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EX-32.2 - EXHIBIT 32.2 - SELECT BANCORP, INC.v472200_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - SELECT BANCORP, INC.v472200_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - SELECT BANCORP, INC.v472200_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SELECT BANCORP, INC.v472200_ex31-1.htm

 

 

U.S. Securities and Exchange Commission

Washington, D.C. 20549

 

Form 10-Q

 

x Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2017

or

¨ Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the transition period ended from                to                    

 

Commission File Number    000-50400   

 

Select Bancorp, Inc.

(Exact name of Registrant as specified in its charter)

 

North Carolina   20-0218264
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)    
     
700 W. Cumberland Street    
Dunn, North Carolina   28334
(Address of principal executive offices)   (Zip Code)

 

Registrant's telephone number, including area code (910) 892-7080

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

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

 

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

 

Large accelerated filer ¨ Accelerated filer x
   
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨
  Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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

 

As of August 4, 2017, the Registrant had outstanding 11,662,621 shares of Common Stock, $1.00 par value per share.

 

 

 

   

 

  

    Page No.
     
Part I. FINANCIAL INFORMATION  
     
Item 1 - Financial Statements (Unaudited)  
     
  Consolidated Balance Sheets June 30, 2017 and December 31, 2016 3
     
  Consolidated Statements of Operations Three Months and Six Months Ended June 30, 2017 and 2016 4
     
  Consolidated Statements of Comprehensive Income Three Months and Six Months Ended June 30, 2017 and 2016 5
     
  Consolidated Statements of Changes in Shareholders’ Equity Six Months Ended June 30, 2017 and 2016 6
     
  Consolidated Statements of Cash Flows Six Months Ended June 30, 2017 and 2016 7
     
  Notes to Consolidated Financial Statements 9
     
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations 46
     
Item 3 - Quantitative and Qualitative Disclosures about Market Risk 57
     
Item 4 - Controls and Procedures 58
     
Part II. OTHER INFORMATION  
     
Item 1 - Legal Proceedings 59
     
Item 1A - Risk Factors 59
     
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 59
     
Item 3 - Defaults Upon Senior Securities 59
     
Item 4 - Mine Safety Disclosures 59
     
Item 6 - Exhibits 59
     
  Signatures 60

 

 2 

 

 

Part I. Financial Information

Item 1 - Financial Statements

SELECT BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

 

 

   June 30, 2017   December 31, 
   (Unaudited)   2016* 
   (In thousands, except share 
   and per share data) 
ASSETS          
Cash and due from banks  $13,791   $14,372 
Interest-earning deposits in other banks   43,512    40,342 
Certificates of deposit   1,000    1,000 
Investment securities available for sale, at fair value   56,852    62,257 
Loans   738,021    677,195 
Allowance for loan losses   (8,488)   (8,411)
           
NET LOANS   729,533    668,784 
           
Accrued interest receivable   2,646    2,768 
Stock in Federal Home Loan Bank of Atlanta (“FHLB”), at cost   2,141    2,251 
Other non-marketable securities   666    703 
Foreclosed real estate   2,702    599 
Premises and equipment, net   17,517    17,931 
Bank owned life insurance   22,466    22,183 
Goodwill   6,931    6,931 
Core deposit intangible (“CDI”)   629    810 
Assets held for sale   846    846 
Other assets   5,292    4,863 
           
TOTAL ASSETS  $906,524   $846,640 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
           
Deposits:          
Demand  $168,635   $163,569 
Savings   35,162    38,394 
Money market and NOW   174,169    174,205 
Time   361,687    303,493 
           
TOTAL DEPOSITS   739,653    679,661 
           
Short-term debt   33,559    37,090 
Long-term debt   22,839    23,039 
Accrued interest payable   241    221 
Accrued expenses and other liabilities   2,215    2,356 
           
TOTAL LIABILITIES   798,507    742,367 
Shareholders’ Equity:          
Preferred stock, no par value, 5,000,000 shares authorized; 0 shares issued and outstanding at June 30, 2017 and December 31, 2016   -    - 
Common stock, $1.00 par value, 25,000,000 shares authorized; 11,662,471 and 11,645,413 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively   11,662    11,645 
Additional paid-in capital   69,725    69,597 
Retained earnings   26,124    22,673 
Common stock issued to deferred compensation trust, at cost; 284,972 and 280,432 shares at June 30, 2017 and December 31, 2016, respectively   (2,397)   (2,340)
Directors’ Deferred Compensation Plan Rabbi Trust   2,397    2,340 
Accumulated other comprehensive income   506    358 
           
TOTAL SHAREHOLDERS’ EQUITY   108,017    104,273 
          
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  $906,524   $846,640 

 

* Derived from audited consolidated financial statements.

 

See accompanying notes.

 

 

 3 

 

 

SELECT BANCORP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

 

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
   (In thousands, except share and per share data) 
INTEREST INCOME                    
Loans  $9,024   $8,242   $17,731   $16,207 
Federal funds sold and interest-earning deposits in other banks   119    60    207    137 
Investments   326    343    656    733 
TOTAL INTEREST INCOME   9,469    8,645    18,594    17,077 
                     
INTEREST EXPENSE                    
Money market, NOW and savings deposits   117    94    220    193 
Time deposits   880    647    1,639    1,308 
Short-term debt   63    106    118    140 
Long-term debt   137    65    267    198 
TOTAL INTEREST EXPENSE   1,197    912    2,244    1,839 
NET INTEREST INCOME   8,272    7,733    16,350    15,238 
                     
PROVISION FOR LOAN LOSSES   1,083    158    889    510 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES   7,189    7,575    15,461    14,728 
                     
NON-INTEREST INCOME                    
Gain on sale of investment securities   -    -    -    22 
Service charges on deposit accounts   216    246    431    493 
Other fees and income   562    585    1,077    1,182 
TOTAL NON-INTEREST INCOME   778    831    1,508    1,697 
                     
NON-INTEREST EXPENSE                    
Personnel   3,702    3,087    7,116    6,289 
Occupancy and equipment   492    607    1,064    1,181 
Deposit insurance   75    135    147    261 
Professional fees   251    252    571    487 
CDI amortization   88    111    181    227 
Information systems   534    524    1,038    1,033 
Foreclosed-related expenses   (25)   24    (9)   63 
Other   863    779    1,677    1,598 
TOTAL NON-INTEREST EXPENSE   5,980    5,519    11,785    11,139 
INCOME BEFORE INCOME TAX   1,987    2,887    5,184    5,286 
INCOME TAXES   651    980    1,733    1,876 
NET INCOME   1,336    1,907    3,451    3,410 
DIVIDENDS ON PREFERRED STOCK   -    -    -    4 
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS  $1,336   $1,907   $3,451   $3,406 
                     
NET INCOME PER COMMON SHARE                    
Basic  $0.11   $0.16   $0.30   $0.29 
Diluted  $0.11   $0.16   $0.29   $0.29 
                     
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING                    
Basic   11,662,117    11,594,995    11,657,391    11,589,217 
Diluted   11,727,110    11,642,726    11,720,841    11,638,669 

 

See accompanying notes.

 

 4 

 

  

SELECT BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

 

  

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
   (In thousands) 
                 
Net income  $1,336   $1,907   $3,451   $3,410 
                     
Other comprehensive income (loss):                    
Unrealized gain on investment securities available for sale   151    338    233    1,099 
Tax effect   (55)   (113)   (85)   (397)
    96    225    148    702 
Reclassification adjustment for gain included in net income   -    -    -    (22)
Tax effect   -    -    -    8 
    -    -    -    (14)
                     
Total   96    225    148    688 
                     
Total comprehensive income  $1,432   $2,132   $3,599   $4,098 

 

See accompanying notes.

 

 5 

 

 

SELECT BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

 

(in thousands, except share data)

 

                           Common             
                           Stock       Accumulated     
                           Issued       Other     
                   Additional       to Deferred       Compre-   Total 
   Preferred Stock   Common Stock   paid-in   Retained   Compensation   Deferred   hensive   Shareholders’ 
   Shares   Amount   Shares   Amount   Capital   Earnings   Trust   Comp Plan   Income   Equity 
Balance at December 31, 2015   7,645   $7,645    11,583,011   $11,583   $69,061   $15,923   $(2,139)  $2,139   $490    $ 104,702 
Net income   -    -    -    -    -    3,410    -    -    -    3,410 
Other comprehensive income, net   -    -    -    -    -    -    -    -    688    688 
Preferred stock dividends paid   -    -    -    -    -    (4)   -    -    -    (4)
Preferred stock redemption   (7,645)   (7,645)   -    -    -    -    -    -    -    (7,645)
Stock option exercises   -    -    36,173    36    308    -    -    -    -    344 
Stock based compensation   -    -    -    -    36    -    -    -    -    36 
Director equity incentive plan, net   -    -    -    -    -    -    (85)   85    -    - 
Balance at June 30, 2016   -   $-    11,619,184   $11,619   $69,405   $19,329   $(2,224)  $2,224   $1,178   $101,531 
                                                   
Balance at December 31, 2016   -   $-    11,645,413   $11,645   $69,597   $22,673   $(2,340)  $2,340   $358   $104,273 
Net income   -    -    -    -    -    3,451    -    -    -    3,451 
Other comprehensive income, net   -    -    -    -    -    -    -    -    148    148 
Stock option exercises   -    -    17,058    17    85    -    -    -    -    102 
Stock based compensation   -    -    -    -    43    -    -    -    -    43 
Director equity incentive plan, net   -    -    -    -    -    -    (57)   57    -    - 
Balance at June 30, 2017   -   $-    11,662,471   $11,662   $69,725   $26,124   $(2,397)  $2,397   $506   $108,017 

  

See accompanying notes.

 

 6 

 

 

SELECT BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

 

   Six Months Ended 
   June 30, 
   2017   2016 
   (In thousands) 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net income  $3,451   $3,410 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   889    510 
Depreciation and amortization of premises and equipment   575    520 
Amortization and accretion of investment securities   282    400 
Amortization of deferred loan fees and costs   (291)   (236)
Amortization of core deposit intangible   181    227 
Stock-based compensation   43    36 
Accretion on acquired loans   (450)   (534)
Amortization of acquisition premium on time deposits   (161)   (385)
Net accretion of acquisition discount on borrowings   (87)   (153)
Increase in cash surrender value of bank owned life insurance   (283)   (296)
Net (gain) loss on sale and write-downs of foreclosed real estate   (61)   48 
Gain on sale of premises and equipment   (9)   - 
Net gain on investment security sales   -    (22)
Change in assets and liabilities:          
Net change in accrued interest receivable   122    (56)
Net change in other assets   (514)   7 
Net change in accrued expenses and other liabilities   (121)   2,087 
           
NET CASH PROVIDED BY OPERATING ACTIVITIES   3,566    5,563 
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Purchase (redemption) of FHLB stock   110    (206)
Purchase (redemption) of non-marketable security   37    (52)
Purchase of investment securities available for sale   (759)   (1,517)
Maturities of investment securities available for sale   3,255    7,434 
Mortgage-backed securities pay-downs   2,860    5,010 
Proceeds from sale of investment securities available for sale   -    624 
Net change in loans outstanding   (63,323)   (14,436)
Proceeds from sale of foreclosed real estate   384    1,215 
Proceeds from sale of premises and equipment   (247)   - 
Purchases of premises and equipment   95    (456)
           
NET CASH USED BY INVESTING ACTIVITIES   (57,588)   (2,384)

 

See accompanying notes.

 

 7 

 

 

SELECT BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued)

 

 

   Six Months Ended 
   June 30, 
   2017   2016 
   (In thousands) 
CASH FLOWS FROM FINANCING ACTIVITIES          
Net change in deposits  $60,153   $10,498 
Proceeds from short-term debt   -    16,000 
Repayments on short-term debt   (3,444)   (14,390)
Repayments on long-term debt   (200)   (913)
Preferred stock dividends paid   -    (4)
Redemption of preferred stock   -    (7,645)
Proceeds from stock option exercises   102    344 
           
NET CASH PROVIDED BY FINANCING ACTIVITIES   56,611    3,890 
           
NET CHANGE IN CASH AND CASH EQUIVALENTS   2,589    7,069 
           
CASH AND CASH EQUIVALENTS, BEGINNING   55,714    63,409 
           
CASH AND CASH EQUIVALENTS, ENDING  $58,303   $70,478 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION          
Cash paid during the period for:          
Interest  $2,224   $1,820 
Taxes   1,768    - 
           
Non-cash transactions:          
Unrealized gains on investment securities available for sale, net of tax   148    688 
Transfers from loans to foreclosed real estate   2,426    578 
Transfers from premises and equipment to assets held for sale   -    400 

 

See accompanying notes.

 

 8 

 

 

SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE A - BASIS OF PRESENTATION

 

Select Bancorp, Inc. (“Company”) is a bank holding company whose principal business activity consists of ownership of Select Bank & Trust Company (referred to as the “Bank”). In 2004, the Company formed New Century Statutory Trust I, which issued trust preferred securities to provide additional capital for general corporate purposes, including the current and future expansion of the Company. New Century Statutory Trust I is not a consolidated subsidiary of the Company. On July 25, 2014 the Company changed its name from New Century Bancorp, Inc. to Select Bancorp, Inc. following its acquisition by merger of Select Bancorp, Inc., Greenville, NC (which we refer to herein as “Legacy Select”). The Company is subject to the rules and regulations of the Board of Governors of the Federal Reserve System and the North Carolina Commissioner of Banks.

 

Select Bank & Trust Company was originally incorporated as New Century Bank on May 19, 2000 and began banking operations on May 24, 2000. On July 25, 2014, in connection with the Company’s acquisition of Legacy Select, the Bank changed its name from New Century Bank to Select Bank & Trust Company following the merger of the two banking corporations. The Bank is the only banking subsidiary of the Company, and its headquarters and operations center are located in Dunn, NC. The Bank is engaged in general commercial and retail banking in central and eastern North Carolina and operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities

 

All significant inter-company transactions and balances have been eliminated in consolidation. In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and six month periods ended June 30, 2017 and 2016, in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

 

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three and six month periods ended June 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2017.

 

The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the financial statements filed as part of the Company’s 2016 Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”) on March 14, 2017. This quarterly report should be read in conjunction with the Annual Report.

 

Certain reclassifications of the information in prior periods were made to conform to the June 30, 2017 presentation. Such reclassifications had no effect on shareholders’ equity or net income as previously reported.

 

 9 

 

 

SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE B - PER SHARE RESULTS

 

Basic net income per share is computed based upon the weighted average number of shares of common stock outstanding during the period. Diluted net income per share includes the dilutive effect of stock options outstanding during the period. At June 30, 2017 and 2016 there were 23,300 and 123,800 anti-dilutive options outstanding, respectively.

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
Weighted average shares used for basic net income available to common shareholders   11,662,117    11,594,995    11,657,391    11,589,217 
                     
Effect of dilutive stock options   64,993    47,731    63,450    49,452 
                     
Weighted average shares used for diluted net income available to common shareholders   11,727,110    11,642,726    11,720,841    11,638,669 

 

NOTE C - RECENT ACCOUNTING PRONOUNCEMENTS

 

The following summarizes recent accounting pronouncements and their expected impact on the Company:

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 addresses the recognition of revenue from contracts with customers with the core principle being for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also results in enhanced disclosures about revenue, provides guidance for transactions that were not previously addressed comprehensively and improves guidance for multiple-element arrangements. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, to improve the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, to clarify guidance for identifying performance obligations and licensing implementation. The Company is currently evaluating the impact on additional disclosure requirements as each of the standards is adopted, however it does not expect these amendments to have a material effect on its financial position, results of operations or cash flows.

 

In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, to clarify and improve the guidance for certain aspects of Topic 606. 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.

 

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 does not expect these amendments to have a material effect on its financial statements.

 

 10 

 

  

SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Recent Accounting Pronouncements (Continued)

 

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. 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.

 

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-based Payment Accounting, to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, including the tax effect of forfeitures and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them to apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments were effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company has adopted these amendments to its financial statements during the first quarter of 2017 with a positive impact to net earnings as an excess tax benefit of $4,000 was recorded through the income statement rather than additional paid in capital.

 

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, amending 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 ASU 2016-02, Leases (Topic 842). ASU 2016-02 applies a right-of-use (ROU) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. For leases with a term of 12 months or less, a practical expedient is available whereby a lessee may elect, by class of underlying asset, not to recognize an ROU asset or lease liability. At inception, lessees must classify all leases as either finance or operating based on five criteria. Balance sheet recognition of finance and operating leases is similar, but the pattern of expense recognition in the income statement, as well as the effect on the statement of cash flows, differs depending on the lease classification.  For public business entities, the amendments in ASU 2016-02 are effective for interim and annual periods beginning after December 15, 2018.   In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach which includes a number of optional practical expedients that entities may elect to apply.  The Company has reviewed its outstanding lease agreements and has centrally documented the terms of its leases.  The Company is currently evaluating the provisions of ASU 2016-02 in relation to its outstanding leases to determine the potential impact the new standard will have to the Company’s consolidated financial statements.

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Recent Accounting Pronouncements (Continued)

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset.  The CECL model is expected to result in earlier recognition of credit losses.  ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years.  Early adoption is permitted.  Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.   The Company has dedicated staff and resources in place evaluating the Company’s options including evaluating the appropriate model options and collecting and reviewing loan data for use in these models.  The Company is still assessing the impact that this new guidance will have on its consolidated financial statements.

 

In August 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2017, the FASB issued guidance to simplify the accounting related to goodwill impairment. ASU 2017-04, Simplifying the Test for Goodwill Impairment, removes Step 2 of the current goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value. All other goodwill impairment guidance will remain largely unchanged and entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2017, the FASB updated the Accounting Changes and Error Corrections and the Investments—Equity Method and Joint Ventures Topics of the Accounting Standards Codification.  The ASU incorporates into the Accounting Standards Codification recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards.  The ASU was effective upon issuance. The Company is currently evaluating the impact on additional disclosure requirements as each of the standards is adopted, however it does not expect these amendments to have a material effect on its financial position, results of operations or cash flows.

 

In January 2017, the FASB amended the Goodwill and Other Topic of the Accounting Standards Codification to simplify the accounting for goodwill impairment for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The Company does not expect these amendments to have a material effect on its financial statements.

 

 12 

 

 

SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Recent Accounting Pronouncements (Continued)

 

In February 2017, the FASB amended the Other Income Topic of the Accounting Standards Codification to clarify the scope of the guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. 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.

 

In May 2017, the FASB amended the requirements in the Compensation—Stock Compensation Topic of the Accounting Standards Codification related to changes to the terms or conditions of a share-based payment award. The amendments provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The amendments will be effective for the Company for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

From time to time, the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTED D - FAIR VALUE MEASUREMENTS

 

Accounting Standards Codification (“ASC”) 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. ASC 820 creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation.

 

Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.

 

Because no active market readily exists for a portion of the Company’s 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. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

 

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

·Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

 

·Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.

 

·Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

 

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis.

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE D – FAIR VALUE MEASUREMENTS (continued)

 

Investment Securities Available-for-Sale (“AFS”)

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. Level 1 securities include those 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 U.S. government agency securities, mortgage-backed securities issued by government sponsored entities, and municipal bonds. There have been no changes in valuation techniques for the three and six months ended June 30, 2017. Valuation techniques are consistent with techniques used in prior periods.

 

The following tables summarize quantitative disclosures about the fair value measurement for each category of assets carried at fair value on a recurring basis as of June 30, 2017 and December 31, 2016 (in thousands):

 

Investment securities 
available for sale
June 30, 2017
  Fair value   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Significant
Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
                 
U.S. government agencies – GSE's  $12,577   $-   $12,577   $- 
Mortgage-backed securities - GSE’s   30,084    -    30,084    - 
Municipal bonds   14,191    -    14,191    - 
                     
Total  $56,852   $-   $56,852   $- 

 

Investment securities
available for sale
December 31, 2016
  Fair value   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Significant
Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
                 
U.S. government agencies – GSE's  $14,159   $-   $14,159   $- 
Mortgage-backed securities - GSE’s   32,363    -    32,363    - 
Municipal bonds   15,735    -    15,735    - 
                     
Total  $62,257   $-   $62,257   $- 

 

 15 

 

 

SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE D – FAIR VALUE MEASUREMENTS (continued)

 

The following is a description of valuation methodologies used for assets recorded at fair value on a non-recurring basis.

 

Loans

The Company does not record loans at fair value on a recurring basis. 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. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310 “Receivables”. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, or 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 exceed the recorded investments in such loans. At June 30, 2017 and December 31, 2016, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as non-recurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as non-recurring Level 3. The significant unobservable input used in the fair value measurement of the Company’s impaired loans is the discount applied to appraised values to account for expected liquidation and selling costs. At June 30, 2017, the discounts to appraised value used are weighted between 6% and 61%. There were no transfers between levels from the prior reporting periods and there have been no changes in valuation techniques for the three months ended June 30, 2017.

 

Foreclosed Real Estate

Foreclosed real estate are properties recorded at estimated fair value less estimated selling costs. Inputs include appraised values on the properties or recent sales activity for similar assets in the property’s market. Therefore, foreclosed real estate is classified within Level 3 of the hierarchy. The significant unobservable input used in the fair value measurement of the Company’s foreclosed real estate is the discount applied to appraised values to account for expected liquidation and selling costs. At June 30, 2017, the discounts used ranged between 6% and 10%. There have been no changes in valuation techniques for the three months ended June 30, 2017.

 

Assets held for sale 

During 2015, a branch facility was taken out of service as part of the Company’s branch restructuring plan and reclassified as held for sale. The property is recorded at the remaining book balance of the asset or an estimated fair value less estimated selling costs, whichever is less. Inputs include appraised values on the properties or recent sales activity for similar assets in the property’s market. The significant unobservable input used is the discount applied to appraised values to account for expected liquidation and selling costs ranged between 1% and 25 % at June 30, 2017. There have been no changes in the valuation techniques for the three months ended June 30, 2017.

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE D – FAIR VALUE MEASUREMENTS (continued)

 

The following tables summarize quantitative disclosures about the fair value measurement for each category of assets carried at fair value on a non-recurring basis as of June 30, 2017 and December 31, 2016 (in thousands):

 

Asset Category
June 30, 2017
  Fair value   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Significant
Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
                 
Impaired loans  $2,943   $-   $-   $2,943 
Assets held for sale   846    -    -    846 
Foreclosed real estate   2,702    -    -    2,702 
                     
Total  $6,491   $-   $-   $6,491 

 

Asset Category
December 31, 2016
  Fair value   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Significant
Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
                 
Impaired loans  $5,805   $-   $-   $5,805 
Asset held for sale   846    -    -    846 
Foreclosed real estate   599    -    -    599 
                     
Total  $7,250   $-   $-   $7,250 

 

 17 

 

 

SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE D – FAIR VALUE MEASUREMENTS (continued)

 

The following table presents the carrying values and estimated fair values of the Company's financial instruments at June 30, 2017 and December 31, 2016:

 

   June 30, 2017 
   Carrying   Estimated             
   Amount   Fair Value   Level 1   Level 2   Level 3 
   (In thousands) 
Financial assets:                         
Cash and due from banks  $13,791   $13,791   $13,791   $-   $- 
Certificates of deposit   1,000    1,000    1,000    -    - 
Interest-earning deposits in other banks   43,512    43,512    43,512    -    - 
Investment securities available for sale   56,852    56,852    -    56,852    - 
Loans, net   729,533    734,564    -    -    734,564 
Accrued interest receivable   2,646    2,646    -    2,646    - 
Stock in FHLB   2,141    2,141    -    -    2,141 
Other non-marketable securities   666    666    -    -    666 
                          
Financial liabilities:                         
Deposits  $739,653   $738,037   $-   $738,037   $- 
Short-term debt   33,559    33,559    -    33,559    - 
Long-term debt   22,839    17,449    -    17,449    - 
Accrued interest payable   241    241    -    241    - 

 

   December 31, 2016 
   Carrying   Estimated             
   Amount   Fair Value   Level 1   Level 2   Level 3 
   (in thousands) 
Financial assets:                         
Cash and due from banks  $14,372   $14,372   $14,372   $-   $- 
Certificates of deposits   1,000    1,000    1,000    -    - 
Interest-earning deposits in other banks   40,342    40,342    40,342    -    - 
Investment securities available for sale   62,257    62,257    -    62,257    - 
Loans, net   668,784    671,208    -    -    671,208 
Accrued interest receivable   2,768    2,768    -    2,768    - 
Stock in the FHLB   2,251    2,251    -    -    2,251 
Other non-marketable securities   703    703    -    -    703 
                          
Financial liabilities:                         
Deposits  $679,661   $678,328   $-   $678,328   $- 
Short-term debt   37,090    37,177    -    37,177    - 
Long-term debt   23,039    17,649    -    17,649    - 
Accrued interest payable   221    221    -    221    - 

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE D – FAIR VALUE MEASUREMENTS (continued)

 

Cash and Due from Banks, Certificates of Deposit, Interest-Earning Deposits in Other Banks and Federal Funds Sold

 

The carrying amounts for cash and due from banks, certificates of deposit, interest-earning deposits in other banks and federal funds sold approximate fair value because of the short maturities of those instruments.

 

Investment Securities Available for Sale

 

Fair value for investment securities available for sale equals quoted market price if such information is available. If a quoted market price is not available, fair value is estimated using prices quoted for similar investments or quoted market prices obtained from independent pricing services.

 

Loans

 

For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. 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, the values likely do not represent exit prices due to distressed market conditions.

 

Stock in Federal Home Loan Bank of Atlanta

 

The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the FHLB stock.

 

Other Non-Marketable Securities

 

The fair value of equity instruments in other non-marketable securities is assumed to approximate carrying value.

 

Deposits

 

The fair value of demand, savings, and money market and NOW deposits is the amount payable on demand at the reporting date. The fair values of time deposits are estimated using the rates currently offered for instruments of similar remaining maturities.

 

Short-term Debt

 

Short-term debt consists of repurchase agreements and FHLB advances with maturities of less than twelve months. The carrying values of these instruments is a reasonable estimate of fair value.

 

Long-term Debt

 

The fair values of long-term debt are based on discounted expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE D – FAIR VALUE MEASUREMENTS (continued)

 

Accrued Interest Receivable and Accrued Interest Payable

 

The carrying amounts of accrued interest receivable and payable approximate fair value because of the short maturities of these instruments.

 

Financial Instruments with Off-Balance Sheet Risk

 

With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments.

 

NOTE E - INVESTMENT SECURITIES

 

The amortized cost and fair value of available for sale investments (“AFS”), with gross unrealized gains and losses, follow:

 

   June 30, 2017 
      Gross   Gross     
   Amortized   unrealized   unrealized   Fair 
   cost   gains   losses   value 
   (dollars in thousands) 
Securities available for sale:                    
U.S. government agencies – GSE’s  $12,426   $160   $(9)  $12,577 
Mortgage-backed securities – GSE’s   29,727    395    (38)   30,084 
Municipal bonds   13,904    287    -    14,191 
                     
   $56,057   $842   $(47)  $56,852 

 

As of June 30, 2017, accumulated other comprehensive income included net unrealized gains totaling $795,000. Deferred tax liabilities resulting from these net unrealized gains totaled $289,000.

 

The amortized cost and fair value of available for sale investments (“AFS”), with gross unrealized gains and losses, follow:

 

   December 31, 2016 
      Gross   Gross      
   Amortized   unrealized   unrealized   Fair 
   cost   gains   losses   value 
   (in thousands) 
Securities available for sale:                    
U.S. government agencies – GSE’s  $14,086   $98   $(25)  $14,159 
Mortgage-backed securities – GSE’s   32,082    382    (101)   32,363 
Municipal bonds   15,527    209    (1)   15,735 
                     
   $61,695   $689   $(127)  $62,257 

  

As of December 31, 2016, accumulated other comprehensive income included net unrealized gains totaling $562,000. Deferred tax liabilities resulting from these net unrealized gains totaled $204,000.

 

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SELECT BANCORP, INC.

Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE E - INVESTMENT SECURITIES (continued)

 

The scheduled maturities of securities available for sale, with gross unrealized gains and losses, were as follows:

 

   June 30, 2017 
      Gross   Gross     
   Amortized   unrealized   unrealized   Fair 
   cost   gains   losses   value 
   (In thousands) 
Securities available for sale:                    
Within 1 year  $1,554   $7   $-   $1,561 
After 1 year but within 5 years   41,301    572    (47)   41,826 
After 5 years but within 10 years   6,943    142    -    7,085 
After 10 years   6,259    121    -    6,380 
                     
   $56,057   $842   $(47)  $56,852 

 

   December 31, 2016 
      Gross   Gross     
   Amortized   unrealized   unrealized   Fair 
   cost   gains   losses   value 
   (in thousands) 
Securities available for sale:                    
Within 1 year  $3,735   $12   $-   $3,747 
After 1 year but within 5 years   37,615    424    (110)   37,929 
After 5 years but within 10 years   10,695    109    (12)   10,792 
After 10 years   9,650    144    (5)   9,789 
                     
   $61,695   $689   $(127)  $62,257 

 

Securities with a carrying value of $19.6 million and $34.3 million at June 30, 2017 and December 31, 2016, respectively, were pledged to secure public monies on deposit as required by law, customer repurchase agreements, and access to the Federal Reserve Discount Window.

 

None of the unrealized losses relate to the liquidity of the securities or the issuer’s ability to honor redemption obligations and the Company has the intent and ability to hold these securities to recovery, no other than temporary impairments were identified for these investments having unrealized losses for the periods ended June 30, 2017 and December 31, 2016. In 2016 the Company realized a gain on the disposal of eleven securities and has not incurred any gains or losses related to securities sales in 2017.

 

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SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE E- INVESTMENT SECURITIES (continued)

 

The following tables show investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2017 and December 31, 2016.

 

   June 30, 2017 
   Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   value   losses   value   losses   value   losses 
   (dollars in thousands) 
Securities available for sale:                              
U.S. government agencies – GSEs  $1,433   $(9)  $-   $-   $1,433   $(9)
Mortgage-backed securities- GSEs   5,420    (38)   -    -    5,420    (38)
Municipal bonds   110    -    -    -    110    - 
Total temporarily impaired securities  $6,963   $(47)  $-   $-   $6,963   $(47)

 

At June 30, 2017, the Company had no AFS securities with an unrealized loss for twelve or more consecutive months. One U.S. government agency GSE, one municipal and six mortgage-backed GSEs had unrealized losses for less than twelve months totaling $47,000 at June 30, 2017. All unrealized losses are attributable to the general trend of interest rates. During the first six months of 2017 there were no investment security sales. During the first quarter of 2016 gross proceeds of investment sales amounted to $624,000 and gains of $22,000. There were no sales of investment securities in the second quarter of 2016.

 

   December 31, 2016 
   Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   value   losses   value   losses   value   losses 
   (in thousands) 
Securities available for sale:                              
U.S. government agencies – GSEs  $2,748   $(13)  $1,651   $(12)  $4,399   $(25)
Mortgage-backed securities- GSEs   8,778    (101)   -    -    8,778    (101)
Municipal bonds   110    (1)   -    -    110    (1)
Total temporarily impaired securities  $11,636   $(115)  $1,651   $(12)  $13,287   $(127)

 

At December 31, 2016, the Company had two U.S. government agency GSEs with unrealized losses for more than twelve months totaling $12,000. Two U.S. government agency GSEs, one municipal and eight mortgage-backed GSEs had unrealized losses for less than twelve months totaling $115,000 at December 31, 2016. All unrealized losses are attributable to the general trend of interest rates and the abnormal spreads of all debt instruments to U.S. Treasury securities. The Company did not incur a loss on any securities sold during 2016.

 

 22 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE F - LOANS

 

Following is a summary of the composition of the Company’s loan portfolio at June 30, 2017 and December 31, 2016:

 

   June 30,   December 31, 
Total Loans:  2017   2016 
       Percent       Percent 
   Amount   of total   Amount   of total 
   (dollars in thousands) 
Real estate loans:                    
1-to-4 family residential  $103,644    14.04%  $97,978    14.47%
Commercial real estate   297,406    40.30%   281,723    41.60%
Multi-family residential   71,066    9.63%   56,119    8.29%
Construction   126,265    17.11%   100,911    14.90%
Home equity lines of credit (“HELOC”)   42,305    5.73%   41,158    6.08%
                     
Total real estate loans   640,686    86.81%   577,889    85.34%
                    
Other loans:                    
Commercial and industrial   88,206    11.95%   90,678    13.39%
Loans to individuals   10,365    1.40%   9,756    1.44%
Overdrafts   57    0.01%   71    0.01%
Total other loans   98,628    13.36%   100,505    14.84%
                     
Gross loans   739,314        678,394      
Less deferred loan origination fees, net   (1,293)   (0.17)%   (1,199)   (0.18)%
Total loans   738,021    100.00%   677,195    100.00%
                     
Allowance for loan losses   (8,488)        (8,411)     
                     
Total loans, net  $729,533        $668,784      

 

Loans are primarily secured by real estate located in eastern and central North Carolina. Real estate loans can be affected by the condition of the local real estate market and by local economic conditions.

 

At June 30, 2017, the Company had pre-approved but unused lines of credit for customers totaling $135.8 million. In management’s opinion, these commitments, and undisbursed proceeds on loans reflected above, represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity.

 

A floating lien of $92.2 million of loans was pledged to the FHLB to secure borrowings at June 30, 2017.

 

 23 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE F - LOANS (continued)

 

A description of the various loan products provided by the Bank is presented below.

 

1-to-4 Family Residential Loans

Residential 1-to-4 family loans are mortgage loans secured by residential real estate within the Bank’s market areas. These loans may also include loans that convert from construction loans into permanent financing and are secured by properties within the Bank’s market areas.

 

Commercial Real Estate Loans

Commercial real estate loans are underwritten based on the borrower’s ability to generate adequate cash flow to repay the subject debt within reasonable terms. Commercial real estate loans typically include both owner and non-owner occupied properties with higher principal loan amounts. The repayment of these loans is generally dependent on the successful management of the property. Commercial real estate loans are sensitive to market and general economic conditions. Repayment analysis must be performed and consists of an identified primary/cash flow source of repayment and a secondary/liquidation source of repayment. The primary source of repayment is cash flow from income generated from rental or lease of the property. However, the cash flow can be supplemented with the borrower's and guarantor's global cash flow position. Other credit issues such as the business fundamentals and financial strength of the borrower/guarantor can be considered in determining adequacy of repayment ability. The secondary source of repayment is liquidation of the collateral, supplemented by a liquidation cushion provided by the financial assets of the borrower/guarantor. Management monitors and evaluates commercial real estate loans based on collateral, cash flow, market area, and risk grade.

 

Multi-family Residential Loans

Multi-family residential loans are typically non-farm properties with 5 or more dwelling units in structures which include apartment buildings used primarily to accommodate households on a more or less permanent basis. Successful performance of these types of loans is primarily dependent on occupancy rates, rental rates, and property management.

 

Construction Loans

Construction loans are non-revolving extensions of credit secured by real property of which the proceeds are used to acquire and develop land and to construct commercial or residential buildings. The primary source of repayment for these types of loans is the sale of the improved property or permanent financing in which case the property is expected to generate the cash flow necessary for repayment on a permanent loan basis. Property cash flow may be supplemented with financial support from the borrowers/guarantors. Proper underwriting of a construction loan consists of the initial process of obtaining, analyzing, and approving various aspects of information pertaining to: the analysis of the permanent financing source, creditworthiness of the borrower and guarantors, ability of the contractor to perform under the terms of the contract, and the feasibility, marketability, and valuation of the project.

 

 24 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE F - LOANS (continued)

 

Also, consideration is given to the cost of the project and sources of funds needed to complete construction as well as identifying any sources of equity funding. Construction loans are traditionally considered to be higher risk loans involving technical and legal requirements inherently different from other types of loans; however with thorough credit underwriting, proper loan structure, and diligent loan servicing, these risks can often be mitigated. Some examples of risks inherent in this type of lending include: underestimated costs, inflation of material and labor costs, site difficulties (i.e. rock, soil), project not built to plans, weather delays and natural disasters, borrower/contractor/subcontractor disputes which prompt liens, and interest rates increasing beyond budget.

 

Home Equity Lines of Credit

Home equity lines of credit are consumer-purpose revolving extensions of credit which are secured by first or second liens on owner-occupied residential real estate. Appropriate risk management and compliance practices are exercised to ensure that loan-to-value, lien perfection, and compliance risks are addressed and managed within the Bank’s established guidelines. The degree of utilization of revolving commitments within this loan segment is reviewed periodically to identify changes in the behavior of this borrowing group.

 

Commercial and Industrial Loans

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to generate positive cash flow, operate profitably and prudently expand its business. Underwriting standards are designed to promote relationships to include a full range of loan, deposit, and cash management services. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and the guarantors. The cash flows of the borrower, however, may not be as expected and the collateral securing these loans may fluctuate in value. In the case of loans secured by accounts receivable, the availability of funds for repayment can be impacted by the borrower’s ability to collect amounts due from its customers.

 

Loans to Individuals & Overdrafts

Consumer loans are approved using Bank policies and procedures established to evaluate each credit request. All lending decisions and credit risks are required to be clearly documented. Several factors are considered in making these decisions such as credit score, adjusted net worth, liquidity, debt ratio, disposable income, credit history, and loan-to-value of the collateral. This process, combined with the relatively smaller loan amounts spreads the risk among many individual borrowers. Overdrafts on customer accounts are classified as loans for reporting purposes.

 

 25 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE F - LOANS (continued)

 

The following tables present an age analysis of past due loans, segregated by class of loans as of June 30, 2017 and December 31, 2016, respectively:

 

Total Loans:  June 30, 2017 
   30+   Non-   Total         
   Days   Accrual   Past       Total 
   Past Due   Loans   Due   Current   Loans 
   (dollars in thousands) 
     
Commercial and industrial  $19   $70   $89   $88,117   $88,206 
Construction   207    91    298    125,967    126,265 
Multi-family residential   -    48    48    71,018    71,066 
Commercial real estate   118    1,442    1,560    295,846    297,406 
Loans to individuals & overdrafts   32    6    38    10,384    10,422 
1-to-4 family residential   26    921    947    102,697    103,644 
HELOC   117    365    482    41,823    42,305 
Deferred loan (fees) cost, net   -    -    -    -    (1,293)
                          
   $519   $2,943   $3,462   $735,852   $738,021 

 

There were five loans that amounted to $956,000 that were more than 90 days past due and still accruing interest at June 30, 2017.

 

   December 31, 2016 
   30+   Non-   Total         
   Days   Accrual   Past       Total 
   Past Due   Loans   Due   Current   Loans 
   (in thousands) 
                     
Total Loans                         
Commercial and industrial  $1,459   $73   $1,532   $89,146   $90,678 
Construction   221    151    372    100,539    100,911 
Multi-family residential   46    346    392    55,727    56,119 
Commercial real estate   589    3,807    4,396    277,327    281,723 
Loans to individuals & overdrafts   23    46    69    9,758    9,827 
1-to-4 family residential   631    602    1,233    96,745    97,978 
HELOC   24    780    804    40,354    41,158 
Deferred loan (fees) cost, net   -    -    -    -    (1,199)
   $2,993   $5,805   $8,798   $669,596   $677,195 

 

There were three loans in the aggregate amount of $529,000 greater than 90 days past due and still accruing interest at December 31, 2016.

 

 26 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE F - LOANS (continued)

 

Impaired Loans

 

The following tables present information on loans that were considered to be impaired as of June 30, 2017 and December 31, 2016:

 

               Three months ended   Six months ended 
   As of June 30, 2017   June 30, 2017   June 30, 2017 
       Contractual           Interest Income       Interest Income 
       Unpaid       Average   Recognized on   Average   Recognized on 
   Recorded   Principal   Related   Recorded   Impaired   Recorded   Impaired 
   Investment   Balance   Allowance   Investment   Loans   Investment   Loans 
   (In thousands) 
With no related allowance recorded:                                   
Commercial and industrial  $1,053   $1,063   $-   $1,077   $21   $1,119   $40 
Construction   164    251    -    169    1    198    5 
Commercial real estate   3,674    4,867    -    3,958    54    4,019    113 
Loans to individuals & overdrafts   -    -    -    -    -    -    - 
Multi-family residential   48    48    -    48    -    197    - 
1-to-4 family residential   1,222    1,435    -    1,022    20    1,111    33 
HELOC   648    832    -    654    12    844    22 
Subtotal:   6,809    8,496    -    6,928    108    7,488    213 
With an allowance recorded:                                   
Commercial and industrial   -    -    -    -    -    1    - 
Construction   -    -    -    -    -    -    - 
Commercial real estate   630    686    12    1,429    10    1,563    20 
Loans to individuals & overdrafts   -    -    -    -    -    -    - 
Multi-family residential   -    -    -    -    -    -    - 
1-to-4 family residential   300    304    16    302    5    298    11 
HELOC   33    35    -    16    -    33    - 
Subtotal:   963    1,025    28    1,747    15    1,895    31 
Totals:                                   
Commercial   5,569    6,915    13    6,681    86    7,097    178 
Consumer   -    -    -    -    -    -    - 
Residential   2,203    2,606    15    1,994    37    2,286    66 
Grand Total:  $7,772   $9,521   $28   $8,675   $123   $9,383   $244 

 

Impaired loans at June 30, 2017 were approximately $7.8 million and were composed of $2.9 million in nonaccrual loans and $4.9 million in loans that were still accruing interest. Recorded investment represents the current principal balance of the loan. Approximately $963,000 in impaired loans had specific allowances provided for them while the remaining $6.8 million had no specific allowances recorded at June 30, 2017. Of the $6.8 million with no allowance recorded, $1.4 million of those loans have had partial charge-offs recorded.

 

 27 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Impaired Loans (continued)

 

               Three months ended   Six months ended 
   As of December 31, 2016   June 30, 2016   June 30, 2016 
       Contractual           Interest Income       Interest Income 
       Unpaid       Average   Recognized on   Average   Recognized on 
   Recorded   Principal   Related   Recorded   Impaired   Recorded   Impaired 
   Investment   Balance   Allowance   Investment   Loans   Investment   Loans 
   (In thousands) 
With no related allowance recorded:                                   
Commercial and industrial  $46   $46   $-   $469   $2   $237   $8 
Construction   231    318    -    558    2    563    6 
Commercial real estate   4,364    5,983    -    3,304    29    4,378    72 
Loans to individuals & overdrafts   1,139    1,144    -    -    -    -    - 
Multi-family residential   346    365    -    368    3    397    8 
1 to 4 family residential   1,000    1,278    -    1,257    36    1,656    52 
HELOC   1,041    1,378    -    658    10    661    18 
Subtotal:   8,167    10,512    -    6,614    82    7,892    164 
With an allowance recorded:                                   
Commercial and industrial   -    -    -    35    -    39    1 
Construction   -    -    -    -    -    -    - 
Commercial real estate   2,496    2,905    80    3,389    4    2,165    18 
Loans to individuals & overdrafts   1    1    1    -    -    2    - 
Multi-family residential   -    -    -    -    -    -    - 
1 to 4 family residential   296    296    17    314    2    284    8 
HELOC   34    35    19    41    -    16    - 
Subtotal:   2,827    3,237    117    3,779    6    2,506    27 
Totals:                                   
Commercial   7,483    9,617    80    8,123    40    7,779    113 
Consumer   1,140    1,145    1    -    -    2    - 
Residential   2,371    2,987    36    2,270    48    2,617    78 
Grand Total:  $10,994   $13,749   $117   $10,393   $88   $10,398   $191 

 

Impaired loans at December 31, 2016 were approximately $11.0 million and consisted of $5.8 million in non-accrual loans and $5.2 million in loans still in accruing status. Recorded investment represents the current principal balance for the loan. Approximately, $2.8 million of the $11.0 million in impaired loans at December 31, 2016 had specific allowances aggregating $117,000 while the remaining $8.2 million had no specific allowances recorded. Of the $8.2 million with no allowance recorded, partial charge-offs to date amounted to $2.3 million.

 

Loans are placed on non-accrual status when it has been determined that all contractual principal and interest will not be received. Any payments received on these loans are applied to principal first and then to interest only after all principal has been collected. In the case of an impaired loan that is still on accrual basis, payments are applied to both principal and interest.

 

 28 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Troubled Debt Restructurings

 

The following table presents loans that were modified as troubled debt restructurings (“TDRs”) with a breakdown of the types of concessions made by loan class during the three and six months ended June 30, 2017 and 2016:

 

   Three months ended June 30, 2017   Six months ended June 30, 2017 
       Pre-   Post-       Pre-   Post- 
       Modification   Modification       Modification   Modification 
       Outstanding   Outstanding       Outstanding   Outstanding 
   Number   Recorded   Recorded   Number   Recorded   Recorded 
   of loans   Investment   Investment   of loans   Investment   Investment 
   (Dollars in thousands) 
Extended payment terms:                              
1-to-4 family residential   1   $17   $17    1   $17   $17 
Commercial & industrial   1    44    44    1    44    44 
                               
Total   2   $61   $61    2   $61   $61 

 

   Three months ended June 30, 2016   Six months ended June 30, 2016 
       Pre-   Post-       Pre-   Post- 
       Modification   Modification       Modification   Modification 
       Outstanding   Outstanding       Outstanding   Outstanding 
   Number   Recorded   Recorded   Number   Recorded   Recorded 
   of loans   Investment   Investment   of loans   Investment   Investment 
   (Dollars in thousands) 
Extended payment terms:                              
1-to-4 family residential   1   $49   $49    1   $49   $49 
Commercial & industrial   2    251    160    3    296    206 
Loans to individuals   1    4    4    1    4    4 
                               
Total   4   $304   $213    5   $349   $259 

 

Loans may be considered troubled debt restructurings for reasons other than below market interest rates, extended payment terms or forgiveness of principal.

 

 29 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Troubled Debt Restructurings (continued)

 

The following table presents loans that were modified as TDRs within the past twelve months with a breakdown of the types for which there was a payment default during that period together with concessions made by loan class during the twelve month period ended June 30, 2017 and 2016:

 

   Twelve months ended   Twelve months ended 
   June 30, 2017   June 30, 2016 
   Number   Recorded   Number   Recorded 
   of loans   investment   of loans   investment 
   (Dollars in thousands) 
Extended payment terms:                    
Commercial real estate   -   $-    3   $206 
Commercial & industrial   2   $927    -    - 
Loans to individuals   -    -    1    4 
Multi-family residential   -    -    1    370 
1-to-4 family residential   1    77    1    49 
Total   3   $1,004    6   $629 

 

At June 30, 2017, the Bank had thirty two loans with an aggregate balance of $4.7 million that were considered to be troubled debt restructurings. Of those TDRs, seventeen loans with a balance totaling $3.2 million were still accruing as of June 30, 2017. The remaining TDRs with balances totaling $1.5 million as of June 30, 2017 were in non-accrual status.

 

At June 30, 2016, the Bank had thirty five loans with an aggregate balance of $4.2 million that were considered to be troubled debt restructurings. Of those TDRs, twenty-six loans with a balance totaling $2.9 million were still accruing as of June 30, 2016. The remaining TDRs with balances totaling $1.3 million as of June 30, 2016 were in non-accrual status.

 

Credit Quality Indicators

 

As part of the on-going monitoring of the credit quality of the loan portfolio, management utilizes a risk grading matrix to assign a risk grade to each of the Company’s loans. All non-consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of these nine different risk grades is as follows:

 

·Risk Grade 1 (Superior) - Credits in this category are virtually risk-free and are well-collateralized by cash-equivalent instruments. The repayment program is well-defined and achievable. Repayment sources are numerous. No material documentation deficiencies or exceptions exist.

·Risk Grade 2 (Very Good) - This grade is reserved for loans secured by readily marketable collateral, or loans within guidelines to borrowers with liquid financial statements. A liquid financial statement is a financial statement with substantial liquid assets relative to debts. These loans have excellent sources of repayment, with no significant identifiable risk of collection, and conform in all respects to Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).

 

 30 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Credit Quality Indicators (continued)

 

·Risk Grade 3 (Good) - These loans have excellent sources of repayment, with no significant identifiable risk of collection. Generally, these loans will be in conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind). Loans assigned this risk grade will demonstrate the following characteristics:
oDocumented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.
oAdequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

 

·Risk Grade 4 (Acceptable) - This grade is given to acceptable loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this risk grade will demonstrate the following characteristics:
oGeneral conformity to the Bank's policy requirements, product guidelines and underwriting standards, with limited exceptions. Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.
oDocumented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  
oAdequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

 

·Risk Grade 5 (Acceptable With Care) - This grade is given to acceptable loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this grade may demonstrate some or all of the following characteristics:
oAdditional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.
oUnproven, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.
oMarginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.

 

·Risk Grade 6 (Watch List or Special Mention) – Loans in this category can have the following characteristics:
oLoans with underwriting guideline tolerances and/or exceptions and with no mitigating factors.
oExtending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.

 

 31 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Credit Quality Indicators (continued)

 

oLoans where adverse economic conditions that develop subsequent to the loan origination that do not jeopardize liquidation of the debt but do substantially increase the level of risk may also warrant this rating.
·Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must 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. Loans consistently not meeting the repayment schedule should be downgraded to substandard. Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action.
·Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus 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. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.
·Risk Grade 9 (Loss) - Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future.

 

Consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of the nine risk grades is as follows:

 

·Risk Grades 1 – 5 (Pass) – The loans in this category range from loans secured by cash with no risk of principal deterioration (Risk Grade 1) to loans that show signs of weakness in either adequate sources of repayment or collateral but have demonstrated mitigating factors that minimize the risk of delinquency or loss (Risk Grade 5).
·Risk Grade 6 (Watch List or Special Mention) - Watch List or Special Mention loans include the following characteristics:
oLoans within guideline tolerances or with exceptions of any kind that have not been mitigated by other economic or credit factors.
oExtending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.
oLoans where adverse economic conditions that develop subsequent to the loan origination that don't jeopardize liquidation of the debt but do substantially increase the level of risk may also warrant this rating.
·Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must 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.

 

 32 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Credit Quality Indicators (continued)

 

·Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus 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. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.
·Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be affected in the future.

 

 33 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

The following tables present information on risk ratings of the commercial and consumer loan portfolios, segregated by loan class as of June 30, 2017 and December 31, 2016, respectively:

 

Total loans:

 

June 30, 2017
Commercial                
Credit                
Exposure By  Commercial       Commercial     
Internally  and       real   Multi-family 
Assigned Grade  industrial   Construction   estate   residential 
(In thousands)
                 
Superior  $402   $-   $-   $- 
Very good   815    260    440    - 
Good   10,680    6,089    38,673    10,732 
Acceptable   31,509    18,517    168,342    40,469 
Acceptable with care   43,124    100,869    84,288    19,578 
Special mention   1,444    302    2,175    - 
Substandard   232    228    3,488    287 
Doubtful   -    -    -    - 
Loss   -    -    -    - 
   $88,206   $126,265   $297,406   $71,066 

 

Consumer Credit        
Exposure By        
Internally  1-to-4 family     
Assigned Grade  residential   HELOC 
         
Pass  $97,834   $40,717 
Special mention   2,934    485 
Substandard   2,876    1,103 
   $103,644   $42,305 

 

Consumer Credit    
Exposure Based  Loans to 
On Payment  individuals & 
Activity  overdrafts 
     
Pass  $10,411 
Non –pass   11 
   $10,422 

 

 34 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Total Loans:

 

December 31, 2016
Commercial                
Credit                
Exposure By  Commercial       Commercial     
Internally  and       real   Multi-family 
Assigned Grade  industrial   Construction   estate   residential 
   (in thousands) 
                 
Superior  $435   $-   $-   $- 
Very good   326    245    460    - 
Good   13,632    4,506    36,501    12,139 
Acceptable   35,720    12,922    152,608    29,873 
Acceptable with care   37,351    82,771    81,231    13,467 
Special mention   2,905    173    4,868    - 
Substandard   309    294    6,055    640 
Doubtful   -    -    -    - 
Loss   -    -    -    - 
   $90,678   $100,911   $281,723   $56,119 

 

Consumer Credit        
Exposure By        
Internally  1-to-4 family     
Assigned Grade  residential   HELOC 
         
Pass  $92,115   $39,554 
Special mention   3,015    439 
Substandard   2,848    1,165 
   $97,978   $41,158 

 

Consumer Credit    
Exposure Based  Loans to 
On Payment  individuals & 
Activity  overdrafts 
     
Pass  $9,820 
Non-pass   7 
   $9,827 

 

 35 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Determining the fair value of Purchased Credit Impaired (PCI) loans at acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of cash flows expected to be collected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carry-over of previously established allowance for credit losses from the acquired company.

 

The following table documents changes to the amount of the accretable yield on PCI loans for the three and six months ended June 30, 2017 (dollars in thousands):

 

   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2017   2017 
   (Dollars in thousands) 
         
Accretable yield, beginning of period  $2,465   $2,626 
Accretion   (260)   (520)
Reclassification from (to) nonaccretable difference   72    79 
Other changes, net   3    95 
Accretable yield, end of period  $2,280   $2,280 

 

Allowance for Loan Losses

 

The allowance for loan losses is a reserve established through provisions for loan losses charged to income and represents management’s best estimate of probable loan losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated losses and risk inherent in the loan portfolio. The Company’s allowance for loan loss methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of reserves is designed to account for changes in credit quality as they occur. The provision for loan losses reflects loan quality trends, including the levels of and trends related to past due loans and economic conditions at the local and national levels. It also considers the quality and risk characteristics of the Company’s loan origination and servicing policies and practices.

 

Individual reserves are calculated according to ASC Section 310-10-35 against loans evaluated individually and deemed to most likely be impaired. Impaired loans include all loans in non-accrual status, all troubled debt restructures, all substandard loans that are deemed to be collateral dependent, and other loans that management determines require reserves.

 

The Company’s allowance for loan losses model calculates historical loss rates by using a loss migration analysis associating losses to the risk-graded pool to which they relate for each of the previous twelve quarters. Then, using the twelve quarter look back period, loss factors are calculated for each risk-graded pool. The model incorporates various internal and external qualitative and environmental factors as described in the Interagency Policy Statement on the Allowance for Loan and Lease Losses, dated

 

 36 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Allowance for Loan Losses (continued)

 

December 2006. Input for these factors is determined on the basis of management observation, judgment, and experience. The factors utilized by the Company in the model for all loan classes are as follows:

 

Internal Factors

·Concentrations – Measures the increased risk derived from concentration of credit exposure in particular industry segments within the portfolio.
·Policy exceptions – Measures the risk derived from granting terms outside of underwriting guidelines.
·Compliance exceptions– Measures the risk derived from granting terms outside of regulatory guidelines.
·Document exceptions– Measures the risk exposure resulting from the inability to collect due to improperly executed documents and collateral imperfections.
·Financial information monitoring – Measures the risk associated with not having current borrower financial information.
·Nonaccrual – Reflects increased risk of loans with characteristics that merit nonaccrual status.
·Delinquency – Reflects the increased risk deriving from higher delinquency rates.
·Personnel turnover – Reflects staff competence in various types of lending.
·Portfolio growth – Measures the impact of growth and potential risk derived from new loan production.

 

External Factors

·GDP growth rate – Impact of general economic factors that affect the portfolio.
·North Carolina unemployment rate – Impact of local economic factors that affect the portfolio.
·Peer group delinquency rate – Measures risk associated with the credit requirements of competitors.
·Prime rate change – Measures the effect on the portfolio in the event of changes in the prime lending rate.

 

Each pool is assigned an adjustment to the potential loss percentage by assessing its characteristics against each of the factors listed above.

 

Reserves are generally divided into three allocation segments:

 

1.Individual reserves. These are calculated according to ASC Section 310-10-35 against loans evaluated individually and deemed to be most likely impaired.  All loans in non-accrual status and all substandard loans that are deemed to be collateral dependent are assessed for impairment. Loans are deemed uncollectible based on a variety of credit, collateral, documentation and other issues. In the case of uncollectible receivables, the collateral is considered unsecured and therefore fully charged off.

 

2.Formula reserves. Formula reserves are held against loans evaluated collectively. Loans are grouped by type or by risk grade, or some combination of the two. Loss estimates are based on historical loss rates for each respective loan group. Formula reserves represent the Company’s best estimate of losses that may be inherent, or embedded, within the group of loans, even if it is not apparent at this time which loans within any group or pool represent those embedded losses.

 

 37 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Allowance for Loan Losses (continued)

 

3.Qualitative and external reserves. If individual reserves represent estimated losses tied to specific loans, and formula reserves represent estimated losses tied to a pool of loans but not yet to any specific loan, then these reserves represent an estimate of likely incurred losses, but are not yet tied to any loan or group of loans.

 

All information related to the calculation of the three segments, including data analysis, assumptions, and calculations are documented. Assigning specific individual reserve amounts, formula reserve factors, or unallocated amounts based on unsupported assumptions or conclusions is not permitted.

 

 38 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Allowance for Loan Losses (Continued)

 

The following tables present a roll forward of the Company’s allowance for loan losses by loan class for the three and six month periods ended June 30, 2017, respectively:

 

   Three months ended June 30, 2017 
   Commercial           1 to 4       Loans to   Multi-     
   and       Commercial   family       individuals &   family     
Allowance for loan losses  industrial   Construction   real estate   residential   HELOC   overdrafts   residential   Total 
   (Dollars in thousands) 
Loans – excluding PCI                                        
Balance, beginning of period  $958   $1,177   $3,169   $770   $589   $465   $583   $7,711 
Provision for loan losses   (119)   111    1,110    143    (28)   (294)   149    1,072 
Loans charged-off   (35)   -    (373)   -    -    (34)   -    (442)
Recoveries   91    4    7    10    2    5    -    119 
Balance, end of period  $895   $1,292   $3,913   $923   $563   $142   $732   $8,460 
                                         
PCI Loans                                        
Balance, beginning of period  $5   $-   $294   $-   $12   $-   $-   $311 
Provision for loan losses   (5)   -    12    16    (12)   -    -    11 
Loans charged-off   -    -    (294)   -    -    -    -    (294)
Recoveries   -    -    -    -    -    -    -    - 
Balance, end of period  $-   $-   $12   $16   $-   $-   $-   $28 
                                         
Total Loans                                        
Balance, beginning of period  $963   $1,177   $3,463   $770   $601   $465   $583   $8,022 
Provision for loan losses   (124)   111    1,122    159    (40)   (294)   149    1,083 
Loans charged-off   (35)   -    (667)   -    -    (34)   -    (736)
Recoveries   91    4    7    10    2    5    -    119 
Balance, end of period  $895   $1,292   $3,925   $939   $563   $142   $732   $8,488 
                                         
Ending Balance: individually evaluated for impairment  $-   $-   $12   $16   $-   $-   $-   $28 
Ending Balance: collectively evaluated for impairment  $895   $1,292   $3,913   $923   $563   $142   $732   $8,460 
                                         
Loans:                                        
Ending Balance: collectively evaluated for impairment  $87,153   $126,101   $293,102   $102,122   $41,624   $10,422   $71,018   $731,542 
Ending Balance: individually evaluated for impairment  $1,053   $164   $4,304   $1,522   $681   $-   $48   $7,772 
Ending Balance  $88,206   $126,265   $297,406   $103,644   $42,305   $10,422   $71,066   $739,314 

 

 39 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

   Six months ended June 30, 2017 
   Commercial           1 to 4       Loans to   Multi-     
   and       Commercial   family       individuals &   family     
Allowance for loan losses  industrial   Construction   real estate   residential   HELOC   overdrafts   residential   Total 
   (Dollars in thousands) 
Loans – excluding PCI                                        
Balance, beginning of period  $1,211   $1,301   $3,448   $846   $611   $317   $628   $8,362 
Provision for loan losses   (466)   (18)   1,081    58    (2)   (139)   102    616 
Loans charged-off   (37)   -    (623)   -    (69)   (50)   -    (779)
Recoveries   187    9    7    19    23    14    2    261 
Balance, end of period  $895   $1,292   $3,913   $923   $563   $142   $732   $8,460 
                                         
PCI Loans                                        
Balance, beginning of period  $37   $-   $-   $-   $12   $-   $-   $49 
Provision for loan losses   (37)   -    306    16    (12)   -    -    273
Loans charged-off   -    -    (294)   -    -    -    -    (294)
Recoveries   -    -    -    -    -    -    -    - 
Balance, end of period  $-   $-   $12   $16   $-   $-   $-   $28 
                                         
Total Loans                                        
Balance, beginning of period  $1,248   $1,301   $3,448   $846   $623   $317   $628   $8,411 
Provision for loan losses   (503)   (18)   1,387    74    (14)   (139)   102    889 
Loans charged-off   (37)   -    (917)   -    (69)   (50)   -    (1,073)
Recoveries   187    9    7    19    23    14    2    261 
Balance, end of period  $895   $1,292   $3,925   $939   $563   $142   $732   $8,488 

 

 40 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE G - LOANS (continued)

 

Allowance for Loan Losses (Continued)

 

The following tables present a roll forward of the Company’s allowance for loan losses by loan class for the three and six month periods ended June 30, 2016, respectively:

 

   Three months ended June 30, 2016 
   Commercial          1 to 4        Loans to   Multi-     
   and      Commercial   family        individuals &   family     
Allowance for loan losses  industrial   Construction   real estate   residential   HELOC   overdrafts   residential   Total 
   (Dollars in thousands) 
Loans – excluding PCI                                        
Balance, beginning of period  $1,055   $1,401   $3,217   $688   $585   $150   $422   $7,518 
Provision for loan losses   66    107    49    (101)   (102)   22    101    142 
Loans charged-off   (40)   (1)   (185)   -    (1)   (9)   -    (236)
Recoveries   5    4    32    185    11    6    -    243 
Balance, end of period  $1,086   $1,511   $3,113   $772   $493   $169   $523   $7,667 
                                         
PCI Loans                                        
Balance, beginning of period  $-   $-   $-   $-   $9   $-   $-   $9 
Provision for loan losses   16    -    -    -    -    -    -    16 
Loans charged-off   -    -    -    -    -    -    -    - 
Recoveries   -    -    -    -    -    -    -    - 
Balance, end of period  $16   $-   $-   $-   $9   $-   $-   $25 
                                         
Total Loans                                        
Balance, beginning of period  $1,055   $1,401   $3,217   $688   $594   $150   $422   $7,527 
Provision for loan losses   82    107    49    (101)   (102)   22    101    158 
Loans charged-off   (40)   (1)   (185)   -    (1)   (9)   -    (236)
Recoveries   5    4    32    185    11    6    -    243 
Balance, end of period  $1,102   $1,511   $3,113   $772   $502   $169   $523   $7,692 
                                         
Ending Balance: individually evaluated for impairment  $7   $-   $96   $12   $-   $-   $-   $115 
Ending Balance: collectively evaluated for impairment  $1,095   $1,511   $3,017   $760   $502   $169   $523   $7,577 
                                         
Loans:                                        
Ending Balance: collectively evaluated for impairment  $79,719   $112,768   $241,091   $93,463   $41,399   $8,554   $45,928   $622,922 
Ending Balance: individually evaluated for impairment  $435   $511   $6,831   $1,527   $656   $-   $367   $10,327 
Ending Balance  $80,154   $113,279   $247,922   $94,990   $42,055   $8,554   $46,295   $633,249 

 

 41 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

   Six months ended June 30, 2016 
   Commercial          1 to 4       Loans to   Multi-     
   and      Commercial   family       individuals &   family     
Allowance for loan losses  industrial   Construction   real estate   residential   HELOC   overdrafts   residential   Total 
   (Dollars in thousands) 
Loans – excluding PCI                                        
Balance, beginning of period  $922   $1,386   $3,005   $605   $564   $137   $393   $7,012 
Provision for loan losses   198    116    219    (114)   (96)   41    130    494 
Loans charged-off   (41)   (2)   (185)   -    (1)   (18)   -    (247)
Recoveries   7    11    74    281    26    9    -    408 
Balance, end of period  $1,086   $1,511   $3,113   $772   $493   $169   $523   $7,667 
                                         
PCI Loans                                        
Balance, beginning of period  $-   $-   $-   $-   $9   $-   $-   $9 
Provision for loan losses   16    -    -    -    -    -    -    16 
Loans charged-off   -    -    -    -    -    -    -    - 
Recoveries   -    -    -    -    -    -    -    - 
Balance, end of period  $16   $-   $-   $-   $9   $-   $2   $25 
                                         
Total Loans                                        
Balance, beginning of period  $922   $1,386   $3,005   $605   $573   $137   $393   $7,021 
Provision for loan losses   214    116    219    (114)   (96)   41    130    510 
Loans charged-off   (41)   (2)   (185)   -    (1)   (18)   -    (247)
Recoveries   7    11    74    281    26    9    -    408 
Balance, end of period  $1,102   $1,511   $3,113   $772   $502   $169   $523   $7,692 

 

 42 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE H – ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The following table presents changes in accumulated other comprehensive income for the three and six months ended June 30, 2017 and 2016.

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2017   2016   2017   2016 
   (In thousands) 
                 
Beginning balance  $410   $953   $358   $490 
                     
Unrealized gain (loss) on investment securities available for sale   151    338    233    1,099 
Tax effect   (55)   (113)   (85)   (397)
Other comprehensive gain (loss) before reclassification   96    225    148    702 
Amounts reclassified from accumulated comprehensive income:                    
Realized gains on investment securities included in net income   -    -    -    (22)
Tax effect   -    -    -    8 
Total reclassifications net of tax   -    -    -    (14)
                     
Net current period other comprehensive income   96    225    148    688 
                     
Ending balance  $506   $1,178   $506   $1,178 

 

The income statement line items impacted by the reclassifications of realized gains (losses) on investment securities are the gain on the sale of securities and income tax expense line items in the consolidated statement of operations.

 

NOTE I - REPURCHASE AGREEMENTS

 

We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and secure long-term funding needs. Repurchase agreements are transactions whereby we offer to sell to a counterparty an undivided interest in an eligible security at an agreed upon purchase price, and which obligates the Company to repurchase the security on an agreed upon date at an agreed upon repurchase price plus interest at an agreed upon rate. Securities sold under agreements to repurchase are recorded at the amount of cash received in connection with the transaction and are reflected as short-term borrowings.

 

We monitor collateral levels on a continuous basis and maintain records of each transaction specifically describing the applicable security and the counterparty’s fractional interest in that security, and we segregate the security from its general assets in accordance with regulations governing custodial holdings of securities. The primary risk with our repurchase agreements is market risk associated with the investments securing the transactions, as we may be required to provide additional collateral based on fair value changes of the underlying investments. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agents. The carrying value of available for sale investment securities pledged as collateral under repurchase agreements totaled $12.7 million and $12.0 million at June 30, 2017 and December 31, 2016, respectively.

 

 43 

 

 

SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE I - REPURCHASE AGREEMENTS (continued)

 

The remaining contractual maturity of the securities sold under agreements to repurchase by class of collateral pledged included in short-term borrowings as of June 30, 2017 and December 31, 2016 is presented in the following tables.

 

   June 30, 2017 
   Remaining Contractual Maturity of the Agreements 
   Overnight and   Up to 30   30-90   Greater than     
(Dollars in thousands)  continuous   Days   Days   90 Days   Total 
Repurchase agreements                         
U.S. government agencies-GSE’s  $6,222   $-   $-   $-   $6,222 
Mortgage-backed Securities-GSEs   6,432    -    -    -    6,432 
Total borrowings  $12,654   $-   $-   $-   $12,654 
Gross amount of recognized liabilities for repurchase agreements   $11,560 

 

   December 31, 2016 
   Remaining Contractual Maturity of the Agreements 
   Overnight and   Up to 30   30-90   Greater than     
(in thousands)  continuous   Days   Days   90 Days   Total 
Repurchase agreements                         
U.S. government agencies-GSE’s  $5,568   $-   $-   $-   $5,568 
Mortgage-backed Securities-GSEs   6,496    -    -    -    6,496 
Total borrowings  $12,064   $-   $-   $-   $12,064 
Gross amount of recognized liabilities for repurchase agreements   $12,003 

 

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SELECT BANCORP, INC.
Notes to Consolidated Financial Statements (Unaudited)

 

 

NOTE J – OTHER REAL ESTATE OWNED

 

The following table explains changes in other real estate owned during the six months ended June 30, 2017 and 2016 (dollars in thousands):

 

   Six Months   Six Months 
   Ended June 30,   Ended June 30, 
   2017   2016 
   (Dollars in thousands) 
         
Beginning balance January 1  $599   $1,401 
Sales   (384)   (1,215)
Write-downs   61    (48)
Transfers   2,426    578 
Ending balance  $2,702   $716 

 

At June 30, 2017 and December 31, 2016, the Company had $2.7 million and $599,000, respectively, of foreclosed residential real estate property in OREO. The recorded investment in consumer mortgage loans collateralized by residential real estate property in the process of foreclosure totaled $135,000 and none at June 30, 2017 and December 31, 2016, respectively.

 

NOTE K – SUBSEQUENT EVENTS

 

The Company and Bank have entered into an Agreement and Plan of Merger and Reorganization dated as of July 20, 2017, with Premara Financial, Inc. (“Premara”) and its subsidiary bank, Carolina Premier Bank, Charlotte, NC. Pursuant to the terms of the merger agreement, the Company would acquire Carolina Premier Bank through the merger of Premara with and into the Company, with the Company as the surviving corporation. Immediately following the parent company merger, Carolina Premier Bank would be merged with and into the Bank, with the Bank as the surviving banking corporation in the bank merger. The transaction is subject to various closing conditions, including the receipt of requisite shareholder approvals and required approvals of State and Federal banking regulators.

 

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

 

Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of Select Bancorp, Inc. (the “Company”). This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 relating to, without limitation, our future economic performance, plans and objectives for future operations, and projections of revenues and other financial items that are based on our beliefs and assumptions and information currently available to us. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “could,” “project,” “predict,” “expect,” “estimate,” “continue,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results, performance or achievements may differ materially from the results expressed or implied by our forward-looking statements. Factors that could influence actual results, performance or achievements include, among other things: changes in national, regional and local market conditions; changes in legislative and regulatory conditions; changes in the interest rate environment; breaches of security or failures of our technology systems due to technological or other factors and cybersecurity threats; adverse change in credit quality trends; and diversion of management’s time and attention to merger-related issues.

 

Overview

 

The Company is a commercial bank holding company and has one banking subsidiary, Select Bank & Trust Company (referred to as the “Bank”), and one unconsolidated subsidiary, New Century Statutory Trust I, which issued trust preferred securities in 2004 to provide additional capital for general corporate purposes. The Company’s only business activity is the ownership of the Bank and New Century Statutory Trust I. This discussion focuses primarily on the financial condition and operating results of the Bank.

 

The Bank’s lending activities are oriented to the consumer/retail customer as well as to the small- to medium-sized businesses located in Harnett, Brunswick, New Hanover, Carteret, Cumberland, Johnston, Pitt, Robeson, Sampson, Wake, Pasquotank, Martin, Alamance, and Wayne counties in North Carolina. The Bank offers the standard complement of commercial, consumer, and mortgage lending products, as well as the ability to structure products to fit specialized needs. The deposit services offered by the Bank include small business and personal checking accounts, savings accounts and certificates of deposit. The Bank concentrates on customer relationships in building its customer deposit base and competes aggressively in the area of transaction accounts.

 

The Company was formerly known as New Century Bancorp, Inc. On July 25, 2014, New Century Bancorp, Inc. acquired Select Bancorp, Inc. (“Legacy Select”) by merger. The combined company is now known as Select Bancorp, Inc., which we refer to in this report as the Company. Legacy Select was a bank holding company headquartered in Greenville, North Carolina, whose wholly owned subsidiary, Select Bank & Trust Company, was a state-chartered commercial bank with approximately $276.9 million in assets. The merger expanded the Company’s North Carolina presence with the addition of six branches located in Greenville (two), Elizabeth City, Washington, Gibsonville, and Burlington. During 2015, Gibsonville and Burlington were combined into a new location in Burlington.

 

We closed our branch located at 6390 Ramsey Street, Fayetteville, North Carolina and transferred accounts to our Fayetteville branch located at 2818 Raeford Road during September 2015. The property that housed our former Ramsey Street branch is included in assets held for sale on the consolidated balance sheet as of June 30, 2017.

 

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Comparison of Financial Condition at

June 30, 2017 and December 31, 2016

 

During the first six months of 2017, total assets increased by $59.9 million to $906.5 million as of June 30, 2017. The increase in assets was due primarily to loan growth funded by demand deposits accounts and time deposits. Earning assets at June 30, 2017 totaled $833.7 million and consisted of $729.5 million in net loans, $56.9 million in investment securities, $44.5 million in overnight investments and interest-bearing deposits in other banks and $2.8 million in non-marketable equity securities, of which $2.1 million is FHLB stock. Total deposits and shareholders’ equity at the end of the second quarter of 2017 were $739.7 million and $108.0 million, respectively.

 

Since the end of 2016, gross loans have increased by $60.8 million to $738.0 million as of June 30, 2017. At June 30, 2017, gross loans consisted of $88.2 million in commercial and industrial loans, $297.4 million in commercial real estate loans, $71.1 million in multi-family residential loans, $10.4 million in loans to individuals, $103.6 million in 1-to-4 family residential real estate loans, $42.3 million in HELOCs, and $126.3 million in construction loans. Deferred loan fees, net of costs, on these loans were $1.3 million at June 30, 2017.

 

At June 30, 2017 and December 31, 2016, there were no federal funds sold and no repurchase agreements. Interest-earning deposits in other banks were $44.5 million at June 30, 2017, a $3.2 million increase from December 31, 2016. The Company’s investment securities at June 30, 2017 were $56.9 million, a decrease of $5.4 million from December 31, 2016 in order to provide funding for higher yielding loans. The investment portfolio as of June 30, 2017 consisted of $12.6 million in government agency debt securities, $30.1 million in mortgage-backed securities and $14.2 million in municipal securities. The net unrealized gain on these securities was $795,000.

 

At June 30, 2017, the Company had an investment of $2.1 million in FHLB stock, which decreased by $110,000 from December 31, 2016. Also, the Company had $666,000 in other non-marketable securities at June 30, 2017, which decreased by $37,000 from December, 31, 2016.

 

At June 30, 2017, non-earning assets were $72.8 million, an increase of $1.5 million from $71.3 million as of December 31, 2016. Non-earning assets included $13.8 million in cash and due from banks, bank premises and equipment of $17.5 million, goodwill of $6.9 million, core deposit intangible of $629,000, accrued interest receivable of $2.6 million, foreclosed real estate of $2.7 million, $22.5 million in bank owned life insurance (“BOLI”), $846,000 of assets held for sale, and other assets of $5.3 million which included $2.7 million in deferred tax assets. Since the income on BOLI is included in non-interest income, this asset is not included in the Company’s calculation of earning assets. The increase in non-earning assets was due primarily to the increase in deposits and the corresponding increase in on-balance sheet cash.

 

Total deposits at June 30, 2017 were $739.7 million and consisted of $168.6 million in non-interest-bearing demand deposits, $174.2 million in money market and NOW accounts, $35.2 million in savings accounts, and $361.7 million in time deposits. Total deposits increased by $60.0 million from $679.7 million as of December 31, 2016, due primarily to an increase in CD deposits from a deposit program and wholesale deposits. The Bank had no brokered demand deposits and $72.6 million in brokered time deposits as of June 30, 2017.

 

As of June 30, 2017, the Company had $33.6 million of short-term debt of which $11.6 million was repurchase agreements with local customers, $32.5 million (of which $10.5 million is identified as long-term debt) in FHLB borrowings, and $12.4 million in junior subordinated debentures that are classified as long-term debt.

 

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Total shareholders’ equity at June 30, 2017 was $108.0 million, an increase of $3.7 million from $104.3 million as of December 31, 2016. This increase is primarily due to year to date earnings of $3.5 million. Accumulated other comprehensive income relating to available for sale securities increased $148,000 during the six months ended June 30, 2017. Other changes in shareholders’ equity included increases of $43,000 in stock-based compensation and $102,000 from the exercise of stock options.

 

Past Due Loans, Non-performing Assets, and Asset Quality

 

At June 30, 2017, the Company had $519,000 in loans that were 30 to 89 days past due. This represented 0.07% of gross loans outstanding on that date. This is a decrease from December 31, 2016 when there were $3.0 million in loans that were 30-89 days past due or 0.44% of gross loans outstanding. Non-accrual loans decreased from $5.8 million at December 31, 2016 to $2.9 million at June 30, 2017. Past dues have decreased due to timely payments from customers and nonaccruals decreased primarily as a result of foreclosure on two loans.

 

The percentage of non-performing loans (non-accrual loans and accruing troubled debt restructurings) to total loans decreased from 1.39% at December 31, 2016 to 0.83% at June 30, 2017. The Company has experienced a decrease in non-accruals from $5.8 million at December 31, 2016 to $2.9 million as of June 30, 2017 and a decrease in accruing troubled debt restructurings from $3.6 million at December 31, 2016 to $3.2 million as of June 30, 2017. Of the $2.9 million decrease in non-accrual loans in the first half of the year, the decrease is related primarily to a reduction of $2.4 million in Commercial Real Estate, $415,000 in HELOCs, $298,000 in Multi-family which was netted against an increase of $319,000 in 1-to-4 Family Residential loan pool classifications.

 

At June 30, 2017, the Company had thirty-two loans totaling $4.7 million that were considered to be troubled debt restructurings. Seventeen of these loans totaling $3.2 million were still in accruing status with the remaining TDRs included in non-accrual loans. All TDRs are considered impaired loans regardless of accrual status and have been included as non-performing assets in the table below.

 

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The table below sets forth, for the periods indicated, information about the Company’s non-accrual loans, loans past due 90 days or more and still accruing interest, total non-performing loans (non-accrual loans plus accruing TDRs), and total non-performing assets.

 

   For Periods Ended 
   June 30,   December 31, 
   2017   2016 
   (Dollars in thousands) 
         
Non-accrual loans  $2,943   $5,805 
Accruing TDRs   3,216    3,625 
Total non-performing loans   6,159    9,430 
Foreclosed real estate   2,702    599 
Total non-performing assets  $8,861   $10,029 
           
Accruing loans past due 90 days or more  $956   $529 
Allowance for loan losses  $8,488   $8,411 
           
Non-performing loans to period end loans   0.83%   1.39%
Non-performing loans and accruing loans past due 90 days or more to period end loans   0.96%   1.47%
Allowance for loans losses to period end loans   1.15%   1.24%
Allowance for loan losses to non-performing loans   138%   89%
Allowance for loan losses to non-performing assets   96%   84%
Allowance for loan losses to non-performing assets and accruing loans past due 90 days or more   86%   80%
Non-performing assets to total assets   0.98%   1.18%
Non-performing assets and accruing loans past due 90 days or more to total assets   1.08%   1.25%

 

Total non-performing assets (non-accrual loans, accruing TDRs, and foreclosed real estate) at June 30, 2017 and December 31, 2016 were $8.9 million and $10.0 million, respectively. The allowance for loan losses at June 30, 2017 represented 96% of non-performing assets compared to 84% at December 31, 2016.

 

Total impaired loans at June 30, 2017 were $7.8 million. This includes $2.9 million in loans that were classified as impaired because they were in non-accrual status and $4.9 million in loans that were determined to be impaired for other reasons. Of these loans, $963,000 required a specific reserve of $28,000 at June 30, 2017.

 

Total impaired loans at December 31, 2016 were $11.0 million. This includes $5.8 million in loans that were considered to be impaired due to being in non-accrual status and $5.2 million in loans that were deemed to be impaired for other reasons. Of these loans, $2.8 million required a specific reserve of $117,000 at December 31, 2016.

 

The allowance for loan losses was $8.5 million at June 30, 2017 or 1.15% of gross loans outstanding. This is a decrease from the 1.24% reported as a percentage of gross loans at December 31, 2016. The Legacy Select loans were recorded at estimated fair value as of the acquisition date and the related credit risk reflected as a fair value adjustment rather than separately in the allowance for losses as required in acquisition accounting. This required accounting under generally accepted accounting principles has resulted in a lower percentage of the allowance for loan losses to gross loans at June 30, 2017 for all periods post acquisition of Legacy Select. The allowance for loan losses at June 30, 2017 and December 31, 2016 represented 138% and 89%, respectively, of non-performing loans. It is management’s assessment that the allowance for loan losses as of June 30, 2017 is appropriate in light of the risk inherent within the Company’s loan portfolio. No assurances, however, can be given that further adjustments to the allowance for loan losses may not be deemed necessary in the future.

 

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Other Lending Risk Factors

 

Besides monitoring non-performing loans and past due loans, management also monitors trends in the loan portfolio that may indicate more than normal risk. A discussion of certain other risk factors follows. Some loans or groups of loans may contain one or more of these individual loan risk factors. Therefore, an accumulation of the amounts or percentages of the individual loan risk factors may not necessarily be an indication of the cumulative risk in the total loan portfolio.

 

Regulatory Loan to Value

 

The Company monitors its exposure to loans that exceed the guidelines established by regulators for loan to value (“LTV”) ratios.

 

At June 30, 2017 and December 31, 2016, the Company had $17.7 million and $21.7 million in non 1-to-4 family residential loans that exceeded the regulatory LTV limits, respectively. At June 30, 2017 and December 31, 2016, the Company had $6.3 million and $4.8 million of 1-to-4 family residential loans that exceeded the regulatory LTV limits, respectively. The total amount of these loans represented 20.7% and 23.6% of total risk-based capital as of June 30, 2017 and December 31, 2016, which is less than the 100% maximum allowed. These loans may present more than ordinary risk to the Company if the real estate market weakens in terms of market activity or collateral valuations.

 

Business Sector Concentrations

 

Loan concentrations in certain business sectors can be impacted by lower than normal retail sales, higher unemployment, higher vacancy rates, and a weakening in real estate market conditions. The Company has established an internal commercial real estate guideline of 40% of risk-based capital for any single product line.

 

At June 30, 2017 the Company had three product type groups which exceeded this guideline; Real Estate Construction – Speculative and Presold, which represented 45% of risk-based capital, or $52.6 million, 1-4 Family Rental, which represented 57%, or $66.3 million and Multifamily Residential, which represented 60% of risk-based capital, or $69.5 million. All other commercial real estate groups were at or below the 40% threshold. At December 31, 2016, the Company exceeded the 40% guideline in two product types. The 1-to-4 Family Residential Rental category represented 66% of Risk-Based Capital or $74.2 million and the Multi-family Residential category represented 49% of Risk-Based Capital or $54.5 million at December 31, 2016. All other commercial real estate product types were under the 40% threshold. 

 

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Acquisition, Development, and Construction Loans (“ADC”)

 

The tables below provide information regarding loans the Company originates for the purpose of acquisition, development, and construction of both residential and commercial properties as of June 30, 2017 and December 31, 2016.

 

Acquisition, Development and Construction Loans

(Dollars in thousands)

 

   June 30, 2017   December 31, 2016 
       Land and Land           Land and Land     
   Construction   Development   Total   Construction   Development   Total 
                         
Total ADC loans  $99,743   $26,522   $126,265   $76,037   $24,874   $100,911 
                               
Average Loan Size  $195   $305        $166   $350      
                               
Percentage of total loans   13.51%   3.76%   17.27%   11.23%   3.67%   14.90%
                               
Non-accrual loans  $134   $21   $155   $151   $-   $151 

 

Management closely monitors the ADC portfolio by reviewing funding based on project completeness, monthly and quarterly inspections as required by the project, collateral value, geographic concentrations, spec-to-presold ratios and performance of similar loans in the Company’s market area.

 

Geographic Concentrations

 

Certain risks exist arising from the geographic location of specific types of higher than normal risk real estate loans. Below is a table showing geographic concentrations for ADC and HELOC loans at June 30, 2017 and December 31, 2016.

 

   June 30, 2017   December 31, 2016 
   ADC Loans   Percent   HELOC   Percent   ADC Loans   Percent   HELOC   Percent 
   (Dollars in thousands) 
                                 
Harnett County  $5,429    4.30%  $5,854    13.84%  $4,505    4.46%  $5,817    14.13%
Alamance County   1,657    1.31%   1,250    2.96%   1,169    1.16%   1,065    2.59%
Beaufort County   165    0.13%   1,212    2.86%   182    0.18%   1,026    2.49%
Brunswick County   8,291    6.57%   1,713    4.05%   4,506    4.46%   1,899    4.61%
Carteret County   2,083    1.65%   2,309    5.46%   585    0.58%   2,350    5.71%
Craven County   1,075    0.85%   445    1.05%   -    -%    -    -% 
Cumberland County   21,823    17.28%   4,202    9.93%   22,610    22.41%   5,278    12.82%
Pasquotank County   1,018    0.81%   1,581    3.74%   947    0.94%   1,258    3.06%
Pitt County   15,081    11.94%   6,151    14.54%   13,697    13.57%   5,151    12.52%
Robeson County   655    0.52%   3,832    9.06%   803    0.80%   3,709    9.01%
Sampson County   26    0.02%   1,702    4.02%   71    0.07%   1,574    3.83%
Wake County   18,518    14.67%   1,381    3.26%   15,689    15.55%   1,536    3.73%
Wayne County   10,424    8.25%   4,045    9.56%   9,734    9.65%   4,281    10.40%
All other locations   40,020    31.70%   6,628    15.67%   26,413    26.17%   6,214    15.10%
                                         
Total  $126,265    100.00%  $42,305    100.00%  $100,911    100.00%  $41,158    100.00%

 

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Interest Only Payments

 

Another risk factor that exists in the total loan portfolio pertains to loans with interest only payment terms. At June 30, 2017, the Company had $193.0 million in loans that had terms permitting interest only payments. This represented 26.2% of the total loan portfolio. At December 31, 2016, the Company had $161.5 million in loans that had terms permitting interest only payments. This represented 23.8% of the total loan portfolio. Notwithstanding the risk inherent with interest only loans, it is customary and general industry practice that loans in the ADC portfolio permit interest only payments during the acquisition, development, and construction phases of such projects.

 

Large Dollar Concentrations

 

Concentrations of high dollar loans or large customer relationships may pose additional risk in the total loan portfolio. The Company’s ten largest loans or lines of credit totaled $64.0 million, or 8.7% of total loans, at June 30, 2017 compared to $62.9 million, or 8.4% of total loans, at December 31, 2016. The Company’s ten largest customer relationships totaled $83.3 million, or 11.2% of total loans, at June 30, 2017 compared to $80.9 million, or 11.9% of total loans, at December 31, 2016. Deterioration or loss in any one or more of these high dollar loan or customer concentrations could have an immediate, significant adverse impact on the Company’s capital position.

 

Comparison of Results of Operations for the

Three months ended June 30, 2017 and 2016

 

General. During the second quarter of 2017, the Company had net income of $1.3 million as compared with net income of $1.9 million for the second quarter of 2016. Net income per common share for the second quarter of 2017 was $0.11, basic and diluted, compared with net income per common share of $0.16, basic and diluted, for the second quarter of 2016. Results of operations for the second quarter of 2017 were primarily impacted by an increase of $539,000 in net interest income, and an increase in non-interest expenses and an increase in the provision for loan losses of $925,000. Noninterest expenses increased $461,000 which was primarily related to increased personnel expense of $615,000 and other expenses of $84,000 which were offset by a reduction in occupancy expense of $115,000, deposit insurance expense of $60,000 and core deposit intangible amortization of $23,000 and other associated expenses. The Company recorded a provision of loan losses of $1.1 million for the second quarter of 2017 due primarily to loan growth and the charge offs related to three loans compared to $158,000 in the second quarter of 2016. Net interest margin of 4.18% in the second quarter of 2017 decreased 6 basis points from the same period in 2016 resulting from the accretion of the credit mark associated with the acquired loan portfolio.

 

Net Interest Income. Net interest income increased to $8.3 million for the second quarter of 2017 from $7.7 million for the second quarter of 2016. The Company’s total interest income was primarily affected by the increase in loan balances due to growth. Average total interest-earning assets were $799.2 million in the second quarter of 2017 compared with $739.0 million during the same period in 2016, while the yield on those assets increased 4 basis points from 4.74% to 4.78% which was primarily due to the yield accretion on the acquired loans and increase of rates on recently originated loans.

 

The Company’s average interest-bearing liabilities increased by $44.1 million to $606.6 million for the quarter ended June 30, 2017 from $562.5 million for the same period one year earlier and the cost of those funds increased from 0.65% to 0.79%, or 14 basis points. During the second quarter of 2017, the Company’s net interest margin was 4.18% and net interest spread was 3.99%. In the same quarter ended one year earlier, net interest margin was 4.24% and net interest spread was 4.08%.

 

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Provision for Loan Losses. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company previously used loss history based on the weighted average net charge off history for the most recent fourteen consecutive quarters, based on the risk-graded pool to which the loss was assigned. Historical loss rates are calculated by using a loss migration analysis associating losses to the risk-graded pool to which they relate for each of the previous twelve quarters. Then, using a twelve quarter look back period, loss factors are calculated for each risk-graded pool. During the second quarter of 2017, the Company recorded a provision for loan losses of $1.1 million based primarily on loan growth and charge offs on three loans, which was an increase of approximately $925,000 compared to the provision for loan losses recorded in the second quarter of 2016. The Company, however, has seen a general trend of improving credit metrics for past dues, non-accruals and TDRs during 2017.

 

Non-Interest Income. Non-interest income for the quarter ended June 30, 2017 was $778,000, a decrease from $831,000 in the second quarter of 2016. Service charges on deposit accounts decreased $30,000 to $216,000 for the quarter ended June 30, 2017 from $246,000 for the same period in 2016. Other non-deposit fees and income decreased $23,000 from the second quarter of 2016 to the second quarter of 2017 due primarily to debit card fees transactions. The Company did not sell any investment securities in the second quarter of 2017 or 2016.

 

Non-Interest Expenses. Non-interest expenses increased by $461,000 to $6.0 million for the quarter ended June 30, 2017, from $5.5 million for the same period in 2016. In general, categories of non-interest expenses that increased were offset by decreases in other areas. The following are highlights of the significant categories of non-interest expenses during the second quarter of 2017 compared to the same period in 2016:

 

·Personnel expenses increased $615,000 to $3.7 million, due to increased staff, employment taxes and benefits costs.
·Deposit insurance expense decreased $60,000, due to reduced rates.
·Core Deposit intangible decreased $23,000 as scheduled.
·Occupancy and equipment decreased by $115,000 to $492,000, due to branch restructuring.
·Other non-interest expenses increased by $84,000, due to increases in several categories of other non-interest expenses.

 

Provision for Income Taxes. The Company’s effective tax rate was 32.8% and 34.0% for the quarters ended June 30, 2017 and 2016, respectively. The effective tax rate for the second quarter of 2017 compared to the same quarter in 2016 was impacted by an adjustment to reduce the Company’s deferred tax asset resulting from enacted lower corporate tax rates for the State of North Carolina in 2017.

 

As of June 30, 2017 and December, 31, 2016, the Company had a net deferred tax asset in the amount of $2.7 million and $3.1 million, respectively. In evaluating whether the Company will realize the full benefit of the net deferred tax asset, management considered both positive and negative evidence, including among other things, recent earnings trends, projected earnings, and asset quality. As of June 30, 2017 and December 31, 2016, management concluded that the net deferred tax assets were fully realizable. The Company will continue to monitor deferred tax assets closely to evaluate whether the full benefit of the net deferred tax asset will require a valuation allowance. Significant negative trends in credit quality or losses from operations, among other trends, could impact the realization of the deferred tax asset in the future.

 

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Comparison of Results of Operations for the

Six months ended June 30, 2017 and 2016

 

General. During the first six months of 2017, the Company had net income of $3.5 million as compared with net income of $3.4 million for the first six months of 2016. Net income per share for the first six months of 2017 was $0.30, basic and $0.29 diluted, compared with net income per share of $0.29, basic and diluted, for the first six months of 2016. Results of operations for the first six months of 2017 compared to 2016 was primarily impacted by an increase of $1.5 million in interest income offset by an increase in interest expense of $405,000 and provision for loan losses of $379,000, a decrease of $189,000 in non-interest income and increased non-interest expenses of $646,000. Net interest margin of 4.21% in the first six months of 2017 increased 2 basis points from the same period in 2016.

 

Net Interest Income. Net interest income increased to $16.4 million for the first six months of 2017 from $15.2 million for the first six months of 2016. The Company’s total interest income was affected by the increase in total loan balances. Average total interest-earning assets were $787.9 million in the first six months of 2017 compared with $736.9 million during the same period in 2016, while the yield on those assets increased 10 basis points from 4.69% to 4.79% as a result of increases in the prime interest rate which contributed to the increase in loan yield.

 

The Company’s average interest-bearing liabilities increased by $29.1 million to $595.2 million for the six months ended June 30, 2017 from $566.1 million for the same period one year earlier and the cost of those funds increased from 0.65% to 0.76%, or 11 basis points. During the first six months of 2017, the Company’s net interest margin was 4.21% and net interest spread was 4.03%. In the same period ended one year earlier, net interest margin was 4.19% and net interest spread was 4.04%.

 

Provision for Loan Losses. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company has previously used loss history based on the weighted average net charge off history for the most recent fourteen consecutive quarters, based on the risk-graded pool to which the loss was assigned. Historical loss rates are now calculated by using a loss migration analysis associating losses to the risk-graded pool to which they relate for each of the previous twelve quarters. Then, using a twelve quarter look back period, loss factors are calculated for each risk-graded pool. Loan growth was the primary contributor to the 2017 provision expense.

 

Non-Interest Income. Non-interest income for the six months ended June 30, 2017 was $1.5 million, a decrease of $189,000 from the first six months of 2016. Service charges on deposit accounts decreased $62,000 to $431,000 for the six months ended June 30, 2017 from $493,000 for the same period in 2016, primarily due to a decrease in overdraft charges. Other non-deposit fees and income decreased $105,000 from the first six months of 2016 to the first six months of 2017, primarily due to decreases in debit card activity. The Company recognized a gain on sale of investment securities of $22,000 for the first six months of 2016 compared to none for the first six months of 2017.

 

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Non-Interest Expenses. Non-interest expenses increased by $646,000 to $11.8 million for the six months ended June 30, 2017, from $11.1 million for the same period in 2016. The following are highlights of the significant categories of non-interest expenses during the first six months of 2017 versus the same period in 2016:

 

·Personnel expenses increased $827,000 to $7.1 million, due to additions in staff, employment taxes and benefits costs.
·Occupancy and equipment expenses decreased by $117,000 due to branch restructuring.
·Professional fees increased by $84,000 in the first six months of 2017 to $571,000 compared to $487,000 in the 2016 period primarily due to contracted internal audit and consulting fees.
·Deposit insurance expense decreased $114,000 due to rate reductions.
·Other non-interest expenses increased by $79,000, due to small increases in several categories of other non-interest expenses.

 

Provision for Income Taxes. The Company’s effective tax rate was 33.4% and 35.5% for the six months ended June 30, 2017 and 2016, respectively. The effective tax rate for the first six months of 2017 was impacted by North Carolina corporate income tax rate reductions compared to 2016 tax rates.

 

As of June 30, 2017 and December, 31, 2016, the Company had a net deferred tax asset in the amount of $2.7 million and $3.1 million, respectively. In evaluating whether the Company will realize the full benefit of the net deferred tax asset, management considered both positive and negative evidence, including among other things recent earnings trends, projected earnings, and asset quality. As of June 30, 2017 and December 31, 2016, management concluded that the net deferred tax asset was fully realizable. The Company will continue to monitor deferred tax assets closely to evaluate whether the full benefit of the net deferred tax asset will require a valuation allowance. Significant negative trends in credit quality or losses from operations, among other trends, could impact the realization of the deferred tax asset in the future.

 

Liquidity

 

The Company’s liquidity is a measure of its ability to fund loans, withdrawals and maturities of deposits, and other cash outflows in a cost effective manner. The principal sources of liquidity are deposits, scheduled payments and prepayments of loan principal, maturities of investment securities, access to liquid deposits, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Liquid assets (consisting of cash and due from banks, interest-earning deposits with other banks, federal funds sold and investment securities classified as available for sale) represented 12.7% of total assets at June 30, 2017 and decreased as compared to 13.9% as of December 31, 2016. This reduction in liquid assets to total assets resulted primarily from loan growth and letting higher rate deposits roll off.

 

The Company has been a net seller of federal funds since its inception and strives to maintain a position of liquidity sufficient to fund future loan demand and to satisfy fluctuations in deposit levels. Should the need arise, the Company would have the capability to sell securities classified as available for sale or to borrow funds as necessary. As of June 30, 2017, the Company had existing credit lines with other financial institutions to purchase up to $135.8 million in federal funds. Also, as a member of the FHLB of Atlanta, the Company may obtain advances of up to 10% of total assets, subject to available collateral. A floating lien of $92.1 million of qualifying loans is pledged to the FHLB to secure borrowings. At June 30, 2017, the Company had $32.5 million in FHLB advances outstanding. Another source of short-term borrowings is securities sold under agreements to repurchase. At June 30, 2017, in addition to FHLB advances, total borrowings consisted of securities sold under agreements to repurchase of $11.6 million and junior subordinated debentures of $12.4 million.

 

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Total deposits were $739.7 million at June 30, 2017. Time deposits, which are the only deposit accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 48.9% of total deposits at June 30, 2017. Time deposits of $250,000 or more represented 10.3% of the Company’s total deposits at June 30, 2017. At quarter-end, the Company had $72.6 million in brokered time deposits and no brokered demand deposits. Management believes most other time deposits are relationship-oriented. While the Bank will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, the Company anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity.

 

Management believes that current sources of funds provide adequate liquidity for the Bank’s current cash flow needs. The Company maintains minimal cash balances at the parent holding company level. Management believes that the current cash balances will provide adequate liquidity for the Company’s current cash flow needs.

 

Capital Resources

 

A significant measure of the strength of a financial institution is its capital base. Federal regulations have classified and defined capital into the following components: (1) Tier 1 capital, which includes common shareholders’ equity and qualifying preferred equity, and (2) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify as Tier 1 capital. Commencing in the first quarter of 2015, financial institutions and their holding companies became subject to the BASEL III capital requirements. A new part of the capital ratios profile under the Basel III rules is the Common Equity Tier 1 risk-based ratio which does not include limited life components such as trust preferred securities and SBLF preferred stock in this calculation. Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a financial institution to maintain capital as a percentage of its assets, and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets). The Company’s equity to assets ratio was 11.9% at June 30, 2017.

 

As the following table indicates, at June 30, 2017, the Company and the Bank both exceeded minimum regulatory capital requirements as specified in the tables below.

 

   Actual   Minimum 
Select Bancorp, Inc.  Ratio   Requirement 
         
Total risk-based capital ratio   14.47%   8.00%
Tier 1 risk-based capital ratio   13.45%   6.00%
Leverage ratio   12.75%   4.00%
Common equity Tier 1 risk-based capital ratio   12.01%   4.50%

 

       Regulatory     
   Actual   Minimum   Well-Capitalized 
Select Bank & Trust  Ratio   Requirement   Requirement 
             
Total risk-based capital ratio   13.94%   8.00%   10.00%
Tier 1 risk-based capital ratio   12.92%   6.00%   8.00%
Leverage ratio   12.25%   4.00%   5.00%
Common equity Tier 1 risk-based capital ratio   12.92%   4.50%   6.50%

 

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During 2004, the Company issued $12.4 million of junior subordinated debentures to a newly formed subsidiary, New Century Statutory Trust I, which in turn issued $12.0 million of trust preferred securities. The proceeds from the sale of the trust preferred securities provided additional capital for the growth and expansion of the Bank. Under the current applicable regulatory guidelines, all of the proceeds from the issuance of these trust preferred securities qualify as Tier 1 capital as of June 30, 2017. On January 20, 2016, all outstanding shares of the Company’s Series A stock were redeemed. While the redemption reduced the capital ratios for the Company and the Bank, both the Company and the Bank continue to meet the definition of “well-capitalized”.

 

Management expects that the Bank will remain “well-capitalized” for regulatory purposes, although there can be no assurance that additional capital will not be required in the future.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

The Company intends to reach its strategic financial objectives through the effective management of market risk. Like many financial institutions, the Company’s most significant market risk exposure is interest rate risk. The Company's primary goal in managing interest rate risk is to minimize the effect that changes in market interest rates have on earnings and capital. This goal is accomplished through the active management of the balance sheet. The goal of these activities is to structure the maturity and repricing of assets and liabilities to produce stable net interest income despite changing interest rates. The Company's overall interest rate risk position is governed by policies approved by the Board of Directors and guidelines established and monitored by the Bank’s Asset/Liability Committee (“ALCO”).

 

To measure, monitor, and report on interest rate risk, the Company begins with two models: (1) net interest income ("NII") at risk, which measures the impact on NII over the next twelve and twenty-four months to immediate changes in interest rates and (2) net economic value of equity ("EVE"), which measures the impact on the present value of net assets to immediate changes in interest rates. NII at risk is designed to measure the potential short-term impact of changes in interest rates on NII. EVE is a long-term measure of interest rate risk to the Company's balance sheet, or equity. Gap analysis, which is the difference between the amount of balance sheet assets and liabilities repricing within a specified time period, is used as a secondary measure of the Company's interest rate risk position. All of these models are subject to ALCO guidelines and are monitored regularly.

 

In calculating NII at risk, the Company begins with a base amount of NII that is projected over the next twelve and twenty-four months, assuming that the balance sheet is static and the yield curve remains unchanged over the period. The current yield curve is then “shocked,” or moved immediately, ±1.0 percent, ±2.0 percent, ±3.0 percent and ±4.0 percent in a parallel fashion, or at all points along the yield curve. New twelve-month and twenty four-month NII projections are then developed using the same balance sheet but with the new yield curves and these results are compared to the base scenario. The Company also models other scenarios to evaluate potential NII at risk such as a gradual ramp in interest rates, a flattening yield curve, a steepening yield curve, and others that management deems appropriate.

 

EVE at risk is based on the change in the present value of all assets and liabilities under different interest rate scenarios. The present value of existing cash flows with the current yield curve serves as the base case. The Company then applies an immediate parallel shock to that yield curve of ±1.0 percent, ±2.0 percent, ±3.0 percent and ±4.0 percent and recalculates the cash flows and related present values.

 

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Key assumptions used in the models described above include the timing of cash flows, the maturity and repricing of assets and liabilities, changes in market conditions, and interest-rate sensitivities of the Company's non-maturity deposits with respect to interest rates paid and the level of balances. These assumptions are inherently uncertain and, as a result, the models cannot precisely calculate future NII or predict the impact of changes in interest rates on NII and EVE. Actual results could differ from simulated results due to the timing, magnitude and frequency of changes in interest rates and market conditions, changes in spreads and management strategies, among other factors. Projections of NII are assessed as part of the Company's forecasting process.

 

NII and EVE Analysis. The following table presents the estimated exposure to NII for the next twelve months due to immediate changes in interest rates and the estimated exposure to EVE due to immediate changes in interest rates. All information is presented as of March 31, 2017.

 

   March 31, 2017 
(Dollars in thousands)  Estimated
Exposure to
NII
   Estimated
Exposure
to EVE
 
         
Immediate change in interest rates:          
+ 4.0%   16.4%   7.1%
+ 3.0%   13.2    6.2 
+ 2.0%   9.1    4.7 
+ 1.0%   4.2    2.5 
No change   -    - 
- 1.0%   (5.2)   (4.9)

 

While the measures presented in the table above are not a prediction of future NII or EVE valuations, they do suggest that if all other variables remained constant, immediate increases in interest rates at all points on the yield curve may produce higher NII in the short term. Other important factors that impact the levels of NII are balance sheet size and mix, interest rate spreads, the slope of the yield curve, the speed of interest rates changes, and management actions taken in response to the preceding conditions.

 

Item 4. Controls and Procedures

 

Disclosure Controls and Procedures. At the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14.

 

Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.

 

Changes in internal control over financial reporting. Management of the Company has evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, changes in the Company's internal controls over financial reporting (as defined in Rule 13a−15(f) and 15d−15(f) of the Exchange Act) during the second quarter of 2017. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the second quarter of 2017 that have materially affected or are reasonably likely to materially affect, the Company's internal control over financial reporting.

 

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Part II.   OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Company is not currently engaged in, nor are any of its properties subject to, any material legal proceedings.  From time to time, the Bank is a party to legal proceedings in the ordinary course of business wherein it attempts to collect loans, enforce its security interest in loans, or other matters of similar nature.

 

Item 1A. Risk Factors

 

There are no material changes from the risk factors set forth under Part II, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2017.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The Company announced a repurchase program on August 31, 2016, by which management was authorized to repurchase up to 581,518 shares of Company common stock in the open market and through privately negotiated transactions. There were no share repurchase transactions conducted during the three-month period covered by this Report.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 6. Exhibits

 

Exhibit
Number
  Description of Exhibit
     
31.1   Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
     
31.2   Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
     
32.1   Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
     
32.2   Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
     
101   Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2017, in XBRL (eXtensible Business Reporting Language)

 

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SIGNATURES

 

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

 

  SELECT BANCORP, INC.
     
Date: August 9, 2017 By: /s/ William L. Hedgepeth II
    William L. Hedgepeth II
    President and Chief Executive Officer
     
Date: August 9, 2017 By: /s/ Mark A. Jeffries
    Mark A. Jeffries
    Executive Vice President and Chief Financial Officer

 

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Exhibit Index

 

Exhibit
Number
  Description of Exhibit
     
31.1   Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
     
31.2   Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
     
32.1   Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
     
32.2   Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
     
101   Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2017, in XBRL (eXtensible Business Reporting Language)

 

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