Item 1. Business
General
Georgia-Carolina Bancshares, Inc. (the “Company” or “we,” “us,” “our”) is a one-bank holding company and owns 100% of the issued and outstanding stock of First Bank of Georgia (the “Bank”), an independent, locally owned, state-chartered commercial bank which opened for business in 1989. The Bank operates three branch offices in Augusta, Georgia, two branch offices in Martinez, Georgia and one branch office in Thomson, Georgia. The Bank is constructing a new branch in Evans, Georgia, which is scheduled to open during the second quarter of 2013. The Bank is also the parent company of Willhaven Holdings, LLC, which formerly held certain other real estate of the Bank.
The Bank operates as a locally owned bank that targets the banking needs of individuals and small to medium-sized businesses by emphasizing personal service. The Bank offers a full range of deposit and lending services and is a member of an electronic banking network that enables its customers to use the automated teller machines of other financial institutions. In addition, the Bank offers commercial and business credit services, as well as various consumer credit services, including home mortgage loans, automobile loans, lines of credit, home equity loans and home improvement loans. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”).
The Company was incorporated under the laws of the State of Georgia in January 1997 at the direction of the Board of Directors of the Bank based on a plan of reorganization developed by the Board to substantially strengthen the Bank’s competitive position. The reorganization, in which the Bank became a wholly owned subsidiary of the Company, was completed in June 1997.
In September 1999, the Bank established a mortgage division which operates as First Bank Mortgage (the “Mortgage Division”). The Mortgage Division originates mortgage loans and offers a variety of other mortgage products. As of December 31, 2012, First Bank Mortgage had locations in the Augusta and Savannah, Georgia markets.
In December 2003, the Bank established a financial services division which operates as FB Financial Services. FB Financial Services offers financial planning and investment services through its relationship with Linsco/Private Ledger (Member NASD/SIPC), one of the nation’s leading independent brokerage firms. A joint office of FB Financial Services and Linsco/Private Ledger is located in the Bank’s Main Office location on Wheeler Road in Augusta.
For further information responsive to this item, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report on Form 10-K.
Market Area and Competition
The primary service area of the Bank includes the counties of Richmond, Columbia and McDuffie, Georgia, the communities of Augusta, Martinez, Evans and Thomson, Georgia, and Aiken County, South Carolina, which are within a 40-mile radius of the Bank’s main office. The Bank encounters competition from other commercial banks, which offer a full range of banking services and compete for all types of services, especially deposits. In addition, in certain aspects of its banking business, the Bank also competes with credit unions, savings and loan associations, mortgage banking companies, consumer finance companies, brokerage houses, insurance companies, money market funds and other financial service companies which attract customers that have traditionally been served by banks.
The extent to which other types of financial services companies compete with commercial banks has increased significantly over the past several years as a result of federal and state legislation which has permitted these organizations to compete for customers and offer products that have historically been offered by banks. The impact of this legislation and other subsequent legislation on the financial services industry cannot be predicted. See the “Supervision and Regulation” section that begins on the next page.
Asset/Liability Management
It is the objective of the Bank to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established cash, loan investment, borrowing and capital policies. An investment committee is responsible for monitoring policies and procedures that are designed to ensure acceptable composition of the asset/liability mix, stability and leverage of all sources of funds while adhering to prudent banking practices. It is the overall philosophy of management to support asset growth primarily through growth of core deposits, which include deposits of all categories made by individuals, partnerships and corporations. Management of the Bank seeks to invest the largest portion of the Bank’s assets in commercial, consumer and real estate loans.
The Bank’s asset/liability mix is monitored on a daily basis and further evaluated with a quarterly report that reflects interest-sensitive assets and interest-sensitive liabilities. This report is prepared and presented to the Bank’s Investment Committee and Board of Directors. The objective of this policy is to control interest-sensitive assets and liabilities so as to minimize the impact of substantial movements in interest rates on the Company’s earnings.
Correspondent Banking
Correspondent banking involves the delivery of services by one bank to another bank which cannot provide that service from an economic or practical standpoint. The Bank purchases correspondent services offered by larger banks, including check collections, purchase and sale of federal funds, wire transfers, security safekeeping, investment services, coin and currency supplies, foreign exchange (currency and check collection), over line and liquidity loan participations, and sales of loans to or participations with correspondent banks. The Bank has established correspondent relationships with First National Bankers Bank, Federal Home Loan Bank of Atlanta and SunTrust Bank. As compensation for services provided by a correspondent, the Bank maintains certain balances with such correspondents in both non-interest bearing and interest bearing accounts. The Bank may also buy or sell loan participations with other non-correspondent banks.
Data Processing
In 2010 the Bank renewed its data processing servicing agreement through 2015 with Fidelity Information Services, under which the Bank receives a full range of data processing services, including an automated general ledger, deposit accounting, commercial, real estate and installment lending data processing, remote deposit capture, central information file and ATM/Debit card processing, and internet banking services, including bill pay, cash management services, and mobile banking. During 2012, the Bank contracted with Encompass to implement comprehensive mortgage origination and processing software for its Mortgage Division. That implementation was substantially completed at the end of 2012.
Employees
At December 31, 2012, the Company and the Bank employed 151 persons on a full-time basis and 8 persons on a part-time basis, including 54 banking officers.
Monetary Policies
The results of operations of the Bank are affected by credit policies of monetary authorities, particularly the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The instruments of monetary policy employed by the Federal Reserve Board include open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against member bank deposits and limitations on interest rates which member banks may pay on time and savings deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of action by monetary and fiscal authorities, including the Federal Reserve Board, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Bank.
SUPERVISION AND REGULATION
The following discussion sets forth the material elements of the regulatory framework applicable to bank holding companies and their subsidiaries and provides certain specific information relative to the Company and the Bank. The regulatory framework is intended primarily for the protection of depositors and the Deposit Insurance Fund (the “DIF”) and not for the protection of security holders and creditors. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions.
Recent Federal Legislation
Economic Stabilization Legislation. In the wake of the 2008 financial crisis, the federal government enacted several laws and certain key federal regulatory agencies enacted various regulations and programs designed to stabilize the economy. The two principal pieces of legislation were the Emergency Economic Stabilization Act of 2008 (the “EESA”) and the American Recovery and Reinvestment Act of 2009. Under these laws and other authority, government agencies enacted the Troubled Asset Relief Program, Capital Purchase Program, Public-Private Investment Program, Temporary Liquidity Guarantee Program (“TLGP”) and other initiatives. The Board of Directors of the Bank elected to participate only in the TLGP (which expired at the end of 2012), although the Bank may elect to participate in other programs in the future.
Effective January 1, 2010, all mortgagees who participate in FHA/VA programs of the U.S. Department of Housing and Urban Development (HUD) are subject to additional requirements. First Bank of Georgia’s Mortgage Division initially fell under the requirement of Section 203(b)(1) of the new “Helping Families Save Their Homes Act of 2009” (HFSH Act) which requires that the Mortgage Division submit annual audited financial statements to HUD prepared and audited in accordance with HUD’s Consolidated Audit Guide for Audits of HUD Programs. The following reports are also required to be submitted as part of the requirement: an audit report on internal controls as it relates to reporting and administering HUD-assisted programs and an audit report on compliance with applicable laws and regulations related to HUD-assisted programs. The new requirements are a prudent safeguard that permits the FHA to ensure that those entities with which it does business are adequately capitalized to meet potential needs. In 2011, the FHA amended the reporting requirements for “Small Supervised Lenders” (those with consolidated assets less than $500 million). The Bank qualifies as a Small Supervised Lender and now is permitted to file its fourth quarter Call Report with HUD rather than an audited report on its consolidated financial statements.
The Dodd-Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law on July 21, 2010 and will result in sweeping changes in the regulation of financial institutions. Many provisions of the Dodd-Frank Act apply to, and are more likely to affect, larger financial institutions. However, the Dodd-Frank Act contains numerous other provisions that affect community banks.
Certain of these provisions may have the consequence of increasing expenses and decreasing revenues of all community banking organizations. Further, the environment in which community banking organizations will operate in the future, including legislative and regulatory changes affecting, among other things, their capital, liquidity, and supervision, may have long-term effects on the business model and profitability of community banking organizations, which effects cannot now be predicted. The specific impact of the Dodd-Frank Act on the current and future financial performance of the Bank, will, in large part, depend on the terms of the required regulations and policies to be developed and implemented by the appropriate regulatory agencies.
The Dodd-Frank Act effected a number of statutory changes that, together with the regulations promulgated thereunder, impact community banks. Certain of these changes are discussed below, as follows:
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Assessment Base for Deposit Insurance. The Dodd-Frank Act changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminated the ceiling on the size of the DIF, and increased the floor applicable to the size of the DIF, which may require an increase in the level of assessments for institutions such as the Bank.
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Deposit Insurance Limits. The Dodd-Frank Act made permanent the $250,000 limit on federal deposit insurance. Further, the Dodd-Frank Act provided unlimited federal deposit insurance for noninterest-bearing transaction accounts (traditional, noninterest-bearing demand deposit (or checking) accounts) at all insured depository institutions until December 31, 2012.
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Consumer Financial Protection Bureau. The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency responsible for implementing, examining, and enforcing compliance with federal consumer financial laws. The new Consumer Financial Protection Bureau (“CFPB”) has been created under the Federal Reserve Board and has rule-making, enforcement and investigative authority over consumer financial protection statutes. Many new consumer protection regulations are expected to be promulgated over the next few years. Many of those regulations will increase compliance costs for depository institutions or limit the fees they can charge. Community banks may find it more difficult than larger institutions to absorb the increased compliance costs and reduction in income. The new CFPB is specifically authorized to take action and promulgate rules to prohibit unfair, deceptive or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product. Unfair and deceptive acts are already prohibited by the Federal Trade Commission Act and many state laws. However, the Dodd-Frank Act provides minimal guidance as to what activities will be considered “abusive.” This will likely be an area of significant consumer litigation in the future. State attorneys general are specifically granted the authority to enforce the regulations promulgated by the CFPB against state-chartered banks, which will likely result in increased enforcement of the new consumer regulations.
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Loss of Federal Preemption. The Dodd-Frank Act restricts the preemption of state law by federal law and disallows subsidiaries and affiliates of national banks from availing themselves of such preemption.
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Interstate Branching. The Dodd-Frank Act, subject to a state’s restrictions on intra-state branching, now permits interstate branching. Therefore a bank may enter a new state by acquiring a branch of an existing institution or by establishing a new branch office. As a result, there will be no need for the entering bank to acquire or merge with an existing institution in the target state. This ability to establish a de novo branch across state lines will have the effect of increasing competition within a community bank’s existing markets and may create downward pressure on the franchise value for existing community banks.
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Requirement for Mortgage Loans. The Dodd-Frank Act created additional requirements for residential mortgage loans made by community banks and other mortgage lenders, including restrictions on prepayment penalties and yield-spread premiums, requirements for verification of a borrower’s ability to repay the mortgage loan, and other requirements and restrictions. These provisions of the Dodd-Frank Act will likely increase the compliance and management costs of community banks associated with the origination of residential mortgage loans.
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Interchange Fees. The Dodd-Frank Act amended the Electronic Funds Transfer Act to, among other things, give the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The Federal Reserve Board issued its final rule establishing these new standards on June 29, 2011. Although community banks have been exempted from the cap on interchange fees, the cap on the fees of large banks will create market forces that force all fees downward. Therefore, community banks should expect lower interchange revenues in the future.
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Source of Financial Strength. The Dodd-Frank Act codified the existing policy of the Federal Reserve Board, that a bank holding company serve as a “source of financial strength” for its subsidiary banks. This provision of the Dodd-Frank Act became effective on July 21, 2011, and clarifies ambiguities that might exist with respect to the requirements of a “policy,” as compared to the requirements of a “statute.” Presumably, the regulations promulgated under the statutory requirements will further clarify these source-of-financial-strength requirements for bank holding companies, together with the enforcement powers of the Federal Reserve Board relating thereto.
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Minimum Capital Requirements and Enhanced Supervision. On June 14, 2011, the federal banking agencies published a final rule regarding minimum leverage and risk-based capital requirements for banks and bank holding companies consistent with the requirements of Section 171 of the Dodd-Frank Act. The Dodd-Frank Act also increased regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency. In addition, new enhanced capital requirements promulgated by the Basel Committee on Board Supervision are likely to take effect in the near future (known as “Basel III”) (see “Capital Adequacy” below).
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Payment of Interest on Demand Deposits. On July 21, 2011, the Federal Reserve Board’s final rule repealing Regulation Q (“Prohibition Against Payment of Interest on Demand Deposits”), became effective. Regulation Q was promulgated to implement the statutory prohibition against payment of interest on demand deposits by institutions that are member banks of the Federal Reserve Board. This will increase community banks’ cost of funds as they may need to pay interest on demand deposits of business entities to retain such customers.
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Transactions with Affiliates. The Dodd-Frank Act enhanced the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained. These requirements became effective on July 21, 2011.
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Enhanced Lending Limits. The Dodd-Frank Act strengthened the previous limits on a depository institution’s credit exposure to one borrower which limited a depository institution’s ability to extend credit to one person (or group of related persons) in an amount exceeding certain thresholds. The Dodd-Frank Act expanded the scope of these restrictions to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions.
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Compensation Practices. The Dodd-Frank Act provides that the appropriate federal regulators must establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding company or other “covered financial institution” that provides an insider or other employee with “excessive compensation” or compensation that gives rise to excessive risk or could lead to a material financial loss to such firm. In June 2010, prior to the Dodd-Frank Act, the bank regulatory agencies promulgated the Interagency Guidance on Sound Incentive Compensation Policies, which requires that financial institutions establish metrics for measuring the impact of activities to achieve incentive compensation with the related risk to the financial institution of such behavior. In addition, public companies must now hold non-binding advisory “say-on-pay” and “say-on-frequency” shareholder votes at defined intervals to give shareholders the opportunity to provide feedback on the company’s compensation practices.
Although a significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized, many of the new requirements called for have yet to be implemented and will likely be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
The Company
Bank Holding Company Regulation. The Company is a bank holding company and a member of the Federal Reserve System under the Bank Holding Company Act of 1956 (the “BHC Act”). As such, the Company is subject to the supervision, examination and reporting requirements of the BHC Act, as well as other federal and state laws governing the banking business. The Federal Reserve Board is the primary regulator of the Company, and supervises the Company’s activities on a continual basis. The Company is required to furnish to the Federal Reserve Board an annual report of its operations at the end of each fiscal year, and such additional information as the Federal Reserve Board may require pursuant to the BHC Act. In general, the BHC Act limits bank holding company business to owning or controlling banks and engaging in other banking-related activities. The BHC Act requires that a bank holding company obtain the prior approval of the Federal Reserve Board before:
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acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank;
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taking any action that causes a bank to become a subsidiary of a bank holding company;
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merging or consolidating with another bank holding company; or
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acquiring most other operating companies.
Subject to certain state laws, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state and out-of-state banks. Under the Gramm-Leach-Bliley Act (described below), a bank holding company meeting certain qualifications may apply to the Federal Reserve Board to become a financial holding company, and thereby engage (directly or through a subsidiary) in certain activities deemed financial in nature, such as securities brokerage and insurance underwriting. With certain exceptions, the BHC Act prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares in any company that is not a bank or a bank holding company unless the Federal Reserve Board determines such activities are incidental or closely related to the business of banking.
The Change in Bank Control Act of 1978 requires a person (or a group of persons acting in concert) acquiring “control” of a bank holding company to provide the Federal Reserve Board with 60 days’ prior written notice of the proposed acquisition. Following receipt of this notice, the Federal Reserve Board has 60 days (or up to 90 days if extended) within which to issue a notice disapproving the proposed acquisition. In addition, any “company” must obtain the Federal Reserve Board’s approval before acquiring 25% (5% if the “company” is a bank holding company) or more of the outstanding shares or otherwise obtaining control over a bank holding company.
Financial Services Modernization. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the “Modernization Act”) amended the BHC Act and:
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allows bank holding companies that qualify as “financial holding companies” to engage in a substantially broader range of non-banking activities than was permissible under prior law;
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allows insurers and other financial services companies to acquire banks;
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allows national banks, and some state banks, either directly or through operating subsidiaries, to engage in certain non-banking financial activities;
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removes various restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and
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establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.
If the Company, which has not obtained qualification as a “financial holding company,” were to do so in the future, the Company would be eligible to engage in, or acquire companies engaged in, the broader range of activities that are permitted by the Modernization Act, provided that if any of the Company’s banking subsidiaries were to cease to be “well capitalized” or “well managed” under applicable regulatory standards, the Federal Reserve Board could, among other things, place limitations on the Company’s ability to conduct these broader financial activities or, if the deficiencies persisted, require the Company to divest the banking subsidiary. In addition, if the Company were to be qualified as a financial holding company and any of its banking subsidiaries were to receive a rating of less than satisfactory under the Community Reinvestment Act of 1977 (the “CRA”), the Company would be prohibited from engaging in any additional activities other than those permissible for bank holding companies that are not financial holding companies. The broader range of activities in which financial holding companies are eligible to engage include activities that are determined to be “financial in nature,” including insurance underwriting, securities underwriting and dealing, and making merchant banking investments in commercial and financial companies.
Transactions with Affiliates. The Company and the Bank are deemed to be affiliates within the meaning of the Federal Reserve Act, and transactions between affiliates are subject to certain restrictions. Generally, the Federal Reserve Act limits the extent to which a financial institution or its subsidiaries may engage in “covered transactions” with an affiliate. It also requires all transactions with an affiliate, whether or not “covered transactions,” to be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions.
Tie-In Arrangements. The Company and the Bank cannot engage in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither the Company nor the Bank may condition an extension of credit on either a requirement that the customer obtain additional services provided by either the Company or the Bank, or an agreement by the customer to refrain from obtaining other services from a competitor. The Federal Reserve Board has adopted exceptions to its anti-tying rules that allow banks greater flexibility to package products with their affiliates. These exceptions were designed to enhance competition in banking and non-banking products and to allow banks and their affiliates to provide more efficient, lower cost service to their customers.
Source of Strength; Cross-Guarantee. Under former Federal Reserve Board policy and now codified by the Dodd-Frank Act, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank. This support may be required at times when, absent such rule, the Company may not find itself able to provide it. Capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Under the BHC Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
Subsidiary Dividends. The Company is a legal entity separate and distinct from the Bank. A major portion of the Company’s revenues is derived from amounts paid as dividends to the Company by the Bank. Under Georgia law, the Bank may pay dividends only when and if the Bank is not insolvent. In addition, dividends may not be declared or paid at any time when the Bank does not have combined paid-in capital and appropriated retained earnings equal to at least 20% of the Bank’s capital stock. The Georgia Department of Banking and Finance’s approval must be obtained before the Bank may pay cash dividends out of retained earnings if (i) the total classified assets at the most recent examination of the Bank exceeded 80% of the equity capital, (ii) the aggregate amount of dividends declared or anticipated to be declared in the calendar year exceeds 50% of the net profits, after taxes but before dividends for the previous calendar year, or (iii) the ratio of equity capital to adjusted assets is less than 6%.
In addition, the Company and the Bank are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof, under certain circumstances relating to the financial condition of a bank or bank holding company. Federal regulatory authorities have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice and that banking organizations should generally pay dividends only out of current operating earnings.
Incentive Compensation. On June 21, 2010, the Federal Reserve Board, along with the Office of the Comptroller of the Currency (the “OCC”), the Office of Thrift Supervision (the “OTS”), and the FDIC, issued final guidance on incentive compensation policies. The guidance is intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking.
The agencies are working to incorporate oversight of incentive compensation policies, as part of the regular, risk-focused examination process, of financial institutions that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the financial institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the institution is not taking prompt and effective measures to correct the deficiencies.
The guidance is designed to ensure that incentive compensation arrangements at banking organizations appropriately tie rewards to longer-term performance and do not undermine the safety and soundness of the institution or create undue risks to the financial system. Because improperly structured compensation arrangements for both executive and non-executive employees may pose safety and soundness risks, the guidance applies not only to top-level managers, but also to other employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group.
The guidance is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the institution’s board of directors.
The scope and content of banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the future.
The Federal Reserve Board and the Dodd-Frank Act addressed loan officer origination compensation practices with new rules in 2010. See the discussion under “Other Laws and Regulations.”
State Law Restrictions. As a Georgia business corporation, the Company may be subject to certain limitations and restrictions under applicable Georgia corporate law.
The Bank
General. The Bank, as a Georgia state-chartered bank, is subject to regulation and examination by the State of Georgia Department of Banking and Finance, as well as the FDIC. Georgia state laws regulate, among other things, the scope of the Bank’s business, its investments, its payment of dividends to the Company, its required legal reserves and the nature, lending limit, maximum interest charged and amount of and collateral for loans. The laws and regulations governing the Bank generally have been promulgated by the Georgia Legislature to protect depositors and not to protect shareholders of the Company or the Bank.
Bank Lending Limit. In September 2009, the Bank became subject to revised regulations from the State of Georgia Department of Banking and Finance regarding its total aggregate lending limit to a single customer and that customer’s related entities. The new regulation revised the definition of how a single customer is defined. As a result, the Board of Directors of the Bank approved an increase in the Bank’s statutory capital base in October 2009 by appropriating a portion of retained earnings. At December 31, 2012, the Bank’s statutory capital base totaled $40.0 million and consisted of $3.18 million in capital stock, $16.32 million of surplus and $20.50 million in appropriated retained earnings, allowing for a $10.0 million lending limit (25%).
Commercial Real Estate Lending. Lending operations that involve concentration of commercial real estate loans are subject to enhanced scrutiny by federal banking regulators. The regulators have issued guidance with respect to the risks posed by commercial real estate lending concentrations. Real estate loans generally include land development, construction loans, loans secured by multi-family property and nonfarm nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for examiners to help identify institutions that are potentially exposed to concentration risk and may warrant greater supervisory scrutiny:
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total reported loans for construction, land development and other land represent 100 percent or more of the institution’s total risk-based capital, or
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total commercial real estate loans as defined in the guidance represent 300 percent or more of the institution’s total risk-based capital and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50 percent or more during the prior 36 months.
In October 2009, the federal banking agencies issued additional guidance on real estate lending that emphasizes these considerations.
Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders, or any related interests of such persons. Extensions of credit must be made on substantially the same terms, including interest rates and collateral, and follow credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with persons not covered above and who are not employees. Also, such extensions of credit must not involve more than the normal risk of repayment or present other unfavorable features.
Transactions with Affiliates and Insiders; Regulation W. The Bank is subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all “covered transactions” is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.
Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.
Federal Deposit Insurance Corporation Improvement Act. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDICIA”), all insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable. The FDICIA directs the FDIC to develop a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition, or any other report of any insured depository institution. Each federal banking agency has prescribed, by regulation, non-capital safety and soundness standards for institutions under its authority. These standards cover internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, such other operational and managerial standards as the agency determines to be appropriate, and standards for asset quality, earnings and stock valuation.
Interstate Banking and Branching. The Dodd-Frank Act modified the federal statute governing de novo interstate branching by state member banks. As a result, as of July 22, 2010, a state member bank is authorized to open its initial branch in a host state by establishing a de novo branch at any location where a bank chartered by that host state could establish a branch. A host state is defined as a state, other than a bank’s home state, in which the bank seeks to establish and maintain a branch. A state member bank seeking to open a de novo interstate branch must file an application with the Federal Reserve Board in addition to adherence to state filing requirements and to capital, management, and community reinvestment standards.
Deposit Insurance and Assessments. The deposits of the Bank are currently insured to a maximum of $250,000 per depositor for substantially all depository accounts. The FDIC insurance also temporarily provided unlimited coverage for certain qualifying and participating non-interest bearing transaction accounts. This increased coverage was in effect until December 31, 2012.
In February 2011, the FDIC board of directors approved a final plan to impose parity among banks in the deposit-insurance system by basing the assessment base on average total consolidated assets minus average tangible equity instead of domestic deposits. The new initial base rate schedule is substantially lower than the current one. Institutions in Risk Category I, which includes more than 90 percent of community banks, pay 5-9 basis points instead of the prior base rate schedule of 12-16 basis points. Institutions in Risk Categories II, III and IV pay 14, 23 and 35 basis points, respectively, compared to the prior rates of 22, 32 and 45 basis points, respectively. In addition, the secured liability adjustment was eliminated under the final rule (although secured liabilities are reflected in a bank’s new assessment base), and the unsecured debt adjustment and the brokered deposit adjustment have remained but with some modifications. The new rate schedule went into effect during the second quarter of 2011. Under the final rule, institutions with less than $1 billion in assets report average weekly balances of their consolidated total assets rather than reporting average daily balances. The final rule allows institutions with less than $1 billion in average consolidated total assets to report the end-of-quarter amount of Tier 1 capital as a proxy for average tangible equity.
The Bank’s FDIC insurance expense totaled $403,273 for 2012. FDIC insurance expense includes deposit insurance assessments and Financing Corporation (“FICO”) assessments related to outstanding FICO bonds to fund interest payments on bonds to recapitalize the predecessor to the DIF. These assessments will continue until the FICO bonds mature in 2017. The FICO assessment rates, which are determined quarterly, are based on average total consolidated assets minus average tangible equity. The assessment rate was .00165% for first quarter 2012, .00165% for second quarter 2012, .00165% for third quarter 2012 and .00160% for fourth quarter 2012.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the banking regulator. It may also suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Our management is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.
Community Reinvestment Act. The CRA requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve Board, the FDIC, or the OCC (as applicable), shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Under the Modernization Act, banks with aggregate assets of not more than $250 million will be subject to a CRA examination only once every sixty months if the bank receives an outstanding rating, once every forty-eight months if it receives a satisfactory rating, and as needed if the rating is less than satisfactory. Additionally, under the Modernization Act, banks are required to publicly disclose the terms of various CRA-related agreements.
The Modernization Act-Consumer Privacy. The Modernization Act also contains provisions regarding consumer privacy. These provisions require financial institutions to disclose their policy for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market an institution’s own products and services. Additionally, financial institutions generally may not disclose customer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing, or other marketing to the consumer.
Capital Adequacy
Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. If capital falls below minimum guideline levels, the holding company or bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities.
The FDIC and Federal Reserve Board use risk-based capital guidelines for banks and bank holding companies. These are designed to make such capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the Federal Reserve Board has noted that bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimum. The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier 1 capital. Tier 1 capital for bank holding companies includes common shareholders’ equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, but excludes goodwill and most other intangibles and excludes the allowance for loan and lease losses. Tier 2 capital includes the excess of any preferred stock not included in Tier 1 capital, mandatory convertible securities, hybrid capital instruments, subordinated debt and intermediate term-preferred stock, and general reserves for loan and lease losses up to 1.25% of risk-weighted assets.
The FDIC and Federal Reserve Board also employ a leverage ratio, which is Tier 1 capital as a percentage of total assets less intangibles, to be used as a supplement to risk-based guidelines. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company or bank may leverage its equity capital base. A minimum leverage ratio of 3% is required for the most highly rated bank holding companies and banks. Other bank holding companies, banks and bank holding companies seeking to expand, however, are required to maintain minimum leverage ratios of at least 4% to 5%.
The FDICIA created a statutory framework of supervisory actions indexed to the capital level of the individual institution. Under the “prompt corrective action” regulations adopted by the FDIC and the Federal Reserve Board, an institution is assigned to one of five capital categories, ranging from “well-capitalized” to “critically undercapitalized,” depending on its total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio, together with certain subjective factors. Institutions which are deemed to be “significantly undercapitalized” or “critically undercapitalized” are subject to certain mandatory supervisory corrective actions.
Increases in regulatory capital requirements appear to be likely, but the federal financial regulators have not yet identified specific increases. In September 2009, the U.S. Treasury Department released a set of principles for financial regulatory reform, including a general recommendation for increased capital for banks and bank holding companies across the board (with even higher requirements for systemically risky banking organizations). In December 2009, the Basel Committee on Board Supervision issued proposals for regulatory capital changes, including greater emphasis on common equity as a component of Tier 1 capital. On September 12, 2010, the Basel Committee announced the calibration of its revised capital framework for major financial institutions (known as “Basel III”). The increased capital requirements were to be phased into national laws and regulations by January 1, 2013, but on November 9, 2012, federal banking regulators imposed an indefinite delay on the implementation of these rules. Both sets of proposals also recommend enhanced leverage and liquidity requirements.
Other Laws and Regulations
International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001. On October 26, 2001, the USA PATRIOT Act was enacted. It includes the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (the “IMLAFA”) and strong measures to prevent, detect and prosecute terrorism and international money laundering. As required by the IMLAFA, the federal banking agencies, in cooperation with the U.S. Treasury Department, established rules that generally apply to insured depository institutions and U.S. branches and agencies of foreign banks.
Among other things, the new rules require that financial institutions implement reasonable procedures to (1) verify the identity of any person opening an account; (2) maintain records of the information used to verify the person’s identity; and (3) determine whether the person appears on any list of known or suspected terrorists or terrorist organizations. The rules also prohibit banks from establishing correspondent accounts with foreign shell banks with no physical presence and encourage cooperation among financial institutions, their regulators and law enforcement to share information regarding individuals, entities and organizations engaged in terrorist acts or money laundering activities. The rules also limit a financial institution’s liability for submitting a report of suspicious activity and for voluntarily disclosing a possible violation of law to law enforcement. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.
Under the USA PATRIOT Act, the Federal Bureau of Investigation (the “FBI”) can send to the bank regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. A bank can be requested to search its records for any relationships or transactions with persons on those lists. If any relationships or transactions are found, the bank must file a suspicious activity report and contact the FBI.
The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, to bank regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If a bank finds a name on any transaction, account or wire transfer that is on an OFAC list, the bank must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of accounts and the filing of any required notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files, utilizing software which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the “SOX”) was enacted to address corporate and accounting fraud. It established a new accounting oversight board that enforces auditing standards and restricts the scope of services that accounting firms may provide to their public company audit clients. Among other things, it also: (i) requires chief executive officers and chief financial officers to certify to the accuracy of periodic reports filed with the SEC; (ii) imposes new disclosure requirements regarding internal controls, off-balance-sheet transactions, and pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting of insider transactions and periodic disclosures by certain public companies; and (iv) requires companies to disclose whether or not they have adopted a code of ethics for senior financial officers and whether the audit committee includes at least one “audit committee financial expert.”
The SOX requires the SEC, based on certain enumerated factors, to review corporate filings regularly and systematically. To deter wrongdoing, it: (i) subjects bonuses issued to top executives to disgorgement if a restatement of a company’s financial statements was due to corporate misconduct; (ii) prohibits an officer or director from misleading or coercing an auditor; (iii) prohibits insider trades during pension fund “blackout periods”; (iv) imposes new criminal penalties for fraud and other wrongful acts; and (v) extends the period during which certain securities fraud lawsuits can be brought against a company or its officers.
Effective September 21, 2010, the SEC adopted amendments to its rules to conform to Section 404(c) of the SOX, as added by Section 989G of the Dodd-Frank Act. Section 404(c) provides that the SOX shall not apply to any audit report prepared by an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934.
With market value of its common equity less than $75 million, the Company does not qualify as an accelerated filer or large accelerated filer and therefore is not presently subject to Section 404(c) of the SOX for the year ended December 31, 2012. Prior to the enactment of the Dodd-Frank Act, the Company, as a non-accelerated filer, would have been required to include an attestation report from its public accounting firm on internal control over financial reporting in its Annual Report on Form 10-K filed with the SEC.
The Company’s management continues to be responsible for establishing and maintaining adequate internal control over financial reporting as detailed in Item 9A of this Annual Report on Form 10-K.
Other Laws and Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:
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Effective April 1, 2011, the Federal Reserve Board implemented new rules regarding all persons who originate loans, including mortgage loan officers and brokers. The new rules include, among other things, prohibition of compensation to loan originators based on the terms or conditions of a loan, prohibiting dual payment of a mortgage originator from both the consumer and the creditor, and prohibiting a loan officer from steering a consumer to a lender with less favorable terms that increase the loan officer or broker’s compensation. The Dodd-Frank Act also addressed loan originator compensation in a similar manner but with additional provisions. The Bank’s Mortgage Division has addressed these new rules and has met the April 1, 2011 implementation date.
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The Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers.
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The Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves.
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The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit.
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The Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies.
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The Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies.
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The Check Clearing for the 21st Century Act, giving “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check, and enacting other provisions related to check status, communication and verification procedures.
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The rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
The deposit operations of the Bank are also subject to:
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the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
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the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
Financial Institutions Reform Recovery and Enforcement Act of 1989. This act expanded and increased the enforcement powers of the federal regulatory agencies in terms of both civil and criminal penalties against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys, accountants and others who participate in the conduct of the financial institution’s affairs. Practices subject to these sanctions can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,000,000 a day for such violations. Criminal penalties for some financial institution crimes have been increased to twenty years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.
Privacy and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer. Additionally, financial institutions generally may not disclose customer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law.
Like other lending institutions, the Bank utilizes credit bureau data in its underwriting activities. Use of such data is regulated under the Fair Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.
Effect of Governmental Monetary Policies. The Bank’s earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.
Future Legislation. Various other legislative and regulatory initiatives affecting the banking system are from time to time introduced in Congress and state legislatures, as well as regulatory agencies. Currently, the United States Congress is actively considering further significant changes to the manner of regulating financial institutions. The current legislation being considered and other future legislation regarding financial institutions may change banking statutes and the operating environment in substantial and unpredictable ways. The nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable at this time. The Company cannot determine the ultimate effect that such potential legislation, if enacted, would have upon its financial condition or operations.
Item 1A.
Item 1A. Risk Factors
Item 1A. Risk Factors
The following is a summary of certain significant risks related to us, our business and an investment in our common stock. This should not be viewed as an all-inclusive or exhaustive list.
Risks Related to Our Industry
The banking crisis that began in 2008 adversely affected our industry, including our business, and may continue to have an adverse effect on our business in the future.
Dramatic declines in the housing market which began in 2008, unemployment and under-employment, negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. The crisis caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in many cases, to fail. This economic turmoil and tightening of credit led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and the lack of confidence in the financial markets adversely affected our business, financial condition and results of operations. Although economic conditions have been slowly improving, future market developments could affect consumer confidence levels and cause adverse changes in loan payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses.
The financial distress of other financial institutions could have a material adverse impact on us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have in the past led, and could in the future lead, to market-wide liquidity problems and thereafter losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our business, financial condition, and results of operations.
Recent legislative reforms have resulted in our business becoming subject to significant and extensive additional regulations and/or could adversely affect our results of operations and financial condition.
The Dodd-Frank Act has resulted in sweeping changes in the regulation of financial institutions aimed at strengthening the sound operation of the financial services sector. The Dodd-Frank Act’s provisions that have received the most public attention generally have been those applying to or more likely to affect larger institutions. However, it contains numerous other provisions that have affected all banks and bank holding companies, and have fundamentally changed the system of oversight described in the section entitled “Supervision and Regulation” above.
Some of these provisions may have the consequence of increasing our expenses, decreasing our revenues, and changing the activities in which we choose to engage. The environment in which banking organizations will operate after the financial crisis, including legislative and regulatory changes affecting capital, liquidity, supervision, permissible activities, corporate governance and compensation, changes in fiscal policy and steps to eliminate government support for banking organizations, may have long-term effects on the business model and profitability of banking organizations that cannot now be foreseen. The specific impact of the Dodd-Frank Act on our current activities or new financial activities we may consider in the future, our financial performance, and the markets in which we operate, will depend on the manner in which the relevant agencies develop and implement the required rules and the reaction of market participants to these regulatory developments.
Risks Related to Our Business
An economic downturn, especially one affecting Richmond, Columbia and McDuffie counties, could adversely affect our business.
Our success significantly depends upon the growth in population, income levels, deposits, and housing in our primary market areas of Richmond, Columbia and McDuffie counties in the State of Georgia. If these communities do not grow or if prevailing local or national economic conditions are unfavorable, our business may be adversely affected. An economic downturn would likely harm the quality of our loan portfolio and reduce the level of our deposits, which in turn would hurt our business. If the strength of the U.S. economy in general and the strength of the local economies in which the Company conducts operations declines, or continues to decline, this could result in, among other things, a deterioration in credit quality, increased loan charge-offs and delinquencies or a reduced demand for credit, including a resultant effect on the Bank’s loan portfolio and allowance for loan losses. These factors could materially adversely affect the Company’s financial condition and results of operations. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. The Bank is a community bank and as such, is mandated by the Community Reinvestment Act and other regulations to conduct most of its lending activities within the geographic area where it is located. As a result, the Bank and its borrowers may be especially vulnerable to the consequences of changes in the local economy.
Weakness in the real estate market, including the secondary residential mortgage loan markets, has adversely affected us in the past and could adversely affect us in the future.
Significant disruptions in the secondary market for residential mortgage loans have reduced the demand for and impaired the liquidity of many mortgage loans. Declining real estate prices have also caused higher delinquencies and losses on certain mortgage loans. Although the market has improved, the effects of mortgage market challenges, combined with a correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans that we hold, mortgage loan originations and profits on sale of mortgage loans. Declines in real estate values and home sales, and financial stress on borrowers as a result of job losses, interest rate resets on adjustable rate mortgage loans or other factors, could have further adverse effects on borrowers, resulting in higher delinquencies and greater charge-offs in future periods, which could adversely affect our financial condition or results of operations.
Our loan portfolio includes a substantial amount of commercial real estate and construction and development loans, which may have more risks than residential or consumer loans.
Our commercial real estate loans and construction and development loans account for a substantial portion of our total loan portfolio. These loans generally carry larger loan balances and usually involve a greater degree of financial and credit risk than home equity, residential or consumer loans. The increased financial and credit risk associated with these types of loans is a result of several factors, including the concentration of principal in a limited number of loans and to borrowers in similar lines of business, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by commercial real estate in some cases is dependent upon the successful operation, development or sale of the related real estate or commercial project. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired. This cash flow shortage may result in the failure to make loan payments. In these cases, we may be compelled to modify the terms of the loan. As a result, repayment of these loans may, to a greater extent than other types of loans, be subject to adverse conditions in the real estate market or economy.
Many of our borrowers have more than one loan or credit relationship with us.
Many of our borrowers have more than one commercial real estate or commercial business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to, for example, a one-to-four family residential mortgage loan.
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:
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the duration of the credit;
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credit risks of a particular customer;
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changes in economic and industry conditions; and
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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 potential losses in our loan portfolio. However, there is no precise method of predicting credit losses, since any estimate of loan losses is necessarily subjective and the accuracy 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 a decrease of our net income, and possibly our capital.
We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract deposits.
The banking business is highly competitive and we experience competition in each of our markets 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 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, in order to grow we have to attract customers from other existing financial institutions or 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 and trust services, which we currently do not provide. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us. There is a risk that we will have a competitive disadvantage with these other financial institutions in our markets, and that we may have to pay higher interest rates to attract deposits and/or lower our interest rates on loans to customers, resulting in reduced profitability. In new markets that we may enter, we will also compete against well-established community banks that have developed relationships within the community.
Changes in monetary policies and interest rates could reduce our profitability and adversely affect our business.
Our profitability is affected by credit policies of monetary authorities, particularly the Federal Reserve Board, and depends in large part on our net interest income, which is the difference between interest earned from interest-earning assets, such as loans and investment securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings. Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments. 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 may suffer.
Our recent operating results may not be indicative of our future operating results.
In 2012, we experienced a decline in loan demand, but were able to increase total assets and deposit levels, and we reported record net income. We may not be able to sustain our historical rate of growth from prior years and may not even be able to grow our business at all. We may not be able to sustain or increase our profitability. Consequently, our historical results of operations are not necessarily indicative of our future operations. Various factors, such as economic conditions, regulatory and legislative considerations and competition may also impede our ability to increase our rate of growth and our profitability.
We could be adversely affected by the loss of one or more key personnel or by an inability to attract and retain employees.
We believe that our growth and future success will depend in large part on the skills of our executive and other senior officers. The loss of the services of one or more of these officers could impair our ability to continue to implement our business strategy. Our executive and other senior officers have extensive and long-standing ties within our primary market areas and substantial experience with our operations, and have contributed significantly to our growth. If we lose the services of any one of them, he or she may be difficult to replace and our business could be materially and adversely affected.
Our success also depends, in part, on our continued ability to attract and retain experienced and qualified employees. The competition for such employees is intense, and our inability to continue to attract, retain and motivate employees could adversely affect our business.
The success of our growth strategy depends on our ability to identify and recruit individuals with experience and relationships in the markets in which we intend to expand.
We intend to expand our banking network over the next several years into both new and existing markets in and around our current market areas. We believe that to expand into new markets successfully, we must identify and recruit 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 their current employers. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy. Our inability to identify, recruit and retain talented personnel to manage new offices effectively and in a timely manner would limit our growth and could materially adversely affect our business, financial condition and results of operations.
We will face risks with respect to future expansion and acquisitions or mergers.
We may expand into new lines of business or offer new products or services. Any expansion plans we undertake may also divert the attention of our management from the operation of our core business, which could have an adverse effect on our results of operations. We may also seek to acquire other financial institutions or assets of those institutions. Any of these activities would involve a number of risks such as the time and expense associated with evaluating new lines of business or new markets for expansion, hiring or retaining local management and integrating new acquisitions. Even if we acquire new lines of business or new products or services, they may not be profitable. Nor can we say with certainty that we will be able to consummate, or if consummated, successfully integrate, future acquisitions, if any, or that we will not incur disruptions or unexpected expense in integrating such acquisitions. Any given acquisition, if and when consummated, may adversely affect our results of operations and financial condition.
Our growth may require us to raise additional capital that may not be available when it is needed or may not be available on terms acceptable to us.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. To support our continued growth, we may need to raise additional capital. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot be assured of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.
We are subject to extensive regulation that could limit or restrict our activities.
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various regulatory agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, purchase and sale of investments, origination and sale of loans, interest rates charged on loans, interest rates paid on deposits and locations of offices. We are also subject to regulatory capital requirements established by our regulators, which require us to maintain adequate capital to support our growth. If we fail to meet these capital and other regulatory requirements, our ability to grow, our cost of funds and FDIC insurance, our ability to borrow funds, our ability to pay dividends on common stock, and our ability to make acquisitions, could be materially and adversely affected.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all banks and bank holding companies, our cost of compliance could adversely affect our profitability. In addition, the purpose of these laws and regulations is to protect and insure the interests and deposits of our depositors, and are not for the protection of our investors.
Efforts to comply with the Sarbanes-Oxley Act have involved significant expenditures, and non-compliance with the Sarbanes-Oxley Act may adversely affect us.
The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. We have experienced, and we expect to continue to experience, greater compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act.
In 2010 the SEC adopted amendments to its rules and forms to implement revised Section 404(c) to exclude smaller reporting companies. We are a smaller reporting company and therefore are not presently subject to the SOX Section 404 as it relates to certain internal control requirements. However, management continues to be responsible for establishing and maintaining adequate internal control over financial reporting. For further discussion see “Supervision and Regulation - Other Laws and Regulations.”
We may be required to pay significantly higher FDIC premiums in the future.
Insured institution failures and a deterioration in banking and economic conditions since 2008 have significantly increased the insurance fund loss provisions of the FDIC, resulting in a decline in the designated reserve ratio to historical lows. The FDIC expects there to be additional insured institution failures in the next few years. Therefore, the reserve ratio may continue to decline. Additionally, the limit on FDIC coverage was increased to $250,000 by the enactment of the Dodd-Frank Act.
These developments caused the premiums assessed by the FDIC to increase. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than current levels. Any future increases in FDIC insurance premiums may materially and adversely affect our results of operations. Additionally, the Dodd-Frank Act changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital. Although we may initially see a decline in premiums as a result of this change, there is still risk that future assessments could increase again.
Changes in accounting policies and practices, as may be adopted by the regulatory agencies, the Financial Accounting Standards Board, or other authoritative bodies, could materially impact our financial statements.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the regulatory agencies, the Financial Accounting Standards Board, and other authoritative bodies change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations.
We must respond to rapid technological changes, and these changes may be more difficult to implement or more expensive than anticipated.
We will have to respond to future technological changes. Specifically, if our competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, then our existing product and service offerings, technology and systems may be impaired or become obsolete. Further, if we fail to adopt or develop new technologies or to adapt our products and services to emerging industry standards, then we may lose current and future customers, which could have a material adverse effect on our business, financial condition and results of operations. The financial services industry is changing rapidly and in order to remain competitive, we must continue to enhance and improve the functionality and features of our products, services and technologies. These changes may be more difficult to implement or more expensive than we anticipate.
Our operations and the operations of our vendors, suppliers and customers may be subject to disruption from events beyond our control.
Our operations and the operations of our vendors, suppliers and customers may be subject to disruption from a variety of causes, including work stoppages, financial difficulties, acts of war, terrorism, fire, earthquakes, flooding or other natural disasters. If a major disruption were to occur it could result in suspension of operations, harm to people or the environment, delays in our ability to provide banking services, or the inability of customers to repay loan obligations. Adverse consequences may also result from disruptions in the operations of our vendors, suppliers and customers, which could have a material adverse effect upon our business.
Risks Related to Investing in Our Common Stock
Although there is a trading market for our common stock, an active trading market may never develop or be maintained.
Although our common stock is traded on the Over-The-Counter Bulletin Board, there is not a consistently active trading market for our common stock. An investor in our stock may be unable to liquidate his or its investment quickly and efficiently and should be prepared to bear the economic risk of an investment in our common stock for an indefinite period. We cannot predict the extent to which an active public market for our common stock may develop or be sustained.
Our ability to pay dividends is limited and we may be unable to pay future dividends. As a result, capital appreciation, if any, of our common stock may be your sole opportunity for gains on your investment for the foreseeable future.
We make no assurances that we will pay any dividends in the future. Holders of our common stock are not entitled to receive dividends unless declared by our board of directors. Our ability to do so will be limited by regulatory restrictions, our financial condition, results of operations, capital requirements, level of indebtedness and such other factors as our board of directors deems relevant. Our ability to pay dividends is limited by our obligations to maintain sufficient capital and by other restrictions on the payment of dividends that are applicable to us. Investors should not purchase our common stock if they require dividend income.
Our securities are not FDIC insured.
Our securities, including our common stock, are not savings or deposit accounts, and are not insured by the Deposit Insurance Fund, the FDIC or any other governmental agency and are subject to investment risk, including the possible loss of the entire investment.
We may issue additional shares of our common stock that could result in dilution of an investor’s investment.
Our board of directors may determine from time to time that there is a need to obtain additional capital through the issuance of additional shares of common stock or other securities. These issuances would likely dilute the ownership interests of our investors and may dilute the per share book value of our common stock. In addition, the issuance of additional shares of common stock under our stock option and equity incentive plans will further dilute each investor’s ownership of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
Not Applicable
Item 2.
Item 2. Properties
The Company’s and the Bank’s main office is located at 3527 Wheeler Road in Augusta, Georgia. This office was opened in September 2005. The Bank operates three banking offices in Augusta, Georgia, two banking offices in Martinez, Georgia and one banking office in Thomson, Georgia. All of these offices are owned by the Bank. The following table sets forth the location of each of the Bank’s branch offices and the date each branch opened for business:
Branch
Date Opened
Hill Street Office, Thomson, Georgia
January 1989
Daniel Village Office, Augusta, Georgia
March 1999
West Town Office, Martinez, Georgia
October 1999
Medical Center Office, Augusta, Georgia
January 2001
Fury’s Ferry Road Office, Martinez, Georgia
April 2002
Main Office, Augusta, Georgia
September 2005
In January 2002, the Bank purchased a site located in Evans, Georgia. In March 2005, the Bank entered into a contract to purchase another site in Evans, Georgia and finalized that purchase in February 2006. The Bank began construction of a full service banking office at one of the sites in Evans, Georgia in 2012. The branch should be completed and in operation during the second quarter of 2013.
The Bank also leases office space at one location in Augusta to house the Mortgage Division. The Mortgage Division also operates offices in Savannah, Georgia out of leased office space.
Item 3.
Item 3. Legal Proceedings
The nature of the business of the Bank is such that it ordinarily results in a certain amount of litigation. In the opinion of management, there are no material pending legal proceedings to which the Company or the Bank is a party or of which any of their properties are the subject; nor are there material proceedings known to the Company or the Bank to be contemplated by any governmental authority; nor are there material proceedings known to the Company or the Bank, pending or contemplated, in which any director, officer, or affiliate or any principal security holder of the Company or the Bank, or any associate of any of the foregoing is a party or has an interest adverse to the Company or the Bank.
In August 2011, the Bank was sued in State Court by a subcontractor related to a residential development project foreclosed upon by the Bank. The suit alleged various claims against the Bank, all of which the Bank denied. Following a mistrial in November 2012 where the jury failed to reach a verdict, a second trial in January 2013 resulted in a verdict against the Bank in the amount of $597,500. The Bank is in the process of appealing this verdict and believes it has meritorious defenses against the verdict. The entire judgment amount was recorded as a contingent liability as of December 31, 2012; therefore management does not expect that there will be any material adverse effects on the Company’s future consolidated financial position, results of operations or cash flows related to this litigation.
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
Market Information
The Company’s common stock trades on the Over-The-Counter Bulletin Board under the symbol “GECR”. The market for the Company’s common stock must be characterized as a limited market due to its relatively low trading volume and lack of analyst coverage. The following table sets forth for the periods indicated the quarterly high and low sales prices per share as reported by the Over-The-Counter Bulletin Board. These quotations also reflect inter-dealer prices without retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions. The share prices below reflect all stock splits.
Holders of Common Stock
As of March 20, 2013, the number of holders of record of the Company’s common stock was approximately 534.
Dividends
Cash dividends of $432,000 and $0 were paid by the Company during the years ended December 31, 2012 and 2011, respectively. The Company commenced paying a quarterly dividend of $0.04 per share in the second quarter of 2012. Future dividends, if any, will be determined by the Board of Directors of the Company in light of circumstances existing from time to time, including the Company’s growth, financial condition and results of operations, the continued existence of the restrictions described below on the Bank’s ability to pay dividends and other factors that the Board of Directors of the Company considers relevant. In addition, the Board of Directors of the Company may determine, from time to time, that it is prudent to pay special nonrecurring cash dividends in addition to or in lieu of regular cash dividends. Such special dividends will depend upon the financial performance of the Company and will take into account its capital position. No special dividend is presently contemplated.
Because the Company’s principal operations are conducted through the Bank, the Company generates cash to pay dividends primarily through dividends paid to it by the Bank. Accordingly, any dividends paid by the Company will depend on the Bank’s earnings, capital requirements, financial condition and other factors. Under Georgia law, the Bank may pay dividends only when and if the Bank is not insolvent. In addition, dividends may not be declared or paid at any time when the Bank does not have combined paid-in capital and appropriated retained earnings equal to at least 20% of the Bank’s capital stock. Moreover, dividends may not be paid by the Bank without the prior approval of the Georgia Department of Banking and Finance (the “Georgia Banking Department”), if the dividends are in excess of specified amounts fixed by the Georgia Banking Department.
Equity Compensation Plan Information
The Company currently has three equity compensation plans: (i) the 1997 Stock Option Plan, which was approved by shareholders; (ii) the Amended and Restated 2004 Incentive Plan, which was approved by shareholders; and (iii) the Directors Equity Incentive Plan, which has not been approved by shareholders. The following table provides information as of December 31, 2012 regarding the Company’s then existing compensation plans and arrangements:
Directors Equity Incentive Plan
The Directors Equity Incentive Plan provides that non-employee directors of the Company and the Bank may elect to purchase shares of the Company’s common stock in lieu of receiving cash for director fees earned in each calendar quarter. Prior to 2012, the purchase price for shares acquired under the plan was $2.00 less than the average closing market price of the Common Stock quoted on the Over-the-Counter Bulletin Board (or other national quotation service) for the ten business days prior to the last trade of the Company’s common stock reported prior to the purchase date. However in January 2012, the plan was amended such that the purchase price for shares acquired under the plan is equal to 85% of the average closing market price of the Company’s common stock for the last ten trading days of each quarter as reported on the Over-the-Counter Bulletin Board. A non-employee director may join the plan at any time during the last seven days of each calendar quarter. The Directors Equity Incentive Plan also provides non-employee directors of the Company and the Bank annual retainer shares in the form of 1) base award shares, plus 2) bonus shares for service as Board chairman, plus 3) bonus shares for service on various committees. Non-employee advisory board members also qualify to receive annual award shares from the Directors Equity Incentive Plan provided they meet an agreed upon annual attendance requirement. During 2012, the Company issued 11,350 shares of stock as retainer stock, and 13,154 shares of stock in lieu of cash for directors’ fees. During 2012, the Company amended the Plan to authorize the issuance of 300,000 shares in the aggregate.
Issuer Stock Repurchases
The table below provides information related to stock repurchases by the Company during the fourth quarter of 2012. The purchase was not part of any ongoing stock repurchase plan maintained by the Company. The purchase was authorized by the Company’s board of directors.
Equity Securities Issued without Registration under the Securities Act of 1933
During 2012, an aggregate of 11,350 shares were issued in payment for the annual retainer fees to certain directors, without registration under the Securities Act of 1933, as amended. These shares were issued in reliance upon the exemption under the Securities Act provided by Section 4(2) of such Act.
Item 6.
Item 6. Selected Financial Data
Our selected consolidated financial data presented below as of and for the years ended December 31, 2008 through 2012 is derived from our audited consolidated financial statements. Our audited consolidated balance sheet as of December 31, 2012 and 2011 and results of operations for each of the years in the two year period ended December 31, 2012 are included elsewhere in this report. All years have been restated as necessary for stock dividends and stock splits.
(1) Non-tax equivalent.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion provides information about the major components of the results of operations and financial condition, liquidity and capital resources of the Company and Bank and should be read in conjunction with the “Business” and “Financial Statements” sections included elsewhere in this report. Information given in response to Item 6 of this report, “Selected Financial Data,” is incorporated by reference in response to this Item 7.
Critical Accounting Policies
The accounting and reporting policies of the Company and Bank are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and the accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported.
Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record the valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.
Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements.
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general component covers non impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent year. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries for the most recent three years; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.
There are many factors affecting the allowance for loan losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all possible factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses could be required that could adversely affect the Bank’s earnings or financial position in future periods.
Mortgage Banking Derivative
Loan commitments, whose underlying mortgage loans at origination will be held for sale upon funding of the loan are derivative instruments. Loan commitments are recognized on the consolidated balance sheet in other assets and other liabilities at fair value, with changes in their fair values recognized in other non-interest income. At the inception of a loan commitment, the Bank generally will simultaneously enter into a best efforts forward commitment to protect the Bank from losses on sales of the loans underlying the loan commitment by securing the ultimate sale price and delivery date of the loan.
Other Real Estate Owned
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of other real estate owned are capitalized.
Additional information on the Bank’s loan portfolio and allowance for loan losses can be found in the “Loan Portfolio” section of this Item 7. Note 1, Note 4 and Note 19 to the consolidated financial statements also include additional information on the Bank’s accounting policies related to the allowance for loan losses and other real estate owned.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 19 to the consolidated financial statements. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
Consolidated Financial Information
Certain consolidated financial information for the Company and Bank as of and for the years ended December 31, 2012 and 2011 is presented below:
The Holding Company only incurred $229,140 and $252,278 in operational costs for the years ended December 31, 2012 and 2011, respectively. The operational costs were partially offset by income tax benefits of $74,990 and $76,002 for 2012 and 2011, respectively. In total, the net loss for the Holding Company only was ($154,150) and ($176,276) for the years ended December 31, 2012 and 2011, respectively. The Holding Company only received $1,500,000 in dividends from the Bank during 2012. The Holding Company’s operational costs are primarily funded by proceeds from the exercise of stock options and the dividends received from the Bank.
Results of Operations - Comparison of 2012 and 2011
Balance Sheet
The Company’s total assets increased $12.9 million or 2.6%, to $506.2 million at December 31, 2012 from $493.3 million at December 31, 2011. Average total assets were $493.0 million in 2012 and $502.4 million in 2011, a decrease of $9.4 million or 1.9%. Loans held for sale increased from $45.2 million at December 31, 2011 to $48.4 million at December 31, 2012, an increase of $3.2 million or 7.1%. Substantially all loans held for sale originated by the Bank consist of well-secured single family residential mortgage loans which are originated with a sales commitment and are sold in the secondary market shortly after origination, thus greatly reducing the Bank’s credit risk. All other loans, net of allowance, totaled $259.9 million at December 31, 2012 compared to $278.8 million at December 31, 2011, a decrease of $18.9 million or 6.8%. Commercial and industrial loans increased $0.9 million or 5.0%, from $18.9 million at December 31, 2011 to $19.8 million at December 31, 2012. Real estate - residential loans decreased $1.1 million or 1.9%, from $56.6 million at December 31, 2011 to $55.5 million at December 31, 2012, and real estate - construction, land and land development loans decreased $17.9 million or 24.2%, from $73.8 million at December 31, 2011 to $55.9 million at December 31, 2012. Real estate - commercial loans decreased $1.0 million or 0.8%, from $131.8 million at December 31, 2011 to $130.8 million at December 31, 2012. Consumer loans decreased $0.8 million or 16.8%, from $4.7 million at December 31, 2011 to $3.9 million at December 31, 2012. The decreases in most categories are primarily the result of weaker loan demand, pay-downs of existing loans, and transfers to other real estate owned. The decline in loan demand coupled with growth in deposit levels, continued the trend of abundant liquidity, resulting in increases in securities available-for-sale. Securities available-for-sale increased $32.5 million or 32.4% to $132.8 million at December, 31, 2012 compared to $100.3 million at December 31, 2011. Cash and due from banks decreased $4.6 million or 13.2% to $30.3 million at December 31, 2012 from $34.9 million at December 31, 2011. At December 31, 2012 and 2011 interest bearing balances with correspondent banks totaled $19.3 million and $25.6 million, respectively.
The allowance for loan losses was $6.0 million at December 31, 2012 and $6.8 million at December 31, 2011. This represents a decrease of $0.8 million or 12.5%. The decrease in the allowance is based upon management’s rating and assessment of the loan portfolio and the credit risk inherent in the portfolio, and is partially due to the decline in the loan volume. The Bank’s ratio of allowance for loan losses to gross loans, excluding loans held for sale, was 2.24% at December 31, 2012, compared to 2.38% at December 31, 2011.
Other real estate owned decreased $1.1 million or 15.9% to $5.9 million at December 31, 2012 compared to $7.0 million at December 31, 2011. The decrease is primarily related to the liquidation of other real estate assets as well as a decrease in the acquisition of other properties.
Total deposit accounts at December 31, 2012 were $417.0 million, an increase of $5.6 million or 1.4%, from $411.4 million at December 31, 2011. Core deposits (DDA, NOW, money market and savings) increased $34.0 million or 15.9% over 2011. Time deposits decreased $28.4 million or 14.4% over 2011. Brokered deposits totaled $15.4 million at December 31, 2012, a decrease of $5.0 million or 24.5%, compared to $20.4 million at December 31, 2011. The Bank utilizes Promontory Interfinancial Network (CDARS) to obtain and retain large time deposits of customers seeking full FDIC insurance coverage. Through network member institutions, the CDARS deposits are broken into smaller deposits in order to receive insurance coverage beyond the FDIC’s limit. CDARS deposits increased $1.4 million or 31.8% to $5.8 million at December 31, 2012 from $4.4 million at December 31, 2011. The overall decline in brokered and CDARS deposits is a direct result of the Bank’s increased reliance on core deposits. Deposits excluding brokered and CDARs increased $9.2 million or 2.4% to $395.8 million at December 31, 2012 compared to $386.6 million at December 31, 2011. Total other borrowings by the Bank were $28.3 million at December 31, 2012, a decrease of $0.3 million or 1.0%, from the balance of $28.6 million at December 31, 2011. The Bank paid off $25.0 million in long-term advances during 2012 and subsequently borrowed $25.0 million from the Federal Home Loan Bank through its short-term line of credit product.
The Bank’s loan to deposit ratio was 75.4% at December 31, 2012 and 80.4% at December 31, 2011. Excluding mortgage loans held for sale, this ratio was 63.8% for 2012 and 69.4% for 2011.
Income Statement
Interest income was $20.6 million for 2012 compared to $22.3 million for 2011, a decrease of $1.8 million or 7.9%. This decrease was primarily the result of declining earning asset yields and weakened loan demand. As a result of reduced loan demand, management increased purchases of lower yielding investment securities. Interest expense decreased $2.0 million or 35.4%, from $5.7 million in 2011 to $3.7 million in 2012. This decrease in interest expense was primarily due to the lower cost of funds resulting from the continued downward repricing of deposits. Cost of funds also declined due to significant increases in low cost core deposits and significant decreases in time deposits. Non-interest bearing deposits increased by $18.2 million or 34.4%, from $52.7 million at December 31, 2011 to $70.9 million at December 31, 2011. NOW accounts increased by $12.8 million or 28.8% from $44.6 million at December 31, 2011 to $57.4 million at December 31, 2012. Savings accounts were $63.2 million at December 31, 2011 compared to $64.2 million at December 31, 2012, an increase of $1.0 million or 1.6%. Money market accounts increased $2.0 million or 3.8%, from $53.0 million at December 31, 2011 to $55.0 million at December 31, 2012. Time deposits decreased $28.4 million or 14.4%, from $197.8 million at December 31, 2011 to $169.4 million at December 31, 2012. Net interest income was $16.9 million for 2012 compared to $16.6 million for 2011, a slight decrease of $0.3 million or 1.6%. Net interest margin increased to 3.71% for the year ended December 31, 2012 from 3.53% for 2011.
The Bank recorded a negative provision for loan losses of $605,000 for the year ended December 31, 2012 compared to a provision expense of $1.7 million for 2011, a decrease in expense of $2.3 million. The credit provision and decrease from 2011 is the result of management’s detailed review of the Bank’s loan portfolio, the level of the Bank’s non-performing loans, net recoveries for the period and level of loan delinquencies. The allowance for loan losses to total loans, excluding loans held for sale, decreased to 2.24% at December 31, 2012 from 2.38% at December 31, 2011. Net charge-offs were $245,000 in 2012, down from the $2.8 million in 2011, resulting in annual charge-off to average loans excluding loans held for sale ratios of 0.09% and 0.90%, respectively. Management considers the current allowance for loan losses to be appropriate based upon its detailed analysis of the potential risk in the portfolio; however, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional provisions will not be required.
Non-interest income for 2012 was $14.7 million compared to $11.2 million for 2011, an increase of $3.5 million or 31.2%. This increase in 2012 is primarily due to the increase in gain on sale of mortgage loans. Gain on sale of mortgage loans increased from $8.2 million in 2011 to $11.4 million in 2012, an increase of $3.2 million or 39.0%. The mortgage origination volume sold in 2012 was $431.5 million compared to $383.7 million in 2011, an increase of $47.8 million or 12.5%. Other income increased from $1.4 million to $1.9 million from 2011 to 2012 primarily due to rental income and gains on sale of other real estate.
Non-interest expense increased from $20.1 million in 2011 to $22.9 million in 2012, an increase of $2.8 million or 13.6%. This increase is due to several factors, including increased valuation adjustments and operating expense for other real estate owned of $1.2 million, a contingent liability of $600,000 related to a lawsuit against the Bank related to OREO, and an FHLB prepayment penalty of $392,000 for the early payoff of two FHLB advances. Salaries and employee benefits increased $446,000 or 3.8% primarily due to an increase in commissions and incentives. This increase is due to the increase in volume of mortgage originations. Additional software programs were implemented during 2012, which increased data processing by $230,000 or 27.6%.
In total, net income increased in 2012 by $2.5 million from $4.1 million in 2011 to $6.6 million in 2012 as a result of the above factors.
Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential
The following table presents the average balance sheet of the consolidated Company for the years ended December 31, 2012, 2011 and 2010. Also presented is the consolidated Company’s actual interest income and expense from each asset and liability, the average yield of each interest-earning asset and the average cost of each interest-bearing liability. This table includes all major categories of interest-earning assets and interest-bearing liabilities:
CONSOLIDATED AVERAGE BALANCE SHEETS (Dollars in thousands)
Rate/Volume Analysis of Net Interest Income
The following table sets forth information regarding changes in net interest income attributable to changes in average balances and changes in rates for the periods indicated. The effect of a change in average balance has been determined by applying the average rate in the earlier period to the change in average balance in the later period, as compared with the earlier period. The balance of the change in interest income or expense and net interest income has been attributed to a change in average rate. Non-accruing loans have been included in the category “Net loans and loans held for sale.”
Loan Portfolio
The Bank engages in a full complement of lending activities, including commercial, real estate and consumer loans. As of December 31, 2012, the Bank’s loan portfolio, excluding loans held for sale, consisted of 7.4% commercial and industrial loans, 21.0% real estate - construction, land and land development loans, 20.9% real estate - residential loans, 49.2% real estate - commercial loans, and 1.5% consumer loans.
Commercial and industrial lending is directed principally towards businesses whose demands for funds fall within the Bank’s legal lending limits and which are potential deposit customers of the Bank. This category of loans includes loans made to individual, partnership or corporate borrowers, for a variety of business purposes. These loans include short-term lines of credit, short- to medium-term plant and equipment loans, and loans for general working capital.
The Bank’s real estate - construction, land and land development loans consist of residential and commercial construction loans as well as land development loans. These loans are primarily construction and development loans to builders in the Augusta and Savannah, Georgia areas.
Real estate - residential loans include residential mortgage lending and are primarily single-family residential loans secured by the residential property. Home equity lines are also included in real estate - residential loans.
Real estate - commercial loans include commercial mortgage loans that are generally secured by office buildings, retail establishments and other types of real property, both owner occupied and non-owner occupied. A significant component of this type of lending is to owner occupied borrowers, including churches.
Consumer loans consist primarily of installment loans to individuals for personal, family or household purposes, including automobile loans to individuals and pre-approved lines of credit.
While risk of loss in the Bank’s loan portfolio is primarily tied to the credit quality of the various borrowers, risk of loss may also increase due to factors beyond the Bank’s control, such as local, regional and/or national economic downturns. General conditions in the real estate market may also impact the relative risk in the Bank’s real estate portfolio.
With respect to loans which exceed the Bank’s lending limits or established credit criteria, the Bank may originate such loans and sell them to another bank. The Bank may also purchase loans originated by other banks. Management of the Bank does not believe that its loan purchase participations will necessarily pose any greater risk of loss than loans which the Bank originates.
The following table presents the categories of loans contained in the Bank’s loan portfolio as of the end of the five most recent fiscal years and the total amount of all loans for such periods:
In addition to the above, the Bank also had $48.4 million and $45.2 million of single family residential mortgage loans held for sale that were originated by the Bank’s Mortgage Division at December 31, 2012 and 2011, respectively.
The table below presents an analysis of maturities of loans by loan type as of December 31, 2012:
The following is a presentation of an analysis of sensitivities of loans to changes in interest rates as of December 31, 2012 (in thousands):
The following table presents information regarding non-accrual and past due loans at the dates indicated:
Accrual of interest is discontinued when a loan becomes 90 days past due as to principal and interest or when, in management’s judgment, the interest will not be collectible in the normal course of business. Additional interest income of approximately $121,500 in 2012 would have been recorded if all loans accounted for on a non-accrual basis had been current in accordance with their original terms. No interest income has been recognized in 2012 on loans that have been accounted for on a non-accrual basis.
Troubled Debt Restructurings
As of December 31, 2012, the Bank had classified 23 loans totaling $6,734,000 as “troubled debt restructurings” as defined in ASC 310-40. As of December 31, 2011, the Bank had classified 20 loans totaling $9,770,000 as troubled debt restructurings. Included in the troubled debt restructurings was $1.6 million of loans also on non-accrual as of December 31, 2012 and December 31, 2011. As of December 31, 2012, three loans totaling $1.0 million classified as troubled debt restructurings were in default. As of December 31, 2011, three loans totaling $811,000 classified as a troubled debt restructuring were in default.
The following table presents loans classified as “troubled debt restructurings” as defined in ASC 310-40:
Related to troubled debt restructurings, the Bank has utilized different types of concessions. The Bank may perform “A note/B note” workout structures as a subset of the Bank’s troubled debt restructuring strategy. Under an A note/B note workout structure, the new A note is underwritten in accordance with customary troubled debt restructuring underwriting standards and is reasonably assured of full repayment while the B note is not. The B note is immediately charged off upon restructuring.
In the case above, if the loan was accruing prior to the troubled debt restructuring (documented with the loan legally bifurcated into an A note fully supporting accrual status and a B note fully contractually forgiven and charged off), the A note may remain on accrual status. If the loan was on nonaccrual prior to the troubled debt restructuring (documented with the loan legally bifurcated into an A note fully supporting accrual status and a B note contractually forgiven and fully charged off), the A note may be returned to accrual status, and risk rated accordingly, after a reasonable period of performance under the troubled debt restructuring terms. Six months of payment performance is generally required to return these loans to accrual status.
The A note will continue to be classified as a troubled debt restructuring and only may be removed from impaired status in years after the restructuring if (a) the restructuring agreement specifies an interest rate equal to or greater than the rate that the Bank was willing to accept at the time of the restructuring for a new loan with comparable risk, and (b) the loan is not impaired based on the terms specified by the restructuring agreement.
The Bank has restructured one loan using this A note/B note structure totaling $690,000 and $1.1 million as of December 31, 2012 and 2011, respectively. The Bank had no loans using this structure prior to 2011.
At December 31, 2012, there were no loans classified for regulatory purposes as doubtful, substandard or special mention that have not been disclosed above which (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
Summary of Loan Loss Experience
The following presents an analysis of the Bank’s loss experience for the periods indicated.
Allowance for Loan Losses
In the normal course of business, the Bank has recognized and will continue to recognize losses resulting from the inability of certain borrowers to repay loans and the insufficient realizable value of collateral securing such loans.
Accordingly, management has established an allowance for loan losses, totaling $5,954,000 at December 31, 2012, which is allocated according to the following table, along with the percentage of loans in each category to total loans:
In evaluating the Bank’s allowance for loan losses, management takes into consideration concentrations within the loan portfolio, past loan loss experience, growth of the portfolio, current economic conditions and the appraised value of collateral securing loans. Although management believes the allowance for loan losses is adequate, management’s evaluation of losses is a continuing process which may necessitate adjustments to the allowance in future periods.
Commercial and industrial loans represented approximately 7.4% of outstanding loans at December 31, 2012. Commercial loans are generally considered by management as having greater risk than other categories of loans in the Bank’s loan portfolio. However, the Bank generally originates commercial loans on a secured basis. Management believes that the secured status of a substantial portion of the commercial loan portfolio greatly reduces the risk of loss inherently present in commercial loans.
Real estate - construction, land and land development loans represented approximately 21.0% of the Bank’s outstanding loans at December 31, 2012. This category of the loan portfolio consists of commercial and residential construction and development loans located in the Bank’s market areas. Management of the Bank closely monitors the performance of these loans and periodically inspects properties and development progress. Management considers these factors in estimating and evaluating the allowance for loan losses.
Real estate - residential loans constituted approximately 20.9% of outstanding loans at December 31, 2012. Residential mortgages are generally secured by the underlying residence. Management of the Bank currently believes that these loans are adequately secured.
Real estate - commercial loans were approximately 49.2% of outstanding loans at December 31, 2012. Management believes the risk of loss for commercial real estate loans is generally higher than residential loans. Management continuously monitors the performance of the commercial real estate portfolio and collateral values.
Consumer loans represented approximately 1.5% of outstanding loans at December 31, 2012 and are also well secured. The majority of the Bank’s consumer loans are secured by collateral primarily consisting of automobiles, boats and other personal property. Management believes that these loans inherently possess less risk than other categories of loans.
Loans held for sale consist of single family residential mortgage loans originated by the Bank’s Mortgage Division. These loans are originated with an investor purchase commitment and are sold shortly after origination by the Bank.
The Bank’s management and Board of Directors monitor the loan portfolio monthly to evaluate the adequacy of the allowance for loan losses. Ratings on classified loans are also reviewed and performance is evaluated in determining the allowance. The provision for loan losses charged to operations is based on this analysis. In addition, management and the Board consider such factors as delinquent loans, collateral values and economic conditions in their evaluation of the adequacy of the allowance for loan losses.
Losses on Mortgage Loans Previously Sold
Losses on mortgage loans previously sold are recorded when the Bank indemnifies or repurchases mortgage loans previously sold. The representations and warranties in our loan sale agreements provide that we repurchase or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application or invalid market value on the collateral property due to deficiencies in the appraisal. In addition to these representations and warranties, our loan sale contracts define a condition in which the borrower defaults during a short period of time, typically 120 days to one year, as an Early Payment Default (“EPD”). In the event of an EPD, we are required to return the premium paid by the investor for the loan as well as certain administrative fees, and in some cases repurchase the loan or indemnify the investor. The Bank incurred losses of $167,000 and $305,000 for indemnification and repurchase for the years ended December 31, 2012 and 2011, respectively.
In the fourth quarter of 2011, the Company established a recourse liability for mortgage loans sold for losses of this type. The following table demonstrates the activity for the years ended December 31, 2012 and 2011:
Recourse Liability for Mortgage Loans Sold Activity
(Dollars in thousands)
Cash and Due from Banks
Cash on hand, cash items in the process of collection, and amounts due from correspondent banks and the Federal Reserve Bank are included in “Cash and Due from Banks.” As of December 31, 2012 and 2011, cash and due from banks totaled $30.3 million and $34.9 million, respectively. Interest-bearing cash on deposit with correspondent banks totaled $4.8 million as of December 31, 2012 compared to $1.7 million as of December 31, 2011. Interest-bearing cash on deposit in the Federal Reserve Bank excess balance fund was $14.5 million as of December 31, 2012 compared to $23.9 million as of December 31, 2011. Other cash funds required to be on reserve with the Federal Reserve Bank totaled $3.8 million and $914,000 as of December 31, 2012 and 2011, respectively.
Investments
As of December 31, 2012, investment securities comprised approximately 26.6% of the Bank’s assets. The Bank invests primarily in obligations or agencies of the United States, mortgage-backed securities and obligations, certain obligations of states and municipalities, corporate securities, Federal Home Loan Bank stock, and bank-owned life insurance. The Bank also enters into federal funds transactions with its principal correspondent banks. The Bank may act as a net seller or net purchaser of such funds.
The following table presents, for the dates indicated, the estimated fair market value of the Bank’s investment securities available for sale. The Bank has classified all of its investment securities as available for sale:
The following tables present the contractual maturities and weighted average yields of the Bank’s investment securities as of December 31, 2012:
The weighted average yields on tax-exempt obligations presented in the table above have been computed on a tax-equivalent basis.
Increased liquidity has resulted in significant increases in investment securities, resulting in greater occurrence of issuer concentrations. The table below reflects investments with issuers having a book value which exceeds 10% of the Company’s shareholders’ equity as of December 31, 2012 and 2011:
In September 2007, an $8.0 million bank-owned life insurance policy (BOLI) was acquired in order to insure the key officers of the Bank. This policy is recorded at its cash surrender value, net of surrender charges and/or early termination charges. As of December 31, 2012, the BOLI cash surrender value was $10.0 million, resulting in other income for 2012 of $392,000 and an annualized net yield of 4.01%.
Deposits
The Bank offers a wide range of commercial and consumer interest bearing and non-interest bearing deposit accounts, including checking accounts, savings accounts, money market accounts, negotiable order of withdrawal (“NOW”) accounts, individual retirement accounts, and certificates of deposit. The sources of deposits are residents, businesses and employees of businesses within the Bank’s market area, obtained through the personal solicitation of the Bank’s officers and directors, direct mail solicitation and advertisements published in the local media. Although de-emphasized in 2011 and 2012, the Bank has also utilized the brokered certificate of deposit market and the CDARS program for funding needs for loan origination and liquidity. These brokered and CDARS deposits are included in time deposits on the balance sheet. The Bank pays competitive interest rates on time and savings deposits. In addition, the Bank has implemented a service charge fee schedule competitive with other financial institutions in the Bank’s market area, covering such matters as maintenance fees on checking accounts, per item processing fees on checking accounts, returned check charges and similar items.
The following table details, for the indicated periods, the average amount of and average rate paid on each of the following deposit categories:
The maturities of certificates of deposit and individual retirement accounts of $100,000 or more as of December 31, 2012 were as follows:
Borrowed Funds
The Bank’s borrowed funds consist of short-term borrowings and long-term debt, including federal funds purchased, retail repurchase agreements and lines of credit with the Federal Home Loan Bank and the Federal Reserve Bank. The average balance of borrowed funds was approximately $22.9 million, and $29.6 million for the years ended December 31, 2012 and 2011.
The most significant borrowed funds categories for the Bank are the lines of credit from the Federal Home Loan Bank, consisting of the “Loans Held for Sale” program, a short-term 1-4 family and commercial real estate loans line of credit (1-4 LOC), and two long-term convertible advances.
At December 31, 2012 and 2011, there was no outstanding balance on the LHFS line of credit. The LHFS line of credit was not used in 2012 or 2011. The interest rate on the LHFS line of credit is equal to the Federal Home Loan Bank’s Daily Rate Credit Program rate plus 50 basis points.
The outstanding balance on the short-term 1-4 LOC was $25.0 million at December 31, 2012, $0.0 million at December 31, 2011 and 2010. The average balance outstanding on the 1-4 LOC was $1.6 million for 2012 with a weighted average interest rate of 0.40%. The average balance outstanding on the 1-4 LOC was $14,000 for 2011 with a weighted average interest rate of 0.36%. The average balance outstanding on the 1-4 LOC was $244,000 for 2010 with a weighted average interest rate of 0.47%. The maximum amount outstanding on the 1-4 LOC at any month end during 2012 was $25.0 million, compared to $5.0 million in 2011, and $7.0 million in 2010. This 1-4 LOC is secured by the Bank’s portfolio of 1-4 family first mortgage loans, excluding those loans that are held for sale, and commercial real estate loans. The interest rate on the 1-4 LOC is equal to the Federal Home Loan Bank’s Daily Rate Credit Program.
During 2007, a long-term convertible advance was established as an additional line of credit. At December 31, 2011, the outstanding balance on this advance was $10.0 million with a weighted average interest rate of 3.83%. This advance was paid off in September 2012. An additional, but similar, long-term convertible advance was also established during 2008. At December 31, 2011, the outstanding balance on this advance was $15.0 million with a weighted average interest rate of 3.33%. This advance was paid off in September 2012.
Return on Equity and Assets
The following table presents certain profitability, return and capital ratios for the Company as of the end of the past three fiscal years.
Liquidity and Interest Rate Sensitivity
Deposit levels and the associated timing and quantity of funds flowing into and out of a bank inherently involve a degree of uncertainty. In order to ensure that it is capable of meeting depositors’ demands for funds, the Bank must maintain adequate liquidity. Liquid assets consisting primarily of cash and deposits due from other banks, federal funds sold, funds held in a Federal Reserve Bank excess balance account, and investment securities maturing within one year provide the source of such funds. Insufficient liquidity may force a bank to engage in emergency measures to secure necessary funding, which could be costly and negatively affect earnings. The Bank monitors its liquidity on a monthly basis and seeks to maintain it at an optimal level.
As of December 31, 2012, the Bank’s liquidity ratio was 42.4% as compared to 34.9% at December 31, 2011. In addition to the liquid assets described above, the Bank has a reserve funding source in the form of federal funds lines of credit with First National Bankers Bank and SunTrust Bank. Management is not aware of any demands, commitments or uncertainties which could materially affect the Bank’s liquidity position. However, should an unforeseen demand for funds arise, the Bank held readily marketable investment securities at December 31, 2012 with a total market value of $132.8 million in its available-for-sale portfolio and $1.9 million in Federal Home Loan Bank stock which would provide an additional source of liquidity.
Gap management is a conservative asset/liability strategy designed to maximize earnings over a complete interest rate cycle while reducing or minimizing the Bank’s exposure to interest rate risk. Various assets and liabilities are termed “rate sensitive” when the interest rate can be replaced. By definition, the “gap” is the difference between rate sensitive assets and rate sensitive liabilities in a given time horizon. At December 31, 2012, the Bank was liability sensitive in the 0-3 month and 3-12 month time frames, but asset sensitive in the 1-5 years and 5 years or more time frames.
The following is an analysis of rate sensitive assets and liabilities as of December 31, 2012 (in thousands):
Capital Resources
The equity capital of the Bank totaled $55.4 million at December 31, 2012, an increase of $5.6 million, or 11.2%, from equity capital of $49.8 million at December 31, 2011. The increase in equity capital was attributable to the Bank’s net income of $6.8 million, partially offset by dividends paid to the Company of $1.5 million and an increase of $0.3 million in the Bank’s after-tax unrealized gain/(loss) on available-for-sale securities which is recognized in the available-for-sale portion of the bond portfolio by making adjustments to the equity capital account. The consolidated equity capital of the Company totaled $56.3 million at December 31, 2012 compared to $50.4 million at December 31, 2011.
The following table sets forth the applicable actual and required capital ratios for the Company and the Bank as of December 31, 2012:
The above ratios indicate that the capital position of the Company and the Bank are sound and that the Company is well positioned for future growth.
There are no commitments of capital resources known to management which would have a material impact on the Bank’s capital position.
Fair Value Measurement
Fair value measurements for assets and liabilities where there exists limited or no observable market data and therefore measurements are based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability, and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Additional information regarding the Company’s fair value measurements for assets and liabilities can be found in Note 19 of the consolidated financial statements.
Market Risk
Market risk is the risk arising from adverse changes in the fair value of financial instruments due to a change in interest rates, exchange rates and equity prices. Our primary market risk is interest rate risk.
The primary objective of asset/liability management is to manage interest rate risk and achieve reasonable stability in net interest income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate sensitive earning assets and rate sensitive liabilities. The relationship that compares rate sensitive earning assets to rate sensitive liabilities is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate sensitive earning assets and interest-bearing liabilities are those that can be re-priced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments in order to manage this risk.
We have not experienced a high level of volatility in net interest income primarily because of the relatively large base of core deposits that do not re-price on a contractual basis. These deposit products include regular savings, interest-bearing transaction accounts and money market savings accounts. Balances for these accounts are reported based on historical re-pricing. However, the rates paid are typically not directly related to market interest rates, since management has some discretion in adjusting these rates as market rates change.
Off-Balance Sheet Arrangements
In the ordinary course of business, the Bank may enter into off-balance sheet financial instruments which are not reflected in the financial statements. These instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when funds are disbursed or the instruments become payable.
Following is an analysis of significant off-balance sheet financial instruments:
Contractual Obligations
We have various contractual obligations that we must fund as part of our normal operations. The following table shows aggregate information about our contractual obligations, including interest, and the periods in which payments are due. The amounts and time periods are measured from December 31, 2012, based upon rates in effect at December 31, 2012.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information in response to this Item 7A is incorporated by reference from the previous sections of Item 7 of this report entitled: “Liquidity and Interest Rate Sensitivity” and “Market Risk.”
Item 8.
Item 8. Financial Statements and Supplementary Data
The following financial statements are filed as Exhibit 99.1 to this Annual Report on Form 10-K and incorporated herein by reference:
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition
as of December 31, 2012 and 2011
Consolidated Statements of Operations
for the years ended December 31, 2012 and 2011
Consolidated Statements of Comprehensive Income
for the years ended December 31, 2012 and 2011
Consolidated Statements of Shareholders’ Equity
for the years ended December 31, 2012 and 2011
Consolidated Statements of Cash Flows
for the years ended December 31, 2012 and 2011
Notes to Consolidated Financial Statements
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There has been no occurrence requiring a response to this item.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the fiscal year covered by this report and have concluded that the Company’s disclosure controls and procedures are effective.
Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. The Company’s management, including its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2012.
Pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report, this report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.
Changes in Internal Control over Financial Reporting
During the fourth quarter of 2012, there were no changes in the Company’s internal control over financial reporting that have materially affected, or that are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Certain information required by Part III of this Form 10-K is incorporated by reference from the Company’s definitive proxy statement to be filed pursuant to Regulation 14A for the Company’s Annual Meeting of Shareholders to be held on May 20, 2013 (the “Proxy Statement”). The Company will, within 120 days of the end of its fiscal year, file the Proxy Statement with the Securities and Exchange Commission.
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information responsive to this item is incorporated by reference from the sections entitled “Corporate Governance and Board Matters,” “Election of Class I Directors”, “Election of Class II Director”, and “Executive Officers” contained in the Proxy Statement.
Item 11.
Item 11. Executive Compensation
The information responsive to this item is incorporated by reference from the section entitled “Executive Compensation” contained in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information responsive to this item is incorporated by reference from the section entitled “Security Ownership of Certain Beneficial Owners and Management” contained in the Proxy Statement. See also the section entitled “Equity Compensation Plan Information” in Item 5 of this Annual Report on Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information responsive to this item is incorporated by reference from the sections entitled “Corporate Governance and Board Matters” and “Transactions with Related Persons, Promoters and Certain Control Persons” contained in the Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information responsive to this item is incorporated by reference from the section entitled “Ratification of Appointment of Independent Registered Public Accounting Firm” contained in the Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)1. The following financial statements are filed as Exhibit 99.1 to this Report and incorporated herein by reference:
Reports of Independent Registered Public Accounting Firms
Consolidated Statements of Financial Condition as of December 31, 2012 and 2011
Consolidated Statements of Operations for the years ended December 31, 2012 and 2011
Consolidated Statements of Comprehensive Income for the years ended December 31, 2012 and 2011
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2012 and 2011
Consolidated Statements of Cash Flows for the years ended December 31, 2012 and 2011
Notes to Consolidated Financial Statements
(a)2. Financial Statement Schedules
Not Applicable
(a)3 & (b). The following exhibits are filed with this report:
Exhibit
Number
Description of Exhibit
3.1
-
Articles of Incorporation of the Company (incorporated herein by reference to the exhibit contained in the Company’s Registration Statement on Form SB-2 under the Securities Act of 1933, as amended, Registration No. 333-69763, previously filed with the Commission).
3.1.1
-
Articles of Amendment to the Articles of Incorporation of the Company (incorporated herein by reference to the exhibit contained in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2000, previously filed with the Commission).
3.2
-
By-Laws of the Company (incorporated herein by reference to the exhibit contained in the Company’s Registration Statement on Form SB-2 under the Securities Act of 1933, as amended (Registration No. 333-69763)).
10.1*
-
1997 Stock Option Plan (incorporated herein by reference to the exhibit contained in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2001, previously filed with the Commission).
10.1.1*
-
Amendment to 1997 Stock Option Plan effective July 28, 2008 (incorporated herein by reference to the exhibit contained in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2010, previously filed with the Commission).
10.1.2*
-
Amendment to 1997 Stock Option Plan effective July 26, 2010 (incorporated herein by reference to the exhibit 10.2 contained in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, previously filed with the Commission).
Exhibit
Number
Description of Exhibit
10.2*
-
Amended and Restated 2004 Incentive Plan effective April 23, 2012 (incorporated herein by reference to Exhibit 10.1 contained in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, previously filed with the Commission).
10.3*
-
Form of Incentive Stock Option Agreement under the Company’s 2004 Incentive Plan (incorporated herein by reference to the exhibit contained in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2005, previously filed with the Commission).
10.4*
-
Severance Protection Agreement between First Bank of Georgia and Remer Y. Brinson, III, dated September 4, 2000 (incorporated herein by reference to the exhibit contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, previously filed with the Commission).
10.5*
-
Severance Protection Agreement with Thomas J. Flournoy (incorporated herein by reference to the exhibit contained in the Company’s Form 8-K filing on June 26, 2009 previously filed with the Commission).
10.6*^
-
Compensation Arrangement with Remer Y. Brinson, III.
10.7*^
-
Compensation Arrangement with Thomas J. Flournoy.
10.8*^
-
First Bank of Georgia Annual Incentive Plan for Remer Y. Brinson, III.
10.9*^
-
First Bank of Georgia Annual Incentive Plan for Thomas J. Flournoy.
10.10*
-
Directors Equity Incentive Plan effective October 26, 2009 (incorporated herein by reference to the exhibit contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, previously filed with the Commission).
10.10.1*
-
Amendment No. 1 to Directors Equity Incentive Plan effective January 23, 2012 (incorporated herein by reference to Exhibit 10.10.1 contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, previously filed with the Commission).
10.10.2*
-
Amendment No. 2 to Directors Equity Incentive Plan effective April 23, 2012 (incorporated herein by reference to Exhibit 10.3 contained in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, previously filed with the Commission).
10.11*
-
Form of Restricted Stock Award and Details (incorporated by reference to Exhibit 10.4 contained in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, previously filed with the Commission).
Exhibit
Number
Description of Exhibit
10.12*^
-
First Bank of Georgia Supplemental Executive Retirement Plan for Key Officers effective October 22, 2007.
14.1
-
Code of Ethics (incorporated herein by reference to Exhibit 99.2 contained in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2004, previously filed with the Commission).
16.1
-
Letter from Cherry, Bekaert & Holland, LLP related to change in certifying accountant (incorporated by reference to Exhibit 16.1 contained in the Company’s Current Report on Form 8-K filed with the Commission on March 22, 2012).
21.1^
-
Subsidiaries of the Registrant.
23.1^
-
Consent of Crowe Horwath LLP for 2012
23.2^
Consent of Cherry Bekaert LLP (formerly Cherry, Bekaert & Holland, L.L.P.) for 2011
31.1^
-
Certification of President and Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2^
-
Certification of Senior Vice President and Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.1^
-
Certifications Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
99.1^
-
Financial Statements.
101.INS^
-
XBRL Instance Document**
101.SCH^
-
XBRL Taxonomy Extension Schema Document**
101.CAL^
-
XBRL Taxonomy Extension Calculation Linkbase Document**
101.DEF^
-
XBRL Taxonomy Extension Definition Linkbase Document**
101.LAB^
-
XBRL Taxonomy Extension Label Linkbase Document**
101.PRE^
-
XBRL Taxonomy Extension Presentation Linkbase Document**
* - Denotes a management contract or compensatory plan or arrangement.
** - In accordance with Regulation S-T, XBRL (Extensible Business Reporting Language) related information in Exhibit No. (101) to this Annual Report on Form 10-K shall be deemed “furnished” and not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section, and shall not be incorporated by reference into any registration statement pursuant to the Securities Act of 1933, as amended.
^ - Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 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.
GEORGIA-CAROLINA BANCSHARES, INC.
By: /s/ Remer Y. Brinson, III
Date: March 20, 2013
Remer Y. Brinson, III
President and Chief Executive Officer
(principal executive officer)
Date: March 20, 2013 By: /s/ Thomas J. Flournoy
Thomas J. Flournoy
Senior Vice President and Chief Financial Officer
(principal financial and accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
DIRECTORS
DATE
DIRECTORS
DATE
/s/ Patrick G. Blanchard
March 20, 2013
/s/ Jefferson B. A. Knox
March 20, 2013
Patrick G. Blanchard
Jefferson B. A. Knox
/s/ Remer Y. Brinson, III
March 20, 2013
/s/ John W. Lee
March 20, 2013
Remer Y. Brinson, III
John W. Lee
/s/ Mac A. Bowman
March 20, 2013
/s/ James L. Lemley, M.D.
March 20, 2013
Mac A. Bowman
James L. Lemley, M.D.
/s/ Philip G. Farr
March 20, 2013
/s/ William D. McKnight
March 20, 2013
Philip G. Farr
William D. McKnight
/s/ Samuel A. Fowler, Jr.
March 20, 2013
/s/ A. Montague Miller
March 20, 2013
Samuel A. Fowler, Jr.
A. Montague Miller
/s/ Arthur J. Gay, Jr.
March 20, 2013
/s/ Robert N. Wilson, Jr.
March 20, 2013
Arthur J. Gay, Jr.
Robert N. Wilson, Jr.
/s/ George H. Inman
March 20, 2013
/s/ Bennye M. Young
March 20, 2013
George H. Inman
Bennye M. Young
/s/ David W. Joesbury, Sr.
March 20, 2013
David W. Joesbury, Sr.
EXHIBIT INDEX
Exhibit Number
Description of Exhibit
10.6*^
-
Compensation Arrangement with Remer Y. Brinson, III.
10.7*^
-
Compensation Arrangement with Thomas J. Flournoy.
10.8*^
-
First Bank of Georgia Annual Incentive Plan for Remer Y. Brinson, III.
10.9*^
-
First Bank of Georgia Annual Incentive Plan for Thomas J. Flournoy.
10.12*^
-
First Bank of Georgia Supplemental Executive Retirement Plan for Key Officers effective October 22, 2007.
21.1^
-
Subsidiaries of the Registrant.
23.1^
-
Consent of Crowe Horwath LLP for 2012
23.2^
Consent of Cherry Bekaert LLP (formerly Cherry, Bekaert & Holland, L.L.P.) for 2011
31.1^
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Certification of President and Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2^
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Certification of Senior Vice President and Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.1^
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Certifications Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
99.1^
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Financial Statements.
101.INS^
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XBRL Instance Document**
101.SCH^
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XBRL Taxonomy Extension Schema Document**
101.CAL^
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XBRL Taxonomy Extension Calculation Linkbase Document**
101.DEF^
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XBRL Taxonomy Extension Definition Linkbase Document**
101.LAB^
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XBRL Taxonomy Extension Label Linkbase Document**
101.PRE^
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XBRL Taxonomy Extension Presentation Linkbase Document**
* - Denotes a management contract or compensatory plan or arrangement.
** - In accordance with Regulation S-T, XBRL (Extensible Business Reporting Language) related information in Exhibit No. (101) to this Annual Report on From 10-K shall be deemed “furnished” and not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section, and shall not be incorporated by reference into any registration statement pursuant to the Securities Act of 1933, as amended.
^ - Filed herewith.