Item 1. Business
This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These 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 which are beyond our control. The words “may,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties include, but are not limited to, those described below under “Risk Factors” and the following:
· reduced earnings due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;
· reduced earnings due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;
· restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals;
· potential non-payment of dividends on preferred stock issued to the U.S. Treasury under the Capital Purchase Program component of the Troubled Asset Relief Program;
· our efforts to raise capital or otherwise increase our regulatory capital ratios;
· our ability to retain our existing customers, including our deposit relationships;
· changes in deposit flows;
· significant increases in competitive pressure in the banking and financial services industries;
· changes in the interest rate environment, which could reduce anticipated or actual margins;
· changes in political conditions or the legislative or regulatory environment, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations adopted thereunder, changes in federal and/or state tax laws or interpretations thereof by taxing authorities, changes in laws, rules or regulations applicable to companies that have participated in the U.S. Treasury’s Capital Purchase Program and other governmental initiatives affecting the financial services industry;
· general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected, resulting in, among other things, a deterioration in credit quality;
· changes occurring in business conditions and inflation;
· increased funding costs due to market illiquidity, increased competition for funding, and/or increased regulatory requirements with regard to funding;
· changes in technology;
· changes in monetary and tax policies;
· the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
· the rate of delinquencies and amounts of loan charge-offs;
· the rates of loan growth;
· the amount of our loan portfolio collateralized by real estate, and the weakness in the real estate market;
· our reliance on available secondary funding sources such as Federal Home Loan Bank advances, Federal Reserve Discount Window borrowings, sales of securities and loans, and federal funds lines of credit from correspondent banks to meet our liquidity needs;
· our ability to maintain effective internal control over financial reporting;
· adverse changes in asset quality and resulting credit risk-related losses and expenses;
· changes in monetary and tax policies, including confirmation of the income tax refund claims received by the Internal Revenue Service;
· loss of consumer confidence and economic disruptions resulting from terrorist activities or other military activity;
· changes in the securities markets; and
· other risks and uncertainties detailed in Part I, Item 1A
Item 1A. Risk Factors.
Difficult market conditions in our market and general economic trends have adversely affected our industry and our business and may continue to do so.
Our business has been directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control. The current economic downturn, increase in unemployment and other events that have negatively affected both household and corporate incomes, both nationally and locally, have decreased the demand for loans and our other products and services and have increased the number of customers who fail to pay interest and/or principal on their loans. As a result, we have experienced significant declines in our real estate markets with decreasing prices and increasing delinquencies and foreclosures, which have negatively affected the credit performance of our loans and resulted in increases in the level of our nonperforming assets and charge-offs of problem loans. At the same time, competition among depository institutions for deposits and quality loans has increased significantly. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. These market conditions and the tightening of credit have led to increased deficiencies in our loan portfolio, increased market volatility and widespread reduction in general business activity.
Our future success significantly depends upon the growth in population, income levels, deposits and housing starts in our market areas. Unlike many larger institutions, we are not able to spread the risks of unfavorable economic conditions across a large number of diversified economies and geographic locations. If the markets in which we operate do not recover and grow as anticipated or if prevailing economic conditions locally or nationally do not improve, our business may continue to be negatively impacted.
A significant portion of our loan portfolio is secured by real estate, and events that negatively affect the real estate market could hurt our business.
Beginning in the second half of 2007 and continuing through 2011, the financial markets were beset by significant volatility associated with subprime mortgages, including adverse impacts on credit quality and liquidity within the financial markets. The volatility has been exacerbated by a significant decline in the value of real estate. As of December 31, 2011, approximately 88.8% of our loans were secured by real estate mortgages. The real estate collateral for these loans provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. We do not generally originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. A further weakening of the real estate market in our market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholder’s equity could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.
We are exposed to higher credit risk by commercial real estate, construction, and commercial lending.
Commercial real estate, commercial, and construction lending usually involves higher credit risks than that of single-family residential lending. As of December 31, 2011, the following loan types accounted for the stated percentages of our total loan portfolio: commercial real estate 37.4%; construction, land development and other land 9.9%; and commercial 9.8%. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.
Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of the property construction (including interest), the availability of permanent take-out financing, and the builder’s ability to ultimately sell the property. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.
Commercial and industrial loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the collateral securing the loans have the following characteristics: (a) they depreciate over time, (b) they are difficult to appraise and liquidate, and (c) they fluctuate in value based on the success of the business.
Commercial real estate, construction, and commercial loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans. The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures.
Our decisions regarding credit risk and reserves for loan losses may materially and adversely affect our business.
Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:
· the duration of the credit;
· credit risks of a particular customer;
· changes in economic and industry conditions; and
· in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.
We attempt to maintain an appropriate allowance for loan losses to provide for probable losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including:
· an ongoing review of the quality, mix, and size of our overall loan portfolio;
· our historical loan loss experience;
· evaluation of economic conditions;
· regular reviews of loan delinquencies and loan portfolio quality; and
· the amount and quality of collateral, including guarantees, securing the loans.
There is no precise method of predicting credit losses since any estimate of loan losses is necessarily subjective and the accuracy of the estimate depends on the outcome of future events. Therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would result in an increase of our net loss, and possibly a decrease in our capital.
While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. As of December 31, 2011, we had $6,709,373 in loans that had loan-to-value ratios that exceeded regulatory supervisory guidelines. In addition, supervisory limits on commercial loan to value exceptions are set at 30% of our Bank’s capital. At December 31, 2011, we had $3,738,887 in commercial loans that exceeded the supervisory loan to value ratio. The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.
Lack of seasoning of our loan portfolio may increase the risk of credit defaults in the future.
Due to our short operating history, all of the loans in our loan portfolio and of our lending relationships are of relatively recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.
Our net interest income could be negatively affected by the lower level of short-term interest rates, recent developments in the credit and real estate markets and competition in our market area.
As a financial institution, our earnings significantly depend upon our net interest income, which is the difference between the income that we earn on interest-earning assets, such as loans and investment securities, and the expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve’s fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and net income.
The Federal Reserve reduced interest rates on three occasions in 2007 by a total of 100 basis points, to 4.25%, and by another 400 basis points, to a range of 0% to 0.25%, during 2009. Rates remained steady for 2010 and 2011. In 2011, the Federal Reserve announced its intentions to attempt to maintain low interest rates. Approximately 48.9% of our loans were variable rate loans at December 31, 2011. The interest rates on a significant segment of these loans decrease when the Federal Reserve reduces interest rates, while the interest that we earn on our assets may not change in the same amount or at the same rates. Accordingly, increases in interest rates may reduce our net interest income. In addition, an increase in interest rates may decrease the demand for loans. Furthermore, increases in interest rates will add to the expenses of our borrowers, which may adversely affect their ability to repay their loans with us.
Increased nonperforming loans and the decrease in interest rates reduced our net interest income during 2011 and could cause additional pressure on net interest income in future periods. This reduction in net interest income may also be exacerbated by the high level of competition that we face in our primary market areas. Any significant reduction in our net interest income could negatively affect our business and could have a material adverse effect on our capital, financial condition and results of operations.
Continuation of the economic downturn could reduce our customer base, our level of deposits, and demand for financial products such as loans.
Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan portfolio. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed. A continuation of the economic downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately 86.3% of our interest income for the year ended December 31, 2011. If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.
There can be no assurance that recently enacted legislation will help stabilize the U.S. financial system.
In response to the challenges facing the financial services sector, a number of regulatory and legislative actions have been enacted or announced. There can be no assurance that these government actions will achieve their
purpose. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity and a continuation or worsening of current financial market and economic conditions, could materially and adversely affect our business, financial condition, results of operations, and the price of our common stock.
We are subject to extensive regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business and limit our ability to receive dividends from our bank.
We are subject to Federal Reserve regulation. Our Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC. Also, as a member of the Federal Home Loan Bank (the “FHLB”), our Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Regulation by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of our shareholders. Our Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against our bank under these laws could have a material adverse effect on our results of operations.
We are exposed to further changes in the regulation of financial services companies.
Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America and the General Assembly of the State of South Carolina. The agencies regulating the financial services industry also periodically adopt changes to their regulations. On September 7, 2008, the Treasury announced that Freddie Mac (along with Fannie Mae) had been placed into conservatorship under the control of the newly created Federal Housing Finance Agency. On October 3, 2008, EESA was signed into law, and on October 14, 2008 the Treasury announced the CPP under EESA. On February 17, 2009, the Recovery Act was signed into law. In November 2009, the FDIC announced a final rule to require FDIC insured banks to prepay the fourth quarter assessment and the next three years assessment by December 31, 2009. On July 21, 2010, the Dodd-Frank Act was signed into law. Pursuant to authority granted under the Dodd-Frank Act, effective on October 1, 2011, the Federal Reserve established new rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion. While we are not subject to the interchange fee restrictions, the new restrictions could negatively impact bank card services income for smaller banks if the reductions that are required of larger banks cause industry-wide reduction of swipe fees. In December 2010, the Basel Committee revised final frameworks for the regulation of capital and liquidity of internationally active banking organizations. Although the U.S. banking agencies have not yet published a notice of proposed rulemaking to implement Basel III in the United States, they are likely to do so (at least with respect to the Basel III capital framework) during 2012. In addition to Basel III, the Dodd-Frank Act requires or permits the federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. We can provide no assurance regarding the manner in which any new laws and regulations will affect us. See “Risk Factors-We are subject to extensive regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business and limit our ability to receive dividends from our bank” above.
We may be adversely affected by the soundness of other financial institutions.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the bank. Any such losses could have a material adverse affect on our financial condition and results of operations.
We could experience a loss due to competition with other financial institutions.
The banking and financial services industry is very competitive. Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to compete with us. The financial services industry has and is experiencing an ongoing trend towards consolidation in which fewer large national and regional banks
and other financial institutions are replacing many smaller and more local banks. These larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources and a wider geographic presence or greater accessibility. In some instances, these larger entities operate without the traditional brick and mortar facilities that restrict geographic presence. Some competitors are able to offer more services, more favorable pricing or greater customer convenience than the company. In addition, competition has increased from new banks and other financial services providers that target our existing or potential customers. As consolidation continues among large banks, we expect other smaller institutions to try to compete in the markets we serve.
Technological developments have allowed competitors, including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers. If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in the industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.
Negative public opinion surrounding our company and the financial institutions industry generally could damage our reputation and adversely impact our earnings.
Reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our company and the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business.
We could experience an unexpected inability to obtain needed liquidity.
Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining a level of liquidity through asset/liability management as well as through, among other things, our ability to borrow funds from the Federal Home Loan Bank and the Federal Reserve Bank. As December 31, 2011, our borrowing capacity with the Federal Home Loan Bank was $12,197,000 of which $5,197,000 is available. Both institution specific events such as deterioration in our credit ratings resulting from a weakened capital position or from lack of earnings and industry-wide events such as a collapse of credit markets may result in a reduction of available funding sources sufficient to cover the liquidity demands. If we are unable to obtain funds when needed, it could materially adversely affect our business, financial condition and results of operations.
Because of our participation in the Treasury Department’s Capital Purchase Program, we are subject to several restrictions including restrictions on compensation paid to our executives.
Pursuant to the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the CPP Purchase Agreement, including the common stock which may be issued pursuant to the CPP Warrant. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.
Legislation or regulatory changes could cause us to seek to repurchase the preferred stock that we sold to the U.S. Treasury pursuant to the Capital Purchase Program.
Legislation that has been adopted after we closed on our sale of Series A and Series B Preferred Stock to the Treasury for approximately $3.3 million pursuant to the CPP on January 9, 2009, or any legislation or regulations that may be implemented in the future, may have a material impact on the terms of our CPP transaction with the Treasury. If we determine that any such legislation or any regulations, in whole or in part, alter the terms of our CPP transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then it is possible that we may seek to unwind, in whole or in part, the CPP transaction by repurchasing some or all of the preferred stock that we sold to the Treasury pursuant to the CPP. If we were to repurchase all or a portion of such preferred stock, then our capital levels could be materially reduced.
The securities purchase agreement between us and the Treasury limits our ability to pay dividends on and repurchase our common stock.
The securities purchase agreement between us and the Treasury provides that prior to January 9, 2012, unless we have redeemed the Series A Preferred Stock and Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock or Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to declare or pay any dividend or make any distribution on our common stock. The purchase agreement further provides that prior to January 9, 2019, unless we have redeemed the Series A Preferred Stock and Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock or Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to redeem, purchase or acquire any shares of our common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the purchase agreement. These restrictions could have a negative effect on the value of our common stock.
Higher FDIC deposit insurance premiums and assessments could adversely impact our financial condition.
Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC. Although we cannot predict what the insurance assessment rates will be in the future, either a deterioration in our risk-based capital ratios or adjustments to the base assessment rates could have a material adverse impact on our business, financial condition, results of operations, and cash flows.
We depend on the accuracy and completeness of information about clients and counterparties and our financial condition could be adversely affected if we rely on misleading information.
In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively affected to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.
Changes in prevailing interest rates may reduce our profitability.
Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Depending on the terms and maturities of our assets and liabilities, a significant change in interest rates could have a material adverse effect on our profitability. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer.
The costs of being an SEC registered company are proportionately higher for smaller companies like us because of the requirements imposed by the Sarbanes-Oxley Act.
The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. These regulations are applicable to our company. We have experienced, and expect to continue to experience, increasing compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act. These necessary costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.
Our continued operations and future growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. To support our continued operations, including any additional growth, we may need to raise additional capital. In addition, we intend to redeem the Series A Preferred Stock that we issued to the Treasury under the CPP before the dividends on the Series A Preferred Stock increase from 5% per annum to 9% per annum in 2014, as we may need to raise additional capital to do so. Our ability to raise additional capital will depend in part on conditions in the capital markets at that time, which are outside our control, and our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to continue our current operations or further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, your interest could be diluted.
We face strong competition for clients, which could prevent us from obtaining clients and may cause us to pay higher interest rates to attract deposits.
The banking business is highly competitive, and we experience competition in our market from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our client base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not provide. There are also a number of other relatively new community banks in our market that share our general marketing focus on small- to medium-sized businesses and individuals. There is a risk that we will not be able to compete successfully with other financial institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.
We will face risks with respect to future expansion and acquisitions or mergers.
Although we do not have any current plans to do so, we may seek to acquire other financial institutions or parts of those institutions. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:
· the potential inaccuracy of the estimates and judgments used to evaluate credit, operations, management, and market risks with respect to a target institution;
· the time and costs of evaluating new markets, hiring or retaining experienced local management, and opening new offices and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;
· the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse effects on our results of operations; and
· the risk of loss of key employees and customers.
We have never acquired another institution before, so we lack experience in handling any of these risks. There is the risk that any expansion effort will not be successful.
The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand.
To expand our franchise successfully, we must identify and retain experienced key management members with local expertise and relationships in these markets. We expect that competition for qualified management in the markets in which we may expand will be intense and that there will be a limited number of qualified persons with knowledge of and experience in the community banking industry in these markets. Even if we identify individuals that we believe could assist us in establishing a presence in a new market, we may be unable to recruit these individuals away from more established financial institutions. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy requires both management and financial resources and is often lengthy. Our inability to identify, recruit, and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition, and results of operations.
We are exposed to the possibility of technology failure and a disruption in our operations may adversely affect our business.
We rely on our computer systems and the technology of outside service providers. Our daily operations depend on the operational effectiveness of their technology. We rely on our systems to accurately track and record our assets and liabilities. If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition. In addition, a disruption in our operations resulting from failure of transportation and telecommunication systems, loss of power, interruption of other utilities, natural disaster, fire, global climate changes, computer hacking or viruses, failure of technology, terrorist activity or the domestic and foreign response to such activity or other events outside of our control could have an adverse impact on the financial services industry as a whole and/or on our business. Our business recovery plan may not be adequate and may not prevent significant interruptions of our operations or substantial losses.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2. Properties.
Our Sunset office, which opened in January, 2009 is located at the intersection of Sunset Boulevard and Kim Street approximately one mile east of the Lexington Medical Center. Our address is 2023 Sunset Boulevard, West Columbia, South Carolina 29169. The building is approximately 4,100 square feet on a site that is approximately 1.5 acres in size and is a full service banking facility with three drive-thru lanes and one drive-thru ATM. The Sunset office is subject to a 15 year lease, with the option to extend the lease for two consecutive renewal terms of five years each.
We also occupy another branch and administration office located at 1201 Knox Abbot Drive, Cayce, South Carolina. This building is approximately 7,500 square feet in administration area and approximately 2,100 square feet branch office with a drive in facility. In December 2009, we entered into a sale-lease back agreement for a portion of this property. The lease is for a period of 15 years, with the option to extend the lease for three consecutive renewal terms of five years each. This property is approximately 5,674 square feet which the Bank leases to other tenants. In June 2010, the Company entered into a sale-lease back agreement for a branch and office building located at 1201 Knox Abbot Drive in Cayce, South Carolina. The lease is for a period of 15 years, with the option to extend the lease for two consecutive renewal terms of five years each.
Item 3.
Item 3. Legal Proceedings.
In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We are not aware of any pending or threatened proceeding against us which we expect to have a material effect on our business, results of operations, or financial condition.
Item 4.
Item 4. Mine Safety Disclosures.
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Since February 2, 2009, our common stock has been quoted on the OTC Bulletin Board under the symbol “CNRB.” Quotations on the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not represent actual transactions. Transactions of our common stock did not begin to occur on the OTC Bulletin Board until February 4, 2009.
The following is a summary of the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated:
As of March 19, 2012, there were 1,764,439 shares of common stock outstanding held by approximately 1,807 shareholders of record. All of our currently issued and outstanding common stock was issued in our initial public offering which was completed on October 16, 2006.
We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future, we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay dividends depends on the ability of our subsidiary, Congaree State Bank, to pay dividends to us. As a South Carolina state bank, our Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, our Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital. In addition, the Bank currently must obtain prior approval from the FDIC and the South Carolina Board of Financial Institutions prior to the payment of any cash dividends.
In addition, on January 9, 2009, as part of the Capital Purchase Program established by the Treasury under the EESA, we entered into the CPP Purchase Agreement with Treasury, pursuant to which we issued and sold to Treasury (i) 3,285 shares of our Series A Preferred Stock, and (ii) a ten-year warrant to purchase 164 shares of our Series B Preferred Stock, for an aggregate purchase price of $3,285,000 in cash. Pursuant to the CPP Purchase Agreement, prior to January 9, 2012, unless we have redeemed the Series A Preferred Stock and the Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock and the Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to declare or pay any dividend or make any distribution on our common stock.
The following table sets forth equity compensation plan information at December 31, 2011.
Equity Compensation Plan Information
(1) At our annual meeting in 2007, we adopted the Congaree Bancshares, Inc. 2007 Stock Incentive Plan.
(2) Each of our organizers received, for no additional consideration, a warrant to purchase one share of common stock for $10.00 per share for each share purchased during our initial public offering up to a maximum of 10,000 warrants. The warrants are represented by separate warrant agreements. The warrants vested over a three year period beginning October 16, 2007, and they are exercisable in whole or in part during the 10 year period ending October 16, 2016. If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the Bank to obtain additional capital, the warrants will be forfeited, if not immediately exercised.
Item 6.
Item 6. Selected Financial Data.
Not applicable.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
General
Our Bank opened for business on October 16, 2006. All activities of the Company prior to that date relate to the organization of the Bank. The following discussion describes our results of operations for the years ended December 31, 2011 and 2010 and also analyzes our financial condition as of December 31, 2011. The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.
Like most community banks, we derive the majority of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits, also known as net interest margin. 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, which is referred to as net interest spread.
We have included a number of tables to assist in our description of these measures. For example, the “Average Balances, Income and Expenses, and Rates” tables show for the periods indicated the average balance for each category of our assets and liabilities, as well as the average yield we earned or the average rate we paid with respect to each category. A review of these tables show that our loans historically have provided higher interest yields than our other types of interest-earning assets, which is why we have invested a substantial percentage of our
earning assets into our loan portfolio. Similarly, the “Rate/Volume Analysis” table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included “Interest Sensitivity Analysis” tables to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, our deposits and other borrowings.
There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the “Loans” and “Provision and Allowance for Loan Losses” sections, we have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.
In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our clients. We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.
The Effect of the Current Economic Environment on our Bank
Like many financial institutions across the United States and in South Carolina, our operations have been adversely affected by the current economic crisis. Beginning in 2008 and continuing through 2011, we recognized that construction, acquisition, and development real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing. Portfolio-wide delinquencies remained at an elevated level throughout 2011. The Bank’s management continues to aggressively manage the level and number of delinquent borrowers. Delinquencies were evenly distributed across portfolios and non-accruing loans were primarily concentrated in real estate loans.
As of December 31, 2011, approximately 88.8% of our loans had real estate as a primary or secondary component of collateral. Included in our loans secured by real estate, we have approximately $8,753,485 of construction, land development and other land loans as of December 31, 2011, most of which are on properties located within the Columbia MSA and consist primarily of loans to individuals or closely held real estate holding companies where the borrower was holding property for current and/or future personal use. Additionally, $480,654 of all construction, land development, and other land loans are single family residence construction loans to the individual who intends on using the constructed house as their primary residence.
Non-performing assets remained virtually unchanged during 2011. As of December 31, 2011, our non-performing assets equaled $4.7 million, or 3.88% of assets, as compared to $4.7 million, or 3.88% of assets, as of December 31, 2010. For the year ended December 31, 2011, we recorded a provision for loan losses of $744,000 and net loan charge-offs of $900,473, or 1.03% of average loans, as compared to a $853,109 provision for loan losses and net loan charge-offs of $799,985, or 0.85% of average loans, for the year ended December 31, 2010. In general, the elevated level of provision for loan losses for 2011 was attributed to the overall strain in the economy.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in footnote 1 to our audited consolidated financial statements as of December 31, 2011, included herein. Management has discussed these critical accounting policies with the audit committee.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan Losses
We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the creditworthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses.
Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.
Income Taxes
We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent nondeductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.
Results of Operations
General
Our net income was $741,007 and net loss was $298,557 for the years ended December 31, 2011 and 2010, respectively. Net income before income tax benefit was $348,499 for the year ended December 31, 2011, an increase of $647,056, compared to a loss of $298,557 for the year ended December 31, 2010. The increase in net income before income taxes in 2011 resulted from a $348,597 decrease in noninterest expense and an increase of $244,495 in net interest income. Noninterest income decreased from $662,066 for the year ended December 31, 2010, to $606,921 for the year ended December 31, 2011. We also recorded a provision for loan losses of $744,000 and $853,109 for the years ended December 31, 2011 and 2010, respectively.
Net Interest Income
Our primary source of revenue is net interest income. Net interest income is the difference between income earned on interest-earning assets and interest paid on deposits and borrowings used to support such assets. The level of net interest income is determined by the balances of interest-earning assets and interest-bearing liabilities and corresponding interest rates earned and paid on those assets and liabilities, respectively. In addition to the volume of and corresponding interest rates associated with these interest-earning assets and interest-bearing liabilities, net interest income is affected by the timing of the repricing of these interest-earning assets and interest-bearing liabilities.
Net interest income was $4,446,699 for the year ended December 31, 2011, an increase of $244,495 or 5.8%, over net interest income of $4,202,204 for the year ended December 31, 2010. Interest income of $5,632,858 for the year ended December 31, 2011, included $4,862,510 on loans, $754,489 on investment securities and $15,859 on federal funds sold. Loan interest and related fees decreased $647,552, or 11.8%, during 2011, due to a decrease in the loan portfolio volume. Total interest expense of $1,186,159 for the year ended December 31, 2011 included $1,093,143 related to deposit accounts and $93,016 on federal funds purchased and Federal Home Loan
Bank borrowings. Interest expense on deposits decreased $857,817, or 44.0%, during 2011 due to the decrease in deposit rates and volume during 2011.
The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees is amortized into interest income over the life of the loans.
Average Balances, Income and Expenses, and Rates
(1) Loan fees, which are immaterial, are included in interest income. There were $1,550,775 in nonaccrual loans for 2011 and $1,417,289 nonaccrual loans in 2010. Nonaccrual loans are included in the average balances, and income on nonaccrual loans is included on the cash basis for yield computation purposes.
Our consolidated net interest margin for the year ended December 31, 2011 was 3.74%, an increase of 46 basis points from the net interest margin of 3.29% for the year ended December 31, 2010. The net interest margin is calculated by dividing net interest income by year-to-date average earning assets. This increase can be attributed to the costs of our funding sources. We rely on a higher volume of money market and time deposits to fund our loan portfolio and, as they mature, these deposits are being replaced at lower interest rates. Earning assets averaged $118,871,302 for the year ended December 31, 2011, decreasing from $127,969,697 for the year ended December 31, 2010. Our net interest spread was 3.59% for the year ended December 31, 2011. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing
liabilities. In pricing deposits, we consider our liquidity needs, the direction and levels of interest rates and local market conditions. As such, higher rates than local competitors have been paid initially to attract deposits.
Rate/Volume Analysis
Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following table sets forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates had on changes in net interest income for the comparative periods presented. Changes attributed to both rate and volume, have been allocated on a pro rata basis.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as a non-cash expense to our statement of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.
Our provision for loan losses for the year ended December 31, 2011 was $744,000, a decrease of $109,109, or 12.8%, over our provision of $853,109, for the year ended December 31, 2010. The allowance as a percentage of gross loans decreased from approximately 1.7% as of December 31, 2010 to 1.6% as of December 31, 2011, due to management’s evaluation of the adequacy of the reserve for possible loan losses given the size, mix, and quality of the current loan portfolio. Management also relies on our limited history of past-dues and charge-offs, as well as peer data to determine our loan loss allowance.
Noninterest Income
Noninterest income for the year ended December 31, 2011 was $606,921 compared to $662,066 for the year ended December 31, 2010. For the year ended December 31, 2011, mortgage loan origination fees were $26,332, a decrease of $49,679, or 65.4%, from 2010, due to the decrease in the volume of mortgage loans originated. We expect this trend to continue and then increase as market conditions improve. Noninterest income included gains on sales of securities available-for-sale of $259,155 for the year ended December 31, 2011, compared to $439,130 in 2010. We did not recognize the amount of gains in 2011 as we did in 2010 in order to maintain the yield on the investment portfolio. In addition, a loss of $174,047 on the sale of bank assets was incurred in 2010 and included in noninterest income. The Bank did not incur any losses on sale of bank assets in 2011.
Noninterest Expenses
The following table sets forth information related to our noninterest expenses for the year ended December 31, 2011 and 2010.
Noninterest expense was $3,961,121 for the year ended December 31, 2011, compared to $4,309,718 for the year ended December 31, 2010. The most significant component of noninterest expense is compensation and benefits, which totaled $1,600,268 for the year ended December 31, 2011, compared to $1,820,278 for the year ended December 31, 2010. The decrease is primarily related to staff reductions in 2011. Occupancy and equipment expense of $913,319 in 2011 increased from $838,949 in 2010 due to the sale of the administration building in June of 2010 and recognizing a full year of lease expense in 2011. Other professional fees decreased from $116,434 in 2010 to $31,123 in 2011 due to reduction in the use of outside consultants. Net cost of operations of other real estate expenses increased from $156,966 in 2010 to $234,493 in 2011 as a result of an increase in the number of real estate owned during the year. Regulatory fees and FDIC insurance decreased from $442,999 in 2010 to $235,327 in 2011, primarily due to a decrease in FDIC insurance assessments in the second quarter of 2011. The increase in other expenses from $96,899 in 2010 to $174,095 was due to an increase in operational expenses.
Income Taxes
The Company had taxable income for the year ended December 31, 2011 and no taxable income for year ended 2010. Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. Management has determined that a partial valuation allowance is needed at December 31, 2011. Management’s judgment is based on estimates concerning future income earned and positive earnings for the year ended December 31, 2011. Management has concluded that sufficient positive evidence exists to overcome any and all negative evidence in order to meet the “more likely than not” standard regarding the realization of a portion of net deferred tax assets. As a result, the valuation allowance was reduced by $427,152 in 2011.
Balance Sheet Review
General
At December 31, 2011, total assets were $121,993,546 compared to $121,176,715 at December 31, 2010, for an increase of $816,831, or 0.67%. The slight increase in assets resulted from an increase in our investment securities, partially offset by a decrease in our loan portfolio and federal funds sold. Interest-earning assets comprised approximately 93.9% and 93.7% of total assets at December 31, 2011 and December 31, 2010, respectively. Gross loans totaled $88,344,578 at December 31, 2011, a decrease of $1,991,031, or 2.20%, from $90,335,609 at December 31, 2010. The reduction in gross loans was the result of our plan to reduce our overall risk profile, specifically to reduce the overall size of the balance sheet, in order to increase our capital ratios. Accordingly, we are actively seeking to improve our credit quality and preserve capital. In addition, we transferred loans in the amount of $625,711 to other real estate owned during the year ended December 31, 2011. Investment securities were $27,568,257 at December 31, 2011, an increase of $5,174,051, or 23.1%, from $22,394,206 at December 31, 2010. Investment in overnight federal funds decreased $2,194,000 to $86,000 at December 31, 2011.
Deposits totaled $102,526,449 at December 31, 2011, a $4,059,543, or 3.81%, decrease from $106,585,992 at December 31, 2010. Shareholders’ equity was $12,281,465 and $11,176,648 at December 31, 2011 and December 31, 2010, respectively.
Investments
At December 31, 2011, our available for sale investment securities portfolio was $26,952,357 and represented approximately 22.1% of our total assets. Available for sale investment securities increased $6,175,700 from $20,776,657 at December 31, 2010. Our portfolio consisted of U.S. government sponsored agencies of $17,640,339, mortgage-backed agencies of $1,597,764 and state, county and municipal investment securities of $7,714,254.
Contractual maturities and yields on our investment securities available for sale at December 31, 2011 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
At December 31, 2011, we had no held to maturity investment securities portfolio. At December 31, 2010, the held to maturity investment securities portfolio was $1,143,249.
The amortized costs and the fair value of our investment securities available-for-sale at December 31, 2011 and 2010 are shown in the following table.
The amortized costs and the fair value of our investment securities held-to-maturity at December 31, 2011 and 2010 are shown in the following table.
We believe, based on industry analyst reports and credit ratings, the deterioration in fair values of individual investment securities available-for-sale is attributed to changes in market interest rates and not in the credit quality of the issuer and, therefore, these losses are not considered other-than-temporary. We have the ability and intent to hold these securities until such time as the value recovers or the securities mature.
Investment securities with market values of approximately $4,506,798 and $3,212,762 at December 31, 2011 and 2010, respectively, were pledged to secure public deposits, as required by law.
Proceeds from sales of available-for-sale securities during 2011 and 2010 were $23,202,326 and $11,368,953, respectively. Net gains of $259,155 and $439,130 were recognized on these sales in 2011 and 2010, respectively.
We held $615,900 of non-marketable equity securities, which consisted of Federal Home Loan Bank stock of $513,900 and Pacific Coast Bankers Bank stock of $102,000, at December 31, 2011. These investments are carried at cost, which approximates fair market value.
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other than temporary.
Loans
Since loans typically provide higher interest yields than other interest-earning assets, it is our goal to ensure that the highest percentage of our earning assets is invested in our loan portfolio. Gross loans outstanding at December 31, 2011 were $88,344,578, or 75.2% of interest-earning and 72.4% of total assets, compared to $90,335,609, or 79.5% of interest-earning and 74.5% of total assets at December 31, 2010. Due to the economic environment, the Bank made selective decisions related to originating loans in 2011. In addition, as the Bank moved into its fifth year of operations, the Bank experienced the attrition of loans due to refinancing and/or payoffs from borrowers.
Loans secured by real estate mortgages comprised approximately 88.8% of loans outstanding at December 31, 2011 and 88.2% at December 31, 2010. Most of our real estate loans are secured by residential and commercial properties. We do not generally originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 85%.
Commercial loans and lines of credit represented approximately 9.8% and 10.2% of our loan portfolio at December 31, 2011 and 2010, respectively.
Our construction and development, and land loan portfolio represented approximately 9.9% and 13.4% at December 31, 2011 and 2010, respectively.
The following table summarizes the composition of our loan portfolio as of December 31, 2011 and 2010:
Maturities and Sensitivity of Loans to Changes in Interest Rates
The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.
The following table summarizes the loan maturity distribution by composition and interest rate types at December 31, 2011.
Provision and Allowance for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. The allowance for loan losses was $1,395,588 and $1,552,061 as of December 31, 2011 and December 31, 2010, respectively, and represented 1.58% of outstanding loans at December 31, 2011 and 1.72% of outstanding loans at December 31, 2010. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons. We adjust the amount of the allowance periodically based on changing circumstances as a component of the provision for loan losses.
We calculate the allowance for loan losses for specific types of loans and evaluate the adequacy on an overall portfolio basis utilizing our credit grading system which we apply to each loan. We combine our estimates of the reserves needed for each component of the portfolio, including loans analyzed on a pool basis and loans analyzed individually. The allowance is divided into two portions: (1) an amount for specific allocations on significant individual credits and (2) a general reserve amount.
Specific Reserve
We analyze individual loans within the portfolio and make allocations to the allowance based on each individual loan’s specific factors and other circumstances that affect the collectability of the credit. Significant individual credits classified as doubtful or substandard/special mention within our credit grading system require both individual analysis and specific allocation, if necessary.
Loans in the substandard category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action such as declining or negative earnings trends and declining or inadequate liquidity. Loans in the doubtful category exhibit the same weaknesses found in the substandard loan; however, the weaknesses are more pronounced. These loans, however, are not yet rated as loss because certain events may occur which could salvage the debt such as injection of capital, alternative financing, or liquidation of assets.
In these situations where a loan is determined to be impaired (primarily because it is probable that all principal and interest due according to the terms of the loan agreement will not be collected as scheduled), the loan is excluded from the general reserve calculations described below and is assigned a specific reserve. These reserves are based on a thorough analysis of the most probable source of repayment which is usually the liquidation of the underlying collateral, but may also include discounted future cash flows or, in rare cases, the market value of the loan itself.
Generally, for larger collateral dependent loans, current market appraisals are ordered to estimate the current fair value of the collateral. However, in situations where a current market appraisal is not available, management uses the best available information (including recent appraisals for similar properties, communications with qualified real estate professionals, information contained in reputable trade publications and other observable market data) to estimate the current fair value. The estimated costs to sell the subject property are then deducted from the estimated fair value to arrive at the “net realizable value” of the loan and to determine the specific reserve on each impaired loan reviewed. The credit risk management group periodically reviews the fair value assigned to each impaired loan and adjusts the specific reserve accordingly.
General Reserve
We calculate our general reserve based on a percentage allocation for each of the effective categories of unclassified loan types. We apply our historical trend loss factors to each category and adjust these percentages for qualitative or environmental factors, as discussed below. The general estimate is then added to the specific allocations made to determine the amount of the total allowance for loan losses.
We also maintain a general reserve in accordance with December 2006 regulatory interagency guidance in our assessment of the loan loss allowance. This general reserve considers qualitative or environmental factors that are likely to cause estimated credit losses including, but not limited to: changes in delinquent loan trends, trends in risk grades and net charge offs, concentrations of credit, trends in the nature and volume of the loan portfolio, general and local economic trends, collateral valuations, the experience and depth of lending management and staff, lending policies and procedures, the quality of loan review systems, and other external factors.
In addition, the current downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these trends are likely to continue. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses. Based on present information and an ongoing evaluation, management considers the allowance for loan losses to be adequate to meet presently known and inherent losses in the loan portfolio. Management’s judgment about the adequacy of the allowance is based upon a number of assumptions about future events which it believes to be reasonable but which may or may not be accurate. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required, especially considering the overall weakness in the commercial real estate market in our market areas. Management believes estimates of the level of allowance for loan losses required have been appropriate and our expectation is that the primary factors considered in the provision calculation will continue to be consistent with prior trends.
The Company identifies impaired loans through its normal internal loan review process. Loans on the Company’s potential problem loan list are considered potentially impaired loans. These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected. Loans are not considered impaired if a minimal payment delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected. Management has determined that the Company had $2,692,395 and $2,251,261 in impaired loans at December 31, 2011 and December 31, 2010, respectively. At December 31, 2011, most of the impaired loans identified by management are collateral dependent loans and therefore the valuation allowance amounts on such loans were recorded as a charge-off. Our valuation allowance related to impaired loans totaled $175,009 and $224,935 at December 31, 2011 and December 31, 2010, respectively.
We have retained an independent consultant to review our loan files on a test basis to assess the grading of samples of loans. In addition, various regulatory agencies review our allowance for loan losses through periodic examinations, and they may require us to record additions to the allowance for loan losses based on their judgment about information made available to them at the time of their examination. Our losses may vary from our estimates, and there is the possibility that charge-offs in future periods will exceed the allowance for loan losses that we have estimated.
The following table presents a summary related to our allowance for loan losses for the years ended December 31, 2011 and 2010:
Allocation of the Allowance For Loan Losses
The following table presents an allocation of the allowance for loan losses at the end of each of the past two years. The allocation is calculated on an approximate basis and is not necessarily indicative of future losses or allocations. The entire amount is available to absorb losses occurring in any category of loans.
Non-Performing Assets
The following table summarizes non-performing assets and the income that would have been reported on non-accrual loans as of December 31, 2011 and 2010:
The Bank had net charge-offs on loans in the amount of $900,473 for the year ended December 31, 2011, compared to $799,985 charged off in 2010. At December 31, 2011, there were 10 loans in non-accrual status totaling $1,550,775 compared to 13 loans in nonaccrual status that totaling $1,417,289 at December 31, 2010. There were no loans contractually past due 90 days or more still accruing interest at December 31, 2011 and December 31, 2010. In addition, there were six loans restructured or otherwise impaired totaling $1,140,502 not already included in nonaccrual status at December 31, 2011. There were four loans restructured or otherwise impaired totaling $843,060 not already included in nonaccrual status at December 31, 2010. At December 31, 2011 and 2010, impaired loans totaled $2,692,395 and $2,251,261, respectively. The increase in impaired loans compared to prior year is the result of an increase in troubled debt restructurings during 2011. The Bank also currently is prohibited from extending any additional credit to a borrower which has a credit that has been charged off by the Bank or classified as Loss or Doubtful in any report of examination, so long as such credit remains uncollected. Management is concerned about the changes in the nonperforming assets but believes that the allowance has been appropriately funded for additional losses on existing loans, based on currently available information. The Company will continue to monitor nonperforming assets closely and make changes to the allowance for loan losses when necessary.
Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is applied against the principal balance. During the years ended December 31, 2011 and 2010, we received approximately $37,452 and $13,513 in interest income in relation to loans on non-accrual status, respectively, and forgone interest income related to loans on non-accrual status was approximately $75,069 and $38,323, respectively.
Management believes that the amount of nonperforming assets could continue to have a negative effect on the Company’s condition if current economic conditions do not improve. As was seen in the 2011 financial results, the effect would be lower earnings caused by larger contributions to the loan loss provision arising from a larger impairment in the loan portfolio and a higher level of loan charge-offs. Management believes the Company has credit quality review processes in place to identify problem loans quickly. Management will work with customers that are having difficulties meeting their loan payments. The last resort is foreclosure.
Potential Problem Loans
Potential problem loans consist of loans that are generally performing in accordance with contractual terms but for which we have concerns about the ability of the borrower to continue to comply with repayment terms because of the borrower’s potential operating or financial difficulties. Management monitors these loans closely and reviews performance on a regular basis. As of December 31, 2011 and 2010, potential problem loans that were not already categorized as nonaccrual totaled $4,793,269 and $6,625,210, respectively. These loans are considered in determining management’s assessment of the adequacy of the allowance for loan losses.
Deposits
Our primary source of funds for our loans and investments is our deposits. Total deposits as of the years ended December 31, 2011 and 2010 were $102,526,449 and $106,585,992, respectively. In trying to attract local deposits and increase our core deposits, we did not renew some wholesale deposits and instead focused on customer relationships with the bank. Accordingly, in 2011, our deposit balances decreased while the core deposits base increased compared to the prior year. The following table shows the average balance outstanding and the average rates paid on deposits during 2011 and 2010.
Core deposits, which exclude time deposits of $100,000 or more and whole sale certificates of deposit, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $86,923,368 at December 31, 2011, compared to $85,189,016 at December 31, 2010. Our loan-to-deposit ratio was 86.16% and 84.75% at December 31, 2011 and 2010, respectively. Due to the competitive interest rate environment in our market, we utilized whole sale certificates of deposit as a funding source when we were able to procure these certificates at interest rates less than those in the local market. We did not have any brokered certificates of deposit purchased outside our primary market at December 31, 2011, compared to $2,217,000 at December 31, 2010. We have decreased our reliance on brokered deposits as our core deposits continue to grow.
The maturity distribution of our time deposits of $100,000 or more time deposits at December 31, 2011 was as follows:
Borrowings and lines of credit
At December 31, 2011, the Bank had short-term lines of credit with correspondent banks to purchase a maximum of $5,800,000 in unsecured federal funds on a one to 14 day basis and $3,750,000 in unused federal funds on a one to 20 day basis for general corporate purposes. The interest rate on borrowings under these lines is the prevailing market rate for federal funds purchased. These accommodation lines of credit are renewable annually and may be terminated at any time at the correspondent banks’ sole discretion. At December 31, 2011 and 2010, we had no borrowings outstanding on these lines.
We are a member of the FHLB of Atlanta, from which applications for borrowings can be made. The FHLB requires that investment securities or qualifying mortgage loans be pledged to secure advances from them. We are also required to purchase FHLB stock in a percentage of each advance. At December 31, 2011 and December 31, 2010, we had $7,000,000 and $3,000,000 outstanding, respectively. The Bank borrowed the funds to reduce the cost of funds on money used to fund loans. The Bank has remaining credit availability of $5,197,000 at the FHLB. We believe that our existing stable base of core deposits along with continued growth in this deposit base will enable us to successfully meet our long term liquidity needs. The following table shows the amount outstanding, grant date, maturity date, and interest rate.
Like all banks, we are subject to the FHLB’s credit risk rating policy which assigns member institutions a rating which is reviewed quarterly. The rating system utilizes key factors such as loan quality, capital, liquidity, profitability, etc. Our ability to access our available borrowing capacity from the FHLB in the future is subject to our rating and any subsequent changes based on our financial performance as compared to factors considered by the FHLB in their assignment of our credit risk rating each quarter. In addition, the Federal Reserve Bank of Richmond as well as our correspondent banks review our financial results and could limit our credit availability based on their review.
Capital Resources
Total shareholders’ equity was $12,281,465 at December 31, 2011, an increase of $1,104,817 from $11,176,648 at December 31, 2010. The increase is primarily due to net income of $741,007 and an increase of $542,820 in unrealized gain (loss) on investment securities available for sale during 2011.
The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. The Federal Reserve guidelines contain an exemption from the capital requirements for “small bank holding companies”, which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC. Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively
traded, the Federal Reserve will interpret its new guidelines to mean that we qualify as a small bank holding company. Nevertheless, our Bank remains subject to these capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on 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 Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.
At the Bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. Under the regulations adopted by the federal regulatory authorities, a bank will be categorized as:
· Well capitalized if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure.
· Adequately capitalized if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, a leverage ratio of 4.0% or greater, and is not categorized as well capitalized.
· Undercapitalized if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0%.
· Significantly undercapitalized if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%.
· Critically undercapitalized if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets.
In addition, an institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of a bank’s overall financial condition or prospects for other purposes.
The following table sets forth the Bank’s capital ratios at December 31, 2011 and 2010. As of December 31, 2011 and 2010, the Bank was considered “well capitalized” and within compliance with the minimum capital requirements specifically established for the Bank by its Supervisory Authorities.
On January 9, 2009, we entered into the CPP Purchase Agreement with the Treasury, pursuant to which the company issued and sold to Treasury (i) 3,285 shares of our Series A Preferred Stock, and (ii) a ten-year warrant to purchase 164 shares of our Series B Preferred Stock, for an aggregate purchase price of $3,285,000 in cash. The Series A and Series B Preferred Stock qualifies as Tier 1 capital under Federal Reserve guidelines.
In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III”. Basel III, if implemented by the U.S. banking agencies and fully phased-in, would require certain bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Although Basel III is intended to be implemented by participating countries for large, internationally active banks, its provisions are likely to be considered by U.S. banking regulators in developing new regulations applicable to other banks in the United States, including those developed pursuant to directives in the Dodd-Frank Act. The U.S. banking agencies have indicated informally that they expect final adoption of implementing regulations in 2012. Notwithstanding its release of the Basel III framework as a final framework, the Basel Committee is considering further amendments to Basel III, including the imposition of additional capital surcharges on globally systemically important financial institutions. In addition to Basel III, the Dodd-Frank Act requires or permits the Federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact our net income and return on equity.
Return on Equity and Assets
The following table shows the return on average assets (net income (loss) divided by average total assets), return on average equity (net income (loss) divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2011 and 2010.
Effect of Inflation and Changing Prices
The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with accounting principles generally accepted in the United States of America.
Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. We attempt to manage the relationships between interest-sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.
Off-Balance Sheet Risk
Through the Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our clients at predetermined interest rates for a specified period of time. We evaluate each client’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes. At December 31, 2011, we had issued commitments to extend credit of approximately $10,453,000 through various types of lending arrangements. There were two standby letters of credit included in the commitments for $225,000. Fixed rate commitments were $811,975 and variable rate commitments were $9,416,242. At December 31, 2010, commitments to extend credit amounted to $11,091,000, which included letters of credit of $125,000.
Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. A significant portion of the unfunded commitments relate to consumer equity lines of credit and commercial lines of credit. Based on historical experience, we anticipate that a portion of these lines of credit will not be funded.
Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings.
Liquidity
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
At December 31, 2011, our liquid assets, consisting of cash and due from banks and federal funds sold, amounted to $2,572,703, or approximately 2.11% of total assets. Our investment securities available for sale at December 31, 2011 amounted to $26,952,357, or approximately 22.1% of total assets. Unpledged investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. At December 31, 2011, $4,506,798 of our investment securities were pledged to secure public entity deposits.
Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits. In addition, we will receive cash upon the maturities and sales of loans and maturities, calls and prepayments on investment securities. We maintain federal funds purchased lines of credit with correspondent banks totaling $9,550,000. Availability on these lines of credit was $9,550,000 at December 31, 2011. We are a member of the FHLB, from which applications for borrowings can be made. The FHLB requires that investment securities or qualifying mortgage loans be pledged to secure advances from them. We are also required to purchase FHLB stock in a percentage of each advance. At December 31, 2011, we had borrowed $7,000,000 from FHLB.
We believe that our existing stable base of core deposits and borrowing capabilities will enable us to successfully meet our long-term liquidity needs.
Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates, which principally arise from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.
We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive. The Company is cumulatively liability sensitive over the three-month to twelve month period and asset sensitive over all periods greater than one year. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based
rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.
Interest Rate Sensitivity
Asset-liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset-liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our asset-liability management committee monitors and considers methods of managing exposure to interest rate risk. The asset-liability management committee is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.
The following table sets forth information regarding our rate sensitivity, as of December 31, 2011 at each of the time intervals. The information in the table may not be indicative of our rate sensitivity position at other points in time. In addition, the repricing distribution indicated in the table differs from the contractual maturities of certain interest-earning assets and interest-bearing liabilities presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO AUDITED FINANCIAL STATEMENTS
Page No.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss)
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
57-84
Corporate Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Congaree Bancshares, Inc. and Subsidiary
Cayce, South Carolina
We have audited the accompanying consolidated balance sheets of Congaree Bancshares, Inc. and Subsidiary (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive income (loss), and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Congaree Bancshares, Inc. and Subsidiary, as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ Elliott Davis, LLC
Columbia, South Carolina
March 27, 2012
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations
The accompanying notes are an integral part of the consolidated financial statements.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss)
For the years ended December 31, 2011 and 2010
The accompanying notes are an integral part of the consolidated financial statements.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of the consolidated financial statements.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization - Congaree Bancshares, Inc. and Subsidiary (the Company) was incorporated to serve as a bank holding company for its subsidiary, Congaree State Bank (the Bank). Congaree State Bank commenced business on October 16, 2006. The principal business activity of the Bank is to provide banking services to domestic markets, principally in West Columbia and Cayce, South Carolina. The Bank is a state-chartered commercial bank, and its deposits are insured by the Federal Deposit Insurance Corporation. The consolidated financial statements include the accounts of the parent company and its wholly-owned subsidiary after elimination of all significant intercompany balances and transactions.
Management’s Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans, including valuation allowances for impaired loans, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.
While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change materially in the near term.
Concentrations of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks.
The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily in the Lexington County region of South Carolina. The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions.
In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.) and loans with high loan-to-value ratios. Management has determined that there is no concentration of credit risk associated with its lending policies or practices. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans). These loans are underwritten and monitored to manage the associated risks. Therefore, management believes that these particular practices do not subject the Company to unusual credit risk.
The Company’s investment portfolio consists principally of obligations of the United States, its agencies or its corporations. In the opinion of Management, there is no concentration of credit risk in its investment portfolio. The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Investment Securities - Securities are classified in one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held to maturity securities are those securities for which the Bank has the ability and intent to hold the securities until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2011 and 2010, the Bank had no trading securities.
Held-to-maturity securities are recorded at cost, adjusted for the amortization or accretion of premiums or discounts. Securities available-for-sale are carried at amortized cost and adjusted to estimated market value by recognizing the aggregate unrealized gains or losses in a valuation account. Aggregate market valuation adjustments are recorded in shareholders’ equity net of deferred income taxes. Management evaluates investment securities for other-than-temporary impairment on a quarterly basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in other comprehensive income. The adjusted cost basis of investments available-for-sale is determined by specific identification and is used in computing the gain or loss upon sale.
Nonmarketable Equity Securities - Nonmarketable equity securities include the cost of the Company’s investment in the stock of the Federal Home Loan Bank and Pacific Coast Bankers Bank. These stocks have no quoted market value and no ready market exists. The Company’s investment in Federal Home Loan Bank stock at December 31, 2011 and 2010 was $513,900 and $372,300, respectively. The Company’s investment in Pacific Coast Bankers Bank stock at December 31, 2011 and 2010 was $102,000.
Loans Receivable - Loans are stated at their recorded investment. Interest income is computed using the simple interest method and is recorded in the period earned.
When serious doubt exists as to the collectibility of a loan or when a loan becomes contractually 90 days past due as to principal or interest, interest income is generally discontinued unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest. When interest accruals are discontinued, income earned but not collected is reversed.
Loan origination and commitment fees and certain direct loan origination costs (principally salaries and employee benefits) are deferred and amortized to income over the contractual life of the related loans or commitments, adjusted for prepayments, using the straight-line method.
The Company identifies impaired loans through its normal internal loan review process. Loans on the Company’s problem loan watch list are considered potentially impaired loans. These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected. Loans are not considered impaired if a minimal payment delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected.
Allowance for Loan Losses - An allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collection of the principal is unlikely. The allowance represents an amount, which, in management’s judgment, will be adequate to absorb probable losses on existing loans that may become uncollectible.
Management’s judgment in determining the adequacy of the allowance is based on evaluations of the probability of collection of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrower’s ability to pay, overall portfolio quality, and review of specific problem loans.
Management uses an outsourced independent loan review specialist on an annual basis to corroborate and challenge the internal loan grading system and methods used to determine the adequacy of the allowance for loan losses.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Allowance for Loan Losses (continued) - Management believes the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such regulators may require additions to the allowance based on their judgments of information available to them at the time of their examination.
Premises, Furniture and Equipment - Premises, furniture and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed by the straight-line method, based on the estimated useful lives for buildings and improvements of 40 years, furniture and equipment of 5 to 10 years and software of 5 years. The cost of assets sold or otherwise disposed of and the related allowance for depreciation are eliminated from the accounts and the resulting gains or losses are reflected in the income statement when incurred. Maintenance and repairs are charged to current expense. The costs of major renewals and improvements are capitalized.
Other Real Estate Owned - Other real estate owned represents properties acquired through or in lieu of loan foreclosure and is initially recorded at fair market value less estimated disposal costs. Costs of improvements are capitalized, whereas costs relating to holding other real estate and valuation adjustments are expensed. Revenue and expenses from operations and changes in valuation allowance are included in other real estate owned expense.
Income Taxes - Income taxes are the sum of amounts currently payable to taxing authorities and the net changes in income taxes payable or refundable in future years. Income taxes deferred to future years are determined utilizing a liability approach. This method gives consideration to the future tax consequences associated with differences between financial accounting and tax bases of certain assets and liabilities which are principally the allowance for loan losses, depreciable premises and equipment, and the net operating loss carry forward. The Bank believes its loss positions in prior years may adversely impact its ability to recognize the full benefit of its deferred tax asset. Therefore, the Bank currently has placed a valuation allowance for a portion of its deferred tax asset. The Bank believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Bank’s financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded.
Advertising Expense - Advertising and public relations costs are generally expensed as incurred. External costs incurred in producing media advertising are expensed the first time the advertising takes place. External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent.
Income (Loss) Per Share - Basic income (loss) per share for 2011 and 2010 represents income (loss) available to shareholders divided by the weighted-average number of common shares outstanding during the period. Dilutive income (loss) per share is adjusted to reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. The only potential common share equivalents are those related to stock options and warrants. Stock options and warrants which are anti-dilutive are excluded from the calculation of diluted net income per share. Since the Company was in a net loss position for the year ended December 31, 2010, potential dilutive common shares were not included, because to do so would be anti-dilutive. The Company deemed the options and warrants not dilutive for the year ended December 31, 2011 due to the exercise price of all options and warrants exceeding the average market price of the Company’s stock during the period.
Stock-Based Compensation - The Company accounts for its stock compensation plans using a fair value based method whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period.
Comprehensive Income - Accounting principles generally require that recognized income, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income (loss), are components of comprehensive income.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Comprehensive Income (continued) - The components of other comprehensive income and related tax effects are as follows for the years ended December 31, 2011 and 2010.
Statement of Cash Flows - For purposes of reporting cash flows in the financial statements, the Company considers certain highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Interest paid on deposits and other borrowings totaled $1,202,088 and $2,065,482 for the years ended December 31, 2011 and 2010, respectively. Changes in the valuation account for securities available-for-sale, including deferred tax effects, are considered non-cash transactions for purposes of the statement of cash flows and are presented in detail in the notes to the financial statements. In addition, transfers of loans to other real estate owned and changes in dividends payable are also considered non-cash transactions. The Bank transferred loans in the amount of $625,711 and $3,260,032 to other real estate owned during the years ended December 31, 2011 and 2010, respectively. The change in dividends payable was ($179,010) and $179,010 during the years ended December 31, 2011 and 2010, respectively. The bank did not pay the dividends owed on the Preferred stock during 2010, resulting in an increase in dividends payable at the end of 2010 of $179,010. During 2011 the bank paid the dividends on the Preferred stock that were owed for 2010 and resumed making quarterly payments which resulted in the decrease in dividends payable of $179,010 at the end of 2011. The Bank did not transfer any investment securities between categories during the year ended December 31, 2011.
There were income tax payments during the year ended December 31, 2011 in the amount of $18,000. There were no income tax payments in 2010.
Off-Balance Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. These financial instruments are recorded in the financial statements when they become payable by the customer.
Fair Values of Financial Instruments - Fair values of financial instruments are estimated using relevant market value information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Risks and Uncertainties - In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets. Credit risk is the risk of default on the Company’s loan portfolio that results from a borrower’s inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.
The Company is subject to the regulations of various governmental agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
Recent Accounting Pronouncements - The following is a summary of recent authoritative pronouncements that may affect accounting, reporting, and disclosure of financial information by the Company:
In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company is required to include these disclosures in its interim and annual financial statements. See Note 4.
Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011, the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present. Disclosures related to TDRs under ASU 2010-20 have been presented in Note 4.
In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.
ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.
The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in shareholders’ equity. The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The amendments are applicable to the Company beginning January 1, 2012 and will be applied retrospectively.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
Reclassifications - Certain captions and amounts in the 2010 consolidated financial statements were reclassified to conform with the 2011 presentation. The reclassifications did not have an impact on the previously reported loss or shareholders’ equity.
NOTE 2 - CASH AND DUE FROM BANKS
The Company is required to maintain cash balances with its correspondent banks to cover all cash letter transactions. At December 31, 2011 and 2010, the requirement was met by the cash balance in the vault.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities available-for-sale were:
The amortized cost and estimated fair values of securities held-to-maturity were:
There were no securities classified as held-to-maturity at December 31, 2011.
Proceeds from sales of available-for-sale securities during 2011 and 2010 were $23,202,326 and $11,368,953, respectively. Gross gains of $245,242 and $439,130 were recognized on those sales in 2011 and 2010, respectively. Gross losses of $51,546 and $0 were recognized on those sales in 2011 and 2010, respectively. Proceeds from sales of held to maturity securities during 2011 were $1,205,623. Gross gains of $65,459 were recognized on those sales in 2011. There were no sales of held to maturity securities during 2010.
The amortized costs and fair values of investment securities at December 31, 2011, by contractual maturity, are shown in the following chart. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Callable securities and mortgage-backed securities are included in the year of their contractual maturity date.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES - continued
The following table shows gross unrealized losses and fair value of securities available-for-sale, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2011.
The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2010.
Securities classified as available-for-sale are recorded at fair market value. There were no securities in a continuous unrealized loss position for more than twelve months at December 31, 2011 or 2010.
There were no held to maturity securities at December 31, 2011.
The following table shows gross unrealized losses and fair value of securities held-to-maturity, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2010.
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES - continued
In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, no declines are deemed to be other-than-temporary.
Investment securities with market values of approximately $4,506,798 and $3,212,762 at December 31, 2011 and 2010, respectively, were pledged to secure public deposits, as required by law.
NOTE 4 - LOANS RECEIVABLE
Major classifications of loans receivable at December 31 are summarized as follows:
The credit quality indicators utilized by the Company to internally analyze the loan portfolio are the internal risk ratings. Loans classified as pass credits have no material weaknesses and are performing as agreed. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Loans classified as substandard or worse are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
The following is an analysis of our loan portfolio by credit quality indicators at December 31, 2011:
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE - continued
The following is an analysis of our loan portfolio by credit quality indicators at December 31, 2010:
The following is an aging analysis of our loan portfolio at December 31, 2011:
The following is an aging analysis of our loan portfolio at December 31, 2010:
The following is an analysis of loans receivable on nonaccrual status as of December 31:
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE - continued
Transactions in the allowance for loan losses during 2011 and 2010 are summarized below:
The following table summarizes the allowance for loan losses and recorded investment in gross loans, by portfolio segment, at and for the period ended December 31, 2011:
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE - continued
The following table summarizes the allowance for loan losses and recorded investment in gross loans, by portfolio segment, at and for the period ended December 31, 2010:
The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts of principal and interest due according to the original terms of the loan agreement. The Company measures impairment of a loan on a loan-by-loan basis. Impaired loans and related amounts included in the allowance for loan losses at December 31, 2011 and 2010 are as follows:
At December 31, 2011, the Company had 18 impaired loans totaling $2,692,395 or 3.05% of gross loans. At December 31, 2010, the Company had 16 impaired loans totaling $2,251,261 or 2.49% of gross loans. There were no loans that were contractually past due 90 days or more and still accruing interest at December 31, 2011 or 2010. There were 12 loans restructured or otherwise impaired totaling $1,999,781 not already included in nonaccrual status at December 31, 2011. There were four loans restructured or otherwise impaired totaling $843,060 not already included in nonaccrual status at December 31, 2010. During the year ended December 31, 2011 and 2010, we received approximately $37,452 and $13,513 in interest income in relation to loans on non-accrual status, respectively, and forgone interest income related to loans on non-accrual status was approximately $75,069 and $38,323, respectively.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE - continued
The Company’s analysis under generally accepted accounting principles indicates that the level of the allowance for loan losses is appropriate to cover estimated credit losses on individually evaluated loans as well as estimated credit losses inherent in the remainder of the portfolio. We recognized $126,216 and $88,250 in interest income on loans that were impaired during the years ended December 31, 2011 and 2010.
The following is an analysis of our impaired loan portfolio detailing the related allowance recorded at December 31, 2011:
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE - continued
The following is an analysis of our impaired loan portfolio detailing the related allowance recorded at December 31, 2010:
Troubled Debt Restructurings
The Company considers a loan to be a TDR when the debtor experiences financial difficulties and the Company provides concessions such that we will not collect all principal and interest in accordance with the original terms of the loan agreement. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. At December 31, 2011 and December 31, 2010, we had 12 loans totaling $1,999,781 and four loans totaling $1,346,034, respectively, which we considered to be TDRs. During the year ended December 31, 2011, we modified eight loans that were considered to be TDRs. We extended the terms for five of these loans and the interest rate and term were modified for three of these loans.
Our policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If a borrower was materially delinquent on payments prior to the restructuring but shows capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE - continued
We will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms. If, after previously being classified as a TDR, a loan is restructured a second time, then that loan is automatically placed on nonaccrual status. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. To date, we have not restored any nonaccrual loan classified as a TDR to accrual status. We believe that all of our modified loans meet the definition of a TDR.
As a result of adopting the amendments in ASU 2011-02, the Bank reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered TDRs under the amended guidance. The Bank identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, we identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired. At the end of the first period of adoption (December 31, 2011), the recorded investment in loans for which the allowance was previously measured under a general allowance methodology and are now impaired under ASC 310-10-35 was $786,000, and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss was $90,100. In the determination of the allowance for loan losses, management considers TDRs on loans and subsequent defaults in these restructurings by measuring impairment, on a loan by loan basis, based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
The following table summarizes the recorded investment in our TDRs before and after their modification during the respective period.
Seven loans that had been previously restructured subsequently defaulted during the twelve months ended December 31, 2011.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 5 - PREMISES, FURNITURE AND EQUIPMENT
Premises, furniture and equipment consisted of the following:
Depreciation expense was $194,024 and $220,995 for the years ended 2011 and 2010, respectively.
NOTE 6 - OTHER REAL ESTATE OWNED
Transactions in other real estate owned for the years ended December 31, 2011 and 2010 are summarized below:
NOTE 7 - DEPOSITS
At December 31, 2011, the scheduled maturities of certificates of deposit were as follows:
At December 31, 2011 , the Company did not have any third party brokered deposits and at December 31, 2010 had $2,217,000 in time deposits obtained through third party brokers.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 8 - FHLB ADVANCES
At December 31, 2011 and December 31, 2010, we had $7,000,000 and $3,000,000 advances outstanding, respectively. FHLB advances at December 31, 2011 consisted of the following:
NOTE 9 - STOCK COMPENSATION PLAN
Under the terms of employment agreements with the Chief Business Development Officer, the Chief Financial Officer (CFO), and the former Chief Executive Officer (CEO) and President, stock options were granted to each as part of their compensation and benefits package. Under these agreements, the former CEO and President was granted 79,399 stock options, the Chief Business Development Officer 61,755 options and the CFO 44,110 options. The former CEO and President resigned on January 21, 2009 at which time 79,399 options were forfeited. All options granted to the executive officers vest over five years. The options have an exercise price of $10.00 per share and terminate ten years after the date of grant.
The Company also established the 2007 Stock Incentive Plan (the Plan) which provides for the granting of options to employees of the Company. The Plan has 194,481 shares available to grant at December 31, 2011 with 71,819 options still outstanding. The Company did not grant any options during 2011 or 2010.
The Company did not recognize any stock-based employee compensation expense associated with its stock option grants during 2011. The Company recognized $29,384 of stock-based employee compensation expense during 2010 associated with its stock option grants. The Company recognized the compensation expense for stock option grants with graded vesting schedules on a straight-line basis over the requisite service period of the award. As of December 31, 2011, all the compensation cost related to stock option grants had been recognized.
A summary of the activity under the stock option plan for the year ended December 31, 2011 and 2010 is as follows:
The weighted average contractual life of the options outstanding as of December 31, 2011 is 5.07 years. There was no aggregate intrinsic value of options outstanding or exercisable at December 31, 2011. All of the options outstanding as of December 31, 2011 are fully vested.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 10 - STOCK WARRANTS
The organizers of the Company received stock warrants giving them the right to purchase one share of common stock for every share they purchased in the initial offering of the Company’s common stock up to 10,000 shares at a price of $10 per share. The warrants vest over three years and expire on October 16, 2016. Warrants held by directors and officers of the Company will expire 90 days after the director ceases to be a director or officer of the Company (365 days if due to death or disability). Upon resignation of the Company’s former CEO and President, 10,000 warrants were forfeited.
At December 31, 2011, 90,000 shares of the outstanding warrants were exercisable. There was no compensation expense related to warrants for the years ended December 31, 2011 and 2010. As of December 31, 2011, all the compensation cost related to stock warrants had been recognized.
NOTE 11 - INCOME TAXES
Income tax benefit is summarized as follows:
The gross amounts of deferred tax assets and deferred tax liabilities are as follows:
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 11 - INCOME TAXES - continued
Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. Management has determined that a partial valuation allowance is needed at December 31, 2011. Management’s judgment is based on estimates concerning future income earned and positive earnings for the year ended December 31, 2011. Management has concluded that sufficient positive evidence exists to overcome any and all negative evidence in order to meet the “more likely than not” standard regarding the realization of a portion of net deferred tax assets. The valuation allowance was reduced by $427,152 in 2011. Net deferred tax assets are recorded in other assets on the Company’s consolidated balance sheet.
The Company has a federal net operating loss of $6,569,326 and a state net operating loss of $843,983 as of December 31, 2011. These net operating losses expire in the years 2026 through 2031.
A reconciliation of the income tax provision and the amount computed by applying the federal statutory rate of 34% to income before income taxes follows:
The Company had 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. Tax returns for 2008 and subsequent years are subject to examination by taxing authorities.
NOTE 12 - RELATED PARTY TRANSACTIONS
Certain parties (principally certain directors and executive officers of the Company, their immediate families and business interests) were loan customers of and had other transactions in the normal course of business with the Company. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility. The following table summarizes the Bank’s related party loan activity for the year ended December 31, 2011 and 2010:
Deposits by directors, including their affiliates and executive officers, at December 31, 2011 and 2010 were $1,636,019 and $940,657, respectively.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 13 - LEASES
The Company has entered into an agreement to lease an office facility under a noncancellable operating lease agreement expiring in 2023. The Company may, at its option, extend the lease of its office facility at 2023 Sunset Boulevard in West Columbia, South Carolina, for two additional five year periods. The Company also entered into a sale-leaseback agreement in December 2009 for a portion of the property located in Cayce, South Carolina. The lease is for a period of 15 years. The Company may, at its option, extend the lease for three consecutive renewal terms of five years each. In June 2010, the Company entered into a sale-leaseback agreement for the branch and office building located at 1201 Knox Abbot Drive in Cayce, South Carolina. The lease is for a period of 15 years. The Company may, at its option, extend the lease for two consecutive renewal terms of five years each. Minimum rental commitments as of December 31, 2011 are as follows:
The leases have various renewal options and require increased rentals under various standard percentages. Rental expenses, net of rental income, charged to occupancy and equipment expense in 2011 and 2010 were $337,326 and $266,981, respectively.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
The Company is subject to claims and lawsuits which arise primarily in the ordinary course of business. Management is not aware of any legal proceedings which would have a material adverse effect on the financial position or operating results of the Company.
NOTE 15 - INCOME (LOSS) PER SHARE
All income (loss) per share calculations have been made using the weighted average number of shares outstanding during the period. The potentially dilutive securities are incentive stock options and unvested shares of restricted stock granted to certain key members of management and warrants granted to the organizers of the Company. The number of dilutive shares is calculated using the treasury method, assuming that all options and warrants were exercisable at the end of each period. No TARP warrants are outstanding. Outstanding options and warrants are out-of-the-money and thus, are not considered in the calculation of dilutive earnings per share as the effect is not deemed to be dilutive.
NOTE 16 - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct adverse material effect on the 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 Bank’s 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 judgments by the regulators about components, risk weightings, and other factors.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 16 - REGULATORY MATTERS - continued
As previously disclosed, following the FDIC’s safety and soundness examination of the Bank in the fourth quarter of 2009, the Bank entered into a Consent Order (the “Consent Order”) with the FDIC and the South Carolina Board of Financial Institutions (the “SCBFI”) on May 11, 2010. The Consent Order set forth specific actions needed to address certain findings from the FDIC’s Report of Examination and to address the Bank’s financial condition, primarily related to capital planning, liquidity/funds management, policy and planning issues, management oversight, loan concentrations and classifications, and non-performing loans. The Board of Directors and management of the Bank have aggressively worked to improve these practices and procedures. As a result, on April 12, 2011, the Bank received notices from the FDIC and SCBFI pursuant to which these regulatory agencies determined that the protection of the depositors, other customers and shareholders of the Bank, as well as the Bank’s safe and sound operation, do not require the continued existence of the Consent Order. Accordingly, the FDIC and SCBFI terminated the Consent Order as of April 8, 2011. Although the Consent Order has been terminated, certain regulatory restrictions and requirements remain, including, among other things, a requirement that the Bank achieve and maintain Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. As of December 31, 2011 and December 31, 2010, the Bank was considered to be in compliance with the minimum capital requirements established by the regulatory restrictions and was considered “well-capitalized” under regulatory capital framework. The Board of Directors and management intend to continue to take all actions necessary to enable the Bank to comply with the requirements of the regulatory restrictions.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets. Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital.
The Bank is also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio. Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%. All others are subject to maintaining ratios 1% to 2% above the minimum.
The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at December 31:
Under the Bank’s current regulatory restrictions, we are required to achieve and maintain Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. As of December 31, 2011, the Bank was considered to be in compliance with the minimum capital requirements established in the regulatory restrictions and “well-capitalized” under prompt corrective action provisions.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 17 - UNUSED LINES OF CREDIT
As of December 31, 2011 and 2010, the Company had unused lines of credit to purchase federal funds from unrelated banks totaling $9,550,000 and $9,100,000, respectively. These lines of credit are available on a one to twenty day basis for general corporate purposes. The Company also has a credit line to borrow funds from the FHLB. The remaining credit availability as of December 31, 2011 was $5,197,000.
NOTE 18 - RESTRICTIONS ON DIVIDENDS, LOANS, OR ADVANCES
The ability of the Company to pay cash dividends to shareholders is dependent upon receiving cash in the form of dividends from the Bank. A South Carolina state bank may not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. In general, the Bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions, provided that the Bank received a composite rating of one or two at the last federal or state regulatory examination. The Bank must obtain approval from the SCBFI prior to the payment of any other cash dividends. In addition, the Bank currently must obtain prior approval from the FDIC and the SCBFI prior to the payment of any cash dividends. In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. Currently, the Company also has to obtain the prior written approval of the Federal Reserve Bank of Richmond before declaring or paying any dividends.
Under Federal Reserve Board regulations, the amount of loans or advances from the Bank to the Company are also restricted.
NOTE 19 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company uses the same credit policies in making commitments and conditional obligations as it does 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. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s 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 $10,228,217 and $10,965,617 at December 31, 2011 and 2010, respectively.
Standby letters of credit represent an obligation of the Company to a third party contingent upon the failure of the Company’s customer to perform under the terms of an underlying contract with the third party or obligates the Company 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. The Company can seek recovery of the amounts paid from the borrower. The majority of these standby letters of credit are unsecured. Commitments under standby letters of credit are usually for one year or less. At December 31, 2011 and 2010, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor; as such amounts are not considered material. The Company had approximately $225,000 and $125,000 in letters of credit outstanding as of December 31, 2011 and 2010 respectively.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 20 - PREFERRED STOCK
On January 9, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (“Treasury”) under the Emergency Economic Stabilization Act of 2009 (the “EESA”), the Company entered into a Letter Agreement with Treasury dated January 9, 2010, pursuant to which the Company issued and sold to Treasury 3,285 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and a ten-year warrant to purchase 164 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, (the “Series B Preferred Stock”), having a liquidation preference of $1,000 per share, at an initial exercise price of $0.01 per share (the “Warrant”), for an aggregate purchase price of $3,285,000 in cash. The Warrant was immediately exercised. The Preferred Stock, Series A, has a dividend rate of 5% for the first five years and 9% thereafter. The Preferred Stock, Series B, has a dividend rate of 9% per year.
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS
The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.
The following methods and assumptions were used to estimate the fair value of significant financial instruments:
Cash and Due from Banks - The carrying amount is a reasonable estimate of fair value, due to the short-term nature of such items.
Federal Funds Sold - Federal funds sold are for a term of one day, and the carrying amount approximates the fair value.
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 security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.
Nonmarketable Equity Securities - The carrying value of these securities approximates the fair value since no ready market exists for the stocks.
Loans Receivable - For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk, fair values are based on the carrying amounts. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.
Deposits - The fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date. The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities.
FHLB Advances - For disclosure purposes, the fair value of the FHLB fixed rate borrowing is estimated using discounted cash flows, based on the current incremental borrowing rates for similar types of borrowing arrangements.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS - continued
Accrued Interest Receivable and Payable - The carrying value of these instruments is a reasonable estimate of fair value.
Off-Balance Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Because these commitments are made using variable rates and have short maturities, the carrying value and the fair value are immaterial for disclosure.
The carrying values and estimated fair values of the Company’s financial instruments are as follows:
Fair Value Measurements
The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These levels are:
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 - Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS - continued
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
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. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Loans
The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2011 and 2010, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.
Other Real Estate Owned
Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charges to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS - continued
The table below presents the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy.
There were no liabilities measured at fair value on a recurring basis at December 31, 2011 or 2010.
Certain assets and liabilities are measured at fair value on a nonrecurring 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 table presents the assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2011 and 2010, aggregated by level in the fair value hierarchy within which those measurements fall.
There were no liabilities measured at fair value on a nonrecurring basis at December 31, 2011 or 2010.
Impaired loans which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying value of $2,692,395 at December 31, 2011 with a valuation allowance of $175,009. Impaired loans had a carrying value of $2,251,261 at December 31, 2010, with a valuation allowance of $224,935.
Other real estate owned, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying value of $3,181,559 at December 31, 2011 and $3,293,167 at December 31, 2010. There was $184,399 in write downs of other real estate owned during the year ended December 31, 2011 and there were $65,891 in write downs of other real estate owned during the year ended December 31, 2010.
The Company has no assets or liabilities whose fair values are measured using level 3 inputs.
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 22 - CONGAREE BANCSHARES, INC. (PARENT COMPANY ONLY)
Presented below are the condensed financial statements for Congaree Bancshares, Inc. (Parent Company Only).
Condensed Balance Sheets
Condensed Statements of Operations
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE 22 - CONGAREE BANCSHARES, INC. (PARENT COMPANY ONLY) - continued
Condensed Statements of Cash Flows
CONGAREE BANCSHARES, INC. AND SUBSIDIARY
CORPORATE DATA
ANNUAL MEETING:
The Annual Meeting of Shareholders of Congaree Bancshares, Inc. and Subsidiary, will be held on May 24, 2012 at Clarion Inn - Airport, 500 Chris Drive, West Columbia, South Carolina 29169.
CORPORATE OFFICE:
1219 Knox Abbott Drive
Cayce, South Carolina 29033
Phone 803.794.2265
INDEPENDENT AUDITORS:
CORPORATE COUNSEL:
Elliott Davis, LLC
Nelson Mullins Riley & Scarborough, LLP
1901 Main Street, Suite 1650
Atlantic Station
Columbia, South Carolina 29202
201 17th Street NW, Suite 1700
Atlanta, Georgia 30363
STOCK INFORMATION:
The Common Stock of Congaree Bancshares, Inc. is listed on the OTC bulletin board under the ticker symbol CNRB.OB. Trading and quotations of the common stock have been limited and sporadic. Trading prices have ranged from $3.55 per share to $1.25 per share during 2011. As of December 31, 2011, there were 1,764,439 shares outstanding.
The ability of Congaree Bancshares, Inc. to pay cash dividends is dependent upon receiving cash in the form of dividends from Congaree State Bank. However, certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends. All of the Bank’s dividends to the Company are payable only from the undivided profits of the Bank.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of December 31, 2011. There have been no significant changes in our internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f). A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, our management has evaluated the effectiveness of our internal control over financial reporting as of December 31, 2011 based on the criteria established in a report entitled “Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the interpretive guidance issued by the Commission in Release No. 34-55929. Based on this evaluation, our management has evaluated and concluded that our internal control over financial reporting was effective as of December 31, 2011.
We are continuously seeking to improve the efficiency and effectiveness of our operations and of our internal controls. This results in modifications to our processes throughout the company. However, there has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our 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 was not subject to attestation by the company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on May 24, 2012.
Item 11.
Item 11. Executive Compensation.
Information required by Item 11 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on May 24, 2012.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information required by Item 12 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on May 24, 2012.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information required by Item 13 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on May 24, 2012.
Item 14.
Item 14. Principal Accountant and Fees.
Information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on May 24, 2012.
PART IV
Item 15.
Item 15. Exhibits.
3.1.
Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form SB-2, File No. 333-131931)
3.2
Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.2 of the Company’s Form SB-2, File No. 333-131931).
3.3
Articles of Amendment to the Company’s Restated Articles of Incorporation establishing the terms of the Series A Preferred Stock (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on January 12, 2009).
3.4
Articles of Amendment to the Company’s Restated Articles of Incorporation establishing the terms of the Series B Preferred Stock (incorporated by reference to Exhibit 3.2 of the Company’s Form 8-K filed on January 12, 2009).
3.5
Bylaws (incorporated by reference to Exhibit 3.3 of the Company’s Form SB-2, File No. 333-131931).
4.1.
See Exhibits 3.1 and 3.2 for provisions in Congaree Bancshares, Inc.’s Articles of Incorporation and Bylaws defining the rights of holders of the common stock (incorporated by reference to Exhibit 4.1 of the Company’s Form SB-2, File No. 333-131931).
4.2.
Form of certificate of common stock (incorporated by reference to Exhibit 4.2 of the Company’s Form SB-2, File No. 333-131931).
4.3
Warrant to Purchase up to 164 shares of Preferred Stock (incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K filed on January 12, 2010).
4.4
Form of Series A Preferred Stock Certificate (incorporated by reference to Exhibit 4.2 of the Company’s Form 8-K filed on January 12, 2019).
4.5
Form of Series B Preferred Stock Certificate (incorporated by reference to Exhibit 4.3 of the Company’s Form 8-K filed on January 12, 2019).
10.1
Employment Agreement between Congaree Bancshares, Inc. and Charlie T. Lovering dated September 14, 2006 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed September 14, 2006).*
10.2
Employment Agreement between Congaree Bancshares, Inc. and Stephen P. Nivens dated February 15, 2006 (incorporated by reference to Exhibit 10.2 of the Company’s Form SB-2, File No. 333-121485).*
10.3
Employment Agreement by and between Charles A. Kirby, Congaree Bancshares, Inc. and Congaree State Bank dated October 20, 2010. (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed October 26, 2010).*
10.4
Letter Amendment by and between Congaree Bancshares, Inc. and Charles A. Kirby, dated October 20, 2010. (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed October 26, 2010).*
10.5
Amendment to the Amended and Restated Employment Agreement of Stephen P. Nivens, dated October 20, 2010. (incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed October 26, 2010).*
10.6
Amendment to the Amended and Restated Employment Agreement of Charlie T. Lovering, dated October 20, 2010. (incorporated by reference to Exhibit 10.4 of the Company’s Form 8-K filed October 26, 2010).*
10.7
Form of Stock Warrant Agreement (incorporated by reference to Exhibit 10.5 of the Company’s Form SB-2, File No. 333-131931).*
10.8
Congaree Bancshares, Inc. 2007 Stock Incentive Plan.*
10.9
Amendment No. 1 to the Congaree Bancshares, Inc. 2007 Stock Incentive Plan adopted October 15, 2008 (incorporated by reference to the Company’s Form 10-Q as Exhibit 10.1 for the period ended September 30, 2008).*
10.10
Letter Agreement, dated January 9, 2009, including the Side Letter Agreement and Securities Purchase Agreement - Standard Terms incorporated by reference therein, between the Company and the United States Department of the Treasury (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed on January 12, 2009).
21.1
Subsidiaries of the Company.
23.1
Consent of Elliott Davis, LLC.
24.1
Power of Attorney (filed as part of the signature page herewith).
31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
Section 1350 Certifications.
99.1
Certification of the Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2009.
99.2
Certification of the Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2009.
The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in eXtensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at December 31, 2011 and December 31, 2010, (ii) Consolidated Statements of Income (Loss) for the years ended December 31, 2011, 2010, and 2009, (iii) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2011, 2010, and 2009, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010, and 2009, and (iv) Notes to Consolidated Financial Statements*.
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
*
Management contract of compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-K.
*
Copies of exhibits are available upon written request to Corporate Secretary, Congaree Bancshares, Inc., 1201 Knox Abbott Drive, Cayce, South Carolina 29033.
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.
CONGAREE BANCSHARES, INC.
Date: March 28, 2012
By:
/s/ Charles A. Kirby
Charles A. Kirby
President and Chief Executive Officer
(Principal Executive Officer)
Date: March 28, 2012
By:
/s/ Charlie T. Lovering
Charlie T. Lovering
Chief Financial Officer
(Principal Financial and Accounting Officer)
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles A. Kirby, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
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 in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Thomas Hal Derrick
Director
March 28, 2012
Thomas Hal Derrick
/s/ Charles A. Kirby
President and Chief Executive Officer
March 28, 2012
Charles A. Kirby
(Principal Executive Officer)
/s/ Stephen P. Nivens
Senior Vice President, Director
March 28, 2012
Stephen P. Nivens
/s/ E. Daniel Scott
Director
March 28, 2012
E. Daniel Scott
/s/ Nitin C. Shah
Director
March 28, 2012
Nitin C. Shah
/s/ J. Larry Stroud
Director
March 28, 2012
J. Larry Stroud
/s/ Donald E. Taylor
Director
March 28, 2012
Donald E. Taylor
/s/ John D. Thompson
Director
March 28, 2012
John D. Thompson
/s/ Charlie T. Lovering
Chief Financial Officer,
March 28, 2012
Charlie T. Lovering
(Principal Financial and Accounting Officer)
Director
Harry Michael White
/s/ Samuel M. Corley
Director
March 28, 2012
Samuel M. Corley
/s/ J. Kevin Reeley
Director
March 28, 2012
J. Kevin Reeley
EXHIBIT INDEX
Exhibit
Description
21.1
Subsidiaries of the Company.
23.1
Consent of Elliott Davis, LLC.
24.1
Power of Attorney (filed as part of the signature page herewith).
31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
Section 1350 Certifications.
99.1
Certification of the Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2009.
99.2
Certification of the Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2009.
The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in eXtensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at December 31, 2011 and December 31, 2010, (ii) Consolidated Statements of Income (Loss) for the years ended December 31, 2011, 2010, and 2009, (iii) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2011, 2010, and 2009, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010, and 2009, and (iv) Notes to Consolidated Financial Statements*.
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.