Attached files

file filename
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - BANK OF SOUTH CAROLINA CORPex32-1.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - BANK OF SOUTH CAROLINA CORPex32-2.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - BANK OF SOUTH CAROLINA CORPex31-2.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - BANK OF SOUTH CAROLINA CORPex31-1.htm

 

 

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

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

 

 For the fiscal year ended December 31, 2019

 

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

 

 For the transition period from __________ to __________

 

 Commission file number: 0-27702

 

BANK OF SOUTH CAROLINA CORPORATION

(Exact name of registrant as specified in its charter)

 

 South Carolina

 

57-1021355

(State or other jurisdiction of

 

(IRS Employer

incorporation or organization)

 

Identification Number)

 

 

 

256 Meeting Street, Charleston, SC

 

29401

(Address of principal executive offices)

 

(Zip Code)

 

Issuer’s telephone number: (843) 724-1500

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common stock

BKSC

NASDAQ

 

Securities registered under Section 12(b) of the Exchange Act:

 

Common Stock

 

 

 (Title of Class)

 

 

  Securities registered under Section 12(g) of the Exchange Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. 

☐ Yes ☒  No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. 

☐ Yes ☒  No

 

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

Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for a shorter period that the registrant was required to submit). 

Yes ☒  No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

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 ☐

Non-accelerated filer ☐

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 by 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 in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

Aggregate market value of the voting stock held by non-affiliates, computed by reference to the closing price of such stock on June 30, 2019 was $68,725,103.

 

As of February 14, 2020, the Registrant has outstanding 5,530,363 shares of common stock.  

 

 

 

 

 

 BANK OF SOUTH CAROLINA CORPORATION 

AND SUBSIDIARY

 

Table of Contents  

 

PART I

 

 

 

 

 

Page

 

 

Item 1. Business

3

Item 1A. Risk Factors

9

Item 1B. Unresolved Staff Comments

9

Item 2. Properties

9

Item 3. Legal Proceedings

10

Item 4. Mine Safety Disclosures

10

 

 

PART II

 

 

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

11

Item 6. Selected Financial Data

13

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

14

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

31

Item 8. Financial Statements and Supplementary Data

32

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

67

Item 9A. Controls and Procedures

67

Item 9B. Other Information

67

 

 

PART III

 

 

 

Item 10. Directors, Executive Officers, and Corporate Governance

68

Item 11. Executive Compensation

68

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

68

Item 13. Certain Relationships and Related Transactions, and Director Independence

69

Item 14. Principal Accounting Fees and Services

69

 

 

PART IV

 

 

 

Item 15. Exhibits and Financial Statement Schedules

70

 

2

 

 

PART I

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This report, including information included or incorporated by reference in this document, contains statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1934. We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1996 and are including this statement for the express purpose of availing the Bank of South Carolina Corporation (the “Company”) of protections of such safe harbor with respect to all “forward-looking statements” contained in this Form 10-K. Forward-looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of the Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors that are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitations, those described under the heading “Risk Factors” in this Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission (the “SEC”) and the following:

 

 

Risk from changes in economic, monetary policy, and industry conditions

 

Changes in interest rates, shape of the yield curve, deposit rates, the net interest margin and funding sources

 

Market risk (including net income at risk analysis and economic value of equity risk analysis) and inflation

 

Risk inherent in making loans including repayment risks and changes in the value of collateral

 

Loan growth, the adequacy of the allowance for loan losses, provisions for loan losses, and the assessment of problem loans

 

Level, composition, and re-pricing characteristics of the securities portfolio

 

Deposit growth and changes in the mix or type of deposit products and services

 

Continued availability of senior management and ability to attract and retain key personnel

 

Technological changes

 

Increased cybersecurity risk, including potential business disruptions or financial losses

 

Ability to control expenses

 

Changes in compensation

 

Risks associated with income taxes including potential for adverse adjustments

 

Changes in accounting policies and practices

 

Changes in regulatory actions, including the potential for adverse adjustments

 

Recently enacted or proposed legislation and changes in political conditions

 

Pandemic risk

 

We will undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings with the SEC, in our press releases, and in oral and written statements, which are not statements of historical fact, constitute forward-looking statements.

 

Item 1.

Business

 

General

 

The Bank of South Carolina (the “Bank”) was organized on October 22, 1986 and opened for business as a state-chartered financial institution on February 26, 1987, in Charleston, South Carolina. The Bank was reorganized into a wholly owned subsidiary of the Company, effective April 17, 1995. At the time of the reorganization, each outstanding share of the Bank was exchanged for two shares of Company stock.

 

Market Area

 

The Bank operates as an independent, community oriented, commercial bank providing a broad range of financial services and products to the Charleston – North Charleston metro area, which includes Charleston, Berkeley, and Dorchester county. We have five banking house locations: 256 Meeting Street, Charleston, SC; 100 North Main Street, Summerville, SC; 1337 Chuck Dawley Boulevard, Mt. Pleasant, SC; 2027 Sam Rittenberg Boulevard, Charleston, SC; and 9403 Highway 78, North Charleston, SC. 

 

3

 

 

The Charleston – North Charleston metro area grew 33.11% between 2012 and 2017 according to the U.S. Bureau of Economic Analysis. From 2017 to 2018 alone, Charleston, Berkeley, and Dorchester county grew 3.2%, 5.1%, and 4.0%, respectively. Charleston and Berkeley county are ranked in the top ten economies in the state based on real gross domestic product according to the U.S. Bureau of Economic Analysis.  The primary economic drivers of our market area are manufacturing, hospitality, technology, and the healthcare industry. This includes manufacturing campuses for Boeing, Volvo Cars, and Mercedes-Benz Vans in the area. Hospitality has also contributed to the economic growth as both Conde Nast Traveler and Travel and Leisure Magazine have recognized the area as a top tourism destination. Additionally, Charleston is considered the number one mid-sized U.S. metro area for IT growth according to the U.S. Bureau of Labor Statistics.

 

References to “we,” “us,” “our,” “the Bank,” or “the Company” refer to the parent and its subsidiary, that are consolidated for financial purposes.

 

The Company (ticker symbol: BKSC) is publicly traded on the National Association of Securities Dealers Automated Quotations (“NASDAQ”), and is under the reporting authority of the SEC. All of our electronic filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are accessible at no cost on our website, http://www.banksc.com, through the “Investor Relations” link. Our filings are also available through the SEC’s web site at http://www.sec.gov or by calling 1-800-SEC-0330.

 

Competition

 

The financial services industry is highly competitive. We face competition in attracting deposits and originating loans based upon a variety of factors including: 

 

 

interest rates offered on deposit accounts

 

interest rates charged on loans

 

credit and service charges

 

the quality of services rendered

 

the convenience of banking facilities and other delivery channels

 

relative lending limits in the case of loans

 

increase in non-banking financial institutions providing similar services

 

continued consolidation, and

 

legislative, regulatory, economic, and technological changes

 

We compete with commercial banks, savings institutions, finance companies, credit unions and other financial services companies. Many of our larger commercial bank competitors have greater name recognition and offer certain services that we do not. However, we believe that we have developed an effective competitive advantage in our market area by emphasizing exceptional service and knowledge of local trends and conditions.

 

Lending Activities

 

We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic markets and typically require personal guarantees. Our primary lending activities are for commercial, commercial real estate, and consumer purposes, with the largest category being commercial real estate. Most of our lending activity is to borrowers within our market area.

 

Commercial Loans

 

As of December 31, 2019, $52.8 million, or 19.28%, of our loan portfolio consisted of commercial loans. We originate various types of secured and unsecured commercial loans to customers in our market area in order to provide customers with working capital and funds for other general business purposes. The terms of these loans generally range from less than one year to 10 years. These loans bear either a fixed interest rate or an interest rate linked to a variable market index, depending on the individual loan, its purpose, and underwriting of that loan.

 

Commercial credit decisions are based upon our credit assessment of each applicant. We evaluate the applicant’s ability to repay in accordance with the proposed terms of the loan and assess the risks involved. In addition to evaluating the applicant’s financial statements, we consider the adequacy of the primary and secondary sources of repayment for the loan. Credit agency reports of the applicant’s personal credit history supplement our analysis of the applicant’s creditworthiness. In addition, collateral supporting a secured transaction is analyzed to determine its marketability. Commercial business loans generally have higher interest rates than residential loans of similar duration because they have a higher risk of default with repayment generally depending on the successful operation of the borrower’s business and the adequacy of any collateral.

 

4

 

 

Commercial Real Estate Loans

 

As of December 31, 2019, commercial real estate construction loans comprised $12.5 million, or 4.56%, of our loan portfolio. We make construction loans for commercial properties to businesses. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction. Loans are typically underwritten with a maximum loan to value ratio of 80% based on current appraisals with value defined as the purchase price, appraised value, or cost of construction, whichever is lower. Repayment of construction loans on non-residential and income-producing properties is normally attributable to rental income, income from the borrower’s operating entity, or the sale of the property. Construction loans are interest-only during the construction period, which typically does not exceed twelve months, and are often paid-off with permanent financing.

 

Before making a commitment to fund a construction loan, we require an appraisal of the property by a state-certified or state-licensed appraiser. We review and inspect properties before disbursement of funds during the term of the construction loan.

 

Construction financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. Construction loans also expose us to risk that improvements will not be completed on time in accordance with specifications and projected costs.

 

As of December 31, 2019, $143.8 million, or 52.48%, of our loan portfolio consisted of other commercial real estate loans, excluding commercial construction loans. Properties securing our commercial real estate loans are primarily comprised of business owner-occupied properties, small office buildings and office suites, and income-producing real estate.

 

We base our decision to lend primarily on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, we emphasize the ratio of the property’s projected net cash flow to the loan’s debt service requirement computed after a deduction for an appropriate vacancy factor and reasonable expenses. We typically require property casualty insurance, title insurance, earthquake insurance, wind and hail coverage, and, if appropriate, flood insurance, in order to protect our security interest in the underlying property.

 

Commercial real estate loans generally carry higher credit risks, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions not within the control of the borrower or lender could affect the value of the underlying collateral or the future cash flow of the property.

 

Consumer Loans

 

Consumer real estate loans were $59.5 million, or 21.72%, of the loan portfolio as of December 31, 2019. Consumer real estate loans consist of consumer construction loans, HELOCs, and mortgage originations. We make construction loans for owner-occupied residential properties. Advances on construction loans are in accordance with a schedule reflecting the cost of construction, but are limited to a maximum loan-to-value ratio of 80%. Before making a commitment to fund a construction loan, we require an appraisal of the property by a state-certified or state-licensed appraiser. We review and inspect properties before disbursement of funds during the term of the construction loan. Similar to commercial real estate construction financing, consumer construction financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. Construction loans also expose us to risk that improvements will not be completed on time in accordance with plans, specifications, and projected costs.

 

This category of loans consists of loans secured by first or second mortgages on primary residences, and originate as adjustable-rate or fixed-rate loans. Owner-occupied properties located in the Company’s market area serve as the collateral for these loans. The Company currently originates residential mortgage loans for our portfolio with a maximum loan-to-value ratio of 80% for traditional owner-occupied homes.

 

We offer home equity loans and lines of credit secured by the borrower’s primary or secondary residence. Our home equity loans and lines of credit currently originate with an adjustable- rate with a floor. We generally underwrite home equity loans and lines of credit with the same criteria that we use to underwrite mortgage loans to be sold. For a borrower’s primary and secondary residences, home equity loans and lines of credit are typically underwritten with a maximum loan-to-value ratio of 80% when combined with the principal balance of the existing mortgage loan. We require a current appraisal or internally prepared real estate evaluations on home equity loans and lines of credit. At the time we close a home equity loan or line of credit, we record a mortgage to perfect our security interest in the underlying collateral.

 

5

 

 

Other consumer loans totaled $5.4 million and were 1.96% of the loan portfolio as of December 31, 2019. These loans are originated for various purposes, including the purchase of automobiles, boats, and other personal purposes.

 

Consumer loans may entail greater credit risk than mortgage loans to be sold, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. The application of various federal and state laws, including bankruptcy and insolvency laws, may also limit the amount which can be recovered on such loans.

 

Loan Approval Procedures and Authority

 

Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by the Board of Directors of the Bank. The loan approval process is intended to assess the borrower’s ability to repay the loan and the value of the collateral that will secure the loan. To assess the borrower’s ability to repay, we review the borrower’s employment, credit history, and information on the historical and projected income and expenses of the borrower.

 

The objectives of our lending program are to: 

 

1.

Establish a sound asset structure

2.

Provide a sound and profitable loan portfolio to:

 

a)

Protect the depositor’s funds

 

b)

Maximize the shareholders’ return on their investment

3.

Promote the stable economic growth and development of the market area served by the Bank

4.

Comply with all regulatory agency requirements and applicable law

 

The underwriting standards and loan origination procedures include officer lending limits, which are approved by the Board of Directors. The individual secured/unsecured lending authority of the President/Chief Executive Officer of the Bank is set at $1,500,000 and the individual secured/unsecured lending authority of the Senior Lender/Executive Vice President is set at $750,000. The President/Chief Executive Officer of the Bank and the Senior Lender/Executive Vice President may jointly lend up to 10% of the Bank’s unimpaired capital for the previous quarter end. In the absence of either of the above, the other may, jointly with the approval of either the Chairman of the Board of Directors or a majority of the Loan Committee of the Board of Directors, lend up to 10% of the Bank’s unimpaired capital for the previous quarter end. The Board of Directors, with two-thirds vote, may approve the aggregate credit in excess of this limit but may not exceed 15% of the Bank’s unimpaired capital. Loan limits apply to the total direct and indirect liability of the borrower. All loans above the loan officer’s authority must have the approval of a loan officer with the authority to approve a loan of that amount. Pooling of loan authority is not allowed except as outlined above for the President/Chief Executive Officer, Senior Lender/Executive Vice President, Chairman of the Board of Directors, and a majority of the Loan Committee or two-thirds of the Board of Directors.

 

All new credit which results in aggregate direct, indirect, and related credit, not under an approved line of credit of a threshold set forth in our loan policy, with the exceptions of mortgage loans in the process of being sold to investors and loans secured by properly margined negotiable securities traded on an established market or other cash collateral, are reviewed in detail on a monthly basis by the Loan Committee. Certain new credits that meet a higher threshold than required for the Loan Committee are reviewed by the Board of Directors of the Bank at its regular monthly meeting.

 

Employees

 

At December 31, 2019, we employed 79 people, with four individuals considered part time and one individual considered hourly, none of whom are subject to a collective bargaining agreement. We provide a variety of benefit programs including an Employee Stock Ownership Plan and Trust, Stock Incentive Plan, health, life, disability and other insurance. We believe our relationship with our employees is excellent.

 

Supervision and Regulation

 

We are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions and provide for general regulatory oversight of virtually all aspects of operations. The regulations are primarily intended to protect depositors, customers, and the integrity of the U.S. banking system and capital markets. The following information describes some of the more significant laws and regulations applicable to us. The description is qualified in its entirety by reference to the applicable laws and regulations. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, state legislatures, and with the various bank regulatory agencies. Changes in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on our business operations and earnings.

 

6

 

 

Dodd-Frank Act

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) became effective. This law has broadly affected the financial services industry by implementing changes to the financial regulatory landscape aimed at strengthening the sound operation of the financial services industry. This legislation will continue to significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including the Company and the Bank.

 

The Dodd-Frank Act created the Consumer Financial Protection Bureau (the “CFPB”) to centralize responsibility for consumer financial protection, including implementing, examining and enforcing compliance with federal consumer financial laws. The CFPB exercises supervisory review of banks under its jurisdiction. The CFPB focuses its rulemaking in several areas, particularly in the areas of mortgage reform involving the Real Estate Settlement Procedures Act, the Truth in Lending Act, the Equal Credit Opportunity Act, and the Fair Debt Collection Practices Act. There are many provisions in the Dodd-Frank Act mandating regulators to adopt new regulations and conduct studies upon which future regulation may be based. Governmental intervention and new regulations could materially and adversely affect our business, financial condition and results of operations.

 

Volcker Rule

 

Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: proprietary trading and the ownership or sponsorship of private equity or hedge funds that are referred to as covered funds. Proprietary trading, in general, is trading in securities on a short-term basis for a banking entity’s own account. In December 2013, federal banking agencies, the SEC and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule. At December 31, 2019, the Company has evaluated our securities portfolio and has determined that we do not hold any covered funds.

 

Bank Holding Company Act

 

The Company is a one-bank holding company under the Federal Bank Holding Company Act of 1956, as amended. As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Board of Governors (the “Federal Reserve Board”) of the Federal Reserve Bank (the “Federal Reserve”) under the act and its regulations promulgated thereunder.

 

Capital Requirements

 

The Federal Reserve Board imposes certain capital requirements on the Company under the Bank Holding Company Act, including a minimum leverage ratio and minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described under “Regulatory Capital Requirements” in the notes to the financial statements (see Note 19). The ability of the Company to pay dividends to shareholders depends on the Bank’s ability to pay dividends to the Company, which is subject to regulatory restrictions as described below in “Dividends.”

 

Standards for Safety and Soundness

 

The Federal Deposit Insurance Act requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to (1) internal controls, information systems and internal audit systems, (2) loan documentation, (3) credit underwriting, (4) interest rate risk exposure, and (5) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees, and benefits. The federal banking agencies have adopted regulations and “Interagency Guidelines Establishing Standards for Safety and Soundness” to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.

 

Regulatory Examination

 

All insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate banking agency against each institution or affiliate, as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the Federal Deposit Insurance Corporation (“FDIC”), their federal regulatory agency, and state supervisor when applicable. As a state chartered bank located in South Carolina, the Bank is also subject to the regulations of the South Carolina State Board of Financial Institutions.

 

7

 

 

The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to, among other things, the following:

 

 

Internal controls

 

Information systems and audit systems

 

Loan documentation

 

Credit underwriting

 

Interest rate risk exposure

 

Asset quality

 

Liquidity

 

Capital adequacy

 

Bank Secrecy Act

 

Sensitivity to market risk

 

Transactions with Affiliates and Insiders

 

We are subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit must be made on substantially the same terms, including interest rates, and collateral, as those prevailing at the time for comparable transactions with third parties and must not involve more than the normal risk of repayment or present other unfavorable features.

 

Dividends

 

The Company’s principal source of cash flow, including cash flow to pay dividends to its shareholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company. As a general rule, the amount of a dividend may not exceed, without prior regulatory approval, the sum of net income in the calendar year to date and the retained net earnings of the immediately preceding two calendar years. A depository institution may not pay any dividend, without regulatory approval, if payment would cause the institution to become undercapitalized or if it already is undercapitalized.

 

Consumer Protection Regulations

 

Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected by the Bank are subject to state usury laws and federal laws concerning interest rates. Our loan operations are also subject to federal laws applicable to credit transactions, such as:

 

 

The federal Truth-In-Lending Act, which governs disclosures of credit terms to consumer borrowers

 

The Home Mortgage Disclosure Act of 1975, which requires financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves

 

The Fair Lending Act, which requires fair, equitable, and nondiscriminatory access to credit for consumers

 

The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit

 

The Fair Credit Reporting Act of 1978, which governs the use and provision of information to credit reporting agencies

 

The Fair Debt Collection Act, which governs the manner in which consumer debt may be collected by collection agencies

 

The rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

The Gramm - Leach - Bliley Act, which governs the protection of consumer information.

 

The deposit operations of the Bank also are subject to:

 

 

The Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records

 

The Electronic Funds Transfer Act and the Federal Reserve Board issued Regulation E to implement the act, which governs automatic deposits to and withdrawals from deposit accounts and customer’s rights and liabilities arising from the use of automated teller machines and other electronic banking services

 

Regulation DD, which implements the Truth in Savings Act to enable consumers to make informed decisions about deposit accounts at depository institutions.

 

8

 

 

Enforcement Powers

 

The Company is subject to supervision and examination by the FDIC, the Federal Reserve and the South Carolina State Board of Financial Institutions. The Bank is subject to extensive federal and state regulations that significantly affect business and activities. These regulatory bodies have broad authority to implement standards and to initiate proceedings designed to prohibit depository institutions from engaging in activities that represent unsafe or unsound banking practices or constitute violations of applicable laws, rules, regulations, administrative orders, or written agreements with regulators. These regulatory bodies are authorized to take action against institutions that fail to meet such standards, including the assessment of civil monetary penalties, the issuance of cease-and-desist orders, and other actions.

 

Bank Secrecy Act/Anti-Money Laundering

 

We are subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001 (“USA Patriot Act”). We must maintain a Bank Secrecy Act Program that includes established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee-training program; and testing of the program by an independent audit function. The enactment of the USA Patriot Act amended and expanded the focus of the Bank Secrecy Act to facilitate information sharing among governmental entities and the Company for the purpose of combating terrorism and money laundering. It improves anti-money laundering and financial transparency laws, information collection tools and the enforcement mechanics for the U.S. government. These provisions include (a) standards for verifying customer identification at account opening; (b) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (c) reports by nonfinancial trades and businesses filed with the U.S. Treasury’s Financial Crimes Enforcement Network for transactions exceeding $10,000; (d) suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws; and (e) regulations and enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

 

Similar in purpose to the Bank Secrecy Act, the Office of Foreign Assets Control (“OFAC”), a division of the U.S. Department of Treasury, controls and imposes economic and trade sanctions based on U.S. foreign policy and national security goals against targeted countries and individuals based on threats to foreign policy, national security, or the U.S. economy. OFAC has and will send banking regulatory agencies lists of names of individuals and organizations suspected of aiding, concealing, or engaging in terrorist acts. Among other things, the Bank must block transactions with or accounts of sanctioned persons and report those transactions after their occurrence.

 

Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

Privacy and Credit Reporting

 

In connection with our lending activities, we are subject to a number of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Community Reinvestment Act (the “CRA”). The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” In addition, federal banking regulators, pursuant to the Gramm-Leach-Bliley Act, have enacted regulations limiting the ability of banks and other financial institutions to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with nonaffiliated third parties.

 

Item 1A.

Risk Factors

 

Under the filer category of “smaller reporting company”, as defined in Rule 12b-2 of the Exchange Act, the Company is not required to provide information requested by Part I, Item 1A of its Form 10-K.

 

Item 1B.

Unresolved Staff Comments

 

None.

 

Item 2.

Properties

 

The Company’s headquarters is located at 256 Meeting Street in downtown Charleston, South Carolina. This site is also the location of the main office of the Bank. The Bank also operates from four additional locations: 100 North Main Street, Summerville, SC; 1337 Chuck Dawley Boulevard, Mount Pleasant, SC; 2027 Sam Rittenberg Boulevard, Charleston, SC; and 9403 Highway 78, North Charleston, SC. The Bank’s mortgage department was located at 1071 Morrison Drive, Charleston, SC for part of the year but relocated to 9403 Highway 78, North Charleston, SC during the second half of 2019. The Company owns the 2027 Sam Rittenberg Boulevard location, which houses the Operations Department of the Bank as well as a banking office. The Company leases all other locations. The owned location is not encumbered and all of the leases have renewal options. Each banking location is suitable and adequate for banking operations.

 

9

 

 

Item 3.

Legal Proceedings

 

In our opinion, there are no legal proceedings pending other than routine litigation incidental to the Company’s business involving amounts that are not material to our financial condition.

 

Item 4.

Mine Safety Disclosures

 

Not applicable.

 

10

 

 

PART II

 

Item 5.

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

 

At December 31, 2019, there were 5,799,637 shares issued and 5,530,001 shares outstanding of the 12,000,000 authorized shares of common stock of the Company. Our common stock is traded on the NASDAQ under the trading symbol “BKSC”.

 

Information regarding the historical market prices of our common stock and dividends declared on that stock is shown below.

 

     High   Low   Dividends 
2019                 
Quarter ended March 31, 2019    $19.30   $18.12   $0.16 
Quarter ended June 30, 2019    $20.01   $17.52   $0.16 
Quarter ended September 30, 2019    $19.32   $18.34   $0.26 
Quarter ended December 31, 2019    $18.99   $18.27   $0.16 
                  
2018                 
Quarter ended March 31, 2018    $21.45   $18.90   $0.15 
Quarter ended June 30, 2018    $21.90   $17.55   $0.15 
Quarter ended September 30, 2018    $21.15   $19.50   $0.25 
Quarter ended December 31, 2018    $20.90   $17.89   $0.15 
                  
2017                 
Quarter ended March 31, 2017    $21.85   $19.28   $0.14 
Quarter ended June 30, 2017    $21.15   $18.80   $0.14 
Quarter ended September 30, 2017    $19.95   $17.47   $0.15 
Quarter ended December 31, 2017    $19.35   $18.00   $0.15 

 

The future payment of cash dividends is subject to the discretion of the Board of Directors and depends upon a number of factors including future earnings, financial condition, cash requirements, and general business conditions. Cash dividends, when declared, are paid by the Bank to the Company for distribution to shareholders of the Company. Certain regulatory requirements restrict the amount of dividends that the Bank can pay to the Company.

 

At our December 1995 Board Meeting, the Board of Directors authorized the repurchase of up to 140,918 shares of its common stock on the open market. At our October 1999 Board Meeting, the Board of Directors authorized the repurchase of up to 45,752 shares of its common stock on the open market and again at our September 2001 Board meeting, the Board of Directors authorized the repurchase of up to 54,903 shares of its common stock on the open market. As of the date of this report, the Company owns 269,636 shares, adjusted for five 10% stock dividends and a 25% stock dividend. At the Annual Meeting in April 2007, the shareholders voted to increase the number of authorized shares from 6,000,000 to 12,000,000.

 

As of February 14, 2020, there were approximately 2,405 shareholders of record with shares held by individuals and in nominee names. The market price for our common stock as of February 14, 2020 was $18.84. As of February 14, 2020, there were 5,799,999 shares of common stock issued and 5,530,363 shares of common stock outstanding.

 

THE BANK OF SOUTH CAROLINA EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

 

During 1989, the Board of Directors of the Bank adopted an Employee Stock Ownership Plan and Trust Agreement (“ESOP”) to provide retirement benefits to eligible employees of the Bank for long and faithful service. An amendment and restatement was made to the ESOP effective January 1, 2007 and approved by the Board of Directors on January 18, 2007. Periodically, the Internal Revenue Service (“IRS”) requires a restatement of a qualified retirement plan to ensure that the plan document includes provisions required by legislative and regulatory changes made since the last restatement. There have been no substantive changes to the plan; however, to comply with the IRS rules, the Board of Directors approved a restated plan on January 26, 2012 (incorporated as Exhibit 10.5 in the 2011 10-K) and submitted the plan to the IRS for approval. The IRS issued a determination letter on September 26, 2013, stating that the plan satisfied the requirements of Code Section 4975 (e) (7). On January 26, 2017, the Board of Directors approved a restated plan (incorporated as Exhibit 10.6 in the 2016 10-K). The restated Plan was submitted to the IRS for approval and a determination letter was issued November 17, 2017, stating that the plan satisfies the requirements of Code Section 4975 (e) (7).

 

11

 

 

The Board of Directors of the Bank approved a cash contribution of $510,000 to the ESOP for the fiscal year ended December 31, 2019. The Board of Directors of the Bank approved cash contributions of $420,000 and $375,000 for the fiscal years ended December 31, 2018 and 2017, respectively. The contributions were made during the respective fiscal years.

 

An employee of the Bank who is not a member of an ineligible class of employees is eligible to participate in the plan upon reaching 21 years of age and being credited with one year of service (1,000 hours of service). All employees are eligible employees except for the following ineligible classes of employees:

 

 

Employees whose employment is governed by a collective bargaining agreement between employee representatives and the Company in which retirement benefits were the subject of good faith bargaining unless the collective bargaining agreement expressly provides for the inclusion of such employees in the plan

 

Employees who are non-resident aliens who do not receive earned income from the Company which constitutes income from sources within the United States

 

Any person who becomes an employee as the result of certain asset or stock acquisitions, mergers, or similar transactions (but only during a transitional period)

 

Certain leased employees

 

Employees who are employed by an affiliated company that does not adopt the plan

 

Any person who is deemed by the Company to be an independent contractor on his or her employment commencement date and on the first day of each subsequent plan year, even if such person is later determined by a court or a governmental agency to be or to have been an employee.

 

The employee may enter the Plan on the January 1st that occurs nearest the date on which the employee first satisfies the age and service requirements described above. No contributions by employees are permitted. The amount and time of contributions are at the sole discretion of the Board of Directors of the Bank. The contribution for all participants is based solely on each participant’s respective regular or base salary and wages paid by the Bank including commissions, bonuses and overtime, if any.

 

A participant becomes vested in the ESOP based upon the employee’s credited years of service. The vesting schedule is as follows:

 

 

1 Year of Service

0% Vested

 

 

2 Years of Service

25% Vested

 

 

3 Years of Service

50% Vested

 

 

4 Years of Service

75% Vested

 

 

5 Years of Service

100% Vested

 

 

The Bank is the Plan Administrator. Eugene H. Walpole, IV, Fleetwood S. Hassell, Sheryl G. Sharry and Douglas H. Sass, currently serve as the Plan Administrative Committee and Trustees for the Plan. At December 31, 2019, the Plan owned 313,703 shares of common stock of the Company.

 

THE BANK OF SOUTH CAROLINA STOCK INCENTIVE PLAN

 

We have a Stock Incentive Plan, which was approved in 1998, with 180,000 (329,422 adjusted for four 10% stock dividends, and a 25% stock dividend) shares reserved, and a Stock Incentive Plan, which was approved in 2010, with 300,000 (363,000 adjusted for two 10% stock dividends) shares reserved. Under both plans, options are periodically granted to employees at a price not less than the fair market value of the shares at the date of grant. Participating employees become 20% vested after five years and then vest 20% each year until fully vested. The right to exercise each such 20% of the options is cumulative and will not expire until the tenth anniversary of the date of the grant. Employees are eligible to participate in this plan if the Executive/Long-Range Planning Committee, in its sole discretion, and the Compensation Committee as to Executive Officers who are members of the Executive/Long-Range Planning Committee, determines that an employee has contributed or can be expected to contribute to our profits or growth.

 

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model. Expected volatilities are based on historical volatilities of our common stock. The expected term of the options granted will not exceed ten years from the date of grant (the amount of time options granted are expected to be outstanding). The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

 

12

 

 

Item 6.

Selected Financial Data

 

The following table sets forth certain selected financial information concerning the Company and its wholly-owned subsidiary. The information was derived from audited consolidated financial statements. The information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which follows, and the audited consolidated financial statements and notes, which are presented elsewhere in this report.

 

   2019   2018   2017   2016   2015 
For December 31:                         
Net income  $7,318,433   $6,922,934   $4,901,825   $5,247,063   $4,884,288 
Selected Year End Balances:                         
Total assets   445,012,520    429,135,198    446,566,498    413,949,636    399,172,512 
Total loans(1)   279,134,958    275,863,705    272,274,363    264,962,325    248,442,944 
Investment securities available for sale   100,449,956    119,668,874    139,250,250    119,978,944    119,997,585 
Interest-bearing deposits at the Federal Reserve   39,320,526    25,506,784    24,034,194    18,101,300    23,898,862 
Earning assets   418,905,440    421,039,363    435,558,807    403,042,569    392,339,391 
Total deposits   379,191,655    382,378,388    402,888,300    372,522,851    358,718,612 
Total shareholders’ equity   51,168,032    45,462,561    42,764,635    40,612,974    39,151,712 
Weighted Average Shares Outstanding - basic   5,522,025    5,500,027    5,471,001    5,428,884    5,403,749 
Weighted Average Shares Outstanding - diluted   5,588,090    5,589,012    5,568,493    5,561,739    5,573,794 
                          
For the Year:                         
Selected Average Balances:                         
Total assets   440,615,140    430,495,412    428,174,359    410,581,560    379,527,104 
Total loans(1)   281,508,711    277,223,600    264,881,222    265,151,258    243,729,630 
Investment securities available for sale   106,421,507    123,347,669    130,161,937    110,762,289    110,633,399 
Interest-bearing deposits at the Federal Reserve   34,713,982    20,151,823    23,558,893    26,474,258    17,549,903 
Earning assets   422,644,200    420,723,092    418,602,052    402,387,805    371,912,932 
Total deposits   381,687,960    386,025,147    384,524,305    367,822,900    337,969,217 
Total shareholders’ equity   49,242,545    43,691,359    43,121,778    41,479,755    38,631,718 
                          
Performance Ratios:                         
Return on average equity   14.86%   15.85%   11.37%   12.65%   12.64%
Return on average assets   1.66%   1.61%   1.14%   1.28%   1.29%
Average equity to average assets   11.18%   10.15%   10.07%   10.10%   10.18%
Net interest margin   4.28%   4.15%   3.76%   3.71%   3.72%
Net (recoveries) charge-offs to average loans   0.14%   (0.01)%   0.01%   0.05%   0.04%
Allowance for loan losses as a percentage of total loans(2)   1.46%   1.53%   1.43%   1.48%   1.41%
                          
Per Share:                         
Basic income per common share(3)  $1.33   $1.26   $0.90   $0.96   $0.90 
Diluted income per common share(3)  $1.31   $1.24   $0.88   $0.94   $0.88 
Year end book value(3)  $9.25   $8.25   $7.79   $7.45   $7.24 
Dividends per common share  $0.74   $0.70  $0.58   $0.54   $0.52 
Dividend payout ratio   55.88%   54.68%   58.87%   50.86%   49.94%
Full time employee equivalents   79    79    77    74    81 

 

(1)Including mortgage loans to be sold.
(2)Excluding mortgage loans to be sold.
(3)Adjusted to retroactively reflect 10% stock dividend issued during the year ended December 31, 2018.

 

13

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis is included to assist the shareholder in understanding our financial condition, results of operations, and cash flow. This discussion should be reviewed in conjunction with the audited consolidated financial statements and accompanying notes presented in Item 8 of this report and the supplemental financial data appearing throughout this report. Since the primary asset of the Company is its wholly-owned subsidiary, most of the discussion and analysis relates to the Bank.

 

OVERVIEW

 

The Company is a bank holding company headquartered in Charleston, South Carolina, with $445.0 million in assets as of December 31, 2019 and net income of $7.3 million for the year ended December 31, 2019. The Company offers a broad range of financial services through its wholly owned subsidiary, the Bank. The Bank is a state-chartered commercial bank, which operates principally in the Charleston, Dorchester, and Berkeley counties of South Carolina. The Bank’s original and current concept is to be a full service financial institution specializing in personal service, responsiveness, and attention to detail to foster long-standing relationships.

 

We derive most of our income from interest on loans and investment securities. The primary source of funding for making these loans and investment securities is our interest-bearing and non-interest-bearing deposits. Consequently, one of the key measures of our success is the amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

 

A consequence of lending activities is that we may incur credit losses. The amount of such losses will vary depending upon the risk characteristics of the loan portfolio as affected by economic conditions such as rising interest rates and the financial performance of borrowers. The reserve for credit losses consists of the allowance for loan losses (the “allowance”) and a reserve for unfunded commitments (the “unfunded reserve”). The allowance provides for probable and estimable losses inherent in our loan portfolio while the unfunded reserve provides for potential losses related to unfunded lending commitments. For a detailed discussion on the allowance for loan losses, see “Allowance for Loan Losses”.

 

In addition to earning interest on loans and investment securities, we earn income through fees and other expenses we charge to the customer. The various components of other income and other expenses are described in the following discussion. The discussion and analysis also identifies significant factors that have affected our financial position and operating results for the year ended as of December 31, 2019 as compared to December 31, 2018 and our operating results for 2018 compared to 2017 and 2017 compared to 2016, and should be read in conjunction with the consolidated financial statements and the related notes included in this report. In addition, a number of tables have been included to assist in the discussion.

 

CRITICAL ACCOUNTING POLICIES

 

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States (“GAAP”) and with general practices within the banking industry in the preparation of our consolidated financial statements. Our significant accounting policies are set forth in the notes to the consolidated financial statements of this report.

 

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

 

We consider our policy regarding the allowance for loan losses to be our most subjective accounting policy due to the significant degree of judgment. We have developed what we believe to be appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations and the discovery of information with respect to borrowers, which were not known at the time of the issuance of the consolidated financial statements. For additional discussion concerning our allowance for loan losses and related matters, see “Allowance for Loan Losses”.

 

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2019 TO DECEMBER 31, 2018

 

Net income increased $0.4 million or 5.71% to $7.3 million, or basic and diluted income per share of $1.33 and $1.31, respectively, for the year ended December 31, 2019 from $6.9 million or basic and diluted income per share of $1.26 and $1.24, respectively, for the year ended December 31, 2018. The increase in net income was primarily due to rising interest rates in the first half of the year on interest-earning assets and a decrease in other operating expenses. Our returns on average assets and average equity for the year ended December 31, 2019 were 1.66% and 14.86%, respectively, compared with 1.61% and 15.85%, respectively, for the year ended December 31, 2018.

 

 14

 

 

Net interest income increased $0.7 million or 3.75% to $18.1 million for the year ended December 31, 2019 from $17.4 million for the year ended December 31, 2018. This increase was primarily due to increases in interest and fees on loans. Interest and fees on loans increased $0.9 million or 5.74% to $16.0 million for the year ended December 31, 2019 from $15.1 million for the year ended December 31, 2018, as the result of the higher Federal Funds target rate set by the Federal Reserve during the first half of the year during an expansion of our loan portfolio.

 

Average earning assets increased $1.9 million or 0.46% to $422.6 million for the year ended December 31, 2019 from $420.7 million for the year ended December 31, 2018. This is primarily related to the increase in the average balance of loans and interest-bearing deposits at the Federal Reserve offset by decreases in average investment securities.

 

The provision to the allowance for loan losses for the year ended December 31, 2019 was $180,000 compared to $325,000 for the year ended December 31, 2018. The decrease was primarily driven by the composition of our loan portfolio in accordance with our allowance for loan loss methodology. The Board of Directors determined that this provision was appropriate based upon the adequacy of our reserve. Charge-offs of $407,027 and recoveries of $16,454, together with the provision to the allowance, resulted in an allowance for loan losses of $4.0 million or 1.46% of total loans at December 31, 2019.

 

Other income increased $0.2 million or 10.23% to $2.2 million for the year ended December 31, 2019, from $2.0 million for the year ended December 31, 2018. Our mortgage banking income increased $0.1 million or 19.54% to $0.9 million for the year ended December 31, 2019 from $0.8 million for the year ended December 31, 2018 due to increased volume. Mortgage banking income is highly influenced by mortgage interest rates and the housing market.

 

Other expense decreased $0.5 million or 4.14% to $10.6 million for the year ended December 31, 2019, from $11.1 million for the year ended December 31, 2018. Other operating expenses decreased $0.8 million to $2.2 million during the year ended December 31, 2019 from $3.0  million during the year ended December 31, 2018. This decrease is directly related to the amortization expense of $354,888 for our investment in a Federal Rehabilitation Tax Credit that was recorded during the year ended December 31, 2018.

 

For the year ended December 31, 2019, the Company’s effective tax rate was 22.91% compared to 13.81% during the year ended December 31, 2018. The increase in the effective tax rate is directly related to the expiration of our 2018 investment in a Federal Rehabilitation Tax Credit.

 

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2018 TO DECEMBER 31, 2017

 

Net income increased $2.0 million or 41.23% to $6.9 million, or basic and diluted income per share of $1.26 and $1.24, respectively, for the year ended December 31, 2018 from $4.9 million or basic and diluted income per share of $0.90 and $0.88, respectively, for the year ended December 31, 2017. The increase in net income was primarily due to improved margins resulting from a lower corporate tax rate due to the enactment of the Tax Cuts and Jobs Act and rising interest rates on interest-earning assets. Our returns on average assets and average equity for the year ended December 31, 2018 were 1.61% and 15.85%, respectively, compared with 1.14% and 11.37%, respectively, for the year ended December 31, 2017.

 

Net interest income increased $1.7 million or 10.78% to $17.4 million for the year ended December 31, 2018 from $15.7 million for the year ended December 31, 2017. This increase was primarily due to increases in interest and fees on loans and investment securities. Interest and fees on loans increased $1.8 million or 13.84% to $15.1 million for the year ended December 31, 2018 from $13.3 million for the year ended December 31, 2017, as the result of the increases in the Federal Funds target rate set by the Federal Reserve. Interest income on investment securities increased $4,980 or 0.31% to $2.6 million for the year ended December 31, 2018.

 

Average earning assets increased $2.1 million or 0.51% to $420.7 million for the year ended December 31, 2018 from $418.6 million for the year ended December 31, 2017. This is primarily related to the increase in the average balance of loans offset by decreases in average investment securities and interest-bearing deposits at the Federal Reserve.

 

The provision to the allowance for loan losses for the year ended December 31, 2018 was $325,000 compared to $55,000 for the year ended December 31, 2017. The increase was primarily driven by the growth of our loan portfolio in accordance with our allowance for loan loss methodology. The Board of Directors determined that this provision was appropriate based upon the adequacy of our reserve. Charge-offs of $115,887 and recoveries of $129,820, together with the provision to the allowance, resulted in an allowance for loan losses of $4,214,331 or 1.53% of total loans at December 31, 2018.

 

Other income decreased $273,846 or 12.07% to $2.0 million for the year ended December 31, 2018, from $2.3 million for the year ended December 31, 2017. Our mortgage banking income decreased $270,564 or 25.59% to $786,893 for the year ended December 31, 2018 from $1.1 million for the year ended December 31, 2017 due to decreased volume. We were also impacted by an increase in competition as new banks entered the market area. Mortgage banking income is highly influenced by mortgage interest rates and the housing market.

 

 15

 

 

Other expense increased $837,938 or 8.18% to $11.1 million for the year ended December 31, 2018, from $10.2 million for the year ended December 31, 2017. Salaries and employee benefits increased $427,398 or 7.05% from $6.1 million for the year ended December 31, 2017 to $6.5 million for the year ended December 31, 2018. Other operating expenses increased $435,726 to $3.0 million during the year ended December 31, 2018 from $2.5 million during the year ended December 31, 2017. This increase is directly related to the amortization expense of $354,888 for our investment in a Federal Rehabilitation Tax Credit.

 

For the year ended December 31, 2018, the Company’s effective tax rate was 13.81% compared to 36.48% during the year ended December 31, 2017. The decrease in the effective tax rate is directly related to the income tax expense recorded due to the revaluation of the deferred tax asset in 2017, as well as our investment in a Federal Rehabilitation Tax Credit in 2018. As a result of the enactment of the Tax Cuts and Jobs Act, which changed the corporate tax rate to 21% from 34%, the deferred tax asset was revalued on December 22, 2017. This revaluation resulted in additional income tax expense of $666,674 in 2017.

 

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2017 TO DECEMBER 31, 2016

 

Net income decreased $345,238 or 6.58% to $4.9 million, or basic and diluted income per share of $0.90 and $0.88, respectively for the year ended December 31, 2017 from $5.2 million or basic and diluted income per share of $0.97 and $0.94, respectively for the year ended December 31, 2016. The decrease in net income was primarily due to the enactment of the Tax Cuts and Jobs Act on December 22, 2017 and the related revaluation of the deferred tax asset. Deferred tax assets and liabilities must be adjusted to legislation based on the enactment date not the effective date; therefore, the deferred tax asset was revalued at a corporate tax rate of 21% instead of 34% in accordance with GAAP at December 22, 2017. This revaluation resulted in additional income tax expense of $666,674. Our returns on average assets and average equity for the year ended December 31, 2017 were 1.14% and 11.37%, respectively, compared with 1.28% and 12.65%, respectively, for the year ended December 31, 2016.

 

Net interest income increased $828,427 or 5.55% to $15.7 million for the year ended December 31, 2017 from $14.9 million for the year ended December 31, 2016. This increase was primarily due to increases in interest and fees on loans and investment securities. Interest and fees on loans increased $435,418 or 3.89% to $13.3 million for the year ended December 31, 2017 from $12.9 million for the year ended December 31, 2016, as the result of the increases in the Federal Funds rate set by the Federal Reserve. Interest income on investment securities increased $306,944 or 13.32% to $2.6 million for the year ended December 31, 2017 from $2.3 million for the year ended December 31, 2016 a result of the increase in the average balance of investment securities from $110.8 million for the year ended December 31, 2016 to $130.2 million for the year ended December 31, 2017.

 

Average earning assets increased $16.2 million or 4.03% to $418.6 million for the year ended December 31, 2017 from $402.4 million for the year ended December 31, 2016. This is primarily related to the increase in the average balance of investment securities as stated in the previous paragraph.

 

The provision to the allowance for loan losses for the year ended December 31, 2017 was $55,000 compared to $570,000 for the year ended December 31, 2016. The decrease was primarily a result of slower loan growth in the first three quarters of the year and lower net charge-offs. The Board of Directors determined that this provision was appropriate based upon the adequacy of our reserve and the anticipation of continued loan growth and an improving economy. Charge-offs of $185,449 and recoveries of $154,230, together with the provision to the allowance, resulted in an allowance for loan losses of $3.9 million or 1.43% of total loans at December 31, 2017.

 

Other income decreased $592,612 or 20.71% to $2.3 million for the year ended December 31, 2017. Our mortgage banking income decreased $330,283 or 23.80% to $1.1 million for the year ended December 31, 2017 from $1.4 million for the year ended December 31, 2016 due to decreased volume. We were also impacted by an increase in competition as new banks enter the market area. Mortgage banking income is highly influenced by mortgage interest rates and the housing market. Mortgage loan originations decreased $20.2 million or 26.62% to $55.8 million for the year ended December 31, 2017 from $76.0 million for the year ended December 31, 2016. We also had gains of $380,904 on the sales of investment securities during the year ended December 31, 2016 compared to gains of $45,820 during the year ended December 31, 2017, a decrease of $335,084 or 87.97%. The decrease in gains was due to the little difference between short-term and long-term rates for bonds of the same credit quality in the current market.

 

Other expense decreased $30,148 or 0.29% to $10.2 million for the year ended December 31, 2017, from $10.3 million for the year ended December 31, 2016. Salaries and employee benefits decreased $27,098 or 0.45% from $6.1 million for the year ended December 31, 2016 to $6.1 million for the year ended December 31, 2017. Other operating expenses decreased $122,039 to $2.5 million during the year ended December 31, 2017 from $2.6 million during the year ended December 31, 2016. This decrease was primarily attributable to a decrease in state and FDIC insurance and fees. Our net occupancy expense increased $43,028 or 2.82% to $1.6 million for the year ended December 31, 2017, from $1.5 million for the year ended December 31, 2016. Our net occupancy expense includes rent and insurance on our banking locations as well as the cost of repairs and maintenance on these facilities. Occupancy expense increased primarily due to annual rent increases at our Meeting Street and Summerville banking locations as well as an increase in insurance on banking locations, offset by a decrease in the cost of maintenance and repairs and depreciation on furniture, fixtures and equipment.

 

 16

 

 

For the year ended December 31, 2017, the Company’s effective tax rate was 36.48% compared to 24.34% during the year ended December 31, 2016. The increase in the effective tax rate is directly related to the income tax expense recorded due to the revaluation of the deferred tax asset. As a result of the enactment of the Tax Cuts and Jobs Act changing the corporate tax rate to 21% from 34%, the deferred tax asset was revalued on December 22, 2017. This revaluation resulted in additional income tax expense of $666,674.

 

ASSET AND LIABILITY MANAGEMENT

 

We manage our assets and liabilities to ensure there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses, and dividends; and to manage daily operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings. The Asset Liability/Investment Committee (“ALCO”) manages asset and liability procedures though the ultimate responsibility rests with the President/Chief Executive Officer. At December 31, 2019, total assets increased 3.70% to $445.0 million from $429.1 million as of December 31, 2018 and total deposits decreased 0.83% to $379.2 million from $382.4 million as of December 31, 2018.

 

As of December 31, 2019, earning assets, which are composed of U.S. Treasury, Government Sponsored Enterprises and Municipal Securities in the amount of $100.4 million, interest-bearing deposits at the Federal Reserve in the amount of $39.3 million and total loans, including mortgage loans held for sale, in the amount of $279.1 million, constituted approximately 34.74% of our total assets.

 

The yield on a majority of our earning assets adjusts in tandem with changes in the general level of interest rates. Some of the Company’s liabilities are issued with fixed terms and can be repriced only at maturity.

 

MARKET RISK

 

Market risk is the risk of loss from adverse changes in market prices and interest rates. Our risk consists primarily of interest rate risk in our lending and investing activities as they relate to the funding by deposit and borrowing activities.

 

Our policy is to minimize interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities and to attempt to maintain an asset sensitive position over a one-year period. By adhering to this policy, we anticipate that our net interest margins will not be materially affected, unless there is an extraordinary and or precipitous change in interest rates. The average net interest rate margin for 2019 increased to 4.28% from 4.15% for 2018. At December 31, 2019 and 2018, our net cumulative gap was liability sensitive for periods less than one year and asset sensitive for periods of one year or more. The reason for the shift in sensitivity is the direct result of management’s strategic decision to invest excess funds held at the Federal Reserve into fixed rate investment securities that match our investment policy objectives. Management is aware of this departure from policy and will continue to closely monitor our sensitivity position going forward.

 

Since the rates on most of our interest-bearing liabilities can vary on a daily basis, we continue to maintain a loan portfolio priced predominately on a variable rate basis. However, in an effort to protect future earnings in a declining rate environment, we offer certain fixed rates, interest rate floors, and terms primarily associated with real estate transactions. We seek stable, long-term deposit relationships to fund our loan portfolio. Furthermore, we do not have any brokered deposits or internet deposits.

 

At December 31, 2019, the average maturity of the investment portfolio was 2.96 years with an average yield of 2.00% compared to 3.69 years with an average yield of 2.08% at December 31, 2018.

 

We do not take foreign exchange or commodity risks. In addition, we do not own mortgage-backed securities nor do we have any exposure to the sub-prime market or any other distressed debt instruments.

 

 17

 

 

The following table summarizes our interest sensitivity position as of December 31, 2019.

 

    One Day    

Less

than
three
months

    Three
months
to less
than six
months
    Six
months
to less
than one
year
   

One
year to

less than
five
years

    Five
years or
more
    Total     Estimated
Fair
Value
 
(in thousands)                                                
Interest-earning assets                                                                
Loans(1)   $ 126,870     $ 19,393     $ 16,001     $ 23,697     $ 92,847     $ 327     279,135     $ 275,740  
Investment securities available for sale(2)           5,885       1,334       3,403       80,247       8,969       99,838       100,450  
Interest-bearing deposits at the Federal Reserve     39,321                                     39,321       39,321  
Total   $ 166,191     $ 25,278     $ 17,335     $ 27,100     $ 173,094     $ 9,296     $ 418,294     $ 415,511  
                                                                 
Interest-bearing liabilities                                                                
CD’s and other time deposits less than $250,000   $     $ 6,406     $ 3,459     $ 4,295     $ 2,055     $     $ 16,215     $ 17,598  
CD’s and other time deposits $250,000 and over           1,387       2,064       2,517                   5,968       4,364  
Money market and interest-bearing demand accounts     194,141                                     194,141       194,141  
Savings     37,247                                     37,247       37,247  
Total   $ 231,388     $ 7,793     $ 5,523     $ 6,812     $ 2,055     $     $ 253,571     $ 253,350  
                                                                 
Net   $ (65,197 )   $ 17,485     $ 11,812     $ 20,288     $ 171,039     $ 9,296     $ 164,723          
Cumulative             (47,712 )     (35,900 )     (15,612 )     155,427       164,723                  

 

(1)

Including mortgage loans to be sold and deferred fees.

(2)

At amortized cost.

 

LIQUIDITY

 

Historically, we have maintained our liquidity at levels believed by management to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets.

 

The following table summarizes future contractual obligations as of December 31, 2019.

 

    Payment Due by Period  

 

 

Total

 

 

Less than
one year

 

 

One to
five years

 

 

After
five years

 

Contractual Obligations

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

$

22,183

 

 

$

20,128

 

 

$ 

2,055

 

 

$

 

Operating leases

 

 

15,405

 

 

 

902

 

 

 

3,763

 

 

 

10,740

 

Total contractual cash obligations

 

$

37,588

 

 

$

21,030

 

 

$ 

5,818

 

 

10,740

 

 

Proper liquidity management is crucial to ensure that we are able to take advantage of new business opportunities as well as meet the credit needs of our existing customers. Investment securities are an important tool in our liquidity management. Our primary liquid assets are cash and due from banks, investments available for sale, interest-bearing deposits at the Federal Reserve, and mortgage loans held for sale. Our primary liquid assets accounted for 34.74% and 35.58% of total assets at December 31, 2019 and 2018, respectively. Investment securities classified as available for sale, which are not pledged, may be sold in response to changes in interest rates and liquidity needs. All of the investment securities presently owned are classified as available for sale. Net cash provided by operations and deposits from customers have been the primary sources of liquidity. At December 31, 2018, we had unused short-term lines of credit totaling approximately $23.0 million (which can be withdrawn at the lender’s option). Additional sources of funds available to us for liquidity include increasing deposits by raising interest rates paid and selling mortgage loans held for sale. We also established a Borrower-In-Custody arrangement with the Federal Reserve. This arrangement permits us to retain possession of assets pledged as collateral to secure advances from the Federal Reserve Discount Window. At December 31, 2019, we could borrow up to $56.8 million. There have been no borrowings under this arrangement.

 

Our core deposits consist of non-interest bearing demand accounts, NOW accounts, money market accounts, time deposits and savings accounts. We closely monitor our reliance on certificates of deposit greater than $250,000 and other large deposits. We maintain a Contingency Funding Plan (“CFP”) that identifies liquidity needs and weighs alternate courses of action designed to address these needs in emergency situations. We perform a quarterly cash flow analysis and stress test the CFP to evaluate the expected funding needs and funding capacity during a liquidity stress event. We believe our liquidity sources are adequate to meet our operating needs and do not know of any trends, events or uncertainties that may result in a significant adverse effect on our liquidity position. At December 31, 2019 and 2018, our liquidity ratio was 36.18% and 34.27%, respectively.

 

 18

 

 

Average earning assets increased by $1.9 million from 2018 to 2019. This increase was primarily due proceeds from the sale or maturity of investment securities reinvested at the Federal Reserve as well as an increase of $4.3 million in average loans.

 

The following table shows the composition of average assets over the past five fiscal years.

 

   2019   2018   2017   2016   2015 
Loans(1), net  $277,395,432   $273,329,677   $260,987,352   $261,587,734   $240,380,985 
Investment securities available for sale   106,421,507    123,347,669    130,161,937    110,762,289    110,633,399 
Interest-bearing deposits at the Federal Reserve   34,713,982    20,151,823    23,558,893    26,474,258    17,549,903 
Non-earning assets   22,084,219    13,666,243    13,466,177    11,757,279    10,962,817 
Total average assets  $440,615,140   $430,495,412   $428,174,359   $410,581,560   $379,527,104 

  

(1)

Including mortgage loans to be sold and deferred fees.

 

ANALYSIS OF CHANGES IN NET INTEREST INCOME

 

The following table shows changes in interest income and expense based upon changes in volume and changes in rates.

                                     
   2019 vs. 2018   2018 vs. 2017   2017 vs. 2016 
   Volume   Rate   Net Dollar
Change(1)
   Volume   Rate   Net Dollar
Change(1)
   Volume   Rate   Net Dollar
Change(1)
 
Loans(2)  $237,995   $629,980   $867,975   $619,462   $1,219,536   $1,838,998   $(12,868)  $448,286   $435,418 
Investment securities available for sale   (364,113)   (64,792)   (428,905)   (133,820)   138,800    4,980    390,667    (83,722)   306,945 
Interest-bearing deposits at the Federal Reserve   284,163    52,108    336,271    (38,839)   162,625    123,786    (16,770)   147,957    131,187 
Interest income  $158,045   $617,296   $775,341   $466,803   $1,520,961   $1,967,764   $361,029   $512,521   $873,550 
                                              
Interest-bearing transaction accounts  $28,048   $137,012   $165,060   $(1,334)  $214,584   $213,250   $12,863   $(2,853)  $10,010 
Savings   (4,507)   20,217    15,710    1,355    40,614    41,969    6,097    (340)   5,757 
Time deposits   (80,972)   20,987    (59,985)   (11,973)   27,277    15,304    (14,974)   44,330    29,356 
Interest expense  $(57,431)  $178,216   $120,785   $(11,952)  $282,475   $270,523   $3,986   $41,137   $45,123 
                                              
Increase in net interest income            $654,556             $1,697,241             $828,427 

  

(1)

Volume/Rate changes have been allocated to each category based on the percentage of each to the total change.

(2)

Including mortgage loans to be sold.

 

 19

 

 

YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES

 

The following table shows the yields on average earning assets and average interest-bearing liabilities.

                                     
   2019   2018   2017 
   Average
Balance
   Interest Paid/Earned   Average Yield/Rate(1)   Average
Balance
   Interest Paid/Earned   Average Yield/Rate(1)   Average
Balance
   Interest Paid/Earned   Average Yield/Rate(1) 
Interest-earning assets                                             
Loans(2)  $281,508,711   $15,994,290   5.68%  $277,223,600   $15,126,316   5.46%  $264,881,222   $13,287,318    5.02%
Investment Securities Available for Sale   106,421,507    2,188,094    2.06%   123,347,669    2,616,998    2.12%   130,161,937    2,612,018    2.01%
Federal Funds Sold & Interest-bearing deposits   34,713,982    729,868    2.10%   20,151,823    393,597    1.95%   23,558,893    269,811    1.15%
Total earning assets  422,644,200   $18,912,252   4.47%  $420,723,092   $18,136,911   4.31%  $418,602,052   $16,169,147    3.86%
                                              
Interest-bearing liabilities                                             
Interest-bearing transaction accounts  $189,114,988   $552,612   0.29%  $176,796,964   $387,552   0.22%  $178,146,123   $174,302    0.10%
Savings   32,934,733    97,707    0.30%   34,857,035    81,997    0.24%   33,694,318    40,028    0.12%
Time Deposits   26,456,064    164,852    0.62%   41,325,783    224,837    0.54%   44,097,537    209,533    0.48%
 Total interest-bearing liabilities  $248,505,785   $815,171   0.33%  $252,979,782   $694,386   0.27%  $255,937,978   $423,863    0.17%
                                              
Net interest spread             4.14%             4.04%             3.69%
Net interest margin             4.28%             4.15%             3.76%
Net interest income       $18,097,081             $17,442,525             $15,745,284      

 

(1)

The effect of forgone interest income as a result of non-accrual loans was not considered in the above analysis.

(2)

Average loan balances include non-accrual loans and mortgage loans to be sold.

 

 20

 

INVESTMENT PORTFOLIO

 

The following tables summarize the carrying value of investment securities as of the indicated dates and the weighted-average yields of those securities at December 31, 2019.

 

   Amortized Cost        
    Within
One Year
    After
One Year
through
Five Years
    After
Five Years
through
Ten Years
    After
Ten Years
    Total     Estimated
Fair
Value
 
(in thousands)                              
U.S. Treasury Notes  $3,000   $20,081   $   $   $23,081   $23,180 
Government-Sponsored Enterprises       45,057    5,083        50,140    50,498 
Municipal Securities   6,186    12,123    8,309        26,618    26,772 
Total  $9,186   $77,261   $13,392   $   $99,839   $100,450 
                               
Weighted average yields                              
U.S. Treasury Notes   1.75%   1.79%   %   %          
Government-Sponsored Enterprises   %   2.09%   1.87%   %          
Municipal Securities   2.00%   2.27%   2.06%   %          
Total   1.98%   2.18%   2.05%   %   2.00%     

 

 21

 

 

The following tables present the amortized cost and estimated fair value of investment securities for the past three years.

 

December 31, 2019

 

Amortized
Cost

 

 

Estimated
Fair Value

 

(in thousands)

 

 

 

 

 

 

U.S. Treasury Notes

 

$

23,080

 

 

$

23,180

 

Government-Sponsored Enterprises

 

 

50,140

 

 

 

50,498

 

Municipal Securities

 

 

26,618

 

 

 

26,772

 

Total

 

$

99,838

 

 

$

100,450

 

 

 

 

 

 

 

 

December 31, 2018

 

Amortized
Cost

 

 

Estimated
Fair Value

 

(in thousands)

 

 

 

 

 

 

U.S. Treasury Notes

 

$

32,966

 

 

$

32,357

 

Government-Sponsored Enterprises

 

 

60,685

 

 

 

59,369

 

Municipal Securities

 

 

28,268

 

 

 

27,943

 

Total

 

$

121,919

 

 

$

119,669

 

 

 

 

 

 

 

 

December 31, 2017
(in thousands)

 

Amortized
Cost

 

 

Estimated
Fair Value

 

U.S. Treasury Notes

 

$

35,971

 

 

$

35,560

 

Government-Sponsored Enterprises

 

 

64,444

 

 

 

63,556

 

Municipal Securities

 

 

40,192

 

 

 

40,134

 

Total

 

$

140,607

 

 

$

139,250

 

 

As of December 31, 2019, we had no U.S. Treasury Notes with an unrealized loss compared to seven U.S. Treasury Notes with an unrealized loss of $609,059 at December 31, 2018. At December 31, 2019, we had one Government-Sponsored Enterprises with an unrealized loss of $43,100 compared to 13 Government-Sponsored Enterprises with an unrealized loss of $1.3 million at December 31, 2018. At December 31, 2019, we had 10 Municipal Securities with an unrealized loss of $16,454 compared to 33 Municipal Securities with an unrealized loss of $437,941 at December 31, 2018. The unrealized losses on these securities are related to the changes in the interest rate environment. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Therefore, these investments are not considered other-than-temporarily impaired. We have the ability to hold these investments until market price recovery or maturity.

 

The primary purpose of the investment portfolio is to fund loan demand, manage fluctuations in deposits and liquidity, satisfy pledging requirements and generate a favorable return on investment.  In doing these things, our main objective is to adhere to sound investment practices.  To that end, all purchases and sales of investment securities are made through reputable securities dealers that have been approved by the Board of Directors. The Board of Directors of the Bank reviews the entire investment portfolio at each regular monthly meeting, including any purchases, sales, calls, and maturities during the previous month.  Furthermore, the Credit Department conducts a financial underwriting assessment of all municipal securities and their corresponding municipalities annually and management reviews the assessments.

 

LOAN PORTFOLIO COMPOSITION

 

We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic market. At December 31, 2019, outstanding loans (including deferred loan fees of $155,697) totaled $274.1 million, which equaled 72.28% of total deposits and 61.59% of total assets.

 

 22

 

 

The following table is a schedule of our loan portfolio, excluding both mortgage loans to be sold and deferred loan fees, as of December 31, 2019, compared to the prior four years.

 

   Book Value of Loans as of December 31, 
(in thousands)  2019   2018   2017   2016   2015 
Commercial  $52,848   $54,829   $51,723   $52,262   $50,938 
Commercial real estate construction   12,491    7,304    2,318    1,209    1,005 
Commercial real estate other   143,824    143,703    140,187    122,968    115,736 
Consumer real estate   59,532    63,787    70,798    77,132    69,777 
Consumer other   5,378    5,040    5,155    7,005    5,166 
Total  $274,073   $274,664   $270,181   $260,576   $242,622 

 

We had no foreign loans or loans to fund leveraged buyouts at any time during the years ended December 31, 2015 through December 31, 2019.

 

The following table presents the contractual terms to maturity for loans outstanding at December 31, 2019. Demand loans, loans having no stated schedule of repayment or stated maturity, and overdrafts are reported as due in one year or less. The table does not include an estimate of prepayments, which can significantly affect the average life of loans and may cause our actual principal experience to differ from that shown.

 

   Selected Loan Maturity as of December 31, 2019 
(in thousands)  One Year
or Less
   Over One
Year but
Less Than
5 years
   Over 5
Years
   Total 
Commercial  $31,448   $20,766   $634   $52,848 
Commercial real estate construction   6,697    5,794        12,491 
Commercial real estate other   39,974    91,656    12,194    143,824 
Consumer real estate   15,169    7,298    37,065    59,532 
Consumer other   1,938    3,368    72    5,378 
Total  $95,226   $128,882   $49,965   $274,073 
                     
Loans maturing after one year with:                    
Fixed interest rates                 $93,087 
Floating interest rates                   
Total                 $93,087 

 

IMPAIRED LOANS

 

A loan is impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement based on current information and events. All loans with a principal balance over $50,000 placed on non-accrual status are classified as impaired. However, not all impaired loans are on non-accrual status nor do they all represent a loss.

 

Impairment loss is measured by:

 

 

a.

The present value of the future cash flow discounted at the loan’s effective interest rate, or

 

b.

The fair value of the collateral if the loan is collateral dependent.

 

The following is a schedule of our impaired loans and non-accrual loans.

 

   Impaired and Non-Accrual Loans as of December 31, 
Loan   2019   2018   2017   2016   2015 
Non-accrual loans  $1,666,301   $823,534   $831,859   $1,741,621   $2,061,088 
Impaired loans  $4,776,928   $4,278,347   $3,724,262   $5,901,784   $6,542,707 

  

 23

 

 

TROUBLED DEBT RESTRUCTURINGS

 

According to GAAP, we are required to account for certain loan modifications or restructurings as a troubled debt restructuring (“TDR”), when appropriate. In general, the modification or restructuring of a debt is considered a TDR if we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise consider. Three factors must always be present: 

 

1. An existing credit must formally be renewed, extended, or modified,  

2. The borrower is experiencing financial difficulties, and  

3. We grant a concession that we would not otherwise consider.

 

The following is a schedule of our TDR’s including the number of loans represented.

 

   Troubled Debt Restructurings as of December 31, 
   2019   2018   2017   2016   2015 
Number of TDRs  3      1   2   3 
Amount of TDRs  $573,473   $   $33,300   $378,382   $458,268 

 

The Financial Accounting Standards Board Accounting (“FASB”) Standards Codification (“ASC”) 310-20-35-9 allows a loan to be removed from TDR status if the terms of the loan reflect current market rates and the loan has been performing under modified terms for an extended period of time or under certain other circumstances.

 

One TDR with a balance of $33,300 at December 31, 2017 was removed from TDR status during the year ended December 31, 2018 since, at the most recent renewal, the loan was amortized at market rate and no concessions were granted. One TDR with a balance of $345,082 at December 31, 2016 paid off during the year ended December 31, 2017. During the year ended December 31, 2016, one TDR was paid off with a balance of $72,919 at December 31, 2015. We do not know of any potential problem loans which will not meet their contractual obligations that are not otherwise discussed herein.

 

ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses represents our estimate of probable losses inherent in our loan portfolio. The adequacy of the allowance for loan losses (the “allowance”) is reviewed by the Loan Committee and by the Board of Directors on a quarterly basis. For purposes of this analysis, adequacy is defined as a level sufficient to absorb estimated losses in the loan portfolio as of the balance sheet date presented. To remain consistent with GAAP, the methodology employed for this analysis has been modified over the years to reflect the economic environment and new accounting pronouncements. The Credit Department reviews this calculation on a quarterly basis. In addition, the Company’s Risk Management Officer validates the allowance calculation on a periodic basis. The methodology is based on a reserve model that is comprised of the three components listed below:

 

 

1)

Specific reserve analysis for impaired loans based on FASB ASC 310-10-35, Receivables - Overall

 

2)

General reserve analysis applying historical loss rates based on FASB ASC 450-20, Contingencies: Loss Contingencies

 

3)

Qualitative or environmental factors.

 

Loans greater than $50,000 are reviewed for impairment on a quarterly basis if any of the following criteria are met: 

 

 

1)

The loan is on non-accrual

 

2)

The loan is a troubled debt restructuring

 

3)

The loan is over 60 days past due

 

4)

The loan is rated sub-standard, doubtful, or loss

 

5)

Excessive principal extensions are executed

 

6)

If we are provided information that indicates we will not collect all principal and interest as scheduled

 

Impairment is measured by the present value of the future cash flow discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An impaired loan may not represent an expected loss.

 

A general reserve analysis is performed on all loans, excluding impaired loans. This analysis includes a pool of loans that are reviewed for impairment but are not found to be impaired. Loans are segregated into similar risk groups and a historical loss ratio is determined for each group over a five-year period. The five-year average loss ratio by loan type is then used to calculate the estimated loss based on the current balance of each group.

 

 24

 

 

Qualitative and environmental loss factors are also applied against the portfolio, excluding impaired loans. These factors include external risk factors that we believe are representative of our overall lending environment. We believe that the following factors create a more comprehensive loss projection, which we can use to monitor the quality of the loan portfolio.

 

 

1)

Portfolio risk

 

a)

Levels and trends in delinquencies and impaired loans and changes in loan rating matrix

 

b)

Trends in volume and terms of loans

 

c)

Over-margined real estate lending risk

 

2)

National and local economic trends and conditions

 

3)

Effects of changes in risk selection and underwriting practices

  

4)

Experience, ability and depth of lending management staff

 

5)

Industry conditions

 

6)

Effects of changes in credit concentrations

 

a)

Loan concentration

 

b)

Geographic concentration

 

c)

Regulatory concentration

 

7)

Loan and credit administration risk

 

a)

Collateral documentation

 

b)

Insurance risk

 

c)

Maintenance of financial information risk

 

 

 

 

 

The sum of each component’s analysis contributes to the total “estimated loss” within our portfolio.

 

Portfolio Risk  

Portfolio risk includes the levels and trends in delinquencies, impaired loans and changes in the loan rating matrix, trends in volume and terms of loans, and overmargined real estate lending. We are satisfied with the stability of the past due and non-performing loans and believe there has been no decline in the quality of our loan portfolio due to any trend in delinquent or adversely classified loans. Sizable unsecured principal balances on a non-amortizing basis are monitored. Although the vast majority of our real estate loans are underwritten on a cash flow basis, the secondary source of repayment is typically tied to our ability to realize on the collateral. Accordingly, we closely monitor loan to value ratios. The maximum collateral advance rate is 80% on all real estate transactions, with the exception of raw land at 65% and land development at 70%.

 

Occasionally, we extend credit beyond our normal collateral advance margins in real estate lending. We refer to these loans as overmargined real estate loans. Although infrequent, the aggregate of these loans represents a notable part of our portfolio. Accordingly, these loans are monitored and the balances reported to the Board of Directors every quarter. An excessive level of this practice (as a percentage of capital) could result in additional regulatory scrutiny, competitive disadvantages and potential losses if forced to convert the collateral. The consideration of overmargined real estate loans directly relates to the capacity of the borrower to repay. We often request additional collateral to bring the loan to value ratio within the policy objectives and require a strong secondary source of repayment.

 

Although significantly under our policy threshold of 100% of capital (currently approximately $51.2 million), the number of overmargined real estate loans currently totals approximately $4.8 million or approximately 1.74% of our loan portfolio at December 31, 2019 compared to $8.6 million or approximately 3.12% of the loan portfolio at December 31, 2018.

 

A credit rating matrix is used to rate all extensions of credit and to provide a more specified picture of the risk each loan poses to the quality of the loan portfolio. There are eight possible ratings used to determine the quality of each loan based on the following characteristics: cash flow, collateral quality, guarantor strength, financial condition, management quality, operating performance, the relevancy of the financial statements, historical loan performance, debt coverage ratio, and the borrower’s leverage position. The matrix is designed to meet our standards and expectations of loan quality. One hundred percent of our loans are graded.

 

National and local economic trends and conditions   

National and local economic trends and conditions are constantly changing and both positively and negatively impact borrowers. Most macroeconomic conditions are not controllable by us and are incorporated into the qualitative risk factors. Natural and environmental disasters, including the rise of sea levels, political uncertainty, international instability, as well as problems in the traditional mortgage market are a few of the trends and conditions that are currently affecting the national and local economies. These changes have impacted borrowers’ ability, in many cases, to repay loans in a timely manner. On occasion, a loan’s primary source of repayment (i.e. personal income, cash flow, or lease income) may be eroded as a result of unemployment, lack of revenues, or the inability of a tenant to make rent payments.

 

 25

 

 

Effects of changes in risk selection and underwriting practices  

The quality of our loan portfolio is contingent upon our risk selection and underwriting practices. All new loans (except for mortgage loans in the process of being sold to investors and loans secured by properly margined negotiable securities traded on an established market or other cash collateral) with exposure over $300,000 are reviewed by the Loan Committee on a monthly basis. The Board of Directors review credits over $750,000 monthly. Annual credit analyses are conducted on credits over $500,000 upon the receipt of updated financial information. Prior to any extension of credit, every significant commercial loan goes through sound credit underwriting. Our Credit Department conducts a detailed cash flow analysis on each proposal using the most current financial information.

 

Experience, ability and depth of lending management staff   

We have over 300 combined years of lending experience among our lending staff. We are aware of the many challenges currently facing the banking industry. As other banks look to increase earnings in the short term, we will continue to emphasize the need to maintain safe and sound lending practices and core deposit growth managed with a long-term perspective.

 

Industry conditions  

There continues to be an influx of new banks and consolidation of existing banks in our geographic area, which creates pricing competition. We believe that our borrowing base is well established and therefore unsound price competition is not necessary.

 

Effects of changes in credit concentrations  

The risks associated with the effects of changes in credit concentration include loan, geographic and regulatory concentrations. As of December 31, 2019, three Standard Industrial Code groups comprised more than 2% of our total outstanding loans. The groups are activities related to real estate, offices and clinics of doctors, and offices of lawyers.

 

We are located along the coast and on an earthquake fault line, increasing the chances that a natural disaster may impact our borrowers and us. We have a Disaster Recovery Plan in place; however, the amount of time it would take for our customers to return to normal operations is unknown. Our plan is reviewed and tested annually.

 

Loan and credit administration risk 

Loan and credit administration risk includes collateral documentation, insurance risk and maintaining financial information risk.

 

The majority of our loan portfolio is collateralized with a variety of our borrowers’ assets. The execution and monitoring of the documentation to properly secure the loan is the responsibility of our lenders and loan department. We require insurance coverage naming us as the mortgagee or loss payee. Although insurance risk is also considered collateral documentation risk, the actual coverage, amounts of coverage and increased deductibles are important to management.

 

Financial Information Risk includes a function of time during which the borrower’s financial condition may change; therefore, keeping financial information up to date is important to us. Our policy requires all new loans (with a credit exposure of $10,000 or more), regardless of the customer’s history with us, to have updated financial information. In addition, we monitor appraisals closely as real estate values are appreciating.

 

Based on our analysis of the adequacy of the allowance for loan loss model, we recorded a provision for loan loss of $180,000 for the year ended December 31, 2019 compared to $325,000 for the year ended December 31, 2018. At December 31, 2019, the five-year average loss ratios were: 0.20% Commercial, 0.00% Commercial Real Estate Construction, 0.01% Commercial Real Estate Other, -0.01% Consumer Real Estate, and 0.41% Consumer Other.

 

During the year ended December 31, 2019, charge-offs of $407,027 and recoveries of $16,454 were recorded to the allowance for loan losses, resulting in an allowance for loan losses of $4.0 million or 1.46% of total loans, compared to charge-offs of $115,887 and recoveries of $129,820 resulting in an allowance for loan losses of $4.2 million or 1.53% of total loans at December 31, 2018. We believe loss exposure in the portfolio is identified, reserved against, and closely monitored to ensure that economic changes are promptly addressed in the analysis of reserve adequacy.

 

The accrual of interest is generally discontinued on loans which become 90 days past due as to principal or interest. The accrual of interest on some loans may continue even though they are 90 days past due if the loans are well secured or in the process of collection and we deem it appropriate. If non-accrual loans decrease their past due status to less than 30 days for a period of six to nine months, they are reviewed individually to determine if they should be returned to accrual status. At December 31, 2019 and 2018, there were no loans over 90 days past due still accruing interest.

 

 26

 

 

The following table represents a summary of loan loss experience for the past five years.

                     
   2019   2018   2017   2016   2015 
(in thousands)                         
Balance of the allowance of loan losses at the beginning of the period  $4,214   $3,875   $3,852   $3,418   $3,335 
                          
Charge-offs                         
Commercial   (399)   (31)       (33)   (100)
Commercial Real Estate Construction                    
Commercial Real Estate Other           (181)   (78)   (55)
Consumer Real Estate               (82)   (6)
Consumer Other   (8)   (85)   (5)   (15)   (40)
Total charge-offs   (407)   (116)   (186)   (208)   (201)
                          
Recoveries                         
Commercial   12    14    6        9 
Commercial Real Estate Construction                    
Commercial Real Estate Other       57    87    65    54 
Consumer Real Estate       45    60        6 
Consumer Other   5    14    1    7    22 
Total recoveries   17    130    154    72    91 
Net (charge-offs) recoveries   (390)   14    (32)   (136)   (110)
                          
Provision charged to operations   180    325    55    570    193 
                          
Balance of the allowance for loan losses at the end of the period  $4,004   $4,214   $3,875   $3,852   $3,418 

 

We believe the allowance for loan losses at December 31, 2019, is adequate to cover estimated losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment. Our judgments are based on numerous assumptions about current events that we believe to be reasonable, but may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that our ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting our operating results.

 

The following table presents a breakdown of the allowance for loan losses for the past five years. 

 

   December 31, 
   2019   2018   2017   2016   2015 
   $   %(1)   $   %(1)   $   %(1)   $   %(1)   $   %(1) 
(in thousands)                                                  
Commercial  $1,430    19%  $1,665    20%  $1,404    20%  $1,545    20%  $897    21%
Commercial Real Estate Construction   109    5%   64    3%   23    3%   52    1%   60    1%
Commercial Real Estate Other   1,271    52%   1,292    52%   1,550    52%   1,375    47%   1,345    47%
Consumer Real Estate   496    22%   387    23%   797    23%   726    29%   941    29%
Consumer Other   698    2%   806    2%   101    2%   154    3%   175    2%
Total  $4,004    100%  $4,214    100%  $3,875    100%  $3,852    100%  $3,418    100%

 

(1)

Loan category as a percentage of total loans.

 

The allowance is also subject to examination testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require us to adjust our allowance based on information available to them at the time of their examination.

 

 27

 

 

The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to the methodology used to determine the allowance for loan losses described above, adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio. During the year ended December 31, 2019, a provision of $3,701 was recorded compared to a provision of $4,482 during the year ended December 31, 2018. The balance for the reserve for unfunded lending commitments was $33,018 and $29,308 as of December 31, 2019 and 2018, respectively.   

 

OTHER REAL ESTATE OWNED

 

Real estate acquired because of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned (“OREO”) until it is sold. When the property is acquired, it is recorded at the lesser of the fair value of the property less estimated selling costs or the total loan balance. It is in our best interest to determine the fair market value by engaging an independent appraisal within 30 days of property being acquired into OREO. We cannot hold the property for a period of more than five years unless we have prior approval from the Commissioner of Banking of the State Board of Financial Institutions. The Bank will pay property taxes along with insurance and various other expenses until the property is sold. There were no properties classified as OREO during the year or at year ended December 31, 2019. During the year ended December 31, 2018, one property in the amount of $411,842 was sold at a loss of $33,476. There were no properties classified as OREO as of December 31, 2018. OREO as of December 31, 2017 consisted of one property in the amount of $435,479 compared to one property in the amount of $521,943 at December 31, 2016. One loan receivable valued at $98,832 transferred to OREO and subsequently sold during the year ended December 31, 2017 for a loss of $1,477. One property sold during the year ended December 31, 2016 for a loss of $13,450.

 

NONPERFORMING ASSETS

 

Nonperforming assets include OREO, nonaccrual loans and loans past due 90 days or more and still accruing interest. The following table summarizes nonperforming assets for the five years ended December 31:

 

 Nonperforming Assets
(in thousands)
  2019    2018    2017    2016    2015  
Nonaccrual loans  $1,666   $824   $832   $1,742   $2,061 
Loans past due 90 days or more and still accruing interest           33    123    2 
Total nonperforming loans   1,666    824    865    1,865    2,063 
Other real estate owned           435    522    620 
Total nonperforming assets  $1,666   $824   $1,300   $2,387   $2,683 
                          
Nonperforming loans to total loans   0.61%   0.30%   0.29%   0.72%   0.85%
Nonperforming assets to total assets   0.37%   0.19%   0.32%   0.58%   0.67%

  

 28

 

DEPOSITS

 

The following table shows the contractual maturities of time deposits in denominations of $100,000 or more at December 31, 2019.

 

   One Day    Less than
three months
   Three
months
to less than
six months
   Six months
to less than
one year
   One year
to less than
five years
   Five years or
more
   Total  
(in thousands)                                   
CD’s and other time deposits less than $100,000  $   $3,108   $1,707   $2,158   $1,041   $   $8,014 
CD’s and other time deposits $100,000 and over       4,684    3,816    4,655    1,014        14,169 
Total  $   $7,792   $5,523   $6,813   $2,055   $   $22,183 

 

Certificates of Deposit $100,000 and over decreased $10.8 million or 43.31% to $14.2 million as of December 31, 2019 from $25.0 million as of December 31, 2018. This decrease was primarily due to the maturity of Public Funds used for construction projects.

 

The following table presents average deposits by category.

 

   2019   2018   2017 
(in thousands)   Average
Balance
  Average
Rate Paid
   Average
Balance
   Average
Rate Paid
   Average
Balance
   Average
Rate Paid
 
Non-interest-bearing demand  $133,182    N/A   $133,045    N/A   $128,586    N/A 
Interest-bearing transaction accounts   189,115    0.29%   176,797    0.22%   178,146    0.10%
Savings   32,935    0.30%   34,857    0.24%   33,694    0.12%
Time deposits   26,456    0.62%   41,326    0.54%   44,098    0.48%
   $381,688        $386,025        $384,524      

 

Deposits decreased $3.2 million or 0.83% to $379.2 million as of December 31, 2019, from $382.4 million as of December 31, 2018. Non-interest bearing deposits decreased $5.3 million to $125.6 million as of December 31, 2019, primarily due to settlements of municipal accounts to fund projects.

 

We fund growth through core deposits. We do not have, nor do we rely on, Brokered Deposits or Internet Deposits.

 

SHORT-TERM BORROWINGS

 

At December 31, 2019 and 2018, we had no outstanding federal funds purchased. We have a Borrower-In-Custody arrangement with the Federal Reserve. This arrangement permits the Company to retain possession of loans pledged as collateral to secure advances from the Federal Reserve Discount Window. Under this agreement, we may borrow up to $56.8 million. We established this arrangement as an additional source of liquidity. There have been no borrowings under this arrangement.

 

At December 31, 2019 and 2018, the Bank had unused short-term lines of credit totaling approximately $23.0 million (which are withdrawable at the lender’s option).

 

 29

 

OFF-BALANCE SHEET ARRANGEMENTS

 

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with GAAP, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. We use such transactions for general corporate purposes or customer needs. General corporate purpose transactions are used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customer requests for funding.

 

Our off-balance sheet arrangements consist principally of commitments to extend credit described below. We estimate probable losses related to binding unfunded lending commitments and record a reserve for unfunded lending commitments in other liabilities on the consolidated balance sheet. At December 31, 2019 and 2018, the balance of this reserve was $33,018 and $29,308, respectively. At December 31, 2019 and 2018, we had no interests in non-consolidated special purpose entities.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on our credit evaluation of the borrower. Collateral held varies but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate. Commitments to extend credit, including unused lines of credit, amounted to $105.5 million and $96.1  million as of December 31, 2019 and 2018, respectively.

 

Standby letters of credit represent our obligation to a third party contingent upon the failure of our customer to perform under the terms of an underlying contract with the third party or obligates us to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation. Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended. We can seek recovery of the amounts paid from the borrower. Commitments under standby letters of credit are usually for one year or less. The maximum potential amount of undiscounted future payments related to standby letters of credit at December 31, 2019 and 2018 was $1.1 million and $1.2 million, respectively.

 

We originate certain fixed rate residential loans and commit these loans for sale. The commitments to originate fixed rate residential loans and the sales commitments are freestanding derivative instruments. We had forward sales commitments, totaling $5.1 million at December 31, 2019, to sell loans held for sale of $5.1 million, compared to forward sales commitments of $1.2 million at December 31, 2018, to sell loans held for sale of $1.2 million. The fair value of these commitments was not significant at December 31, 2019 or 2018. We had no embedded derivative instruments requiring separate accounting treatment.

 

Once we sell certain fixed rate residential loans, the loans are no longer reportable on our balance sheet. With most of these sales, we have an obligation to repurchase the loan in the event of a default of principal or interest on the loan. This recourse period ranges from three to nine months. Misrepresentation or fraud carries unlimited time for recourse. The unpaid principal balance of loans sold with recourse was $19.1 million at December 31, 2019 and $14.9  million at December 31, 2018. For the twelve months ended December 31, 2019 and December 31, 2018, there were no loans repurchased.

 

EFFECT OF INFLATION AND CHANGING PRICES

 

The consolidated financial statements have been prepared in accordance with GAAP, which require the measurement of financial position and results of operations in terms of historical dollars without consideration of changes in the relative purchasing power over time due to inflation.

 

Unlike most other industries, the assets and liabilities of financial institutions like the Company are primarily monetary in nature. As a result, interest rates generally have a more significant impact on our performance than the effects of general levels of inflation and changes in prices. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. We strive to manage the relationship between interest rate sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.

 

CAPITAL RESOURCES

 

Our capital needs have been met to date through the $10.6 million in capital raised in our initial offering, the retention of earnings less dividends paid and the exercise of options to purchase stock. Total shareholders’ equity at December 31, 2019 was $51.2 million. The rate of asset growth since our inception has not negatively impacted our capital base.

 

 30

 

On July 2, 2013, the Federal Reserve Board approved the final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks (“Basel III”). Following the actions by the Federal Reserve, the FDIC also approved regulatory capital requirements on July 9, 2013. The FDIC’s rule is identical in substance to the final rules issued by the Federal Reserve Bank.

 

Basel III became effective on January 1, 2015. The purpose is to improve the quality and increase the quantity of capital for all banking organizations. The minimum requirements for the quantity and quality of capital were increased. The rule includes a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and requires a minimum leverage ratio of 4%. In addition, the rule also implements strict eligibility criteria for regulatory capital instruments and improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. Full compliance with all of the final rule requirements will be phased in over a multi-year schedule.

 

At December 31, 2019, the Bank was categorized as “well capitalized”. To be categorized as “well capitalized” the Bank must maintain minimum total risk based, Tier 1 risk based, common equity Tier 1 risk based capital and Tier 1 leverage ratios of 10.00%, 8.00%, 6.50% and 5.00%, respectively, and to be categorized as “adequately capitalized,” the Bank must maintain minimum total risk based, Tier 1 risk based, common equity Tier 1 risk based capital, and Tier 1 leverage ratios of 8.00%, 6.00%, 4.50%, and 4.00%, respectively.

 

We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a material effect on the financial statements. We must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Current and previous quantitative measures established by regulation to ensure capital adequacy require that we maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and to average assets. We believe, as of December 31, 2019, that the Company and the Bank meet all capital adequacy requirements to which we are subject.

 

There are no current conditions or events that we are aware of that would change the Company’s or the Bank’s category.

 

Please see “Notes to Consolidated Financial Statements” for the Company’s and the Bank’s various capital ratios at December 31, 2019.

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

See the Market Risk section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of this report.

 

 31

 

Item 8.

Financial Statements and Supplementary Data

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and the Board of Directors of Bank of South Carolina Corporation

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Bank of South Carolina Corporation and its subsidiary (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes to the consolidated financial statements and schedules (collectively, the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Elliott Davis, LLC

 

We have served as the Company's auditor since 2006.

 

Columbia, South Carolina

March 6, 2020

 

 32

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED BALANCE SHEETS

 

   DECEMBER 31,   DECEMBER 31, 
   2019   2018 
ASSETS          
Cash and due from banks  $9,773,893   $6,325,457 
Interest-bearing deposits at the Federal Reserve   39,320,526    25,506,784 
Investment securities available for sale (amortized cost of $99,838,799 and $121,918,501 in 2019
     and 2018, respectively)
   100,449,956    119,668,874 
Mortgage loans to be sold   5,062,398    1,199,438 
Loans   274,072,560    274,664,267 
  Less: Allowance for loan losses   (4,003,758)   (4,214,331)
Net loans   270,068,802    270,449,936 
Premises, equipment and leasehold improvements, net   4,290,435    2,335,207 
Right of use asset   13,209,217     
Other real estate owned        
Accrued interest receivable   1,309,772    1,561,915 
Other assets   1,527,521    2,087,587 
           
Total assets  $445,012,520   $429,135,198 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Liabilities          
  Deposits:          
     Non-interest bearing demand  $125,621,031   $130,940,138 
     Interest bearing demand   125,175,935    94,207,731 
     Money market accounts   68,964,879    87,300,433 
     Time deposits over $250,000   5,967,559    15,909,991 
     Other time deposits   16,215,228    18,558,734 
     Other savings deposits   37,247,023    35,461,361 
Total deposits   379,191,655    382,378,388 
           
Accrued interest payable and other liabilities   1,443,616    1,294,249 
Lease liability   13,209,217     
Total liabilities   393,844,488    383,672,637 
Commitments and contingencies in Notes 7 and 12          
Shareholders’ equity          
Common stock - no par 12,000,000 shares authorized; Issued 5,799,637 shares at
    December 31, 2019 and 5,777,474 shares at December 31, 2018. Shares outstanding
    5,530,001 and 5,510,917 at December 31, 2019 and December 31, 2018, respectively.
          
Additional paid in capital   47,131,034    46,857,734 
Retained earnings   5,879,409    2,650,296 
Treasury stock: 269,636 shares as of December 31, 2019 and 266,557 shares as of
      December 31, 2018
   (2,325,225)   (2,268,264)
Accumulated other comprehensive income (loss), net of income taxes   482,814    (1,777,205)
Total shareholders’ equity   51,168,032    45,462,561 
           
Total liabilities and shareholders’ equity  $445,012,520   $429,135,198 

 

See accompanying notes to consolidated financial statements.

 

 33

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF INCOME

 

   Years Ended December 31, 
   2019   2018    2017 
Interest and fee income               
Loans, including fees  $15,994,290   $15,126,316   $13,287,318 
Taxable securities   1,617,471    1,872,285    1,585,505 
Tax-exempt securities   570,623    744,713    1,026,513 
Other   729,868    393,597    269,811 
Total interest and fee income   18,912,252    18,136,911    16,169,147 
                
Interest expense               
Deposits   815,171    694,386    423,863 
Total interest expense   815,171    694,386    423,863 
                
Net interest income   18,097,081    17,442,525    15,745,284 
Provision for loan losses   180,000    325,000    55,000 
Net interest income after provision for loan losses   17,917,081    17,117,525    15,690,284 
                
Other income               
Service charges and fees   1,175,657    1,168,808    1,135,037 
Mortgage banking income   940,671    786,893    1,057,457 
Gain on sales of securities, net   50,707    4,735    45,820 
Other non-interest income   31,574    34,189    30,157 
Total other income   2,198,609    1,994,625    2,268,471 
                
Other expense               
Salaries and employee benefits   6,809,258    6,488,229    6,060,831 
Net occupancy expense   1,623,590    1,580,929    1,571,076 
Other operating expenses   2,189,135    2,953,463    2,517,737 
Net other real estate owned expenses       57,613    92,652 
Total other expense   10,621,983    11,080,234    10,242,296 
                
Income before income tax expense   9,493,707    8,031,916    7,716,459 
Income tax expense   2,175,274    1,108,982    2,814,634 
                
Net income  $7,318,433   $6,922,934   $4,901,825 
                
Weighted average shares outstanding               
Basic   5,522,025    5,500,027    5,471,001 
Diluted   5,588,090    5,589,012    5,568,493 
                
Basic income per common share  $1.33   $1.26   $0.90 
Diluted income per common share  $1.31   $1.24   $0.88 

 

See accompanying notes to consolidated financial statements.

 

 34

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

   Years Ended December 31, 
   2019   2018   2017 
Net income  $7,318,433   $6,922,934   $4,901,825 
Other comprehensive income               
Unrealized gain (loss) on securities arising during the period   2,911,491    (893,070)   (347,066)
Reclassification adjustment for securities gains realized in net income   (50,707)   (4,735)   (45,820)
Other comprehensive income (loss) before tax   2,860,784    (897,805)   (392,886)
Income tax effect related to items of other comprehensive income before tax   (600,765)    192,280    116,007 
Other comprehensive income (loss) after tax   2,260,019    (705,525)   (276,879)
Total comprehensive income  $9,578,452   $6,217,409   $4,624,946 

 

See accompanying notes to consolidated financial statements.

 

 35

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY  

YEARS ENDED DECEMBER 31, 2019, 2018, 2017

 

   Shares
Outstanding
   Additional
Paid in
Capital
   Retained
Earnings
   Treasury
Stock
   Accumulated
Other
Comprehensive
Income (Loss)
   Total 
December 31, 2016   4,956,139   $36,824,022   $6,643,476   $(2,247,415)  $(607,109)  $40,612,974 
Net income           4,901,825            4,901,825 
Other comprehensive loss                   (276,879)   (276,879)
Stock option exercises, net of surrenders   33,140    340,843                340,843 
Stock-based compensation expense       71,701                71,701 
Reclassification of tax effects stranded in accumulated other comprehensive income by tax reform           187,692        (187,692)    
Cash dividends ($0.58 per common share)           (2,885,829)           (2,885,829)
December 31, 2017   4,989,279   $37,236,566   $8,847,164   $(2,247,415)  $(1,071,680)  $42,764,635 
                               
Net income           6,922,934            6,922,934 
Other comprehensive loss                   (705,525)   (705,525)
Stock option exercises, net of surrenders   22,550    214,418        (20,849)       193,569 
Stock-based compensation expense       72,408                72,408 
Cash dividends ($0.70 per common share)           (3,785,460)           (3,785,460)
Common stock dividend, 10%   499,088    9,334,342    (9,334,342)            
December 31, 2018   5,510,917   $46,857,734   $2,650,296   $(2,268,264)  $(1,777,205)  $45,462,561 
                               
Net income            7,318,433            7,318,433 
Other comprehensive gain                   2,260,019    2,260,019 
Stock option exercises, net of surrenders   19,084    195,247        (56,961)       138,286 
Stock-based compensation expense       78,053                78,053 
Cash dividends ($0.74 per common share)           (4,089,320)           (4,089,320)
December 31, 2019   5,530,001   $47,131,034   $5,879,409   $(2,325,225)  $482,814   $51,168,032 

  

See accompanying notes to consolidated financial statements.

 

 36

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   Years Ended December 31, 
   2019   2018   2017 
Cash flows from operating activities:               
Net income  $7,318,433   $6,922,934   $4,901,825 
Adjustments to reconcile net income net cash provided by operating activities:               
Depreciation   230,377    195,921    193,298 
Gain on sale of investment securities   (50,707)   (4,735)   (45,820)
Loss on sale of other real estate owned       33,476    1,477 
Loss on disposal of premises, equipment, and leasehold improvements, net       428     
Valuation and other adjustments to other real estate owned       23,637    86,464 
Provision for loan losses   180,000    325,000    55,000 
Stock-based compensation expense   78,053    72,408    71,701 
Deferred income taxes   432,844   (217,637)   276,362 
Net amortization of unearned discounts on investment securities available for sale   247,624    303,530    381,079 
Origination of mortgage loans held for sale   (67,783,219)   (55,504,124)   (55,791,625)
Proceeds from sale of mortgage loans held for sale   63,920,259    56,398,409    58,084,112 
Decrease (increase) in accrued interest receivable and other assets   (221,400   472,740    (78,328)
Increase in accrued interest payable and other liabilities   91,204    295,071    46,412 
Net cash provided by operating activities   4,443,468    9,317,058    8,181,957 
                
Cash flows from investing activities:               
Proceeds from calls and maturities of investment securities available for sale   9,356,835    6,932,927    4,713,870 
Proceeds from sale of investment securities available for sale   30,412,250    21,434,634    20,231,265 
Purchase of investment securities available for sale   (17,886,300)   (9,978,050)   (44,944,586)
Proceeds from sale of other real estate owned       378,366    89,355 
Net decrease (increase) in loans   201,134    (4,469,694)   (9,726,576)
Purchase of premises, equipment, and leasehold improvements, net   (2,185,605)   (287,031)   (141,199)
Net cash provided by (used in) investing activities   19,898,314    14,011,152    (29,777,871)
                
Cash flows from financing activities:               
Net (decrease) increase in deposit accounts   (3,186,733)   (20,509,912)   30,365,449 
Dividends paid   (4,031,157)   (3,699,845)   (2,832,489)
Stock options exercised, net of surrenders   138,286    193,569    340,843 
Net cash (used in) provided by financing activities   (7,079,604)   (24,016,188)   27,873,803 
Net increase (decrease) in cash and cash equivalents   17,262,178    (687,978)   6,277,889 
Cash and cash equivalents at the beginning of the period   31,832,241    32,520,219    26,242,330 
Cash and cash equivalents at the end of the period  $49,094,419   $31,832,241   $32,520,219 
                
Cash paid during the period for:               
Interest  $940,299   $626,700   $379,302 
Income taxes  $1,761,574   $1,169,085   $2,496,047 
                
Supplemental disclosures for non-cash investing and financing activity:               
Change in unrealized gain on securities available for sale, net of income taxes  $2,260,019   $(705,525)  $(276,879)
Change in dividends payable  $58,163   $85,615   $53,340 
Transfer of loans to other real estate owned  $   $   $90,832 

Right of use assets obtained in exchange for lease obligation

  $13,519,027   $   $ 

Change in right of use assets and lease liabilities

  $309,810   $   $ 

 

See accompanying notes to consolidated financial statements.

 

 37

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.

ORGANIZATION

 

The Bank of South Carolina (the “Bank”) was organized on October 22, 1986 and opened for business as a state-chartered financial institution on February 26, 1987, in Charleston, South Carolina. The Bank was reorganized into a wholly-owned subsidiary of Bank of South Carolina Corporation (the “Company”), effective April 17, 1995. At the time of the reorganization, each outstanding share of the Bank was exchanged for two shares of Bank of South Carolina Corporation Stock.

 

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Our accounting and reporting policies conform, in all material respects, to U.S. generally accepted accounting principles (“GAAP”), and to general practices within the banking industry. The following summarizes the more significant of these policies and practices.

 

Principles of Consolidation:  

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. In consolidation, all significant intercompany balances and transactions have been eliminated.

 

References to “we,” “us,” “our,” “the Bank,” or “the Company” refer to the parent and its subsidiary that are consolidated for financial purposes.

 

Accounting Estimates and Assumptions:  

The financial statements are prepared in conformity with GAAP, which require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ significantly from these estimates and assumptions. Material estimates generally susceptible to significant change are related to the determination of the allowance for loan losses, impaired loans, other real estate owned, deferred tax assets, the fair value of financial instruments and other-than-temporary impairment of investment securities.

 

Reclassification:  

Certain amounts in the prior years’ financial statements have been reclassified to conform to the current year’s presentation. Such reclassifications have no effect on shareholders’ equity or the net income as previously reported.

 

Subsequent Events:  

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed as of the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist as of the date of the balance sheet but arose after that date. We have reviewed events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

 

Cash and Cash Equivalents:  

Cash and cash equivalents include working cash funds, due from banks, interest-bearing deposits at the Federal Reserve, items in process of collection and federal funds sold. All cash equivalents are readily convertible to cash and have maturities of less than 90 days.

 

Depository institutions are required to maintain reserve and clearing balances at the Federal Reserve Bank. Vault cash satisfied our daily reserve requirement for the years ended December 31, 2019 and 2018, respectively.  

 

Interest-bearing Deposits at the Federal Reserve:  

Interest-bearing deposits at the Federal Reserve mature daily and are carried at cost.

 

Investment Securities:  

We classify investments into three categories: (1) Held to Maturity - debt securities that we have the positive intent and ability to hold to maturity, which are reported at amortized cost, adjusted for the amortization of any related premiums or the accretion of any related discounts into interest income using a methodology which approximates a level yield of interest over the estimated remaining period until maturity; (2) Trading - debt and equity securities that are bought and held principally for the purpose of selling them in the near term, which are reported at fair value, with unrealized gains and losses included in earnings; and (3) Available for Sale - debt and equity securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of income taxes. Unrealized losses on securities due to fluctuations in fair value are recognized when it is determined that an other than temporary decline in value has occurred.

 

 38

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Realized gains or losses on the sale of investments are recognized on a specific identification, trade date basis. All securities were classified as available for sale for 2019 and 2018.

 

Mortgage Loans to be Sold:  

We originate fixed and variable rate residential mortgage loans on a service release basis in the secondary market. Loans closed but not yet settled with an investor are carried in our loans held for sale portfolio.   Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with our customers.  Therefore, these loans present very little market risk.  We usually deliver to, and receive funding from, the investor within 30 to 60 days.  Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts” basis. We are not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. Because of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is materially the same as the value of the loan amount at its origination.

 

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations as a component of mortgage banking income. Gains or losses on sales of loans are recognized when control over these assets are surrendered and are included in mortgage banking income in the consolidated statements of income.

 

Loans and Allowance for Loan Losses:   

Loans are carried at principal amounts outstanding. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the weighted average life of the loan as an adjustment to yield. Interest income on all loans is recorded on an accrual basis. The accrual of interest and the amortization of net loan fees are generally discontinued on loans that 1) are maintained on a cash basis because of deterioration in the financial condition of the borrower; 2) the payment of full principal is not expected; or 3) the principal or interest has been in default for a period of 90 days or more. We define past due loans based on contractual payment and maturity dates.

 

The accrual of interest is generally discontinued on loans that become 90 days past due as to principal or interest. The accrual of interest on some loans may continue even though they are 90 days past due if the loans are well secured or in the process of collection and management deems it appropriate. If non-accrual loans decrease their past due status to less than 30 days for a period of six to nine months, they are reviewed individually by management to determine if they should be returned to accrual status.

 

When the ultimate collectability of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest income and then to principal.  

 

We account for impaired loans by requiring that all loans (greater than $50,000) where it is estimated that we will be unable to collect all amounts due according to the terms of the loan agreement be recorded at the loan’s fair value. Fair value may be determined based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral less cost to sell, if the loan is collateral dependent.

 

Additional accounting guidance allows us to use existing methods for recognizing interest income on an impaired loan. The guidance also requires additional disclosures about how we estimate interest income related to our impaired loans.

 

A loan is also considered impaired if its terms are modified in a troubled debt restructuring (“TDR”). For this type of impaired loan, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting, provided they are performing in accordance with their restructured terms.

 

 39

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The allowance for loan losses (the “allowance”) is our estimate of credit losses inherent in the loan portfolio. The allowance is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when we believe the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance is evaluated on a regular basis and is based upon our periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

We believe that the allowance is adequate to absorb inherent losses in the loan portfolio; however, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant circumstances, will not require significant future additions to the allowance, thus adversely affecting our operating results.

 

The allowance is also subject to examination by regulatory agencies, which may consider factors such as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions and other adequacy tests. In addition, such regulatory agencies could require us to adjust our allowance based on information available at the time of the examination.

 

The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to the methodology used to determine the allowance adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.

 

Concentration of Credit Risk:  

Our primary market consists of the counties of Berkeley, Charleston and Dorchester, South Carolina. As of December 31, 2019, the majority of the total loan portfolio, as well as a substantial portion of the commercial and real estate loan portfolios, were to borrowers within this region. No other areas of significant concentration of credit risk have been identified.

 

Premises, Equipment and Leasehold Improvements and Depreciation:  

Land is carried at cost. Buildings and equipment are stated at cost less accumulated depreciation. Depreciation is recorded using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes over the estimated useful lives of the assets ranging from 40 years for buildings and 3 to 15 years for equipment. Leasehold improvements are amortized over the shorter of the asset’s useful life or the remaining lease term, including renewal periods when reasonably assured. The cost of maintenance and repairs is charged to operating expense as incurred.

 

Leases:

In accordance with ASU 2016-02, the Company determines if a contractual arrangement is a lease at inception. Operating leases are included in the operating right of use ("ROU") assets and current operating lease liabilities on the Company's Consolidated Balance Sheet. ROU assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make lease payments arising from the lease. Currently, the Company does not have any finance leases.

 

Beginning January 1, 2019, operating lease ROU assets and lease liabilities are recognized at the commencement of the lease based on the present value of lease payments over the lease term. The lease payments included in the present value are fixed payments and index-based variable lease payments. The Company estimates the incremental borrowing rate, based on information available at the commencement of the lease, as most of the Company's leases do not include an implicit rate.

 

Income Taxes:  

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Net deferred tax assets are included in other assets in the consolidated balance sheet.

 

Accounting standards require the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. These standards also prescribe a recognition threshold and measurement of a tax position taken or expected to be taken in an enterprise’s tax return. We believe that we had no uncertain tax positions for the years ended December 31, 2019 and 2018.

 

 40

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Stock-Based Compensation:  

Compensation cost is recognized for stock options issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Compensation cost is recognized over the required expected term, generally defined as the average vesting period (7.5 years).

 

Income Per Common Share 

Basic income per share is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted-average number of common shares and potential common shares outstanding. Potential common shares consist of dilutive stock options determined using the treasury stock method and the average market price of common stock. Earnings per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

 

Segment Information:  

The Company operates and manages itself within one retail banking segment and therefore has not provided segment disclosures.

 

Interest Rate Lock Commitments and Forward Sale Contracts:  

Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free-standing derivatives. The fair value of the interest rate lock is recorded at the time the commitment to fund the mortgage loan is executed and is adjusted for the expected exercise of the commitments before the loan is funded. In order to hedge the change in interest rates resulting from commitments to fund the loans, we enter into forward commitments for the future delivery of mortgage loans when the interest rate is locked. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. Changes in the fair values of these derivatives are included in income when they occur. As a result of the short-term nature of mortgage loans held for sale (derivative contract), our derivative instruments were considered to be immaterial as of December 31, 2019 and 2018.

 

We had no embedded derivative instruments requiring hedge accounting treatment at December 31, 2019. We do not currently engage in hedging activities.

 

Recent Accounting Pronouncements:  

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

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which revises certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842 – Leases. This update clarifies how to apply certain aspects of the new leases standard. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which gives entities another option for transition and to provide lessors with a practical expedient. In December 2018, the FASB issued ASU 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors, providing narrow-scope improvements for lessors, that provides relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components. The amendments became effective for January 1, 2019. A modified retrospective transition approach was required, applying the new standard to all leases existing at the date of initial application. The Bank has chosen to use the effective date, January 1, 2019, as its date of initial application; therefore, the financial information was not provided for dates or periods prior to January 1, 2019. The Bank considered all relevant contractual provisions, including renewal and termination options, and determined the remaining lease terms of each respective lease. The Bank considered past practices, market area, and contract terms of all leases and assumed all renewal options would be exercised. To determine the incremental borrowing rate, the Bank used the rate of interest it would pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The Bank does not have any finance leases or material subleases or leasing arrangements in which it is the lessor of the property or equipment. The adoption of this standard did not materially affect the change in the Bank’s recognition of lease expense in future periods, but added the ROU asset and corresponding lease liability on the Company’s Consolidated Balance Sheet.

 

 In June 2016, the FASB issued ASU 2016-13, Financial instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to change the accounting for credit losses and modify the impairment model for certain debt securities. In May 2019, the FASB issued guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. In October 2019, the FASB voted to extend the implementation date for smaller reporting companies, non-SEC public companies, and private companies. The amendment will be effective for the Company for periods beginning after December 15, 2022. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows. It will be influenced by the quality, composition, and characteristics of our loan and investment portfolios, as well as the expected economic conditions and forecasts at the time of enactment and future reporting periods.

 

 41

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization of Purchased Callable Debt Securities, which shortens the amortization period for the premium to the earliest call date. The amendment became effective for the Company on January 1, 2019 and did not have a material effect on the financial statements. 

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The amendments remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2018, the FASB issued ASU 2018-15, Intangibles and Goodwill and Other-Internal Use Software (Subtopic 350-40):Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract),which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes, which expands the list of U.S. benchmark interest rates permitted in the application of hedge accounting. The amendments became effective for the Company on January 1, 2019 and did not have a material effect on its financial statements.

 

In October 2018, the FASB issued ASU 2018-07, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, determining whether a decision-making fee is a variable interest. The amendments require organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company will apply a full retrospective approach in which financial statements for each individual prior period presented and the opening balances of the earliest period presented are adjusted to reflect the period-specific effects of applying the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2019, the FASB issued guidance that clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement of financial instruments. The amendments related to credit losses will be effective for the Company for the reporting period beginning after December 15, 2019. The amendments related to hedging became effective January 1, 2019. The amendments related to recognition and measurement of financial instruments will be effective for the Company for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

 

In July 2019, the FASB updated various Topics of the ASC to align the guidance in various SEC sections of the Codification with the requirements of certain SEC final rules. The amendments were effective upon issuance and did not have a material effect on the financial statements.

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which provides guidance to simply accounting for income taxes by removing specific technical exceptions that can produce information investors do not understand. The amendments improve and simplify the application of GAAP for other areas of Topic 740 by clarifying and amending the existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on the financial statements.

 

 42

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

3.

INVESTMENT SECURITIES AVAILABLE FOR SALE

 

The amortized cost and fair value of investment securities available for sale are summarized as follows.

 

   December 31, 2019 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
U.S. Treasury Notes  $23,080,465   $99,735   $   $23,180,200 
Government-Sponsored Enterprises   50,139,959    401,336    (43,100)   50,498,195 
Municipal Securities   26,618,375    169,640    (16,454)   26,771,561 
                     
Total  $99,838,799   $670,711   $(59,554)  $100,449,956 

 

   December 31, 2018 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
                 
U.S. Treasury Notes  $32,965,693   $   $(609,059)  $32,356,634 
Government-Sponsored Enterprises   60,684,878        (1,315,598)   59,369,280 
Municipal Securities   28,267,930    112,971    (437,941)   27,942,960 
                     
Total  $121,918,501   $112,971   $(2,362,598)  $119,668,874 

 

The amortized cost and estimated fair value of investment securities available for sale at December 31, 2019 and 2018, by contractual maturity are in the following table.

 

   December 31, 2019   December 31, 2018 
   Amortized
Cost
   Estimated
Fair Value
   Amortized
Cost
   Estimated
Fair Value
 
                     
Due in one year or less  $9,185,615   $9,191,226   $4,246,325   $4,249,570 
Due in one year to five years   77,261,123    77,815,119    99,753,174    97,915,185 
Due in five years to ten years   13,392,061    13,443,611    17,504,456    17,128,425 
Due in ten years and over           414,546    375,694 
                     
Total  $99,838,799   $100,449,956   $121,918,501   $119,668,874 

 

Securities pledged to secure deposits at December 31, 2019 and 2018, had a carrying amount of $37,648,687 and $41,547,205, respectively.

 

The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2019 and 2018. We believe that all unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

 

 43

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   December 31, 2019 
   Less Than 12 Months   12 Months or Longer   Total 
   #   Fair Value   Gross
Unrealized
Loss
   #   Fair Value   Gross
Unrealized
Loss
   #   Fair Value   Gross
Unrealized
Loss
 
U.S. Treasury Notes      $   $       $   $       $   $ 
Government-Sponsored Enterprises   1    5,039,550    (43,100)               1    5,039,550    (43,100)
Municipal Securities   9    3,199,517    (13,335)   1    330,880    (3,119)   10    3,530,397    (16,454)
                                              
Total   10   $8,239,067   $(56,435)   1   $330,880   $(3,119)   11   $8,569,947   $(59,554)

 

   December 31, 2018 
   Less Than 12 Months   12 Months or Longer   Total 
   #   Fair Value   Gross
Unrealized
Loss
   #   Fair Value   Gross
Unrealized
Loss
   #   Fair Value   Gross
Unrealized
Loss
 
U.S. Treasury Notes      $   $    7   $32,356,634   $(609,059)   7   $32,356,634   $(609,059)
Government-Sponsored Enterprises   2    9,967,000    (14,302)   11    49,402,280    (1,301,296)   13    59,369,280    (1,315,598)
Municipal Securities   2    1,362,286    (7,547)   31    11,840,912    (430,394)   33    13,203,198    (437,941)
                                              
Total   4   $11,329,286   $(21,849)   49   $93,599,826   $(2,340,749)   53   $104,929,112   $(2,362,598)

 

The table below shows the proceeds received from sales of securities available for sale and gross realized gains and losses.

 

   For the Year Ended December 31, 
   2019   2018   2017 
Gross proceeds  $30,412,250   $21,434,634   $20,231,265 
Gross realized gains   114,888    104,634    154,692 
Gross realized losses   (64,181)   (99,899)   (108,872)

 

The tax provision related to these gains was $10,648 and $994 for the year ended December 31, 2019 and 2018, respectively.

 

4.

LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Major classifications of loans (net of deferred loan fees of $155,697 at December 31, 2019, and $156,309  at December 31, 2018) are shown in the table below. 

 

   December 31,
2019
   December 31,
2018
 
Commercial  $52,848,455   $54,829,078 
Commercial real estate:          
Construction   12,491,078    7,304,300 
Other   143,821,990    143,703,401 
Consumer:          
Real estate   59,533,045    63,787,411 
Other   5,377,992    5,040,077 
 Total loans   274,072,560    274,664,267 
Allowance for loan losses   (4,003,758)   (4,214,331)
Loans, net  $270,068,802   $270,449,936 

 

 44

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

We had $85.2 million and $101.9  million of loans pledged as collateral to secure funding with the Federal Reserve Bank (“FRB”) Discount Window at December 31, 2019 and 2018, respectively.

 

Our portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Our internal credit risk grading system is based on experience with similarly graded loans, industry best practices, and regulatory guidance. Our portfolio is graded in its entirety.

 

Our internally assigned grades pursuant to the Board-approved lending policy are as follows:

 

 

Excellent (1) The borrowing entity has more than adequate cash flow, unquestionable strength, strong earnings and capital, and where applicable, no overdrafts.

 

 

Good (2) The borrowing entity has dependable cash flow, better than average financial condition, good capital and usually no overdrafts.

 

 

Satisfactory (3) The borrowing entity has adequate cash flow, satisfactory financial condition, and explainable overdrafts (if any).

 

 

Watch (4) The borrowing entity has generally adequate, yet inconsistent cash flow, cyclical earnings, weak capital, loan to/from stockholders, and infrequent overdrafts. The borrower has consistent yet sometimes unpredictable sales and growth.

 

 

OAEM (5) The borrowing entity has marginal cash flow, occasional past dues, and frequent and unexpected working capital needs.

 

 

Substandard (6) The borrowing entity has cash flow barely sufficient to service debt, deteriorated financial condition, and bankruptcy is a possibility. The borrowing entity has declining sales, rising costs, and may need to look for secondary source of repayment.

 

 

Doubtful (7) The borrowing entity has negative cash flow. Survival of the business is at risk, full repayment is unlikely, and there are frequent and unexplained overdrafts. The borrowing entity shows declining trends and no operating profits.

 

 

Loss (8) The borrowing entity has negative cash flow with no alternatives. Survival of the business is unlikely.

 

The following tables illustrate credit risks by category and internally assigned grades at December 31, 2019 and December 31, 2018. “Pass” includes loans internally graded as excellent, good and satisfactory.

 

      December 31, 2019 
    Commercial   Commercial
Real Estate
Construction
   Commercial
Real Estate
Other
   Consumer
Real Estate
   Consumer
Other
   Total 
Pass   $48,098,936   $12,005,834   $137,641,011   $56,034,247   $4,966,615   $258,746,643 
Watch    2,303,568    485,244    3,758,220    2,096,445    315,375    8,958,852 
OAEM    460,551        649,039    522,600    44,232    1,676,422 
Substandard    1,985,400        1,773,720    879,753    51,770    4,690,643 
Doubtful                         
Loss                         
Total   $52,848,455   $12,491,078   $143,821,990   $59,533,045   $5,377,992   $274,072,560 

 

 45

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

    December 31, 2018 
    Commercial   Commercial
Real Estate
Construction
   Commercial
Real Estate
Other
   Consumer
Real Estate
   Consumer
Other
   Total 

Pass

   $50,663,356   $7,304,300   $136,804,420   $60,480,317   $4,726,494   $259,978,887 

Watch

    1,973,675        4,938,711    2,077,341    226,117    9,215,844 

OAEM

    157,300        590,294    350,000        1,097,594 

Substandard

    2,034,747        1,369,976    879,753    87,466    4,371,942 

Doubtful

                         

Loss

                         

Total

   $54,829,078   $7,304,300   $143,703,401   $63,787,411   $5,040,077   $274,664,267 

 

The following tables include an aging analysis of the recorded investment in loans segregated by class.

 

   December 31, 2019 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater than
90 Days
   Total
Past Due
    Current    Total
Loans
Receivable
   Recorded
Investment ≥
90 Days and
Accruing
 
Commercial  $39,329   $   $178,975   $218,304    $52,630,151    $52,848,455   $ 
Commercial Real Estate Construction                    12,491,078     12,491,078     
Commercial Real Estate Other   620,837    300,240    582,419    1,503,496     142,318,494     143,821,990     
Consumer Real Estate       2,965    629,999    632,964     58,900,081     59,533,045     
Consumer Other   32,842            32,842     5,345,150     5,377,992     
Total  $693,008   $303,205   $1,391,393   $2,387,606    271,684,954    274,072,560   $ 

 

 

   December 31, 2018 
   30-59 Days
Past Due
   60-89 Days 
Past Due
   Greater Than
90 Days
   Total
Past Due
   Current   Total
Loans 
Receivable
   Recorded
Investment ≥
90 Days and
Accruing
 
Commercial  $266,567   $17,492   $229,395   $513,454   $54,315,624   $54,829,078   $ 
Commercial Real Estate Construction                   7,304,300    7,304,300     
Commercial Real Estate Other   35,000    215,049    571,292    821,341    142,882,060    143,703,401     
Consumer Real Estate                   63,787,411    63,787,411     
Consumer Other   24,621            24,621    5,015,456    5,040,077     
Total  $326,188   $232,541   $800,687   $1,359,416   $273,304,851   $274,664,267   $ 

 

There were no loans past due 90 days or more and still accruing interest at December 31, 2019 and 2018.

 

 46

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

The following table summarizes the balances of non-accrual loans.

 

   Loans Receivable on Non-Accrual  
   December 31,
2019
   December 31,
2018
 
           
Commercial  $178,975   $251,219 
Commercial Real Estate Construction        
Commercial Real Estate Other   857,327    571,292 
Consumer Real Estate   629,999     
Consumer Other       1,023 
Total  $1,666,301   $823,534 

 

The following tables set forth the changes in the allowance and an allocation of the allowance by class at December 31, 2019, 2018, and 2017. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors.

 

    December 31, 2019  
   Commercial  

Commercial

Real Estate
Construction

   Commercial
Real Estate

Other
   Consumer
Real Estate
   Consumer
Other
   Total 
Allowance for Loan Losses                              
Beginning Balance  $1,665,413   $63,876   $1,292,346   $386,585   $806,111   $4,214,331 
Charge-offs   (398,685)               (8,342)   (407,027)
Recoveries   12,200                4,254    16,454 
Provisions   150,989    45,359    (21,901)   109,636    (104,083)   180,000 
Ending Balance  $1,429,917   $109,235   $1,270,445   $496,221   $697,940   $4,003,758 

 

   December 31, 2018 
   Commercial   Commercial
Real Estate

Construction
   Commercial
Real Estate

Other
   Consumer
Real Estate
   Consumer
Other
   Total 
Allowance for Loan Losses                              
Beginning Balance  $1,403,588   $23,638   $1,549,755   $796,918   $101,499   $3,875,398 
Charge-offs   (31,250)               (84,637)   (115,887)
Recoveries   14,000        56,827    45,412    13,581    129,820 
Provisions   279,075    40,238    (314,236)   (455,745)   775,668    325,000 
Ending Balance  $1,665,413   $63,876   $1,292,346   $386,585   $806,111   $4,214,331 

 

   December 31, 2017 
   Commercial   Commercial
Real Estate
Construction
   Commercial
Real Estate
Other
   Consumer
Real Estate
   Consumer
Other
   Total 
Allowance for Loan Losses                              
Beginning Balance  $1,545,188   $51,469   $1,374,706   $726,391   $153,863   $3,851,617 
Charge-offs           (180,587)       (4,862)   (185,449)
Recoveries   6,000        87,030    60,000    1,200    154,230 
Provisions   (147,600)   (27,831)   268,606    10,527    (48,702)   55,000 
Ending Balance  $1,403,588   $23,638   $1,549,755   $796,918   $101,499   $3,875,398 

 

47 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

The following tables present, by class and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans.

 

   December 31, 2019 
   Commercial   Commercial
Real Estate
Construction
   Commercial
Real Estate
Other
   Consumer
Real Estate
   Consumer
Other
   Total 
Allowance for Loan Losses                              
Individually evaluated for impairment  $683,278   $   $1,782   $   $90   $685,150 
Collectively evaluated for impairment   746,639    109,235    1,268,663    496,221    697,850    3,318,608 
Total Allowance for Loan Losses   1,429,917    109,235    1,270,445    496,221    697,940    4,003,758 
Loans Receivable                              
Individually evaluated for impairment   2,065,732        1,679,872    879,753    51,770    4,677,127 
Collectively evaluated for impairment   50,782,723    12,491,078    142,142,118    58,653,292    5,326,222    269,395,433 
Total Loans Receivable  $52,848,455   $12,491,078   $143,821,990   $59,533,045   $5,377,992   $274,072,560 

 

    December 31, 2018  
    Commercial     Commercial
Real Estate
Construction
   

Commercial 

Real Estate
Other 

    Consumer
Real Estate
   

Consumer 

Other 

    Total  
Allowance for Loan Losses                                                
Individually evaluated for impairment   $ 1,132,805     $     $ 37,416     $     $ 21,324     $ 1,191,545  
Collectively evaluated for impairment     532,608       63,876       1,254,930       386,585       784,787       3,022,786  
Total Allowance for Losses   $ 1,665,413     $ 63,876     $ 1,292,346     $ 386,585     $ 806,111     $ 4,214,331  
Loans Receivable                                                
Individually evaluated for impairment   $ 1,996,579     $     $ 1,280,890     $ 879,753     $ 21,324     $ 4,178,546  
Collectively evaluated for impairment     52,832,499       7,304,300       142,422,511       62,907,658       5,018,753       270,485,721  
Total Loans Receivable   $ 54,829,078     $ 7,304,300     $ 143,703,401     $ 63,787,411     $ 5,040,077     $ 274,664,267  

   

48 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

As of December 31, 2019 and 2018, loans individually evaluated for impairment and the corresponding allowance for loan losses are presented in the following table.

 

   Impaired and Restructured Loans As of 
   December 31, 2019   December 31, 2018 
   Unpaid
Principal
Balance
   Recorded
Investment
   Related
Allowance
   Unpaid
Principal
Balance
   Recorded
Investment
   Related
Allowance
 
With no related allowance recorded:                              
Commercial  $1,355,875   $1,355,875   $   $115,983   $115,983   $ 
Commercial Real Estate Construction                        
Commercial Real Estate Other   1,432,988    1,432,988        974,249    974,249     
Consumer Real Estate   879,753    879,753        879,753    879,753     
Consumer Other                        
Total   3,668,616    3,668,616        1,969,985    1,969,985     
                               
With an allowance recorded:                              
Commercial   709,857    709,857    683,278    1,880,596    1,880,596    1,132,805 
Commercial Real Estate Construction                        
Commercial Real Estate Other   346,685    246,884    1,782    406,442    306,641    37,416 
Consumer Real Estate                        
Consumer Other   51,770    51,770    90    21,324    21,324    21,324 
Total   1,108,312    1,008,511    685,150    2,308,362    2,208,561    1,191,545 
                               
Total                              
Commercial   2,065,732    2,065,732    683,278    1,996,579    1,996,579    1,132,805 
Commercial Real Estate Construction                        
Commercial Real Estate Other   1,779,673    1,679,872    1,782    1,380,691    1,280,890    37,416 
Consumer Real Estate   879,753    879,753        879,753    879,753     
Consumer Other   51,770    51,770    90    21,324    21,324    21,324 
Total  $4,776,928   $4,677,127   $685,150   $4,278,347   $4,178,546   $1,191,545 

 

49 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

The following table presents average impaired loans and interest income recognized on those impaired loans, by class segment, for the periods indicated.

 

   For the year ended December 31, 
   2019   2018   2017 
   Average
Recorded
Investment
   Interest
Income
Recognized
   Average
Recorded
Investment
   Interest
Income
Recognized
   Average
Recorded
Investment
   Interest
Income
Recognized
 
With no related allowance recorded:                              
Commercial  $1,483,982   $94,779   $133,413   $8,637   $173,964   $7,416 
Commercial Real Estate Construction                        
Commercial Real Estate Other   1,533,720    76,183    982,078    40,174    1,275,402    23,084 
Consumer Real Estate   879,753    30,400    879,753    51,520    451,025    16,938 
Consumer Other                        
Total   3,897,455    201,362    1,995,244    100,331    1,900,391    47,438 
                               
With an allowance recorded:                              
Commercial   725,353    44,299    1,915,139    100,395    1,711,259    76,544 
Commercial Real Estate Construction                        
Commercial Real Estate Other   246,884        416,569    10,999    930,420    5,367 
Consumer Real Estate                   43,119    1,296 
Consumer Other   59,240    3,487    26,314    1,382    36,056    1,419 
Total   1,031,477    47,786    2,358,022    112,776    2,720,854    84,626 
                               
Total                              
Commercial   2,209,335    139,078    2,048,552    109,032    1,885,223    83,960 
Commercial Real Estate Construction                        
Commercial Real Estate Other   1,780,604    76,183    1,398,647    51,173    2,205,822    28,451 
Consumer Real Estate   879,753    30,400    879,753    51,520    494,144    18,234 
Consumer Other   59,240    3,487    26,314    1,382    36,056    1,419 
   $4,928,932   $249,148   $4,353,266   $213,107   $4,621,245   $132,064 

  

In general, the modification or restructuring of a debt is considered a troubled debt restructuring (“TDR”) if we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise consider. As of December 31, 2019, there were 3 TDRs with a balance of $573,473 compared to no TDRs as of December 31, 2018 and one TDR with a balance of $33,300 as of December 31, 2019. These TDRs were granted extended payment terms with no principal reduction. All TDRs were performing as agreed as of December 31, 2019. During the year ended December 31, 2019, one TDR in the amount of $2,008 was charged off and the Company recovered $439. No other TDRs that were modified within the previous twelve months defaulted during the following year for the years ended December 31, 2019, 2018, and 2017.

 

5. CONCENTRATIONS OF CREDIT RISK

 

We grant short to intermediate term commercial and consumer loans to customers throughout our primary market area of Charleston, Berkeley and Dorchester counties of South Carolina. Our primary market area is heavily dependent on tourism, medical, and legal services. Although we have a diversified loan portfolio, a substantial portion of our debtors’ ability to honor their contracts is dependent upon the stability of the economic environment in their primary market. The majority of the loan portfolio is located in our immediate market area with a concentration in real estate related activities and offices, medical offices, and attorneys’ offices.

 

Our loans were concentrated in the following categories.

 

   December 31,
2019
   December 31,
2018
 
Commercial   19.28%   19.96%
Commercial Real Estate Construction   4.56%   2.67%
Commercial Real Estate Other   52.48%   52.32%
Consumer Real Estate   21.72%   23.22%
Consumer Other   1.96%   1.83%
Total   100.00%   100.00%

 

50 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

6. Premises, Equipment and Leasehold Improvements

 

Premises, equipment and leasehold improvements are summarized in the table below.

 

   December 31, 
   2019  

2018

 
Bank buildings  $1,861,237   $1,861,237 
Land   838,075    838,075 
Leasehold purchases   30,000    30,000 
Leasehold improvements   2,555,376    709,520 
Construction in progress       120,849 
Equipment   3,987,002    3,526,404 
    9,271,690    7,086,085 
Accumulated depreciation   (4,981,255)   (4,750,878)
Total  $4,290,435   $2,335,207 

  

Depreciation on our bank premises and equipment charged to operating expense totaled $230,377 in 2019, $195,921 in 2018, and $193,298 in 2017.

 

7. LEASES

 

As of December 31, 2019, the Company had operating right of use (“ROU”) assets of $13.2 million and operating lease liabilities of $13.2 million. The Company maintains operating leases on land, branch facilities, and parking. Most of the leases include one or more options to renew, with renewal terms extending up to 20 years. Leases with an initial term of 12 months or less are not recorded on the balance sheet and are recognized in lease expense.

 

The weighted average remaining lease term is 18.50 years. The weighted average incremental borrowing rate is 4.34%.

 

The exercise of renewal options is based on the sole judgement of management and what they consider to be reasonably certain. Based on the market areas, past practices, and contract terms of all leases, the Bank assumed all renewal options will be exercised. Minimum rental commitments for these leases as of December 31, 2019 are presented in the table below.

     
2020  $901,896 
2021   917,169 
2022   930,750 
2023   957,477 
2024 and thereafter   11,697,343 
Total undisclosed lease payments  $15,404,635 

Less: effect of discounting  (2,195,418)
Present value of estimated lease payments  $ 13,209,217 

 

The table below shows lease expense components for the year ended December 31, 2019.

 

Lease Expense Components    
Operating lease expense  $577,460 
Short-term lease expense   46,538 
Total lease expense  $623,998 

 

Total rental expense was $623,998, $622,396, and $612,717 in 2019, 2018 and 2017, respectively.

 

As of December 31, 2019, we did not maintain any finance leases and we determined that the number and dollar amount of equipment leases was immaterial. As of December 31, 2019, we have no additional operating leases that have not yet commenced.

 

We rented office space at 1071 Morrison Drive, Charleston, South Carolina, from a related party, to house our Mortgage Department during the year ended December 31, 2019. Rent expense for this lease was $46,538, $60,840, and $54,720 for the years ended December 31, 2019, 2018, and 2017, respectively. This lease ended in September 2019.

 

51 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

8. OTHER REAL ESTATE OWNED

 

The following table summarizes the activity in other real estate owned at December 31, 2019 and 2018.

 

   December 31,
2019
   December 31,
2018
 
Balance, beginning of the year  $   $435,479 
Additions - foreclosure        
Sales       (411,842)
Write-downs       (23,637)
Balance, end of the year  $   $ 

 

As of December 31, 2019 and 2018, there were no properties classified as OREO. One property valued at $411,842 was sold at a loss of $33,476 during 2018.

 

9. DEPOSITS

 

As of December 31, 2019 and 2018, certificates of deposit of $250,000 or more totaled approximately $5,967,559 and $15,909,991, respectively.

 

The scheduled maturities of certificates of deposit as of December 31, 2019 are presented in the table below:

 

2020     $ 20,127,684  
2021       1,072,986  
2022       340,257  
2023       368,391  
2024 and thereafter       273,469  
      $ 22,182,787  

 

As of December 31, 2019, deposits with a deficit balance of $25,319 were re-classified as other loans.

 

10. Short-Term Borrowings

 

At December 31, 2019 and 2018, we had no outstanding federal funds purchased. We have a Borrower-In-Custody arrangement with the Federal Reserve. This arrangement permits the Company to retain possession of loans pledged as collateral to secure advances from the Federal Reserve Discount Window. Under this agreement, we may borrow up to $56.8 million. We established this arrangement as an additional source of liquidity. There have been no borrowings under this arrangement.

 

At December 31, 2019 and 2018, the Bank had unused short-term lines of credit totaling approximately $23.0 million (which are withdrawable at the lender’s option).

 

11. Income Taxes

 

On December 22, 2017, the President of the United States signed into law the 2017 Tax Act. The 2017 Tax Act included a number of changes to the existing U.S. tax laws that impact the Company, most notably a reduction in the U.S. corporate income tax rate from 34 percent to 21 percent for tax years beginning after December 31, 2017.

 

The Company recognized the income tax effects of the 2017 Tax Act in its 2017 consolidated financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the 2017 Tax Act was signed into law. As such, the Company’s financial results reflect the income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined.

 

 52

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Total income taxes for the years ended December 31, 2019, 2018 and 2017 are presented in the table below.

 

   For the year ended December 31, 
   2019   2018   2017 
Income tax expense  $2,175,274   $1,108,982   $2,814,634 
Unrealized gains (losses) on securities available for sale presented in accumulated other comprehensive income (loss)   (600,765)   (192,280)   (116,007)
Total  $1,574,509   $916,702   $2,698,627 

 

Income tax expense was as follows:

 

   For the year ended December 31, 
   2019   2018   2017 
Current income taxes               
Federal  $1,742,430   $1,326,619   $2,538,272 
State            
Total current tax expense   1,742,430    1,326,619    2,538,272 
Deferred income tax (benefit) expense   432,844    (217,637)   276,362 
Total income tax expense  $2,175,274   $1,108,982   $2,814,634 

 

The differences between actual income tax expense and the amounts computed by applying the U.S. federal income tax rate of 21% to pretax income from continuing operations for the periods indicated are reconciled in the table below.

 

   For the year ended December 31, 
   2019   2018   2017 
Computed “expected” tax expense  $1,993,679   $1,686,702   $2,623,595 
Increase (reduction) in income taxes resulting from:               
Tax rate change impact           666,674 
Amortization of credit and gain   1,685    196,477    163,411 
Stock based compensation   16,391    15,205    24,378 
Valuation allowance   7,123    7,538    16,952 
Other   6,233    38,938    (4,768)
State income tax, net of federal benefit   268,000   (226,578)   (329,412)
Federal credits       (454,985)    
Tax exempt interest income   (117,837)   (154,315)   (346,196)
   $2,175,274   $1,108,982   $2,814,634 

 

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2019 and 2018 are presented below.

 

   December 31,
2019
   December 31,
2018
 
Deferred tax assets:          
Allowance for loan losses  $806,982   $850,964 
State credit carryforward   307,950    647,190 
Unrealized gain (loss) on securities available for sale      472,421 
Pass-through income   68,438    68,438 
State net operating loss carryforward   81,914    74,791 
Nonaccrual interest   41,453    27,956 
Other   6,934    6,155 
Total gross deferred tax assets  $1,313,671    2,147,915 
Valuation allowance   (81,914)   (74,791)
Total gross deferred tax assets, net of valuation allowance  $1,231,757    2,073,124 
           
Deferred tax liabilities:          
Fixed assets, principally due to differences in depreciation   (109,169)   (39,294)
Unrealized gain (loss) on securities available for sale   (128,344)    
Deferred loan fees   (32,696)   (32,825)
Other   (57,741)   (56,481)
Prepaid expenses   (225)   (210)
Total deferred tax liabilities   (328,175)   (128,810)
           
Net deferred tax assets  $903,582   $1,944,314 

 

 53

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In 2018, the Company invested in a Federal Rehabilitation Credit. The tax credit was used during the year ended December 31, 2018. Amortization expense recognized for the years ended December 31, 2019 and 2018 was $8,022 and $354,888, respectively. In 2016, the Company invested in a South Carolina Rehabilitation Credit. The tax credit was included in deferred tax assets and is being amortized. Amortization expense recognized for the years ended December 31, 2018 and 2017 was $306,105, and was included in other operating expense on the statement of operations.

 

There was a $81,914 valuation allowance for deferred tax assets at December 31, 2019 associated with the Company’s state net operating loss. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and prior to their expiration governed by the income tax code. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods during which the deferred income tax assets are expected to be deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowance at December 31, 2019. The amount of the deferred income tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.

 

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 34 percent to 21 percent, resulting in a $666,674 increase in income tax expense for the year ended December 31, 2017 and a corresponding $666,674 decrease in net deferred tax assets as of December 31, 2017.

 

The Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions in accordance with applicable regulations.

 

Tax returns for 2016 and subsequent years are subject to examination by taxing authorities.

 

12. Commitments and Contingencies

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved in extending loan facilities to customers. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. If deemed necessary, the amount of collateral obtained upon extension of credit is based on our credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate. Commitments to extend credit, including unused lines of credit, amounted to $105,481,545 and $96,115,504 at December 31, 2019 and 2018, respectively.

 

 54

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Standby letters of credit represent our obligation to a third party contingent upon the failure by our customer to perform under the terms of an underlying contract with the third party or obligates us to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation. Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended. We can seek recovery of the amounts paid from the borrower. Commitments under standby letters of credit are usually for one year or less. At December 31, 2019 and 2018, we have recorded no liability for the current carrying amount of the obligation to perform as a guarantor; as such amounts are not considered material. The maximum potential amount of undiscounted future payments related to standby letters of credit at December 31, 2019 and 2018 was $1,042,966 and $1,169,644, respectively.

 

13. RELATED PARTY TRANSACTIONS

 

In the opinion of management, loans to our Executive Officers and Directors are made on substantially the same terms, including interest rates and collateral, as those terms prevailing at the time for comparable loans with persons not related to the lender that do not involve more than the normal risk of collectability. There were no past due loans to our Executive Officers as of December 31, 2019 and 2018.

 

The table below summarizes related party loans.

 

   December 31,
2019
   December 31,
2018
 
Balance at beginning of the year  $4,401,710   $4,569,780 
New loans or advances   370,275    1,428,098 
Repayments   (2,120,078)   (1,596,169)
Balance at the end of the year  $2,651,907   $4,401,710 

 

At December 31, 2019 and 2018, total deposits held by related parties were $4,343,903 and $8,914,967, respectively.

 

The Company also leased office space from a related party during the year ended December 31, 2019 as discussed in the Leases footnote.

 

14. Other Expense

 

The table below summarizes the components of other operating expense.

 

   For the year ended December 31, 
   2019   2018   2017 
Data processing services  $607,467   $579,666   $585,497 
Professional fees   324,628    459,348    451,882 
Telephone and postage   182,801    175,520    207,526 
State and FDIC insurance and fees   113,117    183,867    165,280 
Supplies   103,796    85,984    75,965 
Courier service   49,200    54,044    82,907 
Insurance   43,097    43,866    44,613 
Advertising and business development   16,059    12,217    10,844 
Amortization of federal tax credit   8,022    354,888     
Amortization of state tax credit       306,106    306,105 
Other   740,948    697,957    587,118 
Total other operating expenses  $2,189,135   $2,953,463   $2,517,737 

 

 55

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15. Stock Incentive Plan

 

We have a Stock Incentive Plan which was approved in 1998 with 180,000 (329,422 adjusted for five 10% stock dividends and a 25% stock dividend) shares reserved and a Stock Incentive Plan which was approved in 2010 with 300,000 (363,000 adjusted for two 10% stock dividends) shares reserved. Under both plans, options are periodically granted to employees at a price not less than the fair market value of the shares at the date of grant. Employees become 20% vested after five years and then vest 20% each year until fully vested. The right to exercise each such 20% of the options is cumulative and will not expire until the tenth anniversary of the date of the grant. All employees are eligible to participate in this plan if the Executive/Long-Range Committee, in its sole discretion, determines that such person has contributed or can be expected to contribute to our profits or growth. The Stock Incentive Plan for Executive Officers is administered by the Compensation Committee of the Board of Directors.

 

Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of our common stock. The expected term of the options granted shall not exceed ten years from the date of grant (the amount of time options granted are expected to be outstanding). The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

 

The fair value of options granted was determined using the following weighted-average assumptions as of grant date:

 

   2019   2018   2017 
Risk free interest rate   2.01%   2.88%   2.43%
Expected life (in years)   7.5    7.5    7.5 
Expected stock price volatility   33.13%   33.69%   34.20%
Dividend yield   4.28%   3.61%   4.00%

 

There are currently no options to purchase or shares exercisable under the 1998 Omnibus Stock Incentive Plan as of December 31, 2019.

 

The following table presents a summary of the activity under the 1998 and 2010 Omnibus Stock Incentive Plans for the years ended December 31.

 

   2019   2018   2017 
   Shares   Weighted
Average
Exercise
Price
   Shares   Weighted
Average
Exercise
Price
   Shares   Weighted
Average
Exercise
Price
 
Outstanding, January 1   102,760   $11.89    117,191   $10.79    154,085   $10.19 
Granted   6,250    18.92    11,275    18.23    10,175    20.72 
Expired                         
Exercised   (22,163)   8.81    (24,056)   8.96    (36,454)   9.57 
Forfeited   (750)   18.92    (1,650)   20.02    (10,615)   15.83 
Outstanding, December 31   86,097   $12.92    102,760   $11.89    117,191   $10.79 
Exercisable at year end   27,459   $9.03    32,219   $8.81    31,694   $8.77 

 

Information has been retroactively adjusted for the 2018 10% stock dividend as applicable.

 

The following table presents information pertaining to options outstanding at December 31, 2019.

 

December 31, 2019  
Exercise Price    Number of
Options
Outstanding
   Weighted
Average
Remaining
Contractual
Life
   Weighted
Average
Exercise
Price of
Options
Outstanding
   Intrinsic
Value of
Options
Outstanding
   Number of
Options
Exercisable
   Weighted
Average
Exercise
Price of
Options
Exercisable
   Intrinsic
Value of
Options
Exercisable
 
$8.61    24,236    5.33   $8.61   $208,672    19,389   $8.61   $194,683 
$8.90    1,210    0.75   $8.90   $10,769    1,210   $8.90   $11,799 
$9.18    5,263    2.50   $9.18   $48,314    3,158   $9.18   $29,907 
$9.65    1,210    1.25   $9.65   $11,677    968   $9.65   $8,713 
$9.92    1,210    2.75   $9.92   $12,003    726   $9.92   $6,339 
$12.26    5,202    4.59   $12.26   $63,777    1,040   $12.26   $6,649 
$12.40    2,419    4.00   $12.40   $29,996    968   $12.40   $6,048 
$13.05    14,217    5.33   $13.05   $185,532       $13.05   $ 
$13.62    3,630    5.50   $13.62   $49,441       $13.62   $ 
$14.54    5,500    6.25   $14.54   $79,970       $14.54   $ 
$18.23    10,450    8.25   $18.23   $190,504       $18.23   $ 
$18.92    5,500    9.50   $18.92   $104,060       $18.92   $ 
$19.00    2,750    7.17   $19.00   $52,250       $19.00   $ 
$19.82    3,300    7.09   $19.82   $65,406       $19.82   $ 
      86,097    5.73   $12.92   $1,112,371    27,459   $9.03   $264,138 

 

 56

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The total intrinsic value of options exercised during the years ended December 31, 2019, 2018, and 2017, was $218,116, $262,415, and $311,836, respectively.

 

We recognized compensation cost for the years ended December 31, 2019, 2018 and 2017 in the amount of $78,053, $72,408, and $71,701, respectively, related to the granted options.

 

As of December 31, 2019, there was a total of $189,103 in unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. The cost is expected to be recognized over a weighted average period of 3.86 years.

 

16. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

 

We established an Employee Stock Ownership Plan (“ESOP”) effective January 1, 1989. Any employee of the Bank is eligible to become a participant in the ESOP upon reaching 21 years of age and credited with one-year of service (1,000 hours of service). The employee may enter the Plan on the January 1st that occurs nearest the date on which the employee first satisfies the age and service requirements described above. No contributions by employees are permitted. The amount and time of contributions are at the sole discretion of the Board of Directors of the Bank. The contribution for all participants is based solely on each participant’s respective regular or base salary and wages paid by the Bank including commissions, bonuses and overtime, if any.

 

The Company recognizes expense when the contribution is approved by the Board of Directors. The total expenses amounted to $510,000, $420,000, and $375,000, during the years ended December 31, 2019, 2018, and 2017, respectively. As of December 31, 2019, the plan owned 313,703 shares of common stock of Bank of South Carolina Corporation.

 

A participant vests in the ESOP based upon the participant’s credited years of service. The vesting schedule is as follows:

 

1 Year of Service     0% Vested
2 Years of Service   25% Vested
3 Years of Service   50% Vested
4 Years of Service   75% Vested
5 Years of Service 100% Vested

 

Periodically, the Internal Revenue Service “IRS” requires a restatement of a qualified retirement plan to ensure that the plan document includes provisions required by legislative and regulatory changes made since the last restatement. There have been no substantive changes to the plan. The Board of Directors approved a restated plan, on January 26, 2012 (incorporated as Exhibit 10.5 in the 2011 10-K). The Plan was submitted to the IRS for approval and a determination letter was issued September 26, 2013, stating that the plan satisfies the requirements of Code Section 4975(e)(7). On January 26, 2017, the Board of Directors approved a restated plan (incorporated as Exhibit 10.6 in the 2016 10-K). The Plan was submitted to the IRS for approval and a determination letter was issued November 17, 2017, stating that the plan satisfies the requirements of Code Section 4975(e)(7).

 

 57

 

 

BANK OF SOUTH CAROLINA CORPORATION  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

17. DIVIDENDS

 

The Bank’s ability to pay dividends to the Company is restricted by the laws and regulations of the State of South Carolina. Generally, these restrictions allow the Bank to pay dividends from current earnings without the prior written consent of the South Carolina Commissioner of Banking, if it received a satisfactory rating at its most recent examination. Cash dividends when declared, are paid by the Bank to the Company for distribution to shareholders of the Company. The Bank paid dividends of $4.1 million, $3.8 million, and $2.9 million, to the Company during the years ended December 31, 2019, 2018 and 2017, respectively.

 

On April 10, 2018, the Company’s Board of Directors declared a ten percent stock dividend to our shareholders. The record date was April 30, 2018 and the distribution date was May 31, 2018. Earnings per share and average shares outstanding have been adjusted for all periods presented to retroactively reflect the stock dividend in our consolidated financial statements. Total shares outstanding increased by 499,088 shares.

 

18. Income Per Common Share

 

Basic income per share is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted income per share is computed by dividing net income by the weighted-average number of common shares and potential common shares outstanding. Potential common shares consist of dilutive stock options determined using the treasury stock method and the average market price of common stock. Earnings per share and average shares outstanding have been adjusted for all periods presented to retroactively reflect the ten percent stock dividend declared on April 10, 2018.

 

The following table is a summary of the reconciliation of average shares outstanding for the years ended December 31.

 

    2019     2018     2017  
Net income   $ 7,318,433     $ 6,922,934     $ 4,901,825  
                         
Weighted average shares outstanding     5,522,025       5,500,027       5,471,001  
Effect of dilutive shares     66,065       88,985       97,492  
Weighted average shares outstanding - diluted     5,588,090       5,589,012       5,568,493  
                         
Earnings per share - basic   $ 1.33     $ 1.26     $ 0.90  
Earnings per share - diluted   $ 1.31     $ 1.24     $ 0.88  

 

19. Regulatory Capital Requirements

 

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

 

Current quantitative measures established by regulation to ensure capital adequacy require that we maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and to average assets. We believe that the Company and the Bank meet all capital adequacy requirements to which they were subject at December 31, 2019 and 2018.

 

On July 2, 2013, the Federal Reserve Board approved the final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks (“Basel III”). Following the actions by the Federal Reserve, the FDIC also approved regulatory capital requirements on July 9, 2013. The FDIC’s rule is identical in substance to the final rules issued by the Federal Reserve Bank.

 

58 

 

 

BANK OF SOUTH CAROLINA CORPORATION  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Basel III became effective on January 1, 2015. The purpose is to improve the quality and increase the quantity of capital for all banking organizations. The minimum requirements for the quantity and quality of capital were increased. The rule includes a new common equity Tier 1 capital to risk-weighted assets ratio of 4.50% and a common equity Tier 1 capital conservation buffer of 2.50% of risk-weighted assets. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.00% to 6.00% and requires a minimum leverage ratio of 4.00%. In addition, the rule also implements strict eligibility criteria for regulatory capital instruments and improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. All final rule requirements will be phased in over a multi-year schedule. The capital conservation buffer in effect for the year ended December 31, 2019 was 8.46%.

 

At December 31, 2019, the Bank was categorized as “well capitalized” under Basel III. To be categorized as “well capitalized” the Bank must maintain minimum total risk based, Tier 1 risk based, common equity Tier 1 risk based capital and Tier 1 leverage ratios of 10.00%, 8.00%, 6.50%, and 5.00%, respectively, and to be categorized as “adequately capitalized,” the Bank must maintain minimum total risk based, Tier 1 risk based, common equity Tier 1 risk based capital, and Tier 1 leverage ratios of 8.00%, 6.00%, 4.50%, and 4.00%, respectively.

 

The following tables present the actual and required capital amounts and ratios for the Company and Bank at December 31, 2019 and 2018: 

 

   December 31, 2019 
   Actual   For Capital
Adequacy Purposes
   To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
(in thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Total capital to risk-weighted assets:                              
Company  $54,690    16.69%  $26,221    8.00%   N/A    N/A 
Bank  $53,897    16.46%  $26,199    8.00%  $32,748    10.00%
                               
Tier 1 capital to risk-weighted assets:                              
Company  $50,686    15.46%  $19,666    6.00%   N/A    N/A 
Bank  $49,860    15.23%  $19,649    6.00%  $26,199    8.00%
                               
Tier 1 capital to average assets:                              
Company  $50,686    11.32%  $17,907    4.00%   N/A    N/A 
Bank  $49,860    11.14%  $17,895    4.00%  $22,369    5.00%
                               
Common equity Tier 1 capital:                              
Company  $50,686    15.46%  $14,749    4.50%   N/A    N/A 
Bank  $49,860    15.23%  $14,737    4.50%  $14,737    4.50%

 

    December 31, 2018  
    Actual     For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
(in thousands)   Amount     Ratio     Amount     Ratio     Amount     Ratio  
Total capital to risk-weighted assets:                                                
Company   $ 50,657        16.69 %   $ 24,280        8.00 %     N/A        N/A   
Bank   $ 49,695        16.39 %   $ 24,262        8.00 %   $ 30,328        10.00 %
                                                 
Tier 1 capital to risk-weighted assets:                                                
Company   $ 46,864        15.44 %   $ 18,210        6.00 %     N/A        N/A   
Bank   $ 45,898        15.13 %   $ 18,197        6.00 %   $ 24,262        8.00 %
                                                 
Tier 1 capital to average assets:                                                
Company   $ 46,864        10.76 %   $ 17,428        4.00 %     N/A        N/A   
Bank   $ 45,898        10.54 %   $ 17,419        4.00 %   $ 21,773        5.00 %
                                                 
Common equity Tier 1 capital:                                                
Company   $ 46,864        15.44 %   $ 13,658        4.50 %     N/A        N/A   
Bank   $ 45,898        15.13 %   $ 13,647        4.50 %   $ 13,647        4.50 %

 

59 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

20. Disclosures Regarding Fair Value of Financial Instruments
 

 

Fair value measurements apply whenever GAAP requires or permits assets or liabilities to be measured at fair value either on a recurring or nonrecurring basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. GAAP establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs, which are developed based on market data we have obtained from independent sources, are ones that market participants would use in pricing an asset or liability. Unobservable inputs, which are developed based on the best information available in the circumstances, reflect our estimate of assumptions that market participants would use in pricing an asset or liability.

   
  The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

   

  Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.
  Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.
  Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

 

  Fair value estimates are made at a specific point of 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 our entire holdings of a particular financial instrument. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based on judgements regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value also would affect significantly the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.
   
  The following paragraphs describe the valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:
   
  Investment Securities Available for Sale
   

  Investment securities are recorded at fair value on a recurring basis and are based upon quoted prices if available. If quoted prices are not available, fair value is 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, or by dealers or brokers in active over-the counter markets. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed and municipal securities in less liquid markets.

 

60 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  

 

  Derivative Instruments
   
 

Derivative instruments include interest rate lock commitments and forward sale commitments. These instruments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. We classify these instruments as Level 3.

 

We had no embedded derivative instruments requiring separate accounting treatment. We had freestanding derivative instruments consisting of fixed rate conforming loan commitments with interest rate locks and commitments to sell fixed rate conforming loans on a best efforts basis. We do not currently engage in hedging activities. Based on the short-term fair value of mortgage loans held for sale (derivative contract), our derivative instruments were immaterial to our consolidated financial statements as of December 31, 2019 and 2018. 

 

  Assets and liabilities measured at fair value on a recurring basis at December 31, 2019 and 2018 are in the following table.

 

    Balance as of December 31, 2019  
    Level 1     Level 2     Level 3     Total  
U.S. Treasury Notes   $ 23,180,200     $     $     $ 23,180,200  
Government-Sponsored Enterprises           50,498,195             50,498,195  
Municipal Securities           14,817,110       11,954,451       26,771,561  
Total   $ 23,180,200     $ 65,315,305     $ 11,954,451     $ 100,449,956  

                         
    Balance as of December 31, 2018  
    Level 1     Level 2     Level 3     Total  
U.S. Treasury Notes   $ 32,356,634     $     $     $ 32,356,634  
Government-Sponsored Enterprises           59,369,280             59,369,280  
Municipal Securities           21,701,005       6,241,955       27,942,960  
Total   $ 32,356,634     $ 81,070,285     $ 6,241,955     $ 119,668,874  

    

There were no liabilities recorded at fair value on a recurring basis as of December 31, 2019 or 2018. 

 

The following table reconciles the changes in assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2019 and 2018. 

 

    December 31,
2019
    December 31,
2018
 
Beginning balance   $ 6,241,955     $ 11,458,889  
Total realized/unrealized gains (losses)                
Included in earnings            
Included in other comprehensive income     7,924,331       150,993  
Purchases, issuances, and settlements, net of maturities     (2,211,835 )     (5,367,927 )
Transfers in and/or out of Level 3            
Ending balance   $ 11,954,451     $ 6,241,955  

 

There were no transfers between fair value levels in 2019 or 2018.

 

61 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following paragraphs describe the valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

 

Impaired Loans

 

Impaired loans are carried at the lower of recorded investment or fair value. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, we review the most recent appraisal and if it is over 12 to 18 months old we may request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, we may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically, as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of our primary market area, we would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired.

 

However, as a second example, on a nonperforming commercial real estate loan where we are familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, we may perform an internal analysis whereby the previous appraisal value would be reviewed considering recent current conditions, and known recent sales or listings of similar properties in the area, and any other relevant economic trends. This analysis may result in the call for a new appraisal. These valuations are reviewed and updated on a quarterly basis.

 

In accordance with ASC 820, Fair Value Measurement, impaired loans, where an allowance is established based on the fair value of collateral, require classification in the fair value hierarchy. These impaired loans are classified as Level 3. Impaired loans measured using discounted future cash flows are not deemed to be measured at fair value.

 

Mortgage Loans to be Sold

 

Mortgage loans to be sold carried at the lower of cost or market value. The fair values of mortgage loans to be sold are based on current market rates from investors within the secondary market for loans with similar characteristics. Carrying value approximates fair value. These loans are classified as Level 2.

 

Certain assets and liabilities are measured at fair value on an ongoing basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following tables present information about certain assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2019 and 2018.

 

   December 31, 2019 
    Level 1     Level 2     Level 3     Total  
Impaired loans   $     $     $ 2,657,644     $ 2,657,644  
Mortgage loans to be sold           5,062,398             5,062,398  
Total   $     $ 5,062,398     $ 2,657,644     $ 7,720,042  

 

   December 31, 2018 
   Level 1   Level 2   Level 3   Total 
Impaired loans  $   $   $2,223,028   $2,223,028 
Mortgage loans to be sold       1,199,438        1,199,438 
Total  $   $1,199,438   $2,223,028   $3,422,466 

 

 

62 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

There were no liabilities measured at fair value on a nonrecurring basis as of December 31, 2019 or 2018.

 

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at December 31, 2019:

 

    Inputs
    Valuation
Technique
 

Unobservable

Input  

  General Range
of Inputs
Impaired Loans   Appraisal Value/Comparison Sales/Other Estimates   Appraisals and/or Sales of Comparable Properties   Appraisals Discounted 10% to 20% for Sales Commissions and Other Holding Costs
             
Other Real Estate Owned   Appraisal Value/Comparison Sales/Other Estimates   Appraisals and/or Sales of Comparable Properties   Appraisals Discounted 10% to 20% for Sales Commissions and Other Holding Costs

 

Accounting standards require disclosure of fair value information for all of our assets and liabilities that are considered financial instruments, whether or not recognized on the balance sheet, for which it is practicable to estimate fair value.

 

Under the accounting standard, fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of the assets and liabilities that are not financial instruments. Accordingly, the aggregate fair value amounts of existing financial instruments do not represent the underlying value of those instruments on our books.

 

The following paragraphs describe the methods and assumptions we use in estimating the fair values of financial instruments:

 

a. Cash and due from banks, interest-bearing deposits at the Federal Reserve Bank

The carrying value approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.

 

b. Investment securities available for sale   

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

 

c. Loans 

The fair value of the Company’s loan portfolio includes a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: variable rate loans, impaired loans and all other loans. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. Additionally, in accordance with ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, this consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio.

 

For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral.

 

d. Deposits 

The estimated fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is estimated by discounting contractual cash flows, using interest rates currently being offered on the deposit products. The fair value estimates for deposits do not include the benefit that results from the low cost funding provided by the deposit liabilities as compared to the cost of alternative forms of funding (deposit base intangibles).

 

63 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

e. Accrued interest receivable and payable 

Since these financial instruments will typically be received or paid within three months, the carrying amounts of such instruments are deemed a reasonable estimate of fair value.

 

f. Loan commitments 

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing on the counterparties.

 

The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of our financial instruments as of December 31, 2019 and 2018, respectively.

 

 

Fair Value Measurements at December 31, 2019 

 
   

Carrying

Amount

   

Estimated

Fair Value

    Level 1     Level 2     Level 3  
Financial Assets:                                        
Cash and due from banks   $ 9,773,893     $ 9,773,893     $ 9,773,893     $     $  
Interest-bearing deposits at the Federal Reserve     39,320,526       39,320,526       39,320,526              
Investment securities available for sale     100,449,956       100,449,956       23,180,200       65,315,305       11,954,451  
Mortgage loans to be sold     5,062,398       5,062,398             5,062,398        
Loans, net     270,068,802       271,736,572                   271,736,572  
Accrued interest receivable     1,309,772       1,309,772             1,309,772        
Financial Liabilities:                                        
Demand deposits     357,008,868       357,008,868             357,008,868        
Time deposits     22,182,787       21,962,039             21,962,039        
Accrued interest payable     38,748       38,748             38,748        

 

   Fair Value Measurements at December 31, 2018 
  

Carrying  

Amount  

  

Estimated 

Fair Value 

   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and due from banks  $6,325,457   $6,325,457   $6,325,457   $   $ 
Interest-bearing deposits at the Federal Reserve   25,506,784    25,506,784    25,506,784         
Investment securities available for sale   119,668,874    119,668,874    32,356,634    81,070,285    6,241,955 
Mortgage loans to be sold   1,199,438    1,199,438        1,199,438     
Net loans   270,449,936    263,780,751             263,780,751 
Accrued interest receivable   1,561,915    1,561,915        1,561,915     
Financial Liabilities:                         
Demand deposits   347,909,663    347,909,663        347,909,663     
Time deposits   34,468,725    38,747,898        38,747,898     
Accrued interest payable   163,876    163,876        163,876     

 

21. Bank of South Carolina Corporation - Parent Company
   
  The Company’s principal source of income is dividends from the Bank. Certain regulatory requirements restrict the amount of dividends which the Bank can pay to the Company. The Company’s principal asset is its investment in its Bank subsidiary. The Company’s condensed statements of financial condition as of December 31, 2019 and 2018, and the related condensed statements of income and cash flows for the years ended December 31, 2019, 2018 and 2017, are as follows:

 

 

64 

 

 

BANK OF SOUTH CAROLINA CORPORATION  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Condensed Statements of Financial Condition   

 

    December 31,
2019
    December 31,
2018
 
Assets                
Cash   $ 1,096,474     $ 1,007,501  
Investment in wholly-owned bank subsidiary     50,731,750       45,103,068  
Other assets     224,608       178,629  
Total assets   $ 52,032,832     $ 46,289,198  
                 
Liabilities and shareholders’ equity                
Other liabilities   $ 884,800     $ 826,637  
Shareholders’ equity     51,168,032       45,462,561  
Total liabilities and shareholders’ equity   $ 52,052,832     $ 46,289,198  

 

Condensed Statements of Income

 

    For the year ended December 31,  
    2019     2018     2017  
Interest income   $ 1,280     $ 1,157     $ 484  
Net operating expenses     (221,510 )     (224,316 )     (189,872 )
Dividends received from bank     4,170,000       3,775,000       2,685,000  
Equity in undistributed earnings of subsidiary     3,368,663       3,371,093       2,406,213  
Net income   $ 7,318,433     $ 6,922,934     $ 4,901,825  

    

Condensed Statements of Cash Flows

 

    For the year ended December 31,  
    2019     2018     2017  
Cash flows from operating activities:                        
Net income   $ 7,318,433     $ 6,922,934     $ 4,901,825  
Stock-based compensation expense     78,053       72,408       71,701  
Equity in undistributed earnings of subsidiary     (3,368,663 )     (3,371,093 )     (2,406,213 )
(Increase) decrease in other assets     (45,979 )     (51,355 )     (51,197 )
(Decrease) increase in other liabilities         (6,333 )     151  
Net cash provided by operating activities     3,981,844       3,566,561       2,516,267  
                         
Cash flows from financing activities:                        
Dividends paid     (4,031,157 )     (3,699,845 )     (2,832,489 )
Stock options exercised, net of surrenders     138,286       193,569       340,843  
Net cash used by financing activities     (3,892,871 )     (3,506,276 )     (2,491,646 )
                         
Net increase in cash     88,973       60,285       24,621  
Cash at the beginning of the year     1,007,501       947,216       922,595  
Cash at the end of the year   $ 1,096,474     $ 1,007,501     $ 947,216  
                         
Supplemental disclosure for non-cash investing and financing activity                        
Change in dividends payable   $ 58,163     $ 85,615     $ 53,340  

 

65 

 

 

BANK OF SOUTH CAROLINA CORPORATION 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

22. Quarterly Results of Operations (unaudited)

 

The tables below represent the quarterly results of operations for the years ended December 31, 2019 and 2018, respectively: 

 

   2019 
   Fourth   Third   Second   First 
Total interest and fee income  $4,578,390   $4,827,684   $4,813,345   $4,692,833 
Total interest expense   112,311    213,876    245,226    243,758 
Net interest income   4,466,079    4,613,808    4,568,119    4,449,075 
Provision for loan losses   25,000    10,000    135,000    10,000 
Net interest income after provision for loan losses   4,441,079    4,603,808    4,433,119    4,439,075 
Total other income   601,017    596,070    592,739    408,783 
Total other expense   2,746,019    2,581,823    2,634,782    2,659,361 
Income before income tax expense   2,296,077    2,618,055    2,391,076    2,188,497 
Income tax expense   522,548    603,264    550,229    499,233 
Net income  $1,773,529   $2,014,791   $1,840,847   $1,689,264 
                     
Basic income per common share  $0.33   $0.36   $0.33   $0.31 
Diluted income per common share  $0.32   $0.36   $0.33   $0.30 

 

    2018  
    Fourth     Third     Second     First  
Total interest and fee income   $ 4,727,449     $ 4,665,586     $ 4,423,867     $ 4,320,009  
Total interest expense     249,425       195,434       139,697       109,830  
Net interest income     4,478,024       4,470,152       4,284,170       4,210,179  
Provision for loan losses     95,000       100,000       75,000       55,000  
Net interest income after provision for loan losses     4,383,024       4,370,152       4,209,170       4,155,179  
Other income     532,891       458,693       555,096       447,945  
Other expense     2,970,411       2,816,474       2,651,515       2,641,834  
Income before income tax expense     1,945,504       2,012,371       2,112,751       1,961,290  
Income tax expense     139,310       234,218       386,394       349,060  
Net income   $ 1,806,194     $ 1,778,153     $ 1,726,357     $ 1,612,230  
                                 
Basic income per common share   $ 0.33     $ 0.32     $ 0.31     $ 0.29  
Diluted income per common share   $ 0.32     $ 0.32     $ 0.31     $ 0.29  

 

66

 

 

Item 9.Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

 

None

 

Item 9A.Controls and Procedures

 

An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities and Exchange Act of 1934 as amended (the “Act”) was carried out as of December 31, 2019 under the supervision and with the participation of the Bank of South Carolina Corporation’s management, including its President/Chief Executive Officer and the Chief Financial Officer/Executive Vice President and several other members of the Company’s senior management. Based upon that evaluation, Bank of South Carolina Corporation’s management, including the President/Chief Executive Officer and the Chief Financial Officer/Executive Vice President concluded that, as of December 31, 2019, the Company’s disclosure controls and procedures were effective in ensuring that the information the Company is required to disclose in the reports filed or submitted under the Act has been (i) accumulated and communicated to management (including the President/Chief Executive Officer and Chief Financial Officer/Executive Vice President) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

Management’s Report on Internal Control Over Financial Reporting

 

The Company’s management is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.

 

Under the supervision and with the participation of management, including the President/Chief Executive Officer and the Chief Financial Officer/Executive Vice President, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2019, based on the 2013 framework established in a report entitled “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. Based on this assessment, management believes that as of December 31, 2019, the Company’s internal control over financial reporting was effective. There were no changes in the Company’s internal control over financial reporting that occurred during the year ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by the Company’s registered public accounting firm pursuant to the final ruling by the Securities and Exchange Commission that permit the Company to provide only management’s report in its annual report.

 

The Audit and Compliance Committee, composed entirely of independent Directors, meets periodically with management, the Company’s Compliance Officer, Risk Management Officer and Elliott Davis, LLC (separately and jointly) to discuss audit, financial and related matters. Elliott Davis, LLC, the Compliance Officer, and the Risk Management Officer have direct access to the Audit and Compliance Committee. 

 

Item 9B.Other Information

 

There was no information required to be disclosed in a report on Form 8-K during the fourth quarter of 2019 that was not reported.

 

67

 

 

PART III

 

Item 10.Directors, Executive Officers, Promoters and Corporate Governance

  

The information required by this item contained under the sections captioned “Proposal 1: To elect nineteen Directors of Bank of South Carolina Corporation to serve until the Company’s 2020 Annual Meeting of Shareholders” and “Meetings and Committees of the Board of Directors and Corporate Governance Matters” included in the Company’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 14, 2020, a copy of which has been filed with the SEC, the “Proxy Statement”, is incorporated in this document by reference.

 

Executive Officers The information concerning the Company’s executive officers is contained under the section captioned “Proposal 1: To elect nineteen Directors of Bank of South Carolina Corporation to serve until the Company’s 2021 Annual Meeting of Shareholders,” included in the Company’s Proxy Statement, and is incorporated in this document by reference.

 

Audit and Compliance Committee Financial Expert The Audit and Compliance Committee of the Company is composed of Directors Linda J. Bradley McKee, PhD, CPA, David W. Bunch, William L. Hiott, Jr., Karen J. Phillips, and Steve D. Swanson (Chairman). The Board has selected the Audit and Compliance Committee members based on its determination that they are qualified to oversee the accounting and financial reporting processes of the Company and audits of the Company’s financial statements. Each member of the Audit and Compliance Committee is “independent” as defined in the NASDAQ Stock Market listing standards for audit committee members.

 

The Board of Directors has determined that Linda J. Bradley McKee, PhD, CPA, qualifies as a financial expert within the meaning of SEC rules and regulations and has designated Dr. Bradley McKee as the Audit and Compliance Committee financial expert. Director Bradley McKee is independent as that term is used in Schedule 14A promulgated under the Exchange Act.

 

Code of Ethics The Company has adopted a “Code of Ethics”, applicable to the Chairman of the Board of Directors, the President/Chief Executive Officer, the Chief Financial Officer/Executive Vice President, the Chief Operating Officer/Executive Vice President and the Senior Lender/Executive Vice President and a “Code of Conduct” for Directors, officers and employees. A copy of these policies may be obtained at the Company’s website: http://www.banksc.com.

 

Compliance with Insider Reporting The information contained under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” is included in the Company’s Proxy Statement and is incorporated in this document by reference.

 

Item 11.Executive Compensation

 

The information required by this item is incorporated by reference to the Section captioned “Directors Compensation” and “Executive Compensation-Compensation Discussion and Analysis” included in the Proxy Statement.

 

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Security Ownership and Certain Beneficial Owners

 

Information required by this item is incorporated in this document by reference to the Section captioned “Security Ownership of Certain Beneficial Owners and Management” included in the Proxy Statement.

 

Security Ownership of Management

 

Information required by this item is incorporated in this document by reference to the Section captioned “Security Ownership of Certain Beneficial Owners and Management” included in the Proxy Statement.

 

Changes in Control

 

Management is not aware of any arrangements, including any pledge by any shareholder of the Company, the operation of which may at a subsequent date result in a change of control of the Company.

 

68

 

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

The information required by this item is incorporated in this document by reference to the Sections captioned “Proposal 1: To elect nineteen Directors of Bank of South Carolina Corporation to serve until the Company’s 2021 Annual Meeting of Shareholders” and “Meetings and Committees of the Board of Directors and Corporate Governance Matters”, included in the Proxy Statement.

 

Item 14. Principal Accounting Fees and Services

 

The information required by this item is incorporated in this document by reference to “Proposal 3: to ratify the appointment of Elliott Davis, LLC as the Company’s independent registered public accounting firm for the year ended December 31, 2020” and “Auditing and Related Fees”, included in the Proxy Statement.

 

69

 

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

1. The Consolidated Financial Statements and Report of Independent Auditors are included in this Form 10-K and listed on pages as indicated.
      Page
  (1)  Report of Independent Registered Public Accounting Firm   32
  (2) Consolidated Balance Sheets   33
  (3) Consolidated Statements of Income   34
  (4) Consolidated Statements of Comprehensive Income    35
  (5) Consolidated Statements of Shareholders’ Equity    36
  (6) Consolidated Statements of Cash Flows    37
  (7) Notes to Consolidated Financial Statements    38 - 66

 

2. Exhibits

 

  2.0 Plan of Reorganization (Filed with 1995 10-KSB)
  3.0 Articles of Incorporation of the Registrant (Filed with 1995 10-KSB)
  3.1 By-laws of the Registrant (Filed with 1995 10-KSB)
  3.2 Amendments to the Articles of Incorporation of the Registrant (Filed with Form S-3 on June 23, 2011)
  4.0 2019 Proxy Statement (Filed with 2018 10-K)
  10.0 Lease Agreement for 256 Meeting Street (Filed with 1995 10-KSB)
  10.1 Sublease Agreement for Parking Facilities at 256 Meeting Street (Filed with 1995 10-KSB)
  10.2 Lease Agreement for 100 N. Main Street, Summerville, SC (Filed with 1995 10-KSB)
  10.3 Lease Agreement for 1337 Chuck Dawley Blvd., Mt. Pleasant, SC (Filed with 1995 10-KSB)
  10.4 Lease Agreement for 1071 Morrison Drive, Charleston, SC (Filed with 2010 10-K)
    Lease Agreement for 1071 Morrison Drive, Charleston, SC (Filed with March 31, 2013 10-Q) 
  10.5 1998 Omnibus Stock Incentive Plan (Filed with 2008 10-K/A)
  10.6 Employee Stock Ownership Plan (Filed with 2008 10-K/A)
    Employee Stock Ownership Plan, Restated (Filed with 2011 Proxy Statement) 
    Employee Stock Ownership Plan, Restated (Incorporated herein) 
  10.7 2010 Omnibus Incentive Stock Option Plan (Filed with 2010 Proxy Statement)
  10.8 Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2013 10-K)
  10.9 Assignment and Assumption of Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2015 10-K)
  10.10 First Amendment to Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2015 10-K)
  10.11 Second Amendment to Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2015 10-K)
  10.12 Extension to Lease Agreement for 256 Meeting Street (Filed with September 30, 2017 10-Q)
  10.13 North Charleston Lease Agreement (Filed with June 30, 2017 10-Q)
  10.14 Sublease Amendment for Parking Facilities at 256 Meeting Street (Filed with September 30, 2017 10-Q)
  13.0 2018 10-K (Incorporated herein)
  14.0 Code of Ethics (Filed with 2004 10-KSB)
  21.0 List of Subsidiaries of the Registrant (Filed with 1995 10-KSB)
    The Registrant’s only subsidiary is The Bank of South Carolina (Filed with 1995 10-KSB) 
  31.1 Certification pursuant to Rule 13a-14(a)/15d-14(a) by the Principal Executive Officer
  31.2 Certification pursuant to Rule 13a-14(a)/15d-14(a) by the Principal Financial Officer
  32.1 Certification pursuant to Section 1350
  32.2 Certification pursuant to Section 1350
  101.INS XBRL Instance Document
  101.SCH XBRL Taxonomy Extension Schema Document
  101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
  101.DEF XBRL Taxonomy Extension Definition Linkbase Document
  101.LAB XBRL Taxonomy Extension Label Linkbase Document
  101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

70

 

 

SIGNATURES

 

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

 

Date: March 6, 2020 BANK OF SOUTH CAROLINA CORPORATION
     
  By: /s/ Fleetwood S. Hassell
    Fleetwood S. Hassell
    President/Chief Executive Officer
     
  By: /s/ Eugene H. Walpole, IV
    Eugene H. Walpole, IV
    Chief Financial Officer/Executive Vice President

 

71

 

 

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

 

March 6, 2020 /s/ David W. Bunch
  David W. Bunch, Director
   
March 6, 2020 /s/ Graham M. Eubank, Jr.
  Graham M. Eubank, Jr., Director
   
March 6, 2020 /s/ Elizabeth M. Hagood
  Elizabeth M. Hagood, Director
   
March 6, 2020 /s/ Fleetwood S. Hassell
  Fleetwood S. Hassell, President/
Chief Executive Officer, Director
   
March 6, 2020 /s/ Glen B. Haynes, DVM
  Glen B. Haynes, DVM, Director
   
March 6, 2020 /s/ William L. Hiott, Jr.
  William L. Hiott, Jr., Director
   
March 6, 2020 /s/ Richard W. Hutson, Jr.
  Richard W. Hutson, Jr., Director
   
March 6, 2020 /s/ Charles G. Lane
  Charles G. Lane, Director
   
March 6, 2020 /s/ Hugh C. Lane, Jr.
  Hugh C. Lane, Jr., Chairman of the Board, Director
   
March 6, 2020 /s/ Linda. J. Bradley McKee, PHD, CPA
  Linda J. Bradley McKee, PHD, CPA, Director
   
March 6, 2020 /s/ Alan I. Nussbaum
  Alan I. Nussbaum, MD, Director
   
March 6, 2020 /s/ Karen J. Phillips
  Karen J. Phillips, Director
   
March 6, 2020 /s/ Malcolm M. Rhodes
  Malcolm M. Rhodes, MD, Director
   
March 6, 2020 /s/ Douglas H. Sass
  Douglas H. Sass, Executive Vice President, Director
   
March 6, 2020 /s/ Sheryl G. Sharry
  Sheryl G. Sharry, Director
   
March 6, 2020 /s/ Steve D. Swanson
  Steve D. Swanson, Director
   
March 6, 2020 /s/ Susanne K. Boyd
  Chief Operating Officer/Executive Vice President, Director
   
March 6, 2020 /s/ Eugene H. Walpole, IV
  Chief Financial Officer/Executive Vice President, Director

 

72