan portfolio monthly to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Balance Sheet Review – Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

 

Three Months Ended March 31, 2016 and 2015

 

We had no expense related to the provision for loan losses for the three months ended March 31, 2016 and 2015. The allowance for loan losses was approximately $3.8 million and $4.8 million as of March 31, 2016 and 2015, respectively. The allowance for loan losses as a percentage of gross loans was 1.18% at March 31, 2016 and 1.50% at March 31, 2015. At March 31, 2016, we had 23 nonaccrual loans totaling approximately $7.3 million compared to 25 nonaccrual loans totaling approximately $9.6 million at March 31, 2015. Net (recoveries) amounted to approximately ($45,000) in each of the three months ended March 31, 2016 and 2015.

 

Noninterest Income

 

The following table sets forth information related to our noninterest income during the three months ended March 31, 2016 and 2015:

 

		2016				2015
		(dollars in thousands)
Service fees on deposit accounts		$	10			$	10
Residential mortgage origination income			38				48
Gain on sale of investment securities			—				6
Loss on sale of other assets			(2	)			(2	)
Other service fees and commissions			157				144
Bank owned life insurance			104				105
Other			2				5
Total noninterest income		$	309			$	316

 

Three Months Ended March 31, 2016 and 2015

 

Noninterest income for the three months ended March 31, 2016 was $309,000 compared to $316,000 during the same period in 2015. The decrease was primarily attributable to a decrease in residential mortgage origination income of $10,000 and a decrease in gain on sale of investment securities of $6,000, partially offset by a $13,000 increase in other service fees and commissions. Residential mortgage origination income consists primarily of mortgage origination fees we receive on residential loans sold to third parties. Residential mortgage origination fees were $38,000 and $48,000 for the three months ended March 31, 2016 and 2015, respectively. The decrease of $10,000 is related primarily to a decrease in origination volume in the mortgage department during the first quarter of 2016. The increase in other service fees was primarily related to an increase in loan origination fees.

 

We also earned $104,000 and $105,000 in noninterest income received from bank owned life insurance for both the three months ended March 31, 2016 and 2015, respectively. Other income consists primarily of income received on fees received on debit and credit card transactions, income from sales of checks, and the fees received on wire transfers. Other income was $2,000 and $5,000 for the three months ended March 31, 2016 and 2015, respectively.

Noninterest Expense

 

The following table sets forth information related to our noninterest expense for the three months ended March 31, 2016 and 2015:

 

		2016				2015
		(dollars in thousands)
Salaries and benefits		$	1,689			$	1,636
Occupancy			411				449
Furniture and equipment expense			165				177
Other real estate owned expense			341				129
Professional fees			278				273
Advertising and marketing			35				61
Insurance			113				103
FDIC assessment			256				265
Data processing and related costs			196				187
Telephone			40				51
Postage			7				3
Office supplies, stationery and printing			29				28
Other loan related expense			70				108
Other			131				119
Total noninterest expense		$	3,761			$	3,589

 

Three Months Ended March 31, 2016 and 2015

 

We incurred noninterest expense of approximately $3.8 million for the three months ended March 31, 2016 compared to $3.6 million for the three months ended March 31, 2015. The differences resulted primarily from increases of $212,000 in other real estate owned expenses and $53,000 in salaries and benefits, offset by decreases of $38,000 in other loan related expenses, $26,000 in advertising and marketing expenses, and $38,000 in occupancy expenses.

 

Salaries and employee benefits expense was approximately $1.7 million and $1.6 million for the three months ended March 31, 2016 and 2015, respectively. These expenses represented 45.8% and 45.6% of our total noninterest expense for the three months ended March 31, 2016 and 2015, respectively. The $53,000 increase in salaries and employee benefits expense resulted from increases in base compensation.

 

Other real estate owned expense was $341,000 and $129,000 for the three months ended March 31, 2016 and 2015, respectively. The difference resulted primarily from write-downs of $384,000 in property values in the three months ended March 31, 2016.

 

Data processing and related costs were $196,000 and $187,000 for the three months ended March 31, 2016 and 2015, respectively. During the three months ended March 31, 2016, our data processing costs for our core processing system were $136,000 compared to $160,000 for the three months ended March 31, 2015. This decrease is due to the new contract we negotiated with Fidelity in 2015. We have contracted with an outside computer service company to provide our core data processing services. A significant portion of the fee charged by our third party processor is directly related to the number of loan and deposit accounts and the related number of transactions.

 

Income Tax Expense

 

Three Months Ended March 31, 2016 and 2015

 

Our lack of income tax expense or benefit for March 31, 2016 and 2015 is reflective of our establishing a valuation allowance for deferred tax assets previously recorded. Management has determined that it is more likely than not that the deferred tax asset related to continuing operations at March 31, 2016 will not be realized, and accordingly, has established a full valuation allowance.

Balance Sheet Review

 

General

 

At March 31, 2016, we had total assets of $464.2 million, consisting principally of $321.2 million in loans, $74.6 million in investment securities, $11.4 million in interest bearing balances, $19.5 million in net premises, furniture and equipment, $16.8 million in bank owned life insurance, $11.9 million in other real estate owned and $4.6 million in cash and due from banks. Our liabilities at March 31, 2016 totaled $462.7 million, consisting principally of $413.3 million in deposits, $10.0 million in securities sold under agreements to repurchase, $14.4 million in junior subordinated debentures, and $14.0 million in FHLB advances. At March 31, 2016, our shareholders’ equity was $1.5 million.

 

Investments

 

At March 31, 2016, the $74.6 million in our investment securities portfolio represented approximately 16.1% of our total assets, compared to $78.1 million, or 16.8% of total assets, at December 31, 2015. At March 31, 2016, we held U.S. treasuries, U.S. government agency securities, government sponsored enterprises, small business administration securities, and mortgage-backed securities with a fair value of $74.7 million and an amortized cost of $75.5 million for a net unrealized loss of $828,000. During 2016 and 2015, we utilized the investment portfolio to provide additional income and to absorb liquidity. We anticipate maintaining an investment portfolio to provide both increased earnings and liquidity. As deposit growth outpaces our ability to lend to creditworthy customers, we anticipate maintaining the relative size of the investment portfolio and extinguishing other funding liabilities.

 

Contractual maturities and yields on our investments at March 31, 2016 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		One year or less								After one year through five years								After five years through ten years								After ten years								Total
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
		(dollars in thousands)
Available for Sale:
Government- sponsored enterprises		$	—				—	%		$	10,030				1.17	%		$	—				—	%		$	1,821				3.08	%		$	11,851				1.46	%
US Treasuries			—				—	%			4,493				1.07	%			—				—	%			—				—	%			4,493				1.07	%
SBA loan pools			—				—	%			—				—	%			916				2.17	%			9,171				2.08	%			10,087				2.09	%
Mortgage-backed securities			—				—	%			40				1.46	%			56				0.91	%			42,875				1.80	%			42,971				1.80	%
Total		$	—				—	%		$	14,563				1.14	%		$	972				2.10	%		$	53,867				1.89	%		$	69,402				1.67	%
		One year or less								After one year through five years								After five years through ten years								After ten years								Total
		Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield				Amount				Yield
		(dollars in thousands)
Held to Maturity:
Government-sponsored enterprises		$	—				—	%		$	—				—	%		$	2,004				2.34	%		$	1,006				3.30	%		$	3,010				2.66	%
Mortgage-backed securities			—				—	%			—				—	%			—				—	%			1,230				2.66	%			1,230				2.66	%
SBA loan pools securities			—				—	%			—				—	%			1,005				2.28	%			—				—	%			1,005				2.28	%
Total		$	—				—	%		$	—				—	%		$	3,009				2.32	%		$	2,236				2.95	%		$	5,245				2.59	%

 

At March 31, 2016, our investments included government sponsored enterprises with amortized costs of approximately $11.8 million, U.S. Treasuries with amortized costs of approximately $4.5 million, and small business administration surety bonds with amortized costs of approximately $10.1 million. Mortgage-backed securities consist of securities issued by the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation and Government National Mortgage Association with amortized costs of approximately $6.0 million, $16.3 million and $22.8 million, respectively.

 

Other nonmarketable equity securities at March 31, 2016 consisted of Federal Home Loan Bank stock with a cost of $1.0 million and other investments of approximately $63,150.

The amortized costs and the fair value of our investments at March 31, 2016 and December 31, 2015 are shown in the following table.

 

		March 31, 2016								December 31, 2015
		Amortized  Cost				Fair  Value				Amortized  Cost				Fair  Value
		(dollars in thousands)
Available for Sale:
US Treasuries		$	4,477			$	4,493			$	4,461			$	4,475
Government-sponsored enterprises			11,816				11,851				13,814				13,774
SBA loan pools			10,144				10,088				10,372				10,160
Mortgage-backed securities			43,845				42,970				45,815				44,445
Total		$	70,282			$	69,402			$	74,475			$	72,854

 

		March 31, 2016								December 31, 2015
		Amortized  Cost				Fair  Value				Amortized  Cost				Fair  Value
		(dollars in thousands)
Held to Maturity:
Government-sponsored enterprises			3,010				3,074				3,011				3,016
SBA loan pools			1,230				1,213				1,007				1,003
Mortgage-backed securities		$	1,005			$	1,011			$	1,237			$	1,203
Total		$	5,245			$	5,298			$	5,255			$	5,222

 

Loans

 

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Average loans at March 31, 2016 and December 31, 2015 were $324.7 million and $321.3 million, respectively. Gross loans outstanding at March 31, 2016 and December 31, 2015 were $325.0 million and $324.2 million, respectively.

 

Loans secured by real estate mortgages are the principal component of our loan portfolio. Most of our real estate loans are secured by residential or commercial property. We do not generally originate traditional long term residential mortgages for the portfolio, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 85%. The current mix may not be indicative of the ongoing portfolio mix. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral.

 

The following table summarizes the composition of our loan portfolio at March 31, 2016 and December 31, 2015.

 

		March 31, 2016								December 31, 2015
						% of								% of
		Amount				Total				Amount				Total
		(dollars in thousands)
Commercial
Commercial and industrial		$	26,220				8.1	%		$	23,978				7.4	%
Real Estate
Mortgage			251,757				77.4	%			253,617				78.3	%
Construction			42,484				13.1	%			42,696				13.1	%
Total real estate			294,241				90.5	%			296,313				91.4	%
Consumer
Consumer			4,740				1.4	%			4,059				1.2	%
Total Gross Loans			325,200				100.0	%			324,350				100.0	%
Deferred origination fees, net			(155	)			(0.0	%)			(139	)			(0.0	%)
Total gross loans, net of deferred fees			325,045				100.0	%			324,211				100.0	%
Less: allowance for loan losses			(3,835	)							(4,045	)
Total loans, net		$	321,210							$	320,166

Maturities and Sensitivity of Loans to Changes in Interest Rates

 

The information in the following table is based on the contractual maturities of individual loans, including loans that may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

 

The following table summarizes the loan maturity distribution by type and related interest rate characteristics at March 31, 2016:

 

		One year  or less				After one but  within five years				After five  years				Total
		(dollars in thousands)
Commercial		$	5,351			$	18,814			$	2,055			$	26,220
Real estate			44,124				199,294				50,822				294,240
Consumer			1,256				2,965				519				4,740
Deferred origination fees			(31	)			(122	)			(2	)			(155	)
Total gross loans, net of deferred fees		$	50,700			$	220,951			$	53,394			$	325,045
Gross loans maturing after one year with:
Fixed interest rates														$	200,984
Floating interest rates															73,485
Total														$	274,469

 

Allowance for Loan Losses and Provisions

 

We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of operations. The allowance is maintained at a level deemed appropriate by management to provide adequately for known and inherent losses in the portfolio. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.

 

More specifically, in determining our allowance for loan losses, we review loans for specific and impaired reserves based on current appraisals less estimated closing costs. General and unallocated reserves are determined using historical loss trends applied to risk rated loans grouped by FDIC call report classification code. The general and unallocated reserves are calculated by applying the appropriate historical loss ratio to the loan categories grouped by risk rating (pass, special mention, substandard and doubtful). The quantitative value of the qualitative factors, as described below, is then applied to this amount to estimate the general and unallocated reserve for the specific loans within this rating category and particular loan category. Impaired loans are excluded from this analysis as they are individually reviewed for valuation. The sum of all such amounts determines our general and unallocated reserves.

 

We also track our portfolio and analyze loans grouped by call report categories. The first step in this process is to risk grade each and every loan in the portfolio based on a common set of parameters. These parameters include debt to worth, liquidity of the borrower, net worth, experience in a particular field and other factors. Weight is also given to the relative strength of any guarantors on the loan. We have retained an independent consultant to review the loan files on a test basis to confirm the loan grade assigned to the loan.

After risk grading each loan, we then use fourteen qualitative factors to analyze the trends in the portfolio. These fourteen factors include both internal and external factors. The internal factors considered are the concentration of credit across the portfolio, current delinquency ratios and trends, the experience level of management and staff, our adherence to lending policies and procedures, current loss and recovery trends, the nature and volume of the portfolio’s categories, current nonaccrual and problem loan trends, the quality of our loan review system, policy exceptions, value of underlying collateral and other factors which include insurance shortfalls, loan fraud and unpaid tax risk. The external factors considered are regulatory and legal factors and the current economic and business environment, which includes indicators such as national GDP, pricing indicators, employment statistics, housing statistics, market indicators, financial regulatory economic analysis, and economic forecasts from reputable sources. A quantitative value is assigned to current delinquency ratios and trends and the current nonaccrual and problem loan trends, which, when added together, creates a net qualitative weight. The net qualitative weight is then added to the loss ratio. Negative trends in the loan portfolio increase the quantitative values assigned to each of the qualitative factors and, therefore, increase the loss ratio. As a result, an increased loss ratio will result in a higher allowance for loan loss. For example, as delinquency ratios and trends increase, this qualitative factor’s quantitative value will increase, which will increase the net qualitative weight and the loss ratio (assuming all other qualitative factors remain constant). Similarly, positive trends in the nonaccrual and problem loans trends, will decrease the quantitative value assigned to this qualitative factor, thereby decreasing the net qualitative weight and the loss ratio (assuming all other qualitative factors remain constant). These factors are reviewed and updated by the Bank’s executive management on a quarterly basis to arrive at a consensus for our qualitative adjustments.

 

Our methodology for determining our historical loss ratio is to analyze the most recent losses because we believe this period encompasses the most appropriate time period. In addition, we have moved to a fully migrated loss history for all loan pools and all risk grades as of the period ended March 31, 2016. The resulting historical loss factor is used as a beginning point upon which we add our quantitative adjustments based on the qualitative factors discussed above. Once the qualitative adjustments are made, we refer to the final amount as the total factor. The total factor is then multiplied by the loans outstanding for the period ended, except for any loans classified as non-performing which are addressed specifically as discussed below, to estimate the general and unallocated reserves.

 

Separately, we review all impaired loans individually to determine a specific allocation for each. In our assessment of impaired loans, we consider the primary source of repayment when determining whether or not loans are collateral dependent. Impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. When management determines that a loan is impaired, the difference between our investment in the related loan and the present value of the expected future cash flows, or the fair value of the collateral, is then reserved for or charged against the allowance for loan losses.

 

Periodically, we adjust the amount of the allowance based on changing circumstances. We recognize loan losses to the allowance and add back subsequent recoveries. In addition, on a periodic basis we informally compare our allowance for loan losses to various peer institutions; however, we recognize that allowances will vary as financial institutions are unique in the make-up of their loan portfolios and customers, which necessarily creates different risk profiles for the institutions. We would only consider further adjustments to our allowance for loan losses based on this review of peers if our allowance was significantly different from our peer group. To date, we have not made any such adjustment. There can be no assurance that loan charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

 

The following table summarizes the activity related to our allowance for loan losses for the three months ended March 31, 2016 and 2015.

 

		2016				2015
		(dollars in thousands)
Balance, beginning of year		$	4,045			$	4,750
Provision for loan losses			—				—
Charge offs, Commercial and Industrial			(14	)			—
Charge offs, Real Estate Mortgage			(247	)			—
Charge offs, Real Estate Construction			—				—
Charge offs, Consumer			—				—
Recoveries, Commercial and Industrial			27				1
Recoveries, Real Estate Mortgage			24				43
Recoveries, Real Estate Construction			—				—
Recoveries, Consumer			—				—
Balance, end of period		$	3,835			$	4,794
Total loans outstanding at end of period		$	325,045			$	320,614
Allowance for loan losses to gross loans			1.18	%			1.50	%
Net charge-offs to average loans			0.06	%			0.00	%

Nonperforming Assets

 

The following table sets forth our nonperforming assets at March 31, 2016 and December 31, 2015:

 

		2016				2015
		(dollars in thousands)
Nonaccrual loans		$	7,275			$	7,724
Other real estate owned			11,887				12,753
Accruing TDR’s			8,406				8,450
Total nonperforming assets		$	27,568			$	28,927
Nonperforming assets to total assets			5.94	%			6.20	%

 

The Bank had 23 loans on nonaccrual status at March 31, 2016, totaling $7.3 million and 19 loans on nonaccrual status totaling $7.7 million at December 31, 2015. Of the 23 loans on nonaccrual status at March 31, 2016, it is anticipated that 19 loans totaling approximately $4.9 million will move to other real estate owned through foreclosure or through the Bank’s acceptance of a deed in lieu of foreclosure. An additional three loans amounting to approximately $2.3 million are expected to be paid down or paid in full and one loan for $55,000 is expected to be charged-off. At March 31, 2016 and December 31, 2015, the allowance for loan losses was $3.8 million and $4.0 million, respectively, or 1.18% and 1.25%, respectively, of outstanding loans. At March 31, 2016, the Bank had 39 impaired loans totaling $16.2 million, which is a decrease of $700,000 when compared to December 31, 2015. This decrease was primarily related to one loan that was moved to nonaccrual status. We remain committed to working with borrowers to help them overcome their difficulties and will review loans on a loan by loan basis.

 

To determine current collateral values we obtain new appraisals on loan renewals and potential problem loans. In the process of estimating collateral values for non-performing loans, management evaluates markets for stagnation or distress and discounts appraised values on a property by property basis. Currently, management does not review collateral values for properties located in stagnant or distressed residential areas if the loan is performing and not up for renewal.

 

As of March 31, 2016, we had 44 loans with a current principal balance of $17.6 million on the watch list compared to 47 loans with a current principal balance of $19.6 million at December 31, 2015. The watch list is the classification utilized by us when we have an initial concern about the financial health of a borrower. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either move it to “substandard” or back to its original risk rating after a review of the information. There are times when we may leave the loan on the “watch list,” if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we want to review it on a more regular basis. Loans on the watch list are not considered “potential problem loans” until they are determined by management to be classified as substandard.

 

Loans past due 30-89 days amounted to $2.4 million at March 31, 2016 as compared to $1.9 million at December 31, 2015. Past due loans are often regarded as a precursor to further credit problems which would lead to future increases in nonaccrual loans and other real estate owned. At March 31, 2016, there were no loans past due greater than 90 days that were not already placed on nonaccrual. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is applied against the principal balance. During the three months ended March 31, 2016 and March 31, 2015, the gross interest that we would have recorded if such loans had been in current status was $3,000 and $56,000 respectively. Forgone interest income on impaired loans was $21,000 and $99,000 during the three months ended March 31, 2016 and March 31, 2015.

 

Deposits

 

Our primary source of funds for loans and investments is our deposits. Due to the Consent Order, we may not accept brokered deposits unless a waiver is granted by the FDIC. We no longer have any brokered or wholesale deposits. Our loan-to-deposit ratio was 78.4% and 77.1% at March 31, 2016 and December 31, 2015, respectively. Although we currently do not utilize brokered deposits as a funding source, if we were to seek to begin using such funding source, there is no assurance that the FDIC will grant us the approval when requested. These restrictions could have a substantial negative impact on our liquidity. Additionally, we are restricted from offering an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on their website.

The following table shows the average balance amounts and the average rates paid on deposits held by us for the three months ended March 31, 2016 and the year ended December 31, 2015.

 

		March 31, 2016								December 31, 2015
		Amount				Rate				Amount				Rate
		(dollars in thousands)
Noninterest bearing demand deposits		$	32,039				—	%		$	30,087				—	%
Interest bearing demand deposits			36,270				0.11	%			37,085				0.19	%
Savings and money market accounts			106,408				0.31	%			106,274				0.35	%
Time deposits less than $100,000			87,603				1.26	%			93,025				1.26	%
Time deposits greater than $100,000			153,794				1.33	%			160,458				1.36	%
Total deposits		$	416,114				0.85	%		$	426,929				0.89	%

 

All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $100,000 or more at March 31, 2016 and December 31, 2015 was as follows:

 

		March 31, 2016				December 31, 2015
		(dollars in thousands)
Three months or less		$	46,560			$	26,121
Over three through six months			24,394				34,163
Over six though twelve months			35,833				45,327
Over twelve months			47,030				49,062
Total		$	153,817			$	154,673

 

Borrowings and Other Interest-Bearing Liabilities

 

The following table outlines our various sources of borrowed funds during the three months ended March 31, 2016 and the year ended December 31, 2015, the amounts outstanding at the end of each period, at the maximum point for each component during the periods, on average for each period, and the average and period end interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown.

 

		Ending				Period  End				Maximum  Month  End				Average  for the Period
		Balance				Rate				Balance				Balance				Rate
		(dollars in thousands)
At or for the three months ended March 31, 2016:
Securities sold under agreement to repurchase		$	10,000				4.40	%		$	10,000			$	10,000				4.47	%
Advances from FHLB			14,000				2.69	%			14,000				10,358				3.55	%
Junior subordinated debentures			14,434				3.57	%			14,434				14,434				3.71	%
At or for the year ended December 31, 2015:
Securities sold under agreement to repurchase		$	10,000				4.40	%		$	10,000			$	10,000				4.46	%
Advances from FHLB			9,000				3.96	%			9,000				9,000				4.01	%
Junior subordinated debentures			14,434				3.29	%			14,434				14,434				3.12	%
Federal funds purchased			—				—	%			—				8				—	%

  

In December 2010, we began exercising our right to defer all quarterly distributions on our junior subordinated debentures related to our trust preferred securities. We were permitted to defer these interest payments for up to 20 consecutive quarterly periods, although interest continued to accrue on the junior subordinated debentures and interest on such deferred interest also accrued and compounded quarterly from the date such deferred interest would have been payable were it not for the extension period. However, all of the deferred interest, including interest accrued on such deferred interest, became due and payable at the end of the deferral period, which was on December 30, 2015. We did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under related indentures. In addition, the Consent Order prohibits us from declaring or paying any dividends or making any distributions of interest, principal, or other sums on our junior subordinated debentures without the prior approval of the supervisory authorities.

Federal Home Loan Bank Advances, Fed Funds Lines of Credit and Federal Reserve Discount Window

 

Our other borrowings have traditionally included proceeds from FHLB advances and federal funds lines of credit from correspondent banks. At March 31, 2016, we had $14.0 million in total advances and lines outstanding from the FHLB with a remaining credit availability of $55.5 million and an excess lendable collateral value of approximately $5.1 million. As of March 31, 2016, we had $6.0 million federal funds line from Alostar Bank and a $5.0 million federal funds line from Raymond James. We also have credit availability through the Federal Reserve Discount Window. As of March 31, 2016, $132,000 was available based on qualifying collateral. The Federal Reserve Discount Window borrowing capacity has been curtailed to only overnight terms, contingent upon credit approval for each transaction. Availability of the Federal Reserve Discount Window may be terminated at any time by the Federal Reserve, and we can make no assurances that this funding source will continue to be available to us.

 

Capital Resources

 

Total shareholders’ equity was $1.5 million at March 31, 2016 and $1.9 million at December 31, 2015. The decrease is attributable to the net loss of $420,000 for the three month period ended March 31, 2016, preferred stock dividends accrued of $449,000, and an increase of $459,000 in the fair value of available-for-sale securities for the three month period ended March 31, 2016.

 

The following table shows the return on average assets (net loss divided by average total assets), return on average equity (net loss divided by average equity), and average equity to average assets ratio (average equity divided by average total assets) for the periods ended March 31, 2016 and December 31, 2015:

 

		March 31, 2016				December 31, 2015
Return on average assets			(0.02	%)			(0.38	%)
Return on average equity			(3.80	%)			(44.49	%)
Equity to assets ratio			0.58	%			0.86	%

 

The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. Our bank is required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.

 

To be considered “well-capitalized,” banks must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%. To be considered “adequately capitalized” under capital guidelines, we must maintain a minimum total risk-based capital of 8%, with at least 4% being Tier 1 capital. In addition, banking regulators have established a minimum Tier 1 leverage ratio of at least 4%. In addition, the Consent Order requires us to achieve and maintain Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets by May 27, 2011. As of March 31, 2016, the Bank is not in compliance with the capital requirements established in the Consent Order.

 

The following table sets forth the Company’s various capital ratios at March 31, 2016 and December 31, 2015. As of March 31, 2016 the Company was categorized as “critically undercapitalized.”

 

Tidelands Bancshares, Inc.		March 31,				December 31,
		2016				2015
Common Equity Tier 1			(3.45	%)			(3.22	%)
Leverage ratio			0.60	%			0.84	%
Tier 1 risk-based capital ratio			0.78	%			1.10	%
Total risk-based capital ratio			1.55	%			2.20	%

The following table sets forth the Bank’s various capital ratios at March 31, 2016 and December 31, 2015.

 

Tidelands Bank		March 31,				December 31,
		2016				2015
Common Equity Tier 1			7.10	%			7.19	%
Leverage ratio			5.48	%			5.47	%
Tier 1 risk-based capital ratio			7.10	%			7.19	%
Total risk-based capital ratio			8.17	%			8.33	%

 

On February 22, 2006, Tidelands Statutory Trust (“Trust I”), a non-consolidated subsidiary of the Company, issued and sold floating rate capital securities of the trust, generating net proceeds of $8.0 million. The trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The junior subordinated debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. On October 10, 2006, we closed a public offering in which 1,200,000 shares of our common stock were issued at a purchase price of $15.00 per share. Net proceeds after deducting the underwriter’s discount and expenses were $16.4 million.

 

On June 20, 2008, Tidelands Statutory Trust II (“Trust II”), a non-consolidated subsidiary of the Company, issued and sold fixed/floating rate capital securities of the trust, generating proceeds of $6.0 million. Trust II loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The junior subordinated debentures qualify as Tier I under Federal Reserve Board guidelines. The Trust I securities and Trust II securities are collectively referred to as the trust preferred securities.

 

On December 19, 2008, we entered into the CPP Purchase Agreement with the U.S. Treasury, pursuant to which the Company issued and sold to Treasury (i) 14,448 shares of the Company’s Series T Preferred Stock, having a liquidation preference of $1,000 per share, and (ii) a ten-year warrant to purchase up to 571,821 shares of the Company’s common stock, par value $0.01 per share, at an initial exercise price of $3.79 per share, for an aggregate purchase price of $14,448,000 in cash. The Series T Preferred Stock qualifies as Tier 1 capital under Federal Reserve Board guidelines and was entitled to cumulative dividends at a rate of 5% per annum for the first five years, and beginning with the May 15, 2014 dividend date, is now entitled to a cumulative dividend at a rate of 9% per annum.

 

The Company began deferring dividend payments on the Series T Preferred Stock beginning with the dividend payment date of November 15, 2010. Although the Company is permitted to defer dividend payments, the dividend is a cumulative dividend and failure to pay dividends for six dividend periods triggered board appointment rights for the holder of the Series T Preferred Stock. The Company deferred its seventh dividend payment in May 2012. As such, the Treasury has appointed an observer to our Board of Directors. As of March 31, 2016, the amount of cumulative unpaid dividends on the Series T Preferred Stock was $6,091,462.

 

In December 2010, we began exercising our right to defer all quarterly distributions on our junior subordinated debentures related to our trust preferred securities of Trust I and Trust II. We were permitted to defer these interest payments for up to 20 consecutive quarterly periods, although interest continued to accrue on the junior subordinated debentures and interest on such deferred interest also accrued and compounded quarterly from the date such deferred interest would have been payable were it not for the extension period. However, all of the deferred interest, including interest accrued on such deferred interest, became due and payable at the end of the deferral period, which was on December 30, 2015. We did not pay such deferred interest at the end of the permitted deferral period, constituting an event of default under the Indentures. As a result, on March 8, 2016, we received notices of default from the trustee related to the junior subordinated debentures accelerating all principal and accrued interest and demanding payment of all such amounts from the Company. As of March 31, 2016, the total principal amount outstanding on the junior subordinated debentures plus accrued and unpaid interest was $18.3 million. All deferred distributions will continue to accrue interest and are cumulative. Therefore, in accordance with generally accepted accounting principles, the Company will continue to accrue the monthly cost of the trust preferred securities as it has since issuance.

 

In connection with our the proposed merger with United, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing us into involuntary bankruptcy. In the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures and Series T Preferred Stock must be satisfied before any distributions can be made on our common stock. The holder of our Series T Preferred Stock has consented to a redemption of its Series T Preferred Stock and Warrants at a significant discount in connection with the merger, while still permitting our common shareholders to receive the cash consideration in the merger.

The merger is subject to required regulatory approvals, approval of the Company’s common shareholders and other customary closing conditions. If the merger does not close, the Company will need to raise substantial additional capital to pay all interest accrued on its trust preferred securities, and to increase the Bank’s capital levels to meet the standards set forth by the FDIC in the Consent Order. If the merger does not close, there can be no assurances that the Company or the Bank will be able to raise additional capital. An equity financing transaction by the Company would result in substantial dilution to the Company’s current shareholders and could adversely affect the market price of the Company’s common stock. Likewise, an equity financing transaction by the Bank would result in substantial dilution to the Company’s ownership interest in the Bank. Should these efforts be unsuccessful, the Company could be forced into involuntary bankruptcy by the trustee or the holders of the trust preferred securities, or we could be placed into a federal conservatorship or receivership by the FDIC. If this were to occur, then our common shareholders will likely lose all of their investment in the Company, and the holders of our Series T Preferred Stock and junior subordinated debentures may lose all, or a material portion of, their investment in the Company.

 

Effect of Inflation and Changing Prices

 

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.

 

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

 

Off-Balance Sheet Risk

 

Commitments to extend credit are agreements to lend to a customer as long as the customer has not violated 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. At March 31, 2016, unfunded commitments to extend credit were $21.7 million. A significant portion of the unfunded commitments related to consumer equity lines of credit. Based on historical experience, we anticipate that a significant portion of these lines of credit will not be funded. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

 

At March 31, 2016, there were commitments totaling approximately $480,000 under letters of credit. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.

 

Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements, or transactions that could result in liquidity needs or other commitments that significantly impact earnings.

 

Market Risk

 

Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.

 

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” and net interest income simulations. Interest sensitivity gap is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive. We are currently liability sensitive on a cumulative basis over the one year and three year horizon.

Approximately 28.2% of our loans were variable rate loans at March 31, 2016 and 77.2% of interest-bearing liabilities reprice within one year. However, interest rate movements typically result in changes in interest rates on assets that are different in magnitude from the corresponding changes in rates paid on liabilities. While a smaller portion of our loans reprice within a year, a larger majority of our deposits will reprice within a 12-month period. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

 

Liquidity and Interest Rate Sensitivity

 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

The Company

 

Prior to the recent economic downturn, the Company, if needed, would have relied on dividends from the Bank as its primary source of liquidity. Currently, however, the Company has no available sources of liquidity. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company to meet its obligations, including paying dividends. In addition, the terms of the Consent Order previously discussed further limits the Bank’s ability to pay dividends to the Company to satisfy its funding needs.

 

The Company received notices of default from Wilmington Trust Company, in its capacity as Trustee, relating to the trust preferred securities, declaring the entire principal amount of the trust preferred securities immediately due and payable, and, in accordance with the indentures, demanding payment by the Company of the entire amount due and payable on the trust preferred securities. As of March 31, 2016, the total principal amount outstanding on the trust preferred securities plus accrued and unpaid interest was $18.3 million. In connection with the merger, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing the Company into involuntary bankruptcy.

 

As such, if the proposed merger does not close, unless the Company is able to raise capital, it will have no means of satisfying its funding needs, including the repayment of its trust preferred securities. In addition, the Company will also need to raise additional capital to increase the Bank’s capital levels to meet the standards set forth by the FDIC in the Consent Order. Receivership by the FDIC is based on the Bank’s capital ratios rather than those of the Company. As of March 31, 2016, the Bank is categorized as adequately capitalized, but is not in compliance with the capital requirements in the Consent Order. The Company’s ability to raise capital will depend on conditions in the capital markets, which are outside of the control of management, as well as the Company’s financial condition, business plan, regulatory status, management, customer activity and market trends. If the merger does not close, there is a risk the Company will not be able to raise the capital it needs at all or upon favorable terms.

 

The Bank

 

At March 31, 2016 and December 31, 2015, our liquid assets, which consist of cash and due from banks, amounted to $16.0 million and $13.9 million, or 3.5% and 3.0% of total assets, respectively. Our available-for-sale securities at March 31, 2016 and December 31, 2015 amounted to $69.4 million and $72.9 million, or 15.0% and 15.6% of total assets, respectively. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $17.4 million of these securities are pledged against outstanding debt or borrowing lines of credit. Therefore, the related debt would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the generation of deposits. In addition, we receive cash upon the maturity and sale of loans and the maturity of investment securities. We are also a member of the Federal Home Loan Bank of Atlanta, from which applications for borrowings can be made for leverage or liquidity purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances. At March 31, 2016, we had $14.0 million in total advances and lines from the FHLB with a remaining credit availability of $55.5 million and an excess lendable collateral value of approximately $5.1 million. In addition, we maintain a line of credit with the Federal Reserve Bank of $132,000 secured by securities.

 

Management believes the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, but if the Bank is unable to meet its liquidity needs, then the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed conservator or receiver.

 

Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. The asset/liability committee monitors and considers methods of managing exposure to interest rate risk. The asset/liability committee is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable.

 

Item 4. Controls and Procedures.

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Principal Financial Officer have concluded that our current disclosure controls and procedures are effective as of March 31, 2016. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended March 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Neither the Company nor the Bank is a party to, nor is any of their property the subject of, any pending legal proceedings , the ultimate resolution of which will have a material adverse effect on our financial position, results of operations or liquidity.

 

Item 3. Defaults Upon Senior Securities

 

As previously disclosed in the Current Report on Form 8-K filed on March 22, 2011, the Written Agreement between the Company and the Federal Reserve Bank of Richmond requires that we obtain the written approval of the Federal Reserve Bank before incurring additional debt, purchasing or redeeming our capital stock, or declaring or paying cash dividends on our securities, including dividends on our Series T preferred stock and interest on our trust preferred securities. Furthermore, pursuant to the terms of our trust preferred securities, absent authorization from a majority of its holders, we are prohibited from paying dividends on our Series T preferred stock until we pay all interest payments due and payable on our trust preferred securities.

 

Per the FRB Agreement the Company cannot pay dividends on Series T preferred stock or interest on our trust preferred securities, until such time as the Company has shown sustained profitability, improvement in asset quality indicators, and compliance with existing regulatory guidance related to such payments. Cash dividends on the Series T preferred stock are cumulative and accrue and compound on each subsequent payment date. The Company began deferring dividend payments on the Series T Preferred Stock beginning with the November 15, 2010 dividend date. Although the Company may defer dividend payments, the dividend is a cumulative dividend. The dividend payment that was deferred in February 2016 was the 21st missed dividend payment. As of March 31, 2016, the amount of cumulative unpaid dividend on the Series T Preferred Stock was $6,091,462.

 

As disclosed in the Current Report on Form 8-K filed on March 14, 2016, on March 8, 2016, the Company received notices of default from Wilmington Trust Company, in its capacity as Trustee, relating to the trust preferred securities, declaring the entire principal amount of the trust preferred securities immediately due and payable, and, in accordance with the indentures, demanding payment by the Company of the entire amount due and payable on the trust preferred securities. As of March 31, 2016, the total principal amount outstanding on the trust preferred securities plus accrued and unpaid interest was $18.3 million.

 

In connection with the merger, the holders of the trust preferred securities have agreed to waive the defaults and consent to an assumption of the trust preferred securities by United at the time of completion of the merger. If the merger is not completed, the waivers will be ineffective and the trustee and holders of the trust preferred securities will be able to exercise all rights and remedies under their respective governing instruments, including forcing the Company into involuntary bankruptcy. The merger agreement provides that, at the effective time of the merger, United will assume all of the Company’s obligations relating to its outstanding trust preferred securities. The assumption is conditioned on United’s payment of all amounts required to bring current the payment of interest (including deferred interest) on the trust preferred securities. In addition, the holder of our Series T Preferred Stock has consented to a redemption of its Series T Preferred Stock and Warrants at a significant discount in connection with the merger.

 

Item 6. Exhibits

  

31.1	Rule 13a-14(a) Certification of the Principal Executive Officer.
31.2	Rule 13a-14(a) Certification of the Principal Financial Officer.
32	Section 1350 Certifications.
101	The following financial information from Tidelands Bancshares Inc.’s Quarterly Report on Form 10-Q for the period ended March 31, 2016, filed with the SEC on May 13, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheet at March 31, 2016 and December 31, 2015, (ii) the Consolidated Statement of Operations and Comprehensive Loss for the three month periods ended March 31, 2016 and 2015, (iii) the Consolidated Statement of Changes in Shareholders’ Equity for the three-month periods ended March 31, 2016 and 2015, and (iv) Notes to Consolidated Financial Statements.

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		TIDELANDS BANCSHARES, INC.
Date:	May 13, 2016	By:	/s/ Thomas H. Lyles
			Thomas H. Lyles, President and Chief Executive Officer
			(Principal Executive Officer)
Date:	May 13, 2016	By:	/s/ John D. Dalton
			John D. Dalton, Controller and Vice President
			(Principal Financial and Accounting Officer)

EXHIBIT INDEX

 

Exhibit
Number		Description
31.1		Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2		Rule 13a-14(a) Certification of the Principal Financial Officer.
32		Section 1350 Certifications.
101		The following financial information from Tidelands Bancshares Inc.’s Quarterly Report on Form 10-Q for the period ended March 31, 2016, filed with the SEC on May 13, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheet at March 31, 2016 and December 31, 2015, (ii) the Consolidated Statement of Operations and Comprehensive Loss for the three month periods ended March 31, 2016 and 2015, (iii) the Consolidated Statement of Changes in Shareholders’ Equity for the three-month periods ended March 31, 2016 and 2015, and (iv) Notes to Consolidated Financial Statements.