Item 1.Business
General
The Company is a bank holding company incorporated under the laws of the State of North Carolina (“NC”) and registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company’s principal asset is stock of its banking subsidiary, NewBridge Bank (the “Bank”). Accordingly, throughout this Annual Report on Form 10-K, there are frequent references to the Bank. The principal executive offices of the Company and the Bank are located at 1501 Highwoods Boulevard, Suite 400, Greensboro, NC 27410. The telephone number is (336) 369-0900 and its website is www.newbridgebank.com. The Bank maintains operations facilities in Lexington and Reidsville, NC.
Business of Bank and Other Subsidiaries
Through its branch network, the Bank, a NC chartered non-member bank, provides a wide range of banking products to small to medium-sized businesses and retail clients in its market areas, including interest-bearing and noninterest-bearing demand deposit accounts, certificates of deposits, individual retirement accounts, overdraft protection, personal and corporate trust services, safe deposit boxes, online banking, corporate cash management, brokerage, financial planning and asset management, and secured and unsecured loans.
As of December 31, 2012, the Bank operated two active non-bank subsidiaries: LSB Properties, Inc. (“LSB Properties”) and Henry Properties, LLC (“Henry Properties”). LSB Properties and Henry Properties together own the real estate acquired in settlement of loans of the Bank.
The Company has one non-bank subsidiary, FNB Financial Services Capital Trust I (“FNB Trust”), a Delaware statutory trust, formed to facilitate the issuance of trust preferred securities. FNB Trust is not consolidated in the Company’s financial statements.
As part of its operations, the Company regularly holds discussions and evaluates the potential acquisition of, or merger with, various financial institutions and other businesses. The Company also regularly considers the potential disposition of certain assets, branches, subsidiaries, or lines of business. As a general rule, the Company only publicly announces any material acquisitions or dispositions once a definitive agreement has been reached.
The Company operates one reportable segment, the Bank. Reference is made to Item 8 - “Financial Statements and Supplementary Data.” Management believes that the Company is not dependent upon any single customer, or a few customers, the loss of any one or more of which would have a material adverse effect on the Company’s operations.
Market Areas
The Bank’s primary market area is the Piedmont Triad Region of NC. On December 31, 2012, the Bank operated 30 branch offices in its two markets: the Piedmont Triad Region and the Coastal Region of NC. The Bank also had loan production offices in Winston-Salem, Asheboro, Morganton, Raleigh, and Charlotte, NC. The following table lists the Bank’s branch offices, categorized by region and city.
Piedmont Triad Region: Piedmont Triad Region (continued):
Greensboro (five offices) Midway
Lexington (three offices) Thomasville
Reidsville (two offices) Tyro
Winston-Salem (two offices) Walkertown
Archdale Wallburg
Clemmons Welcome
Danbury
Eden Coastal Region:
High Point Wilmington (two offices)
Jamestown Burgaw
Kernersville
King
Madison
As of December 31, 2012, the Bank operated 27 branches and one loan production office in the Piedmont Triad Region of North Carolina. The Piedmont Triad Region is a 12 county area, located in the interstate corridor between Charlotte, NC and the Research Triangle Park, and has a combined population of approximately 1.6 million people. The Piedmont Triad Region includes the cities of Greensboro, Winston-Salem and High Point, respectively the third, fourth and ninth largest cities in NC.
The Piedmont Triad Region economy was once centered on the textile, furniture and tobacco industries, but has transitioned to a more service-oriented economy by successfully diversifying into areas related to transportation, logistics, health care, education and technology. Benefiting the Piedmont Triad Region’s economy are decisions by FedEx to locate a national hub at Piedmont Triad International Airport (“PTIA”) and by Honda Aircraft Company to locate its world headquarters at PTIA.
In addition to its strategic proximity to key markets, the Piedmont Triad Region has a well-defined transportation infrastructure, providing access to both global and national markets. Interstates I-40, I-85 and I-77 provide both North-South and East-West routes. In addition, local manufacturers and distribution hubs will have direct access to both Midwest markets and additional Southeast ports when Interstates I-73 and I-74, which will bisect the Piedmont Triad Region, are completed. Moreover, extensive rail services are offered by Norfolk Southern, CSX and Amtrak, as well as a number of short-line railroads.
The Piedmont Triad Region is home to numerous institutions of higher education, including Wake Forest University, Wake Forest University Baptist Medical Center, North Carolina School of the Arts, Salem College and Winston-Salem State University (Winston-Salem); High Point University (High Point); the University of North Carolina at Greensboro, North Carolina A&T University, Elon University School of Law and the Joint School of Nanoscience and Nanoengineering (Greensboro); and a number of well-respected private colleges, as well as many community colleges and technical schools. All are recognized for academic excellence and enhance the Piedmont Triad Region’s business development efforts, particularly in the field of biotechnology.
As of June 30, 2012, the Bank was the largest community bank in the Piedmont Triad Region, based on deposit market share.
As of December 31, 2012, the Bank operated three branches in the Coastal Region, which includes Pender County and New Hanover County, located on the Southeast coast of NC. Wilmington is the county seat and industrial center of New Hanover County. A historic seaport and a popular tourist destination, Wilmington has diversified and developed into a major resort area, a busy seaport (one of NC’s two deep water ports), a light manufacturing center, a chemical manufacturing center and the distribution hub of southeastern NC. During the past 20 years, the Wilmington area has experienced extensive industrial development and growth in the service and trade sectors. Industries in the Wilmington region produce fiber optic cables for the communications industry, aircraft engine parts, pharmaceuticals, nuclear fuel components and various textile products. The motion picture industry has a significant presence in the Wilmington area. Wilmington also serves as a regional retail center, a regional medical center and the home of the University of North Carolina at Wilmington.
The total population of New Hanover County is approximately 200,000. The County is served by Interstate 40 and U.S. Highways 17 and 74, major rail connections and national and regional airlines through facilities at the New Hanover International Airport, located near Wilmington.
On May 20, 2011, the Bank sold its remaining Virginia operations, which consisted of one branch and a parcel of land.
Management believes that unemployment data is the most significant indicator of the economic health of its market areas and monitors this data on a regular basis. As reflected in the table below, the unemployment rate in each of the Company’s market areas has been elevated since the end of 2008. In addition to the relatively high unemployment rates, Coastal Region property values were substantially impacted by speculative real estate development. The table also shows the Bank’s nonperforming loans as a percentage of its total loans in each market as of December 31, 2012.
The following table reflects the Bank’s loans, deposits and branch locations by region at December 31, 2012, and the Bank’s rank by deposit market share as of June 30, 2012 (dollars in thousands):
(1)Excludes loans held for sale.
(2)Excludes loans and deposits held in corporate centers and loan production offices.
(3)As of June 30, 2012, rank for community financial institutions; excludes banks greater than $10 billion in assets.
Deposits
The Bank offers a variety of deposit products to small to medium-sized businesses and retail clients at interest rates generally competitive with those of other financial institutions. The table below sets forth the mix of depository accounts at the Bank as a percentage of total deposits of the Bank at the dates indicated.
The Bank accepts deposits at its banking offices, all of which have automated teller machines (“ATMs”). Its memberships in multiple ATM networks allow customers access to their depository accounts from ATM facilities throughout the United States. Competitive fees are charged for the use of its ATM facilities by customers not having an account with the Bank. Deposit flows are controlled primarily through the pricing of deposits.
At December 31, 2012, the Bank had $172.7 million in certificates of deposit of $100,000 or more, including $109.6 million in certificates of deposit of $250,000 or more. The Bank is a member of an electronic network that allows it to post interest rates and attract certificates of deposit nationally. It also utilizes brokered deposits and deposits obtained through the Promontory InterFinancial Network, also known as CDARS, to supplement in-market deposits. The accompanying table presents the scheduled maturities of time deposits of $100,000 or more and $250,000 or more at December 31, 2012.
See also Note 6 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Marketing
The Bank focuses its marketing efforts on small to medium-sized businesses and retail clients, and on achieving certain strategic objectives, including increasing noninterest income and growing core deposits and loans. The Bank promotes its brand through its association with the Greensboro minor league baseball team and ballpark (NewBridge Bank Park), traditional advertising and promotions, sponsorship of local events and other community-focused campaigns.
Competition
Commercial banking in North Carolina is extremely competitive, due in large part to intrastate and interstate branching laws. Many of the Bank’s competitors are significantly larger and have greater resources. The Bank encounters significant competition from a number of sources, including commercial banks, thrift institutions, credit unions and other financial institutions and financial intermediaries. The Bank competes in its market areas with some of the largest banking organizations in the Southeast and nationally, almost all of which have numerous branches in NC. Many of its competitors have substantially higher lending limits due to their greater total capitalization, and some perform functions for their customers that the Bank generally does not offer. The Bank primarily relies on providing quality products and services at a competitive price within its market areas. As a result of interstate banking legislation, the Bank’s market is open to future penetration by out-of-state banks thereby further increasing future competition.
In the Piedmont Triad Region, as of June 30, 2012, the Bank competed with 29 commercial banks and savings institutions, as well as numerous credit unions, and with 21 commercial banks and savings institutions, and several credit unions, in the Coastal Region.
Employees
At December 31, 2012, the Company had a total of 442 employees, including 408 full time employees, all of whom were compensated by the Bank or its subsidiaries. None of the Company’s employees are represented by a collective bargaining unit, and the Company has not recently experienced any type of strike or labor dispute. The Company considers its relationship with its employees to be good.
Supervision and Regulation
Bank holding companies and commercial banks are extensively regulated under both federal and state law. The following is a brief summary of certain statutes and rules and regulations that affect or will affect Bancorp, the Bank and the Bank’s subsidiaries. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of Bancorp and the Bank. Supervision, regulation and examination of Bancorp and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than shareholders of Bancorp. Statutes and regulations which contain wide-ranging proposals for altering the structures, regulations and competitive relationship of financial institutions are introduced regularly. Bancorp cannot predict whether, or in what form, any proposed statute or regulation will be adopted or the extent to which the business of Bancorp and the Bank may be affected by such statute or regulation.
General. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event the depository institution becomes in danger of default or in default. For example, to mitigate the risk of failure, holding companies are required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the bank’s total assets at the time the bank became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all applicable capital standards as of the time the bank fails to comply with such capital restoration plan. Bancorp, as a registered bank holding company, is subject to the regulation of the Board of Governors of the Federal Reserve System (“Federal Reserve”). Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve, under the BHCA, also has the authority to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the holding company.
As a result of Bancorp’s ownership of the Bank, Bancorp is also registered under the bank holding company laws of North Carolina. Accordingly, Bancorp is also subject to supervision and regulation by the North Carolina Commissioner of Banks (the “Commissioner”).
U.S. Treasury Capital Purchase Program. Pursuant to the U.S. Department of the Treasury (the “U.S. Treasury”) Capital Purchase Program (the “CPP”), on December 12, 2008, Bancorp issued and sold to the U.S. Treasury (i) 52,372 shares of Bancorp’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 2,567,255 shares of Bancorp’s common stock for an aggregate purchase price of $52,372,000 in cash. The Securities Purchase Agreement, dated December 12, 2008, pursuant to which the securities issued to the U.S. Treasury under the CPP were sold, grants the holders of the Series A Preferred Stock, the Warrant and the common stock of Bancorp to be issued under the Warrant, certain registration rights, and subjects Bancorp to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (“EESA”), the American Recovery and Reinvestment Act of 2009 (“ARRA”) and subsequent regulations issued by the U.S. Treasury.
Capital Adequacy Guidelines for Bank Holding Companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies and banks that are members of the Federal Reserve System and have consolidated assets of $150 million or more. Bank holding companies subject to the Federal Reserve’s capital adequacy guidelines are required to comply with the Federal Reserve’s risk-based capital guidelines. Under these regulations, the minimum ratio of total capital to risk-weighted assets is 8%. At least half of the total capital is required to be “Tier I capital,” principally consisting of common stockholders’ equity, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock less certain goodwill items. The remainder (“Tier II capital”) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance. In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the stated minimum. Bancorp exceeded all applicable minimum capital adequacy guidelines as of December 31, 2012.
Capital Requirements for the Bank. As a FDIC insured commercial bank that is not a member of the Federal Reserve, the Bank is also subject to capital requirements imposed by the FDIC. Under the FDIC’s regulations, state non-member banks that (a) receive the highest rating during the examination process and (b) are not anticipating or experiencing any significant growth, are required to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio of not less than 4%. The Bank exceeded all applicable minimum capital requirements as of December 31, 2012.
Dividend and Repurchase Limitations. Federal regulations provide that Bancorp must obtain Federal Reserve approval prior to repurchasing common stock for consideration in excess of 10% of its net worth during any 12 month period unless Bancorp (i) both before and after the redemption satisfies capital requirements for a “well capitalized” bank holding company; (ii) received a one or two rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues.
The ability of Bancorp to pay dividends or repurchase shares is dependent upon Bancorp’s receipt of dividends from the Bank. NC commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay. The Bank was restricted as of December 31, 2012, from paying dividends to Bancorp unless it received advance approval from the FDIC and the Commissioner. This restriction was removed in February of 2013. Also, an insured depository institution, such as the Bank, is prohibited from making distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations).
During 2008, the Company first reduced its quarterly cash dividend, and later suspended the payment of cash dividends.
Deposit Insurance Assessments. The Bank is subject to insurance assessments imposed by the FDIC. Under current law, the insurance assessment to be paid by members of the Deposit Insurance Fund, such as the Bank, is specified in a schedule issued by the FDIC. The assessment rate schedule can change from time to time at the discretion of the FDIC, subject to certain limits. In 2010, FDIC assessments for deposit insurance ranged from 12 to 50 basis points per $100 of insured deposits, depending on the institution’s capital position and other supervisory factors. On February 7, 2011, the FDIC adopted a new assessment formula, effective with the second quarter of 2011, which reduced the Bank’s assessments. In the third quarter of 2011, the Bank received a new rating which further reduced the Bank’s assessments.
Federal Home Loan Bank System. The Federal Home Loan Bank (“FHLB”) system provides a central credit facility for member institutions. As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta in an amount at least equal to 0.20% of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta. At December 31, 2012, the Bank was in compliance with these requirements.
Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the FDIC, an insured institution has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions’ records of meeting the credit needs of their communities, using the ratings “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination, which was completed during September 2011.
Prompt Corrective Action. The FDIC has broad powers to take corrective action to resolve the problems of insured depository institutions. The extent of these powers will depend upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Under the regulations, an institution is considered “well capitalized” if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater, and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An “adequately capitalized” institution is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with the highest examination rating). An institution is considered (A) “undercapitalized” if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of less than 4%, or (iii) a leverage ratio of less than 4% (or 3% in the case of an institution with the highest examination rating); (B) “significantly undercapitalized” if the institution has (i) a total risk-based capital ratio of less than 6%, (ii) a Tier I risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%; and (C) “critically undercapitalized” if the institution has a ratio of tangible equity to total assets equal to or less than 2%. At December 31, 2012, the Bank had the requisite capital levels to qualify as “well capitalized.”
Changes in Control. The BHCA prohibits Bancorp from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or savings bank or merging or consolidating with another bank or financial holding company or savings bank holding company without prior approval of the Federal Reserve. Similarly, Federal Reserve approval (or, in certain cases, non-objection) must be obtained prior to any person acquiring control of Bancorp. Control is deemed to exist if, among other things, a person acquires 25% or more of any class of voting stock of Bancorp or controls in any manner the election of a majority of the directors of Bancorp. Control is presumed to exist if a person acquires 10% or more of any class of voting stock, the stock is registered under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”), and the acquiror will be the largest shareholder after the acquisition.
Federal Securities Law. Bancorp has registered a class of its common stock with the Securities and Exchange Commission (“SEC”) pursuant to Section 12(g) of the Exchange Act. As a result of such registration, the proxy and tender offer rules, insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to Bancorp.
Transactions with Affiliates. Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans to one borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The FDIC has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits on the amount a bank can loan to an executive officer.
Loans to One Borrower. The Bank is subject to the loans to one borrower limits imposed by NC law, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any single borrower outstanding at one time and not fully secured by readily marketable collateral shall exceed 15% of the Bank’s capital, as used in the calculation of its risk-based capital ratios. At December 31, 2012, this limit was $26.2 million. This limit is increased by an additional 10% of the Bank’s capital, or $17.5 million as of December 31, 2012, for loans and extensions of credit that are fully secured by readily marketable collateral.
Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act, enacted in 1999 (the “GLB Act”), dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. In doing so, it increased competition in the financial services industry, presenting greater opportunities for our larger competitors, which were more able to expand their service and products than smaller, community-oriented financial institutions, such as the Bank.
USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Act was intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Act on financial institutions of all kinds has been significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act (“SOX”) was signed into law in 2002 and addresses accounting, corporate governance and disclosure issues. The impact of SOX is wide-ranging as it applies to all public companies and imposes significant requirements for public company governance and disclosure requirements.
In general, SOX established new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process and created a new regulatory body to oversee auditors of public companies. It backed these requirements with new SEC enforcement tools, increased criminal penalties for federal mail, wire and securities fraud, and created new criminal penalties for document and record destruction in connection with federal investigations. It also increased the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.
The economic and operational effects of SOX on public companies, including the Company, have been and will continue to be significant in terms of the time, resources and costs associated with compliance with its requirements.
Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act was intended primarily to overhaul the financial regulatory framework following the global financial crisis and has impacted, and will continue to impact, all financial institutions including Bancorp and the Bank. The Dodd-Frank Act contains provisions that have, among other things, established a Consumer Financial Protection Bureau, established a systemic risk regulator, consolidated certain federal bank regulators and imposed increased corporate governance and executive compensation requirements. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting and implementing regulations. Although some of these regulations have been promulgated, many additional regulations are expected to be issued in 2013 and thereafter. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
Limits on Rates Paid on Deposits and Brokered Deposits. FDIC regulations limit the ability of insured depository institutions to accept, renew or roll-over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in such depository institution’s normal market area. Under these regulations, “well capitalized” depository institutions may accept, renew or roll-over such deposits without restriction; “adequately capitalized” depository institutions may accept, renew or roll-over such deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates); and “undercapitalized” depository institutions may not accept, renew, or roll-over such deposits. Definitions of “well capitalized,” “adequately capitalized” and “undercapitalized” are the same as the definitions adopted by the FDIC to implement the prompt corrective action provisions discussed above.
Taxation. Federal Income Taxation. Financial institutions such as the Company are subject to the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), in the same general manner as other corporations. The Bank computes its bad debt deduction under the specific chargeoff method.
State Taxation. Under NC law, the Company and its subsidiaries are each subject to corporate income taxes at a 6.90% rate and an annual franchise tax at a rate of 0.15% of equity.
Other. Additional regulations require annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small, well capitalized institutions and state chartered institutions examined by state regulators, and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards.
The Bank is subject to examination by the FDIC and the Commissioner. In addition, it is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit, equal credit and fair credit reporting laws and laws relating to branch banking. The Bank, as an insured NC commercial bank, is prohibited from engaging as a principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the Deposit Insurance Fund and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.
As an FHA-approved Title II supervised lender, the Bank is required to report to the Department of Housing and Urban Development (“HUD”) its annual, audited financial and non-financial information necessary for HUD to evaluate compliance with FHA recertification requirements.
Future Requirements. Statutes and regulations, which contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions, are introduced regularly. Neither the Company nor the Bank can predict whether or what form any proposed statute or regulation will be adopted or the extent to which the business of the Company or the Bank may be affected by such statute or regulation.
Available Information
The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports available free of charge on its internet website www.newbridgebank.com as soon as reasonably practicable after the reports are electronically filed with the SEC. The Company’s Annual Report on Form 10-K and Quarterly Reports on Form 10-Q are also available on its internet website in interactive data format using the eXtensible Business Reporting Language (XBRL), which allows financial statement information to be downloaded directly into spreadsheets, analyzed in a variety of ways using commercial off-the-shelf software and used within investment models in other software formats. Any materials that the Company files with the SEC may be read and/or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. These filings are also accessible on the SEC’s website at www.sec.gov.
Additionally, the Company’s corporate governance policies, including the charters of the Audit and Risk Management, Compensation, and Corporate Governance and Nominating Committees, the Corporate Governance Guidelines, Code of Business Conduct and Ethics, and Code of Business Conduct and Ethics for CEO and Senior Financial Officers may also be found under the “Investor Relations” section of the Company’s website. A written copy of the foregoing corporate governance policies is available upon written request to the Company.
Item 1A.
Item 1A.Risk Factors
An investment in Bancorp’s common stock is subject to risks inherent in Bancorp’s business. The material risks and uncertainties that management believes affect Bancorp are described below. Before making an investment decision, you should carefully consider these risks and uncertainties, together with all of the other information included or incorporated by reference in this Annual Report on Form 10-K. These risks and uncertainties are not the only ones facing Bancorp. Additional risks and uncertainties that management is not aware of or focused on, or that management currently deems immaterial may also impair Bancorp’s business operations. This report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, Bancorp’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of Bancorp’s common stock could decline significantly, and you could lose all or part of your investment.
Risks Related to Recent Economic Conditions and Governmental Response Efforts
Our business has been and may continue to be adversely affected by current conditions in the financial markets and economic conditions generally. The global, U.S. and North Carolina economies are continuing to experience significantly reduced business activity and consumer spending as a result of, among other factors, disruptions in the capital and credit markets that first occurred during 2008. Since 2008, dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant writedowns of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business:
•a decrease in the demand for loans or other products and services offered by us;
•a decrease in the value of our loans or other assets secured by consumer or commercial real estate;
•a decrease in deposit balances due to overall reductions in the accounts of customers;
•an impairment of certain intangible assets or investment securities;
•a decreased ability to raise additional capital on terms acceptable to us or at all; or
•an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net chargeoffs and provision for credit losses, which would reduce our earnings.
Until conditions improve, we expect our business, financial condition and results of operations to continue to be adversely affected.
Financial reform legislation enacted by Congress and resulting regulations have increased, and are expected to continue to increase our costs of operations. Congress enacted the Dodd-Frank Act in 2010. This law has significantly changed the structure of the bank regulatory system and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations. Although some of these regulations have been promulgated, many additional regulations are expected to be issued in 2013 and thereafter. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
Certain provisions of the Dodd-Frank Act are having an effect on us. For example, a provision eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. Although not currently quantifiable, this significant change to existing law could have an adverse effect on our interest expense.
The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and noninterest-bearing transaction accounts had unlimited deposit insurance through December 31, 2012.
The Dodd-Frank Act requires publicly traded companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.
The Dodd-Frank Act created the Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. It also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.
It is difficult to quantify what specific impact the Dodd-Frank Act and related regulations have had on the Company to date and what impact yet to be written regulations will have on us in the future. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.
Increases in FDIC insurance premiums may adversely affect Bancorp’s net income and profitability. Since 2008, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC insured banks: deposit accounts are now insured up to $250,000 per customer (up from $100,000), and noninterest-bearing transactional accounts were fully insured (unlimited coverage) through December 31, 2012. These programs have placed additional stress on the Deposit Insurance Fund. In order to maintain a strong funding position and restore reserve ratios of the Deposit Insurance Fund, the FDIC has increased assessment rates of insured institutions. Bancorp is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Bank may be required to pay higher FDIC premiums than those currently in force. Any future increases or required prepayments of FDIC insurance premiums may adversely impact Bancorp’s earnings and financial condition.
The capital and credit markets have experienced unprecedented levels of volatility. During the economic downturn, the capital and credit markets experienced extended volatility and disruption. In some cases, the markets produced downward pressure on financial institution stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. Although Bancorp was able to acquire privately offered equity capital in 2012, if these levels of market disruption and volatility continue, worsen or abate and then arise at a later date, Bancorp’s ability to access further capital could be materially impaired. Bancorp’s inability to access the capital markets could constrain the Bank’s ability to make new loans, to meet the Bank’s existing lending commitments and, ultimately jeopardize the Bank’s overall liquidity and capitalization.
Additional requirements under our regulatory framework, especially those imposed under ARRA, EESA or other legislation or regulations intended to strengthen the U.S. financial system, could adversely affect us. Recent government efforts to strengthen the U.S. financial system, including the implementation of ARRA, EESA, the TLGP and special assessments imposed by the FDIC, subject participants to additional regulatory fees and requirements, including corporate governance requirements, executive compensation restrictions, restrictions on declaring or paying dividends, restrictions on share repurchases, limits on executive compensation tax deductions and prohibitions against golden parachute payments. These requirements, and any other requirements that may be subsequently imposed, may have a material and adverse affect on our business, financial condition, and results of operations.
Our participation in the CPP imposes restrictions and obligations on us that may limit our ability to access the capital markets, and reduce our liquidity. On December 12, 2008, we issued and sold (i) 52,372 shares of Series A Preferred Stock and (ii) a Warrant to purchase 2,567,255 shares of Bancorp’s common stock to the U.S. Treasury as part of its CPP. The Securities Purchase Agreement, pursuant to which such securities were sold, among other things, grants the holders of such securities certain registration rights which, in certain circumstances, impose lock-up periods during which we would be unable to issue equity securities. In addition, unless we are able to redeem the Series A Preferred Stock during the first five years, the dividends on this capital will increase substantially at that point, from 5% to 9%. Depending on market conditions at the time, this increase in dividends could significantly impact our liquidity.
The limitations on incentive compensation contained in the ARRA and subsequent regulations may adversely affect our ability to retain our highest performing employees. In the case of a company such as Bancorp that received CPP funds, the ARRA, and subsequent regulations issued by the U.S. Treasury, contain restrictions on bonus and other incentive compensation payable to the company’s senior executive officers. As a consequence, we may be unable to create a compensation structure that permits us to retain our highest performing employees and attract new employees of a high caliber. If this were to occur, our businesses and results of operations could be adversely affected.
The soundness of other financial institutions could adversely affect us. Since 2008, the financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. Financial institutions in particular have been subject to increased volatility and an overall loss in investor confidence.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies 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 services industry, including brokers and dealers, commercial banks, and other institutional clients.
From time to time, we may utilize derivative financial instruments, primarily to hedge our exposure to changes in interest rates, but also to hedge cash flow. By entering into these transactions and derivative instrument contracts, we expose ourselves to counterparty credit risk in the event of default of our counterparty or client. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to us, which creates credit risk for us. We attempt to minimize this risk by selecting counterparties with investment grade credit ratings, limiting our exposure to any single counterparty and regularly monitoring our market position with each counterparty. Nonetheless, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan due us. There is no assurance that any such losses would not materially and adversely affect our businesses, financial condition or results of operations.
Market developments may adversely affect our industry, business and results of operations. Significant declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant writedowns of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. These writedowns, initially of mortgage backed securities but spreading to credit default swaps and other derivative securities, caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. As a consequence, the Company experienced significant challenges, its credit quality deteriorated and its net income and results of operations were adversely impacted. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers including other financial institutions. Although to date Bancorp and the Bank remain “well capitalized,” and have performed better than many of their peers, we are part of the financial system and a systemic lack of available credit, a lack of confidence in the financial sector, increased volatility in the financial markets and/or reduced business activity could materially adversely affect our business, financial condition and results of operations.
Risks Associated with Our Business
We rely on dividends from the Bank for most of our revenue. Bancorp is a separate and distinct legal entity from the Bank. Bancorp receives substantially all of its revenue from dividends received from the Bank. These dividends are the principal source of funds to pay dividends on Bancorp’s common and preferred stock, and interest and principal on its outstanding debt securities. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to Bancorp. The Bank was restricted from paying dividends to Bancorp in 2012 unless it received advance approval from the FDIC and the Commissioner. This restriction was removed in February of 2013. In the event the Bank were unable to pay dividends to Bancorp, Bancorp might not be able to service debt, pay obligations, or pay dividends on Bancorp’s common stock. Such an inability to receive dividends from the Bank could have a material adverse effect on Bancorp’s business, financial condition and results of operations. See Item 1 “Business - Supervision and Regulation” and Note 17 of the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K.
The Bank is exposed to risks in connection with the loans it makes. A significant source of risk for Bancorp and the Bank arises from the possibility that losses will be sustained by the Bank because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. Losses from such failures have materially impacted the Bank’s operating results during the past three years. The Bank has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that it believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying its loan portfolio. Such policies and procedures, however, cannot fully prevent unexpected losses that could adversely affect the Bank’s results of operations.
Our allowance for loan losses may be insufficient. All borrowers carry the potential to default and our remedies to recover (seizure and/or sale of collateral, legal actions, guarantees, etc.) may not fully satisfy money previously lent. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable credit losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance for loan losses reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of additional loan chargeoffs, based on judgments different than those of management. An increase in the allowance for loan losses results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our financial condition and results of operations.
If the value of real estate in the markets we serve were to further decline, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us. At December 31, 2012, our loans secured by real estate totaled $1.01 billion, or 87.5% of total loans (excluding loans held for sale). With these loans concentrated within our two markets, the Piedmont Triad Region and Coastal Region, a further decline in local economic conditions in these markets could adversely affect the value of the real estate collateral securing our loans. A further decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. See Allocation of Allowance for Credit Losses in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion related to the Bank’s process for determining the appropriate level of the allowance for possible credit losses. Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would negatively impact our profits. Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies, and natural disasters.
Our commercial real estate lending may expose us to risk of loss and hurt our earnings and profitability. We regularly make loans secured by commercial real estate. These types of loans generally have higher risk-adjusted returns and shorter maturities than traditional one to four family residential mortgage loans. Further, loans secured by commercial real estate properties are generally for larger amounts and involve a greater degree of risk than one to four family residential mortgage loans. Payments on loans secured by these properties are often dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans is subject to adverse conditions in the real estate market or the local economy. Because of the current general economic slowdown, these loans represent higher risk, could result in an increase in our total net chargeoffs and could require us to increase our allowance for loan losses, which could have a material adverse effect on our financial condition or results of operations. At December 31, 2012, our loans secured by commercial real estate totaled $434.5 million, which represented 37.6% of total loans (excluding loans held for sale). While we seek to minimize these risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses.
Our construction loans and land development loans involve a higher degree of risk than other segments of our loan portfolio. A portion of our loan portfolio is comprised of construction loans and land development loans. Construction financing typically involves a higher degree of credit risk than commercial real estate lending. Risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property’s value at completion of construction and the bid price and estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment. When lending to builders, the cost of construction breakdown is provided by the builder, as well as supported by the appraisal. Although our underwriting criteria are designed to evaluate and minimize the risks of each construction loan, there can be no guarantee that these practices will safeguard against material delinquencies and losses to our operations. Repayment of construction and land development loans are dependent on the successful completion of the projects they finance, however, in many cases such construction and development projects in our primary market areas are not being completed in a timely manner, if at all. At December 31, 2012, we had loans of $75.7 million, or 6.6% of total loans (excluding loans held for sale), outstanding to finance construction and land development.
Our lending on unimproved land may expose us to a greater risk of loss and may have an adverse effect on results of operations. A portion of our construction and land development lending is secured by unimproved land. Loans secured by unimproved land are generally more risky than loans secured by improved property for one to four family residential mortgage loans. Since unimproved land is generally held by the borrower for investment purposes or future use, payments on loans secured by unimproved land will typically rank lower in priority to the borrower than a loan the borrower may have on their primary residence or business. These loans are susceptible to adverse conditions in the real estate market and local economy. At December 31, 2012, loans secured by unimproved property totaled $25.5 million, or 2.2% of our loan portfolio (excluding loans held for sale).
If our investment in the common stock of the FHLB of Atlanta is classified as other than temporarily impaired or as permanently impaired, our earnings and stockholders’ equity could decrease. We own common stock of the FHLB of Atlanta. We hold this stock to qualify for membership in the FHLB System and to be eligible to borrow funds under the FHLB of Atlanta’s advance program. The aggregate cost and fair value of our FHLB of Atlanta common stock as of December 31, 2012 was $7.7 million based on its par value. There is no market for our FHLB of Atlanta common stock.
Published reports indicate that certain member banks of the FHLB System may be subject to accounting rules and asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capital of an FHLB, including the FHLB of Atlanta, could be substantially diminished or reduced to zero. Consequently, there is a risk that our investment in FHLB of Atlanta common stock could be impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the after-tax amount of the impairment charge.
If the Bank loses key employees with significant business contacts in its market areas, its business may suffer. The Bank’s success is largely dependent on the personal contacts of our officers and employees in its market areas. If the Bank loses key employees temporarily or permanently, this could have a material adverse effect on the business. The Bank could be particularly affected if its key employees go to work for competitors. The Bank’s future success depends on the continued contributions of its existing senior management personnel, many of whom have significant local experience and contacts in its market areas. The Bank has employment agreements or non-competition agreements with several of its senior and executive officers in an attempt to partially mitigate this risk.
Bancorp’s growth strategy may not be successful. As a strategy, Bancorp seeks to increase the size of its franchise by pursuing business development opportunities. Bancorp can provide no assurance that it will be successful in increasing the volume of Bancorp’s loans and deposits at acceptable risk levels and upon acceptable terms, expanding its asset base while managing the costs and implementation risks associated with this growth strategy. There can be no assurance that any expansion will be profitable or that Bancorp will be able to sustain its growth, either through internal growth or through successful expansions of its banking markets, or that Bancorp will be able to maintain sufficient levels of capital to support its continued growth. If further deterioration of the Bank’s credit quality should occur, the need to preserve capital levels above the minimum to be deemed “well capitalized” could further restrict the Bank’s ability to pursue a growth strategy.
The Bank is subject to interest rate risk. The Bank’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and investment securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Bank’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Bank receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Bank’s ability to originate loans and obtain deposits, (ii) the fair value of the Bank’s financial assets and liabilities, and (iii) the average duration of certain of the Bank’s interest-rate sensitive assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Bank’s net interest income and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In addition, there are costs associated with the Bank’s risk management techniques, and these costs could be material. Fluctuations in interest rates are not predictable or controllable and, therefore, there can be no assurances of the Bank’s ability to continue to maintain a consistent, positive spread between the interest earned on the Bank’s earning assets and the interest paid on the Bank’s interest-bearing liabilities. See Item 7A Quantitative and Qualitative Disclosures about Market Risk for further discussion related to Bancorp’s management of interest rate risk.
We may face increasing deposit-pricing pressures, which may, among other things, reduce our profitability. Checking and savings account balances and other forms of deposits can decrease when our deposit customers perceive alternative investments, such as the stock market or other non-depository investments, as providing superior expected returns or seek to spread their deposits over several banks to maximize FDIC insurance coverage. Furthermore, technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments, including products offered by other financial institutions or non-bank service providers. Increases in short-term interest rates could increase transfers of deposits to higher yielding deposits. Efforts and initiatives we undertake to retain and increase deposits, including deposit pricing, can increase our costs. When bank customers move money out of bank deposits in favor of alternative investments or into higher yielding deposits, or spread their accounts over several banks, we can lose a relatively inexpensive source of funds, thus increasing our funding costs.
Bancorp’s operating results and financial condition would likely suffer if there is a further deterioration in the general economic condition of the areas in which the Bank does business. Unlike larger national or other regional banks that are more geographically diversified, the Bank primarily provides services to customers located in the Piedmont Triad Region and Coastal Region in NC. Because the Bank’s lending and deposit-gathering activities are concentrated in these markets, particularly the Piedmont Triad Region, the Bank will be affected by the business activity, population, income levels, deposits and real estate activity in these markets. Adverse developments in local industries have had and could continue to have a negative effect on the Bank’s financial condition and results of operations. Even though the Bank’s customers’ business and financial interest may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce the Bank’s growth rate, affect the ability of the Bank’s customers to repay their loans and generally affect Bancorp’s financial condition and results of operations. A further decline in general economic conditions in the Bank’s market areas, caused by inflation, recession, higher unemployment or other factors which are beyond the Bank’s control would also impact these local economic conditions and could have an adverse effect on Bancorp’s financial condition and results of operations.
The Bank competes with much larger companies for some of the same business. The banking and financial services business in our market areas continues to be a competitive field and it is becoming more competitive as a result of changes in regulations, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers.
We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and customers with various bank and nonbank financial services providers, many of which are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services.
Negative publicity could damage our reputation. Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.
The Bank is subject to environmental liability risk associated with lending activities. A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on Bancorp’s financial condition and results of operations.
Financial services companies depend on the accuracy and completeness of information about customers and counterparties. In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows. Liquidity is essential to our business. Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital, possible acquisitions and other general corporate purposes. An inability to raise funds through deposits, borrowings, securities sold under repurchase agreements, the sale of loans and other sources could have a substantial negative effect on our liquidity. We do not anticipate that our retail and commercial deposits will be sufficient to meet our funding needs in the foreseeable future. We therefore rely on deposits obtained through intermediaries, FHLB advances, securities sold under agreements to repurchase and other wholesale funding sources to obtain the funds necessary to manage our balance sheet.
Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general, including a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.
Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition. Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.
From time to time the Financial Accounting Standards Board (the “FASB”) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.
Impairment of investment securities, certain other intangible assets, or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations. In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, and the intent and ability of Bancorp to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Under current accounting standards, certain other intangible assets with indeterminate lives are no longer amortized but, instead, are assessed for impairment periodically or when impairment indicators are present. Assessment of certain other intangible assets could result in circumstances where the applicable intangible asset is deemed to be impaired for accounting purposes. Under such circumstances, the intangible asset’s impairment would be reflected as a charge to earnings in the period during which such impairment is identified. In assessing the realizability of our deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and the corporate income tax rate during the periods in which those temporary differences become deductible. The value of our deferred tax assets reflects the current corporate income tax rate of approximately 35 percent. Failure to generate future taxable income in line with our current projections and/or a reduction in the corporate income tax rate could cause us to further impair our deferred tax assets, which impairment would be reflected as a charge to earnings in the period during which such impairment is identified. The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.
Technological advances impact the Bank’s business. The banking industry continues to undergo technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Bancorp’s future success will depend, in part, on our ability to address the needs of the Bank’s customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in operations. Many competitors have substantially greater resources to invest in technological improvements. The Bank may not be able to effectively implement new technology-driven products and services or successfully market such products and services to its customers.
We rely on other companies to provide key components of our business infrastructure. Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.
Our information systems may experience an interruption or breach in security. We rely heavily on communications and information systems to conduct our business. Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of our information systems, we cannot make assurances that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
Government regulations may prevent or impair Bancorp’s ability to engage in mergers or operate in other ways. Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. The Bank is subject to supervision and periodic examination by the FDIC and the Commissioner. Bancorp is subject to regulation by the Federal Reserve and the Commissioner. The Bank was restricted from paying dividends to Bancorp as of December 31, 2012, unless it received advance approval from the FDIC and the Commissioner. This restriction was removed in February of 2013. Banking regulations, designed primarily for the protection of depositors, and the withholding of necessary approvals by the bank regulatory agencies may limit the growth and the return to Bancorp’s shareholders by restricting certain activities, such as:
•The payment of dividends to our stockholders;
•The payment of dividends on trust preferred securities;
•Possible mergers with or acquisitions of or by other institutions;
•Making desired investments;
•Making loans and interest rates charged on loans;
•Interest rates paid on our deposits;
•The possible expansion of our branch offices; and
•Our ability to provide securities or trust services.
The Bank also is subject to capitalization guidelines set forth in federal legislation, and could be subject to enforcement actions to the extent that it is found by regulatory examiners to be undercapitalized. Bancorp cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on Bancorp’s future business and earnings prospects. The cost of compliance with regulatory requirements may adversely affect our ability to operate profitably.
Unpredictable catastrophic events could have a material adverse effect on Bancorp. The occurrence of catastrophic events such as hurricanes, tropical storms, earthquakes, pandemic disease, windstorms, floods, severe winter weather (including snow, freezing water, ice storms and blizzards), fires and other catastrophes could adversely affect Bancorp’s consolidated financial condition or results of operations. Unpredictable natural and other disasters could have an adverse effect on the Bank in that such events could materially disrupt its operations or the ability or willingness of its customers to access the financial services offered by the Bank. The incidence and severity of catastrophes are inherently unpredictable. Although the Bank carries insurance to mitigate its exposure to certain catastrophic events, these events could nevertheless reduce Bancorp’s earnings and cause volatility in its financial results for any fiscal quarter or year and have a material adverse effect on Bancorp’s financial condition and/or results of operations.
Risks Related to our Common Stock
Our stock price can be volatile. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
•Actual or anticipated variations in quarterly results of operations;
•Recommendations by securities analysts;
•Operating results and stock price performance of other companies that investors deem comparable to us;
•News reports relating to trends, concerns, and other issues in the financial services industry;
•Perceptions in the marketplace regarding us and/or our competitors;
•New technology used or services offered by competitors;
•Significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors; and
•Changes in government regulations.
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of operating results.
Bancorp’s trading volume is low compared with larger national and regional banks. A class of Bancorp’s common stock is traded on the NASDAQ Global Select Market. However, the trading volume of Bancorp’s common stock is relatively low when compared with larger companies listed on the NASDAQ, the NYSE or other consolidated reporting systems or stock exchanges. Thus, the market in Bancorp’s common stock may be limited in scope relative to larger companies. In addition, Bancorp cannot say with any certainty that a more active and liquid trading market for its common stock will develop.
Bancorp has issued preferred stock and subordinated debentures, all of which rank senior to our common stock. Bancorp has issued and outstanding 52,372 shares of Series A Preferred Stock. The 422,456 shares of Series B Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock (the “Series B Preferred Stock”) and the 140,217 shares of Series C Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock (the “Series C Preferred Stock) that were issued and outstanding as of December 31, 2012 were converted into 9,601,262 shares of voting Class A Common Stock and 3,186,748 shares of nonvoting Class B Common Stock on February 22, 2013. The Series A Preferred Stock ranks senior to shares of our common stock. As a result, Bancorp must make dividend payments on the Series A Preferred Stock before any dividends can be paid on the common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the Series A Preferred Stock must be satisfied before any distributions can be made on the common stock. If Bancorp does not remain current in the payment of dividends on the Series A Preferred Stock, no dividends may be paid on the common stock. In addition, Bancorp has issued $25.8 million in subordinated debentures in connection with its issuance of trust preferred securities. These debentures also rank senior to the common stock.
Our preferred stock reduces net income available to holders of our common stock and earnings per common share and the Warrant may be dilutive to holders of our common stock. The dividends payable on our preferred stock will reduce any net income available to holders of common stock and our earnings per common share. The preferred stock will also receive preferential treatment in the event of sale, merger, liquidation, dissolution or winding up of our company. Additionally, the ownership interest of holders of our common stock will be diluted to the extent the Warrant is exercised.
There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock. We may issue additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.
Our common stock is not FDIC insured. Bancorp’s common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, holders of our common stock may lose some or all of their investment.
Item 1B.
Item 1B.Unresolved Staff Comments
None
Item 2.
Item 2.Properties
The Company and the Bank’s executive offices are located at 1501 Highwoods Boulevard in Greensboro, NC. The Bank’s principal support and operational functions are located at 38 West First Avenue, Lexington, NC and 202 South Main Street in Reidsville, NC. On December 31, 2012, the Bank operated 30 branch offices in its two markets, the Piedmont Triad Region and Coastal Region of NC, and five loan production offices. The locations of the Bank’s executive and banking offices, their form of occupancy, deposits as of December 31, 2012, and year opened, are provided in the accompanying table:
(1)Executive offices of the Company and the Bank.
(2)Serves as a full service branch as well as an operations center for the Bank.
(3)The decision to close these locations on April 19, 2013 was announced in January, 2013.
(4)This location is an express drive through facility that only processes transactions and does not open customer accounts.
The Bank operates loan production offices in leased premises in Winston-Salem, Asheboro, Morganton, Raleigh, and Charlotte, NC.
In addition, as of December 31, 2012, the Bank also operated 10 offsite ATM machines in various locations throughout its markets.
Item 3.
Item 3.Legal Proceedings
In the ordinary course of operations, the Company and its subsidiaries are often involved in legal proceedings. In the opinion of management, neither the Company nor its subsidiaries is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the fourth quarter of the Company’s fiscal year ended December 31, 2012.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Prices and Dividend Policies
A class of Bancorp’s common stock is traded on the Global Select Market of the NASDAQ Stock Market (“NASDAQ GSM”) under the symbol “NBBC.” The following table shows the high, low and closing sales prices of Bancorp’s common stock on the NASDAQ GSM, based on published financial sources, for each quarter within the last two fiscal years.
At a Special Meeting of Shareholders on February 20, 2013, shareholders approved the conversion of 422,456 shares of Series B Preferred Stock and 140,217 shares of Series C Preferred Stock into Class A Common Stock and Class B Common Stock, respectively. As a result, on February 22, 2013, the Series B Preferred Stock was converted into 9,601,262 shares of voting Class A Common Stock, and the Series C Preferred Stock was converted into 3,186,748 shares of nonvoting Class B Common Stock. As of February 22, 2013, there were approximately 5,967 beneficial owners, including 2,934 holders of record, of Bancorp’s Class A Common Stock, and approximately seven holders of record of Bancorp’s Class B Common Stock.
Holders of Bancorp’s common stock are entitled to receive ratably such dividends as may be declared by Bancorp’s Board of Directors out of legally available funds. No cash dividends have been declared for Bancorp’s common stock since 2008. The ability of Bancorp’s Board of Directors to declare and pay dividends on its capital stock is subject to the terms of applicable North Carolina law and banking regulations. Bancorp must make dividend payments on its Series A Preferred Stock before any dividends can be paid on its common stock. Also, Bancorp may not pay dividends on its capital stock if it is in default or has elected to defer payments of interest under its junior subordinated debentures. The declaration and payment of future dividends to holders of Bancorp’s common stock will also depend upon Bancorp’s earnings and financial condition, the capital requirements of Bancorp’s subsidiaries, regulatory conditions and other factors as Bancorp’s Board of Directors may deem relevant. For a further discussion as to restrictions on Bancorp and the Bank’s ability to pay dividends, please refer to “Item 1 - Supervision and Regulation”.
The following table sets forth certain information regarding shares issuable upon exercise of outstanding options, warrants and rights under equity compensation plans, and shares remaining available for future issuance under equity compensation plans, in each case as of December 31, 2012. Individual equity compensation arrangements are aggregated and included within this table.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Bancorp did not repurchase any of its equity securities during 2012.
Recent Sales of Unregistered Securities
On November 30, 2012, the Company completed a transaction pursuant to securities purchase agreements with 22 separate purchasers, including certain officers and directors of the Company, pursuant to which the purchasers invested an aggregate of approximately $56.3 million in cash in the Company through direct purchases of 422,456 shares of newly issued Series B Preferred Stock and 140,217 shares of newly issued Series C Preferred Stock. The shares of Preferred Stock were offered and sold by the Company to accredited investors in reliance upon an exemption from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. On February 20, 2013, the Company convened a Special Meeting of Shareholders for the purposes of obtaining shareholder approval of proposals to create a new class of nonvoting common stock (“Class B Common Stock”), to increase the Company’s authorized common stock from 50,000,000 to 100,000,000 shares and its authorized preferred stock from 10,000,000 to 30,000,000 shares, and to approve the Company’s issuance of up to 9,601,273 shares of voting Class A Common Stock upon conversion of up to 422,456 shares of Series B Preferred Stock and the Company’s issuance of up to 3,186,750 shares of nonvoting Class B Common Stock upon conversion of up to 140,217 shares of Series C Preferred Stock. All proposals were approved.
FIVE-YEAR STOCK PERFORMANCE TABLE
The following graph compares the cumulative total shareholder return on Bancorp’s common stock with the S&P 500 Index (U.S.) and the SNL Southeast Bank Index. The graph assumes that $100 was originally invested on December 31, 2007, and that all subsequent dividends were reinvested in additional shares.
NEWBRIDGE BANCORP
Comparison of Cumulative Total Shareholder Return
Years Ended December 31
The SNL Southeast Bank Index is comprised of a peer group of 91 bank holding companies headquartered in Alabama, Arkansas, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, Virginia and West Virginia, whose common stock is traded on the NYSE, NYSE Amex or NASDAQ stock exchanges. The total five year return was calculated for each of the bank holding companies in the peer group taking into consideration changes in stock price, cash dividends, stock dividends and stock splits since December 31, 2007. The individual results were then weighted by the market capitalization of each company relative to the entire peer group. The total return approach and the weighting based upon market capitalization are consistent with the preparation of the S&P 500 total return index.
Item 6.
Item 6. Selected Financial Data
The following table should be read in conjunction with “Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following presents management’s discussion and analysis of the Company’s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.
Executive Overview
In 2012 the Company accomplished two primary goals: an aggressive reduction of its adversely classified assets and the completion of a $56 million convertible preferred equity raise. These two achievements are transformative for the Company. Our strengthened balance sheet, our increased regulatory capital and the significant reduction of the expense weight of adversely classified assets will allow the Company to pursue its vision of being a high performing community bank.
Asset Quality. In mid-2012 the Company formulated an asset disposition plan to resolve the lingering impact of the recession on its asset quality. Our 2012 operating results reflect the impact of the implementation of this plan. The Company had a net loss of $25.3 million for the year. We anticipated this result.
Under the plan, the Company projected that it would dispose of $71 million in classified assets during 2012. We decided these dispositions would be handled internally, not through a broker, so that the Company could eliminate broker fees, execute efficient sales and target the assets for liquidation that had the greatest imbedded losses. We also decided that dispositions would be made through direct negotiations with customers, direct sales of notes, auctions and sales of small pools of homogeneous assets. We began to execute on the plan in the third quarter and provisioned and expensed more than $41 million of credit-related costs in that period. We also wrote down our deferred tax asset by $11 million in the third quarter. By year end, the Company had reduced total classified assets by $96 million, or $25 million more than the projected total under the plan. Total classified assets were $53 million at December 31, 2012, one-third the level of 2011 year end balance of $159 million.
We believe the asset disposition plan was highly successful. The negative impact of adversely classified assets on the Company’s earnings was markedly reduced. As a result, our fourth quarter net income climbed to a record level of $4.8 million, an increase of 230% over the prior year’s fourth quarter. We believe that our future earnings will also be favorably impacted by the increased quality of our assets.
Equity Raise. Following the 2007 merger of FNB Financial Services Corporation into the Company, our Board and management established a disciplined business model built on an operating vision of Quality, Profitability and Growth. Additionally, our President and Chief Executive Officer, Pressley A. Ridgill, brought together a management team united behind a simple, but powerful, principle - “Financial Success Begins With Integrity.”
During this time, however, the effects of the economic recession were increasing and direct pursuit of our vision was not possible. We had to pause and deal with the challenges before us. We elected not to defer credit costs. Instead, we aggressively charged off and wrote down credits. From late 2007 through the completion of the asset disposition plan in the fourth quarter of 2012, the Company charged off over $194 million of loans and other real estate owned, or 11.94% of the Company’s peak level of loan balances in September of 2008. In addition, the Company made the difficult but necessary decisions to close or sell multiple branches and reduce the number of its full-time employees by one-third. The results of our commitment to directly confront our challenges were mounting losses, declining capital, a reduction in size and decreasing valuation of our shares in the market.
By late 2008, the Company’s well capitalized status was threatened. We accepted $52 million of capital through the Troubled Asset Relief Program (“TARP”). Our acceptance of TARP capital has presented challenges. It currently requires the payment of a dividend at an annual rate of 5%. Moreover, the market value of the Company’s shares likely has been depressed in part because of investors’ concerns over our ability to repay the TARP capital and the cost of the necessary replacement capital.
As with our asset quality difficulties, we decided to aggressively resolve our TARP capital challenges. On November 1, 2012, the Company agreed to issue approximately $56 million of convertible preferred stock to a number of selected investors at a price of $4.40 per common share equivalent. The market price of the Company’s common stock on the last trading day before November 1, 2012 was $4.26. The closing of this private placement occurred on November 30, 2012. At a Special Shareholders Meeting on February 20, 2013, the shareholders of the Company overwhelmingly approved resolutions providing for the conversion of the convertible preferred stock into 9.6 million shares of voting Class A Common Stock and 3.2 million shares of nonvoting Class B Common Stock.
The Company believes that the combination of the significant enhancement of its asset quality and its ability to redeem its TARP capital, without impacting materially its well capitalized status, as a result of its equity raise, have transformed the opportunities available to it. Although the economy remains difficult and presently unknown challenges may well arise, the Company believes that it has the financial strength and management depth needed to aggressively pursue its vision of Quality, Profitability and Growth.
2012 Highlights. The Company took significant actions in 2012 in pursuit of its operating vision.
Quality
·Nonperforming assets declined $44.4 million
·As a percentage of assets, nonperforming assets declined from 4.10% to 1.56%
·Total adversely classified assets declined from $159.1 million to $53.2 million
·Other real estate owned declined 82% to $5.4 million
Profitability
·The net interest margin averaged 4.06%
·Core deposit costs declined to 0.16% at year end
·Core deposits represented 75% of total deposits at year end
·Total noninterest expense declined $1.3 million, or 2.3%, excluding $1.8 million of one-time expense
·The closing of two branch locations was decided as part of our redeployment of resources in more vibrant markets
·Branch locations were reduced to 30 (down from 42 in 2007)
·Annual operating expenses have declined by $16 million since
Growth
·Loan balances increased 5%, net of classified loans
·Our footprint was expanded into the Raleigh and Charlotte markets through loan production offices
·Twelve senior level experienced community bankers were employed, including new market executives in the Piedmont Triad and Charlotte markets
Pursuing Our Community Banking Strategy
The Company will remain focused on opportunities to achieve our vision of Quality, Profitability and Growth. We will continue to manage our progress in achieving these goals through basic, measurable operating objectives that communicate throughout the organization the steps needed to enhance the Company’s financial results. Many of these steps have been taken, others are underway and still others will be taken in coming periods.
Sustained Asset Quality. We believe we have resolved our asset quality issues and achieved the asset base necessary to achieve sustained profitability. The balance of nonperforming assets at December 31, 2012 totaled $26.7 million, or 1.56% of total assets, down from $71.1 million, or 4.11% of total assets, at December 31, 2011. Our nonperforming assets consist of nonperforming loans, loans that have been impaired and on which management no longer believes all principal and interest will be collected, loans that have been restructured to aid the financial distress of a borrower, and other real estate owned which is physical real estate that the Company has taken in settlement of troubled debt. Likewise, total classified loans declined 62.75%, or $80.6 million, for the year to $47.9 million. This total is down 71.44%, or $119.7 million, from the peak level at September 30, 2010. At December 31, 2012, other real estate owned totaled $5.4 million, down from $30.6 million at December 31, 2011. At December 31, 2012, the allowance for credit losses totaled $26.6 million, or 2.30% of loans held for investment, and 124.7% of nonperforming loans. Management believes that substantially all losses in the Company’s impaired and nonperforming loans have been recognized and charged off through the allowance for credit losses.
Profitability. The Company’s ability to achieve sustained profitability depends not only on the maintenance of a high level of asset quality, but on careful management of interest income, interest expense and other expense. Management has identified and implemented a number of steps to increase net interest and fee income, preserve an acceptable net interest margin and control our controllable expenses.
·Expanded our presence into key North Carolina markets and redeployed resources previously dedicated to less vibrant areas. The Company has opened loan production offices in Raleigh and Charlotte, NC - the two largest and fastest growth banking markets in North Carolina. The Company also established loan production offices in smaller markets in which particular growth opportunities were identified. Our goal is to pursue opportunities to increase our portfolio of creditworthy loans with attractive interest rates. Additionally, the Company sold its Harrisonburg, Virginia operations and closed 11 branches not meeting its profitability requirements.
·Reduced the Company’s dependence on high cost time deposits in favor of lower cost core accounts, including DDA, NOW checking, money market and savings accounts.
·Acquired a mortgage brokerage operation (2012 fee revenues increased 124% over the prior year).
·Established a loan pricing committee to better evaluate risk-based and relationship pricing to include deposit and other relationships. Management has also focused on maintaining consistency on loan pricing relative to credit characteristics of loans.
·Redirected portfolio investments to corporate debt and commercial mortgage backed securities.
·Expanded our trust and wealth management services (assets under management increased 30% in 2012 and have increased 164% since 2010).
·Maintained a disciplined and accountable budget process that includes monitoring loan, investment and deposit yields; carefully reviewing variances every month, and reviewing controllable expenses every month.
Expense management is critical to the achievement of our profitability goals. Management has implemented a disciplined cost management culture where “that which is within our control is controlled.” A key element to creating this culture is our line item accountable budget process. The foundation of our budgeting process is the “CAST” philosophy:
·Conservative in forecasts and expectations
·Accountable on an account by account basis
·Specific to each individual in the organization so goals and budgets are understood
·Timely so that continued monitoring and adjustments can be made
Several major cost reduction initiatives focused on eliminating excess costs and non-core or unprofitable activities are continuing. These initiatives include an ongoing franchise validation plan, which carefully reviews each of our branch locations and targets the elimination of waste, inefficiency and duplication throughout our franchise. Each branch is evaluated for its pre-tax contribution, the age and state of the branch facility, the ease of closure, market demographics and the branch’s overall fit within our strategic vision. Execution of the franchise validation plan and other expense reduction initiatives have resulted in a net reduction of 12 bank locations and 254 full time equivalent employees since the third quarter of 2007. The reduction in the number of branch locations and other expense reductions resulted in an improvement of our core efficiency from a high of 90% in 2009 to 68% in 2012.
Growth. As a community bank, we believe our opportunities to achieve exceptional returns for our shareholders depend upon consistent delivery of superior customer service to small to medium-sized business and retail clients in a manner that the large national and super regional banks are unable or unwilling to emulate. The Piedmont Triad has approximately $33 billion of deposits. The market is dominated by large national and regional banks, with 76% of the market’s deposits residing in banks with more than $10 billion of assets. We believe that we have an opportunity to materially increase our deposit share of this market.
While deposit growth is available in our primary market of the Piedmont Triad, quality loan opportunities in that market and elsewhere in our footprint have been insufficient in recent quarters to offset loan portfolio pay downs. Although we will continue to aggressively compete in the Piedmont Triad and in our Coastal market, the Company has determined that to achieve its growth goals it must seek out additional opportunities. Consequently, we have opened loan production offices in Raleigh, NC and in Charlotte, NC, two of the fastest growing metropolitan statistical areas (“MSAs”) in our country. These offices will be converted to branch offices in 2013. The Company now has a lending presence in each of the four largest MSAs in NC - Charlotte, Raleigh, the Piedmont Triad and Wilmington. We believe this expansion of our footprint will enhance our ability to significantly grow our deposit base and loan portfolio.
Although we intend to grow our deposit base and loan portfolio in our traditional and new markets, we will also consider other opportunities to expand our operations in these markets or in markets complementary to our existing franchise. We intend, however, to employ a disciplined approach, consistent with our management philosophy, in evaluating any such opportunities.
The Future. We cannot predict with assurance the performance of the Company in the coming years. Banks operate in an environment where factors beyond their control impact their performance. Recessions, stricter government regulations, interest rates, real property values, consumer spending, investment yields, regulatory capital requirements, and unemployment rates - to name a few - can and do adversely impact the profitability of financial institutions.
We do believe, however, that our aggressive resolution of our asset quality issues, the capital strength provided by our equity raise, our commitment to careful management of the drivers of our income and our expenses, and our focus on thoughtful growth, position our Company to move beyond the challenges of the past and seize upon opportunities available to us now and in the future.
Financial Condition at December 31, 2012 and 2011
The Company’s consolidated assets of $1.71 billion at year end 2012 reflect a decrease of 1.5% from year end 2011. The decrease was primarily a result of a decline in the Company’s loan portfolio. Total average assets decreased 1.4% from $1.75 billion in 2011, to $1.72 billion in 2012, while average earning assets decreased 1.6%, from $1.60 billion in 2011, to $1.58 billion in 2012. The decreases in total average assets and average earning assets were also primarily the result of a decrease in loans outstanding.
Loans (excluding loans held for sale) decreased $44.6 million during 2012, or 3.7%, compared to a decrease of 4.8% in 2011. The decline in loans was due primarily to our asset disposition plan. In our Quarterly Report on Form 10-Q for the second quarter of 2012, we disclosed that a plan was being developed to accelerate the workout and disposition of a substantial portion of remaining problem assets. During the third quarter, management initiated the asset disposition plan.
Using March 31, 2012 problem asset levels, management established the following goals:
·Nonperforming Loans - Reduce by $20.0 million to $23.7 million
·Performing Classified Loans - Reduce by $26.0 million to $49.3 million
·Real Estate Acquired in Settlement of Loans (“OREO”) - Reduce by $25.0 million to $5.0 million
·Total Classified Assets - Reduce by $71.0 million to $78.0 million
·Classified Assets - Reduce to 45.00% of Tier 1 capital plus allowance for credit losses
·Nonperforming Assets - Reduce to 2.00% or less of total assets
By December 31, 2012, the asset disposition plan was completed. As of that date, total problem assets were reduced by approximately $95.8 million from the March 31, 2012 levels as follows:
·Nonperforming Loans - Reduced by $22.4 million to $21.4 million
·Performing Classified Loans - Reduced by $48.8 million to $26.5 million
·OREO - Reduced by $24.7 million to $5.4 million
·Total Classified Assets - Reduced by $95.8 million to $53.2 million
·Classified Assets - Reduced to 30.53% of Tier 1 capital plus allowance for credit losses
·Nonperforming Assets - Reduced to 1.56% of total assets
The results achieved through the asset disposition plan are reflected in the amounts reported for December 31, 2012 and for the periods then ended and are the principal reasons for changes from prior period amounts.
Loans secured by real estate totaled $1.01 billion at year end 2012 and represented 87.5% of total loans (excluding loans held for sale), compared with 86.4% at year end 2011. Within this category, residential real estate loans decreased 4.1% to $501.4 million, and construction loans decreased 15.4% to $75.7 million. Commercial loans totaled $545.3 million at year end 2012, a decrease of 0.4% from the end of 2011. Consumer loans decreased 22.6% during 2012, ending the year at $26.9 million.
Investment securities (at amortized cost) totaled $379.1million at year end 2012, a 12.5% increase from $337.0 million at year end 2011. U.S. Government agency securities totaled $67.1 million, or 17.7% of the portfolio, at year end 2012, compared to $39.0 million, or 11.6% of the portfolio one year earlier. Mortgage backed securities totaled $64.7 million, or 17.1% of the portfolio, at December 31, 2012, compared to $62.1 million, or 18.4% of the portfolio, at the previous year end. State and municipal obligations amounted to $18.0 million at year end 2012, and comprised 4.7% of the portfolio, compared to $19.4 million, or 5.7% of the portfolio, a year earlier. Corporate bonds totaled $195.5 million, or 51.6% of the portfolio at December 31, 2012, of which $44.9 million were covered bonds, compared to total corporate bonds of $180.0 million, or 53.4% of the portfolio at December 31, 2011, of which $61.4 million were covered bonds. Collateralized mortgage obligations (“CMOs”) totaled $10.4 million, or 2.7% of the portfolio at year end 2012, compared to $23.6 million, or 7.0% of the portfolio, at the end of the previous year. The Company’s investment strategy is to achieve acceptable total returns through investments in securities with varying maturity dates, cash flows and yield characteristics. U.S. Government agency securities are generally purchased for liquidity and collateral purposes, mortgage backed securities are purchased for yield and cash flow purposes, corporate bonds are purchased for yield, and longer maturity municipal bonds are purchased for yield and income tax advantage. The table, “Investment Securities,” on page 52, presents the composition of the securities portfolio for the last three years, as well as information about cost and fair value, and the table “Investment Securities Portfolio Maturity Schedule” presents the maturities, fair values and weighted average yields.
Total deposits decreased $86.2 million to $1.33 billion at December 31, 2012, a 6.1% decrease from a total of $1.42 billion one year earlier. The decline in deposits was due primarily to lower time deposit balances, which fell $59.4 million for the year. Retail time deposits declined $75.9 million for the year as the Company has chosen not to compete for high priced time deposits. Noninterest-bearing deposits increased $33.7 million for the year to $206.0 million due in part to changes in the rate and fee structures the Company applied to certain product offerings in the fourth quarter of 2012.
In order to attract additional deposits, when necessary the Bank uses several different sources such as membership in an electronic deposit gathering network that allows it to post interest rates and attract deposits from across the U.S. (bulletin board deposits), brokered certificates of deposit secured through broker/dealer partnerships and deposits obtained through the Promontory InterFinancial Network, also known as CDARS. CDARS increased $27.2 million, from $15.2 million at year end 2011 to $42.4 million at year end 2012, while brokered deposits decreased $10.7 million, from $28.4 million at year end 2011 to $7.7 million at year end 2012.
The Bank also has a credit facility available with the FHLB of Atlanta. The Bank utilized a portion of the $342.5 million credit line with the FHLB of Atlanta to fund earning assets. FHLB borrowings totaled $113.0 million at year end 2012, and based on collateral pledged, $95.3 was available to be borrowed. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $7.7 million, and has federal funds lines of $25.0 million, of which there were no borrowings outstanding at December 31, 2012. Management believes these credit lines are a cost effective and prudent alternative to deposit balances, since particular amounts, terms and structures may be selected to meet changing needs.
Financial Condition at December 31, 2011 and 2010
The Company’s consolidated assets of $1.73 billion at year end 2011 reflected a decrease of 4.2% from year end 2010. The decrease was primarily a result of a decline in the Company’s loan portfolio. Total average assets decreased 8.4% from $1.91 billion in 2010, to $1.75 billion in 2011, while average earning assets decreased 9.6%, from $1.77 billion in 2010, to $1.60 billion in 2011. The decreases in total average assets and average earning assets were also primarily the result of a decrease in loans outstanding.
Loans (excluding loans held for sale) decreased $60.5 million during 2011, or 4.8%, compared to a decrease of 13.5% in 2010. The decrease in loans in 2011 is due primarily to principal repayment on existing loans and loan chargeoffs and foreclosures, coupled with soft loan demand from qualified borrowers. The decrease in loans in 2010 is due primarily to the reclassification of $72.5 million of loans from loans held for investment to loans held for sale in connection with the sale of the Bank’s Virginia operation in May 2011. Loans secured by real estate totaled $1.04 billion in 2011 and represented 86.4% of total loans (excluding loans held for sale), compared with 84.8% at year end 2010. Within this category, residential real estate loans decreased 4.0% to $522.8 million and construction loans decreased 35.7% to $89.4 million. Commercial loans totaled $547.4 million at year end 2011, an increase of 6.1% from the end of 2010. Consumer loans decreased 34.5% during 2011, ending the year at $34.7 million.
Investment securities (at amortized cost) totaled $337.0 million at year end 2011, a 4.9% increase from $321.3 million at year end 2010. U.S. Government agency securities totaled $39.0 million, or 11.6% of the portfolio, at year end 2011, compared to $109.3 million, or 34.0% of the portfolio one year earlier. Mortgage backed securities totaled $62.1 million, or 18.4% of the portfolio, at December 31, 2011, compared to $56.0 million, or 17.4% of the portfolio, at the previous year end. State and municipal obligations amounted to $19.4 million at year end 2011, and comprised 5.7% of the portfolio, compared to $17.4 million, or 5.4% of the portfolio, a year earlier. Corporate bonds totaled $180.0 million, or 53.4% of the portfolio at December 31, 2011, of which $61.4 million were covered bonds, compared to total corporate bonds of $82.8 million, or 25.8% of the portfolio at December 31, 2010, of which $46.1 million were covered bonds. Collateralized mortgage obligations (“CMOs”) totaled $23.6 million, or 7.0% of the portfolio at year end 2011, compared to $39.7 million, or 12.3% of the portfolio, at the end of the previous year. The Company’s investment strategy is to achieve acceptable total returns through investments in securities with varying maturity dates, cash flows and yield characteristics. U.S. Government agency securities are generally purchased for liquidity and collateral purposes, mortgage backed securities are purchased for yield and cash flow purposes, corporate bonds are purchased for yield, and longer maturity municipal bonds are purchased for yield and income tax advantage. The table, “Investment Securities,” on page 52, presents the composition of the securities portfolio for the last three years, as well as information about cost and fair value, and the table “Investment Securities Portfolio Maturity Schedule” presents the maturities, fair values and weighted average yield.
Total deposits decreased $34.3 million to $1.42 billion at December 31, 2011, a 2.4% decrease from a total of $1.45 billion one year earlier. This change was primarily the result of a $102.2 million reduction in time deposits, as the interest rates offered by the Bank were reduced substantially during the year. This decrease was partially offset by a $54.2 million increase in money market account deposits. In May 2011, $54.1 million of total deposits, which included $24.9 million of core deposits, were sold as part of the sale of the Bank’s Virginia operations. The Bank’s “FastForward Checking” product, introduced in the third quarter of 2009, totaled $184.8 million at December 31, 2011.
Net Interest Income
Like most financial institutions, the primary component of the Company’s revenue is net interest income. Net interest income is the difference between interest income, principally from loans and investments, and interest expense on customer deposits and borrowings. Changes in net interest income result from changes in volume and mix of the various interest-earning asset and interest-bearing liability components and changes in interest rates earned and paid. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Spread and margin are influenced by the levels and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities.
Average Balances and Net Interest Income Analysis. The accompanying table sets forth, for the years 2010 through 2012, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or rates, net interest income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. Average loans include nonaccruing loans, the effect of which is to lower the average yield.
Average Balances and Net Interest Income Analysis
Fully taxable-equivalent basis(1) (dollars in thousands)
(1)Average loans receivable include nonaccruing loans. Amortization of loan fees, net of deferred costs, and other loan-related fees of $600, $741 and $935, for 2012, 2011 and 2010, respectively, are included in interest income.
(2)Income related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35%, and is then reduced by the non-deductible portion of interest expense. The adjustments made to convert to a fully taxable-equivalent basis were $369 for 2012, $358 for 2011 and $1,497 for 2010.
(3)Net interest margin is computed by dividing taxable-equivalent net interest income by average earning assets.
(4)Interest rate spread is computed by subtracting interest-bearing liability rate from earning asset yield.
Volume and Rate Variance Analysis
The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table identifies (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) have been allocated, based on the absolute value, between changes attributable to volume and changes attributable to rate.
Volume and Rate Variance Analysis
Fully taxable-equivalent basis(1) (dollars in thousands)
(1)Income related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35% and is then reduced by the non-deductible portion of interest expense.
(2)The volume/rate variance for each category has been allocated on a consistent basis between rate and volume variances, based on the percentage of rate, or volume, variance to the sum of the two absolute variances.
Results of Operations - Years Ended December 31, 2012 and 2011
Net Income (Loss). Net loss available to common shareholders for 2012 was $28.2 million, representing a net loss per diluted share of $1.80, compared to net income available to common shareholders of $1.8 million, or $0.11 per diluted share, the prior year. The results for 2012 were largely impacted by the Company’s previously discussed plan to accelerate the disposition of problem assets. Provision for credit losses was $35.9 million in 2012 compared to $16.8 million in 2011, and writedowns and loss on sale of real estate acquired in settlement of loans was $14.5 in 2012 million compared to $5.2 million in 2011. In the fourth quarter 2012, the Company initiated the closure of two bank branch offices. Results for the year include $1.8 million of one-time items to write down facilities and other assets, as well as a $10 million valuation allowance against the Company’s deferred tax asset. Net interest income for 2012 after provision for credit losses decreased by $22.7 million, or 45.0%, as compared to 2011. The taxable-equivalent net interest margin decreased 16 basis points for 2012 to 4.06%, from 4.22% for 2011. Noninterest income decreased $10.8 million, or 82.0%, in 2012, while noninterest expense for 2012 increased $0.5 million, or 0.9%. The decrease in noninterest income is due primarily to $14.5 million in writedowns and losses on real estate acquired in settlement of loans. The provision for loan losses in 2012 was $35.9 million, up $19.1 million, or 113.8% from $16.8 million in 2011. Return on average assets for 2012 was (1.46)% compared to 0.27% for 2011. Return on average shareholders' equity for 2012 was (15.18)% compared to 2.81% in 2011.
Net Interest Income. Net interest income for 2012, on a taxable-equivalent basis, decreased $3.6 million, or 5.3%, compared to 2011. This was primarily due to a decrease in average earning assets, which declined $26.0 million, or 1.6%, to $1.58 billion from $1.60 billion for the prior year. Average interest-bearing liabilities for 2012 decreased $58.1 million, or 4.2%, to $1.34 billion, compared to $1.40 billion for 2011.
The net interest margin for the year ended December 31, 2012 was 4.06%, down from 4.22% for the prior year. In 2012, the average yield on earning assets decreased by 45 basis points while the average rate on interest-bearing liabilities decreased by 32 basis points, which resulted in a decrease in the interest rate spread in 2012 of 13 basis points compared to the prior year.
The table, “Average Balances and Net Interest Income Analysis,” above summarizes net interest income and average yields earned, and rates paid for the years indicated, on a taxable-equivalent basis. The table, “Volume and Rate Variance Analysis” above presents the changes in interest income and interest expense attributable to volume and rate changes between the years indicated.
Provision for Credit Losses and Allowance for Credit Losses. The Company recorded a $35.9 million provision for credit losses during the year ended December 31, 2012, compared to a $16.8 million provision during the previous year. The Company’s allowance for credit losses was $26.6 million at December 31, 2012. The allowance for credit losses expressed as a percentage of total loans (excluding loans held for sale) decreased to 2.30% at December 31, 2012 from 2.40% at December 31, 2011. Since the current adverse credit cycle began in 2007, the Company has charged off $194.4 million of loans and OREO, or 12.0% of peak loan balances of $1.627 billion at September 30, 2008.
Noninterest Income. In 2012, noninterest income decreased $10.8 million to $2.4 million due primarily to $14.5 million in writedowns and losses on disposals of OREO. Pre-tax gains on sale of investment securities totaled $3,000 in 2012 compared to $2.0 million in 2011. Retail banking revenue declined $0.2 million to $9.7 million, or 1.9%, for the year, due primarily to ongoing regulatory changes in the industry and changes in consumer behavior. Wealth management fees declined $0.2 million for the year. Mortgage banking revenue increased $0.9 million, or 52.5%, for the year due to a higher volume of production. Income on bank-owned life insurance rose $0.1 million, or 7.9%.
Noninterest Expense. In 2012, noninterest expense increased $0.5 million, or 0.9%, compared to 2011. The Company has continued to focus on improving efficiencies and controlling costs. Furniture and equipment, FDIC insurance and OREO expense fell an aggregate of $1.6 million from the prior year, while all other expense categories rose an aggregate of $2.1 million. The rise in occupancy and other expenses was due primarily to one-time charges of $1.8 million taken in the third quarter for impairments on facilities related to branch offices closed or to be closed and for adjustments for various nonrecurring accruals. For the detailed change in other operating expense please see the table “Other Operating Expenses” in Note 12 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Provision for Income Taxes. The Company recorded an income tax benefit of $2.6 million in 2012, compared to a tax expense of $1.4 million in 2011. The Company’s effective tax rate was 9.3% in 2012 and 23.6% in 2011. In 2012, the difference between the effective tax rate and the statutory rate was primarily a result of an increase of $10.0 million in the valuation allowance against deferred tax assets, while in 2011, the difference between the effective tax rate and the statutory rate was primarily due to tax-exempt items such as income on bank-owned life insurance and municipal securities.
Results of Operations - Years Ended December 31, 2011 and 2010
Net Income. Net income available to common shareholders for 2011 was $1.8 million, representing net income per diluted share of $0.11, compared to net income available to common shareholders of $461,000, or $0.03 per diluted share the prior year. The improvement to net income in 2011 was mostly attributed to a reduction in the provision for credit losses and continued reductions in noninterest expense. Net interest income for 2011 after provision for credit losses increased by $2.1 million, or 4.4%, as compared to 2010. The taxable-equivalent net interest margin increased 22 basis points for 2011 to 4.22%, from 4.00% for 2010. Noninterest income decreased $2.7 million, or 16.8%, in 2011, while noninterest expense for 2011 decreased $3.5 million, or 5.8%. The provision for loan losses in 2011 was $16.8 million, down $4.5 million, or 21.0% from $21.3 million in 2010. Return on average assets for 2011 was 0.27% compared to 0.18% for 2010. Return on average shareholders' equity for 2011 was 2.81% compared to 2.00% in 2010.
Net Interest Income. Net interest income for 2011, on a taxable-equivalent basis, decreased $3.5 million, or 4.9%, compared to 2010. This was primarily due to a decrease in average earning assets, which declined $170.6 million, or 9.6%, to $1.60 billion from $1.77 billion for the prior year. The decline was partially offset by an increase in taxable-equivalent net interest margin, which rose to 4.22% for 2011 compared to 4.00% for 2010. Average interest-bearing liabilities for 2011 decreased $158.5 million, or 10.2%, to $1.40 billion, compared to $1.56 billion for 2010.
During 2011, the Bank continued to reduce its dependence on high cost time deposits, and, as a result, the net interest margin improved from 2010 levels. In 2011, the average yield on earning assets decreased by 17 basis points while the average rate on interest-bearing liabilities decreased by 43 basis points, which resulted in an increase in the interest rate spread in 2011 of 26 basis points compared to the prior year.
The table, “Average Balances and Net Interest Income Analysis,” above summarizes net interest income and average yields earned, and rates paid for the years indicated, on a taxable-equivalent basis. The table, “Volume and Rate Variance Analysis” above presents the changes in interest income and interest expense attributable to volume and rate changes between the years indicated.
Provision for Credit Losses and Allowance for Credit Losses. The Company recorded a $16.8 million provision for credit losses during the year ended December 31, 2011, compared to a $21.3 million provision during the previous year. The decrease in 2011 was primarily a result of a lower level of chargeoffs in 2011 than in 2010. During the fourth quarter of 2010, the Company charged off $6.2 million, and during the first quarter of 2011 charged off an additional $1.3 million, of a $10.0 million subordinated debt loan to a financial institution. The remaining $2.5 million was exchanged for preferred stock in the institution and is carried in other assets on the Company’s balance sheet. The Company does not have any other loans to financial institutions. The Company’s allowance for credit losses was $28.8 million at December 31, 2011, essentially unchanged from the end of 2010. The allowance for credit losses expressed as a percentage of total loans (excluding loans held for sale) increased to 2.40% at December 31, 2011 from 2.28% at December 31, 2010.
Noninterest Income. In 2011, noninterest income decreased $2.7 million to $13.2 million. Pre-tax gains on sale of investment securities totaled $2.0 million in 2011 compared to $3.6 million in 2010. Retail banking revenue declined 14.4% for the year, or $1.7 million, due primarily to ongoing regulatory changes in the industry and changes in consumer behavior. These declines were partially offset by an increase of $366,000, or 17.2%, in wealth management service income, due primarily to a 94% increase in assets under management, which totaled $146.4 million at December 31, 2011. Mortgage revenue decreased $710,000, or 29%, for the year due to the volatility of interest rates, resulting in a lower level of mortgage loan production. Income on bank-owned life insurance rose $520,000, or 60%, as the Company purchased additional insurance policies.
Noninterest Expense. In 2011, noninterest expense declined $3.5 million, or 5.8%, compared to 2010. The Company has continued to focus on improving efficiencies and controlling costs, and has reduced its expenses in nearly all categories, including personnel, occupancy, furniture and equipment, technology and data processing, legal and professional, and FDIC assessments. For the detailed change in other operating expense please see the table “Other Operating Expenses” in Note 12 of the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Provision for Income Taxes. The Company recorded an income tax expense of $1.4 million in 2011, compared to a tax benefit of $0.2 million in 2010. This change was primarily attributable to the increase in pre-tax income in 2011, combined with a reduction in tax-exempt income in 2011. The Company’s effective tax rate was 23.6% in 2011 and (7.9) % in 2010. In both years, the difference between the effective tax rate and the statutory rate was primarily due to tax-exempt items such as income on bank-owned life insurance and municipal securities.
Liquidity and Cash Flow
Liquidity management refers to the policies and practices that ensure the Bank has the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Bank’s customers. Management measures our liquidity position by giving consideration to both on- and off-balance sheet sources of, and demands for, funds on a daily and other periodic bases. Deposit withdrawals, loan funding and general corporate activity create the primary needs for liquidity for the Bank. Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities, investments available for sale, loan repayments, loan sales, increases in deposits, and increases in borrowings from the FHLB secured with pledged loans and securities, and from correspondent banks under overnight federal funds credit lines and securities sold under repurchase agreements.
On November 30, 2012, the Company completed a $56.3 million capital raise, which sufficiently bolsters the balance sheet for the future, including the anticipated repurchase of the $52.4 million of the TARP Series A Preferred Stock. Bancorp had sufficient cash and cash equivalents on hand at December 31, 2012 to provide for the anticipated repurchase of the TARP preferred shares and to provide for Bancorp’s anticipated obligations and service its debt for approximately one year.
The investment portfolio at December 31, 2012 included securities with a par value of approximately $96.2 million with call features, whereby the issuers of such securities have the option to repay the securities before the contractual maturity dates. The Company anticipates that a number of these securities may be called by their issuers during 2013, due to the current low interest rate environment.
The Bank has the ability to manage, within competitive and cost of funds constraints, increases in deposits within its market areas. The Bank is a member of an electronic network that allows it to post interest rates and attract certificates of deposit nationally. It also utilizes CDARS and brokered deposits to supplement in-market deposit growth.
The Bank has established wholesale repurchase agreements with regional brokerage firms. The Bank can access this additional source of liquidity by pledging investment securities with the brokerage firms.
Liquidity is further enhanced by a line of credit with the FHLB, amounting to approximately $342.5 million, collateralized by FHLB stock, investment securities, qualifying residential one to four family first mortgage loans, qualifying multi-family first mortgage loans, qualifying commercial real estate loans, and qualifying home equity lines of credit and second mortgage loans. Based upon collateral pledged, as of December 31, 2012, the borrowing capacity under this line was $258.3 million, with $95.3 million available to be borrowed. The Bank provides various reports to the FHLB on a regular basis to maintain the availability of the credit line. Each borrowing request to the FHLB is initiated through an advance application that is subject to approval by the FHLB before funds are advanced under the line of credit. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $7.7 million, and has federal funds lines of $25.0 million, of which there were no borrowings outstanding at December 31, 2012.
As presented in the Consolidated Statement of Cash Flows, the Company generated $22.8 million in operating cash flow during 2012, compared to $99.9 million in 2011 and $36.4 million in 2010. The decrease from 2011 to 2012 and the increase from 2010 to 2011 was primarily the result of the sale during 2011 of $73.0 million in loans held for sale in connection with sale of the Bank’s Virginia operations.
Cash used in investing activities in 2012 was $26.9 million, compared to cash provided by investing activities of $2.9 million in 2011 and $87.0 million in 2010. Cash outflows for 2012 included $56.3 million related to an increase in the loan portfolio. Cash outflows for 2012 also included $264.8 million in purchases of securities available for sale compared to $165.3 million in 2011 and $211.5 million in 2010. Cash inflows for 2012 included $54.4 million in proceeds from sales of loans. Cash inflows for 2011 and 2010 included $20.7 million and $73.6 million, respectively, related to a decrease in the loan portfolio. The Company also invested $12.0 million in bank-owned life insurance during 2011.
Cash used by financing activities was $10.1 million in 2012, compared to $77.9 million in 2011 and $139.2 million in 2010. Cash flows for 2012, 2011 and 2010 included outflows of $59.4 million, $102.2 million and $178.8 million, respectively related to decreases in time deposits. During 2012, the Company had a cash inflow of $52.3 million from the issuance of preferred stock. During 2011, the Company had a cash inflow of $67.9 million related to increase in core deposits, partially offset by cash outflows of $41.0 million used to reduce outstanding borrowings. During 2010, the Company had a cash inflow of $132.5 million related to increase in core deposits, partially offset by cash outflows of $90.3 million used to reduce outstanding borrowings.
Contractual Obligations and Commitments
In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, which may or may not require future cash outflows. Payments for borrowings do not include interest. Payments related to leases and service contracts are based on actual payments specified in the underlying contracts. The following table reflects the material contractual obligations of the Company outstanding as of December 31, 2012.
Contractual Obligations
(dollars in thousands)
Capital Resources
Banks, bank holding companies, and financial holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve and the FDIC have minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are required to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. On August 26, 2005, the Company completed a private placement of trust preferred securities in the amount of $25.0 million. See Note 7 of the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K for a discussion of the issuance of the trust preferred securities. On December 12, 2008, the Company sold Series A Preferred Stock and a Warrant to the U.S. Treasury for $52.4 million as part of the CPP. On November 30, 2012, the Company completed a private placement of Series B Preferred Stock and Series C Preferred Stock for an aggregate of $56.3 million. As shown in Note 17 of the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K, the Company and the Bank both maintained capital levels exceeding the minimum levels required to be categorized as “well capitalized” for each of the three years presented.
Lending Activities
General. The Bank offers a broad array of lending services, including construction, real estate, commercial and consumer loans, to individuals and small to medium-sized businesses and retail clients that are located in or conduct a substantial portion of their business in the Bank’s market areas. The Bank’s total loans (excluding loans held for sale) at December 31, 2012 were $1.16 billion, or 67.6% of total assets. At December 31, 2012, the Bank had no large loan concentrations (exceeding 10% of its portfolio) in any particular industry, other than real estate. The Bank’s legal lending limit at December 31, 2012 was $26.2 million (absent fully marketable collateral), and the largest credit relationship was approximately $15.0 million.
Loan Composition. The following table summarizes, at the dates indicated, the composition of the Bank’s loan portfolio and the related percentage composition (excluding loans held for sale).
Summary of Loan Portfolio
(dollars in thousands; excluding loans held for sale)
The Company has no foreign loan activity.
Real Estate Loans. Loans secured by real estate totaled $1.01 billion, or 87.5% of total loans (excluding loans held for sale), at December 31, 2012. At year end 2012, the Bank had real estate loan relationships of various sizes ranging up to $14.5 million and commitments up to $15.0 million, secured by office buildings, retail establishments, residential development and construction, warehouses, motels, restaurants and other types of property. Loan terms are typically limited to five years, with payments through the date of maturity generally based on a 15-20 year (15-30 year for owner-occupied single and multi-family properties) amortization schedule. Interest rates may be fixed or adjustable, based on market conditions, and the Bank generally charges an origination fee. Management has attempted to reduce credit risk in the real estate portfolio by emphasizing loans on owner-occupied office, multi-family and retail buildings where the loan to value ratio, established by independent appraisals, does not exceed 70% to 80%, and net projected cash flow available for debt service amounts to at least 120% to 135% of the debt service requirement. The Bank also generally requires personal guarantees and personal financial statements from the principal owners in such cases.
Real Estate - Mortgage. The Bank originates fixed and adjustable rate mortgages as well as FHA, VA and USDA government supported loans for resale into the secondary market. The Bank provides bank-held mortgage products to accommodate qualified borrowers who may not meet all the standards for a conventional secondary market mortgage. During 2012, the Bank originated $205.2 million of loans in these various categories. Also included in real estate mortgage loans are home equity revolving lines of credit, with $200.5 million outstanding as of December 31, 2012. The Bank recorded net chargeoffs from mortgage loans of $12.6 million during 2012, compared to $6.4 million in 2011 and $7.0 million in 2010.
Real Estate - Construction Loans. The Bank’s current lending strategy is to moderately increase exposure in this portfolio segment. The Bank expects that the majority of its new construction and development loans on commercial and residential projects will be in the range of $300,000 to $5.0 million. At December 31, 2012 and 2011, the Bank held $75.7 million and $89.4 million, respectively, of such loans. To reduce credit risk associated with such loans, the Bank emphasizes small commercial centers that are substantially pre-leased, or residential projects that are substantially pre-sold and built in strong, proven markets. The leases on commercial projects must generally result in a loan to appraised value of 75% to 80% or less and a net cash flow to debt service of no less than 120% to 135%. The Bank typically requires a personal guarantee from the developer or builder. Loan terms are generally 12-15 months, although the Bank will make a “mini-permanent” loan for purposes of construction and development of up to a five year term. Rates can be either fixed or variable, and the Bank usually charges an origination fee. The Bank experienced net chargeoffs from real estate - construction loans of $8.4 million in 2012, $3.5 million in 2011 and $5.3 million in 2010.
Commercial Loans. The Bank makes loans for commercial purposes to various types of businesses. At December 31, 2012, the Bank held $545.3 million of commercial loans, or 47.2% of its total loan portfolio. Equipment loans are typically made on terms up to five years at fixed or variable rates, with the financed equipment pledged as collateral to the Bank. The Bank attempts to reduce its credit risk on these loans by limiting the loan to value percentage to 80%. Working capital loans are made on terms typically not exceeding one year. These loans may be secured or unsecured, but the Bank attempts to limit its credit risk by requiring the borrower to demonstrate its capacity to produce net cash flow available for debt service equal to 120% to 150% of its debt service requirements. The Bank experienced net chargeoffs from commercial loans of $16.4 million in 2012, $4.6 million in 2011, and $7.7 million in 2010.
Consumer Loans. Using a centralized underwriting process, the Bank makes a variety of loans to individuals for personal and household purposes, including (i) secured and unsecured installment and term loans originated directly by the Bank; (ii) unsecured revolving lines of credit, and (iii) amortizing secured lot loans. Certain of the direct loans are secured by the borrowers’ residences. At December 31, 2012, the Bank held $26.9 million of consumer loans. During 2012, 2011, and 2010, the Bank experienced net consumer loan chargeoffs of $0.9 million, $1.0 million, and $2.2 million, respectively.
Loan Approval and Review. When the aggregate outstanding loans to a single borrower or related entities exceed an individual officer’s lending authority, the loan request must be considered and approved by an officer with a higher lending limit. All consumer purpose loan decisions are made through a centralized underwriting process. Commercial banking managers (“CBM”) can generally approve commercial relationships up to $750,000. If the lending request exceeds the CBM’s lending limit, the loan must be submitted to and approved by a senior credit officer. A senior credit officer has authority to approve commercial relationships up to $2,500,000 on a secured basis. All loan relationships between $2,500,000 and $4,000,000 must be approved by the Chief Commercial Credit Officer (“CCCO”). All loans between $4,000,000 and $7,500,000 must be approved by the Chief Credit Officer (“CCO”). Loan relationships exceeding $7,500,000 up to $10,000,000 must be unanimously approved by a committee of the CCCO, the CCO, and the Bank’s CEO. Loan relationships over $10,000,000 must be approved by the Credit Management Committee of the Bank’s Board of Directors.
The Bank’s Loan Review Program is headed by the Loan Review Manager, who reports directly to the Credit Management Committee of the Bank’s Board of Directors. The Program includes the Annual Loan Review Coverage Plan which is approved by the Credit Management Committee and which stipulates a certain number of loan reviews to be completed by the Loan Review Manager and employees under his or her guidance, and an additional number of loan reviews to be completed by independent loan review consulting firms. The Bank’s credit review system supplements its loan rating system, pursuant to which the Bank may place a loan on its criticized asset list or may classify a loan in one of various other classification categories. In addition, all loan officers are charged with the responsibility of reviewing their portfolios and making adjustments to the risk ratings as needed. The “Watch Loan Committee,” which includes the CCO, the CCCO, the Special Assets Manager and the Special Assets Officers, reviews all commercial loans graded special mention, substandard, doubtful and loss on a monthly basis, and provides a summary to the Credit Management Committee, also on a monthly basis. In addition, a committee made up of the Special Assets Manager, Special Assets Officers, senior credit officers and senior lenders reviews all past due loans on a monthly basis and provides a summary to management.
The Bank’s loan portfolio is analyzed on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. Its allowance for credit losses is also analyzed monthly by management. This analysis includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. A specified minimum percentage of loans in each adverse asset classification category, based on the probability of default and on the historical loss experience of the Bank in each such category, as well as other environmental factors such as the unemployment level or other economic conditions affecting that type of loan, are used to determine the adequacy of the Bank’s allowance for credit losses monthly. These loans are also individually reviewed by the Bank’s Watch Loan Committee to determine whether a greater allowance allocation is justified due to the facts and circumstances of a particular adversely classified loan. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. The provisions of ASC 310-10-35 “Loans that Are Identified for Evaluation or that Are Individually Considered Impaired” are applied to individually significant loans. Finally, individual reserves may be recorded based on a review of loans on the watch list. See Note 4 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Loan Portfolio - Maturities and Interest Rate Sensitivities
(dollars in thousands, excluding loans held for sale)
Asset Quality
The Bank considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to its lending policy as approved by its Board of Directors. See “Lending Activities - Loan Approval and Review.” It is the responsibility of each commercial lending officer to assign an appropriate risk grade to every loan they originate. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, it is the lending officer’s responsibility to recommend appropriate changes in the borrower’s risk grade.
Currently, the grading process utilized by the Bank is segmented by product type. This methodology does not provide a direct correlation with groupings utilized in the other tables presenting loan information.
The following table summarizes, by internally assigned risk grade, the risk grade for loans for which the bank has assigned a risk grade.
Risk Profile by Internally Assigned Risk Grade
(dollars in thousands)	
The Bank’s loan portfolio consists of loans made for a variety of commercial and consumer purposes. Because commercial loans are made based to a great extent on its assessment of a borrower’s income, cash flow, character and ability to repay, such loans are generally viewed as involving a higher degree of credit risk than is the case with residential mortgage loans or consumer loans. To manage this risk, the Bank’s commercial loan portfolio is managed under a defined process which includes underwriting standards and risk assessment, procedures for loan approvals, loan grading, ongoing identification and management of credit deterioration and portfolio reviews to assess loss exposure and to ascertain compliance with the Bank’s credit policies and procedures.
Allocation of Allowance for Credit Losses (1)
(dollars in thousands)	
(1)The allowance for credit losses has been allocated on an approximate basis. The allocation is not necessarily indicative of future losses.
In general, consumer loans (including mortgage and home equity) have a lower risk profile than commercial loans. Commercial loans (including commercial real estate, commercial non real estate and construction loans) are generally larger in size and more complex than consumer loans. Commercial real estate loans are deemed less risky than commercial non real estate and construction loans, because the collateral value of real estate generally maintains its value better than non real estate or construction collateral. The Bank has little or no exposure to subprime lending. Consumer loans, which are smaller in size and more geographically diverse across the Bank’s entire primary market areas, provide risk diversity across the portfolio. Because mortgage loans are secured by first liens on the consumer’s residential real estate, they are the Bank’s lowest risk profile loan type. Home equity loans are deemed less risky than unsecured consumer loans because home equity loans are secured by first or second deeds of trust on the borrower’s residential real estate. A centralized decision-making process is in place to control the risk of the consumer, home equity and mortgage loan portfolio. The consumer real estate appraisal process is also centralized relative to appraisal engagement, appraisal review, and appraiser quality assessment. These processes are detailed in the underwriting guidelines, which cover each retail loan product type from underwriting, servicing, compliance issues and closing procedures.
The Bank’s loan review program is designed to evaluate the credit risk in its loan portfolio. Through this loan review process, the Bank maintains an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for credit losses. In establishing the appropriate classification for specific loans, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as special mention, substandard, doubtful or loss as described below, and reserves are allocated based on management’s judgment and historical experience.
Special Mention - These loans have potential weaknesses, which may, if not corrected or reversed, weaken the bank's credit position at some future date. The loans may not currently show problems due to the borrower(s)’ apparent ability to service the debt, but special circumstances surround the loans of which the bank and management should be aware. This category may also include loans where repayment has not been satisfactory, where constant attention is required to maintain a set repayment schedule, or where terms of a loan agreement have been violated but the borrower still appears to have sufficient financial strength to avoid a lower rating. It also includes new loans that significantly depart from established loan policy and loans to weak borrowers with a strong guarantor.
Substandard - These are loans whose full final collectability may not appear to be a matter for serious doubt, but which nevertheless have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and require close supervision by management, such as unprofitable and/or undercapitalized businesses, inability to generate sufficient cash flow for debt reduction, deterioration of collateral and special problems arising from the particular condition of an industry. It also includes workout loans on a liquidation basis when a loss is not expected. Some of these loans are considered impaired.
Doubtful - These loans have all the weakness inherent in loans graded substandard with the added provision that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and value, highly questionable. In some instances, the extent of the potential loss is not currently determinable. Most of these loans are considered impaired.
The process of determining the allowance for credit losses is driven by the risk grade system and the loss experience on non risk graded homogeneous types of loans. The allowance for credit losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio. In determining the allowance for credit losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in the Bank’s market areas. For loans determined to be impaired, the impairment is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral, less selling and other handling costs, for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to recognize changes to the allowance based on their judgments about information available to them at the time of their examinations. Loans are charged off when in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.
Management believes the allowance for credit losses of $26.6 million at December 31, 2012 is adequate to cover inherent losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus, there can be no assurance that credit losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting future operating results of the Bank.
The following table presents an analysis of the changes in the allowance for credit losses.
Analysis of Allowance for Credit Losses
(dollars in thousands)
Commercial loans. All commercial loans within the portfolio are risk graded among nine risk grades based on management’s evaluation of the overall credit quality of the loan, including the payment history, the financial position of the borrower, the underlying collateral value, an internal credit risk assessment and examination results. As a result, the allowance is adjusted upon any migration of a loan to a higher or lower risk grade within the commercial loan portfolio. The reserve percentages utilized have been determined by management to be appropriate based on historical loan loss levels and the risk for each corresponding risk grade.
Mortgage, home equity, and credit lines. Reserves are calculated on mortgage, home equity, and credit lines based on historical loss experience. The average rolling 20 quarter net loss percentage is calculated for each of these loan categories, and is multiplied by the dollar balance of loans in each of these categories to determine the required reserve.
Consumer loans. The consumer loans are pooled together to determine the reserve requirement. The average rolling 20 quarter net loss percentage is calculated for this loan category, and is multiplied by the dollar balance of retail loans to determine a required reserve. An additional reserve, equal to 25.0% of all retail loans past due 90 days or more, is added to the above.
Specific impairment. Management evaluates significant loans graded substandard, doubtful and loss on an individual basis for impairment. The specific allowance is calculated based upon a review of these loans and the estimated losses at the balance sheet date. At December 31, 2012 and 2011, the recorded investment in loans specifically identified and evaluated for impairment was approximately $16.4 million and $32.6 million, respectively and the specific allowance for credit losses associated with those loans was approximately $1.6 million and $4.2 million, respectively. The decrease in the amount of specifically impaired loans held by the Bank and the associated allowance for credit losses resulted primarily from the Bank’s decision to take appropriate aggressive action with our problem credits through chargeoffs and foreclosure.
Performing classified loans. Loans graded substandard, doubtful and loss which do not fit the criteria to be considered significant are not evaluated on an individual basis for impairment. However, the Bank closely monitors such loans as a result of their elevated risk profile. As a result of the Bank’s discipline, the balance of these performing classified loans decreased to $26.5 million at December 31, 2012 from $88.0 million at December 31, 2011. The loans that make up this category trended as management had projected and reached a peak level in the third quarter of 2010. These loans, while exhibiting signs of weakness, continue to perform pursuant to stated terms and conditions and therefore do not have specifically identified expected losses. Approximately 60% of the loans in this category are identified as commercial and industrial or income producing commercial real estate, which management assigns a lower probability of default and/or loss given default. The allowance for credit losses associated with such loans was $2.2 million at December 31, 2012, which was based on a model that uses probability of default, and expected loss in the event of default, to determine inherent losses within a given group of loans.
Provision for credit losses. The 2012 provision for credit losses totaled $35.9 million, compared to $16.8 million in 2011. As of December 31, 2012, nonperforming assets totaled $26.7 million, comprised of $21.4 million in nonperforming loans and $5.3 million in OREO. Those figures compare to $40.5 million in nonperforming loans and $30.6 million in OREO at the end of 2011, totaling $71.1 million in nonperforming assets. Net chargeoffs increased in 2012 to $38.1 million, or 3.26% of average loans outstanding, compared with $16.7 million, or 1.32% of average loans outstanding, in the prior year. During the fourth quarter of 2010, the Company charged off $6.2 million of a $10.0 million loan composed of subordinated debt to a financial institution. In the first quarter of 2011, an additional writedown of $1.3 million was recorded on this loan. The Bank forgave $5.0 million of the loan and all unpaid interest and the remaining $5.0 million was exchanged for preferred stock with a liquidation preference value of $5.0 million in the institution. The Bank’s recorded investment of $2.5 million is carried in other assets on the Company’s balance sheet as of December 31, 2012. Periodic impairment evaluations are performed and management believes this asset is currently not impaired. The Company does not have any other loans to financial institutions. At December 31, 2012 and 2011 the allowance for credit losses as a percentage of year end loans (excluding loans held for sale) was 2.30% and 2.40%, respectively. The 2012 and 2011 results have been impacted by the continued weakness in the regional and national economies as well as the 2012 problem asset disposition plan.
Nonperforming Assets
(dollars in thousands)
(1)Loans restructured in a previous year without an interest rate concession or forgiveness of debt that are performing in accordance with their modified terms.
Nonperforming assets include nonaccrual loans, accruing loans contractually past due 90 days or more, restructured loans, and real estate acquired in settlement of loans. Loans are placed on nonaccrual status when: (i) management has concerns relating to the ability to collect the loan principal and interest and (ii) generally when such loans are 90 days or more past due. No assurance can be given, however, that economic conditions will not adversely affect borrowers and result in increased credit losses.
The Bank’s policy for impaired loan accounting subjects all loans to impairment recognition except for large groups of smaller balance homogeneous loans such as credit card, residential mortgage and consumer loans. The Bank generally considers loans 90 days or more past due, all nonaccrual loans, and all troubled debt restructurings (“TDRs”) to be impaired. Loans specifically indentified and evaluated for impairment totaled $16.4 million and $32.6 million at December 31, 2012 and December 31, 2011, respectively, as summarized in the following tables (in thousands):
Impaired, nonperforming and other classified loans and related information are summarized in the following table (in thousands):
Investment Activities
Our investment portfolio plays a primary role in the management of liquidity and interest rate sensitivity and, therefore, is managed in the context of the overall balance sheet. In 2012, the securities portfolio generated approximately 19% of our interest income and served as a necessary source of liquidity.
Management attempts to deploy investable funds into instruments that are expected to increase the overall return of the portfolio given the current assessment of economic and financial conditions, while maintaining acceptable levels of credit, interest rate and liquidity risk, as well as capital usage and risk.
The following tables present the carrying values, fair values, unrealized gains and losses, and weighted average yields and durations of our investment portfolio at December 31, 2012, 2011 and 2010, as well as the interval of maturities or repricings at December 31, 2012.
Investment Securities
(dollars in thousands)
Investment securities at December 31 consist of the following (dollars in thousands):
(1) Average remaining duration to maturity, in years
(2) Fully taxable-equivalent basis
Investment Securities Portfolio Maturity Schedule
(dollars in thousands)
(1)The yield related to securities exempt from federal income taxes is stated on a fully taxable-equivalent basis, assuming a federal income tax rate of 35%.
See also Note 3 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
Information about the Company’s off-balance sheet risk exposure is presented in Note 10 in the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K.
Market Risk
Market risk is the risk of loss arising from adverse changes in the fair values of financial instruments or other assets caused by changes in interest rates, currency exchange rates, or equity prices. Interest rate risk is the Company’s primary market risk and results from timing differences in the repricing of assets and liabilities, changes in relationships between rate indices, and the potential exercise of explicit or embedded options.
For a complete discussion on market risk and how the Company addresses this risk, see Item 7A
Item 7A of this Annual Report on Form 10-K, the effect of interest rate movements in response to changes in the actual and perceived rates of inflation can materially impact bank operations, which rely on net interest margins as a major source of earnings. Noninterest expense, such as salaries and wages, occupancy and equipment are also negatively affected by inflation.
Application of Critical Accounting Policies
The Company's accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry, and are fundamental to understanding management's discussion and analysis of results of operations and financial condition. The Company's significant accounting policies are discussed in detail in Note 1 in the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K.
The preparation of the financial information contained in this Annual Report on Form 10-K requires the Company’s management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company’s management evaluates these estimates on an ongoing basis. A summary of the allowance for credit losses, the most complex and subjective accounting policy of the Company, is discussed under the heading “Lending Activities” as well as in Note 4 of the Notes to Consolidated Financial Statements. Income taxes and the valuation allowance against deferred tax assets are discussed in Note 9 of the Notes to Consolidated Financial Statements.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
The Company’s primary market risk is considered to be the Bank’s interest rate risk which could potentially have the greatest impact on operating earnings. The Bank is not subject to other types of market risk, such as foreign currency exchange rate risk, commodity or equity price risk. Interest rate risk on our balance sheet arises from the maturity mismatch of interest-earning assets versus interest-bearing liabilities, as well as the potential for maturities to shorten or lengthen our interest-earning assets and interest-bearing liabilities. In addition, market risk is the possible chance of loss from unfavorable changes in market prices and rates. These changes may result in a reduction of current and future period net interest income, which is the favorable spread earned from the excess of interest income on interest-earning assets, over interest expense on interest-bearing liabilities.
Interest rate risk management is a part of the Bank’s overall asset/liability management process. The primary oversight of asset/liability management rests with the Bank’s Asset and Liability Committee, which is comprised of the Bank’s CEO, Chief Financial Officer (“CFO”) and other senior executives. The Committee meets approximately twice per quarter to review the asset/liability management activities of the Bank and monitor compliance with established policies. Activities of the Asset and Liability Committee are reported to the Audit and Risk Management Committees of the Company’s and the Bank’s Board of Directors.
The Bank uses several interest rate risk measurement tools provided by a national asset liability management consultant to help manage this risk. The Bank’s Asset/Liability Policy provides guidance for acceptable levels of interest rate risk and potential remediations. Management provides the consultant with key assumptions, which are used as inputs into the measurement tools. Following is a summary of two different tools management uses on a quarterly basis to monitor and manage interest rate risk.
Earnings Simulation Modeling. Net income is affected by changes in the level of interest rates, the shape of the yield curve and the general market pressures affecting current market interest rates at the time of simulation. Many interest rate indices do not move uniformly, creating certain disunities between them. For example, the spread between a 30 day, prime-based asset and a 30 day, FHLB advance may not be uniform over time. The earnings simulation model projects changes in net interest income caused by the effect of changes in interest rates on interest-earning assets and interest-bearing liabilities. Simulation results are measured as a percentage change in net interest income compared to the static-rate or “base case” scenario. The model uses the Bank’s current balance sheet, but considers decreases in asset and liability volumes based on prepayment assumptions as well as rate changes. Rate changes are modeled gradually over a 12 month period, referred to as a “rate ramp.” The model projects only changes in interest income and expense and does not project changes in noninterest income, noninterest expense, provision for loan losses or the impact of changing tax rates. At December 31, 2012, net interest income simulation showed a positive 0.09% change from the base case in a 200 basis point ramped rising rate environment and a negative 0.27% change from the base case in a 100 basis point ramped declining rate environment. The projected changes in net interest income are within the Board of Directors’ guidelines in a 200 basis point increasing or 100 basis point decreasing interest rate environment. However, management continually monitors signs of elevated risks and takes certain actions to limit these risks.
The following table summarizes the results of the Bank’s income simulation model as of December 31, 2012.
Net Portfolio Value Analysis. Net portfolio value (“NPV”) represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 200 basis point increase or decrease in market interest rates with no effect given to any actions management might take to counter the effect of that interest rate movement. The following is a summary of the results of the report compiled by the Bank’s outside consultant using data and assumptions management provided as of December 31, 2012.
The preceding table indicates that, at December 31, 20112, in the event of a 200 basis point increase in prevailing market interest rates, NPV would be expected to decrease by $2.9 million, or 1.43% of the base case scenario value of $205.8 million. In the event of a decrease in prevailing market rates of 100 basis points, NPV would be expected to decline by $20.8 million, or 10.12% of the base case scenario value. The projected changes in NPV are within the Board of Directors’ guidelines in a 200 basis point increasing or 100 basis point decreasing interest rate environment. However, management continually monitors signs of elevated risks and takes certain actions to limit these risks.
A primary objective of interest rate sensitivity management is to ensure the stability and quality of the Bank’s primary earnings component, net interest income. This process involves monitoring the Bank’s balance sheet in order to determine the potential impact that changes in the interest rate environment may have on net interest income. Rate sensitive assets and liabilities have interest rates that are subject to change within a specific time period, due to either maturity or to contractual agreements which allow the instruments to reprice prior to maturity. Interest rate sensitivity management seeks to ensure that both assets and liabilities react to changes in interest rates within a similar time period, thereby minimizing the risk to net interest income.
Interest Sensitivity Analysis
At December 31, 2012
(dollars in thousands, except ratios)
The measurement of the Bank’s interest rate sensitivity, or “gap,” is a technique traditionally used in asset/liability management. The interest sensitivity gap is the difference between repricing assets and repricing liabilities for a particular time period. The table, “Interest Sensitivity Analysis,” indicates a ratio of rate sensitive assets to rate sensitive liabilities within one year at December 31, 2012, to be 0.47. This ratio indicates that a larger balance of liabilities, compared to assets, could potentially reprice during the upcoming 12 month period. Included in rate sensitive liabilities are certain deposit accounts (Negotiable Order of Withdrawal (“NOW”), Money Market Investment (“MMI”), and savings) that are subject to immediate withdrawal and repricing. These balances are presented in the category that management believes best identifies their actual repricing patterns. The overall risk to net interest income is also influenced by the Bank’s level of variable rate loans. These are loans with a contractual interest rate tied to an interest rate index, such as the prime rate. A portion of these loans may reprice on multiple occasions during a one-year period due to changes in the underlying interest rate index. Approximately 45.0% of the total loan portfolio at December 31, 2012 had a variable interest rate and reprices in accordance with the underlying rate index subject to terms of individual note agreements.
The table, “Market Sensitive Financial Instruments Maturities,” presents the Bank’s financial instruments that are considered to be sensitive to changes in interest rates, categorized by contractual maturities, average interest rates and estimated fair values as of December 31, 2012.
Market Sensitive Financial Instruments Maturities
(dollars in thousands)
Market Sensitive Financial Instruments Maturities (continued)
(dollars in thousands)
Item 8.
Item 8. Financial Statements and Supplementary Data
QUARTERLY FINANCIAL INFORMATION - UNAUDITED
The following table sets forth, for the periods indicated, certain of the Company’s consolidated quarterly financial information. This information is derived from the Company’s unaudited financial statements, which include all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with the Company’s consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.
Quarterly Financial Data
(dollars in thousands, except per share data)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
NewBridge Bancorp
We have audited the accompanying consolidated balance sheets of NewBridge Bancorp (a North Carolina corporation) and subsidiary (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NewBridge Bancorp and subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Raleigh, North Carolina
March 25, 2013
NewBridge Bancorp and Subsidiary
Consolidated Balance Sheets
December 31, 2012 and 2011
(dollars in thousands, except per share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Income
Years ended December 31, 2012, 2011 and 2010
(dollars in thousands, except per share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Comprehensive Income
Years ended December 31, 2012, 2011 and 2010
(dollars in thousands, except per share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity
Years ended December 31, 2012, 2011 and 2010
(dollars in thousands, except share data)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Consolidated Statements of Cash Flows
Years ended December 31, 2012, 2011 and 2010
(dollars in thousands)
See notes to consolidated financial statements
NewBridge Bancorp and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2012, 2011, and
Note 1 - Summary of significant accounting policies
Principles of consolidation
The accompanying consolidated financial statements include the accounts of NewBridge Bancorp (“Bancorp” or the “Company”) and its wholly owned subsidiary NewBridge Bank (the “Bank”). All significant intercompany balances and transactions have been eliminated in consolidation.
Nature of operations
The Bank provides a variety of financial services to individual and corporate clients in North Carolina (“NC”). As of December 31, 2012, the Bank operated 30 branches in the Piedmont Triad Region and Coastal Region of NC. The majority of the Bank’s clients are located in Davidson, Rockingham, Guilford, Forsyth and New Hanover Counties. The Bank’s primary deposit products are noninterest-bearing checking accounts, interest-bearing checking accounts, money market accounts, certificates of deposit and individual retirement accounts. Its primary lending products are commercial, real estate and consumer loans.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses. A majority of the Bank’s loan portfolio consists of loans in the geographic areas cited above. The local economies of these areas depend heavily on the industrial, agricultural and service sectors. Accordingly, the ultimate collectability of a large portion of the Bank’s loan portfolio would be affected by changes in local economic conditions.
Cash and cash equivalents
Cash and cash equivalents include cash and due from banks and interest-bearing bank deposits. Cash and cash equivalents are defined as cash and short-term investments with maturities of three months or less at the time of acquisition.
Investment securities
The Bank classifies its investment securities at the time of purchase into three categories as follows:
-Held to Maturity - reported at amortized cost,
-Trading - reported at fair value with unrealized gains and losses included in earnings, or
-Available for Sale - reported at fair value with unrealized gains and losses reported in other comprehensive income.
The Bank is required to maintain certain levels of Federal Home Loan Bank (“FHLB”) of Atlanta stock based on various criteria established by the issuer. Gains and losses on sales of securities are recognized when realized on a specific identification basis. Premiums and discounts are amortized into interest income using methods that approximate the level yield method.
Other than temporary impairment of investment securities
The Company’s policy regarding other than temporary impairment of investment securities requires continuous monitoring. Individual investment securities with a fair market value that is materially less than its original cost over a continuous period of two quarters are evaluated for impairment during the subsequent quarter. The evaluation includes an assessment of both qualitative and quantitative measures to determine whether, in management’s judgment, the investment is likely to recover its original value. If the evaluation concludes that the investment is not likely to recover its original value, the unrealized loss is reported as an “other than temporary impairment,” and the loss is recorded as a securities transaction on the Consolidated Statement of Income.
Loans
Interest on loans is accrued and credited to income based on the principal amount outstanding. The accrual of interest on a loan is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Loans are placed on nonaccrual status when: (i) management has concerns relating to the ability to collect the loan principal and interest and (ii) generally when such loans are 90 days or more past due. Interest income is subsequently recognized on the cash basis only to the extent payments are received and only if the loan is well secured. Commercial loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) of interest and principal by the borrower in accordance with the contractual terms. Residential mortgage and consumer loans are typically returned to accrual status once they are no longer past due. Loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis.
Loan origination fees and costs
Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan.
Impaired loans
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Generally, a loan will be considered impaired if it exhibits the same level of underlying weakness and probability of loss as loans classified doubtful or loss.
The impairment evaluation compares the recorded book value of the loan, or loan relationship, to the present value of the expected cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, management may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is a collateral dependent loan.
Allowance for credit losses
The Bank’s allowance for credit losses is based on management’s best estimate of probable loan losses incurred as of the balance sheet date. Factors impacting estimated probable loan losses include credit quality trends, past loan loss experience, current economic conditions, and loan volume among loan categories.
While management uses the best available information to establish the allowance for credit losses, future additions to the allowance may be necessary based on the factors cited above. In addition, the allowance is reviewed by regulatory agencies as an integral part of their examination processes. Such agencies may require the Company to recognize changes to the allowance based on their judgments about information available to them at the times of their examinations.
Real estate acquired in settlement of loans
Real estate acquired in settlement of loans, through partial or total satisfaction of loans, is initially recorded at fair market value, less estimated costs to sell, which becomes the property’s new basis. At the date of acquisition, losses are charged to the allowance for credit losses. Expenses to maintain the property are charged to noninterest expense in the period they are incurred. Subsequent writedowns and gains or losses on sales of foreclosed properties are offset to noninterest income in the period they are incurred.
Premises and equipment
Premises and equipment are stated at cost (or at fair value for premises and equipment acquired in business combinations) less accumulated depreciation and amortization. The provision for depreciation and amortization is computed principally by the straight-line method over the estimated useful lives of the assets. Useful lives are estimated at 20 to 40 years for buildings and three to ten years for equipment. Leasehold improvements are amortized over the expected terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Expenditures for maintenance and repairs are charged to operations, and expenditures for major replacements and betterments are added to the premises and equipment accounts. The cost and accumulated depreciation of premises and equipment retired or sold are eliminated from the appropriate asset accounts at the time of retirement or sale and the resulting gain or loss is reflected in current operations.
Income taxes
Provisions for income taxes are based on taxes payable or refundable, for the current year (after exclusion of non-taxable income such as interest on state and municipal securities and bank-owned life insurance and non-deductible expenses) and deferred taxes on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation allowance is established against deferred tax assets when it is more likely than not that the assets will not be realized.
Per share data
Basic net income per share of common stock is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during each year. Diluted net income per share of common stock is computed by dividing net income available to common shareholders plus any adjustments to net income related to the issuance of dilutive potential common shares, comprised of convertible preferred stock, outstanding options and warrants to purchase shares of common stock and restricted stock grants, by the weighted average number of shares of common stock outstanding during each year plus the number of dilutive potential common shares.
Sales of loans
Gains and losses on the sales of loans are accounted for as the difference between the proceeds received and the carrying value of the loans. Such gains or losses are recognized in the financial statements at the time of the sale. Loans held for sale are recorded at the lower of cost or fair value, on an aggregate basis.
Off-balance sheet arrangements
In the ordinary course of business, the Bank enters into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded.
Accumulated other comprehensive income (loss)
The balances of accumulated other comprehensive income, net of tax, at December 31, 2012 are $8,898,000 of unrealized gains on available for sale securities and $(6,614,000) for funded status of pension plans. At December 31, 2011, the balances of accumulated other comprehensive income, net of tax, were $488,000 of unrealized gains on available for sale securities and $(6,259,000) for funded status of pension plans.
Segment information
Operating segments are components of an enterprise with separate financial information available for use by the chief operating decision maker to allocate resources and to assess performance. The Company has determined that it has one significant operating segment, providing financial services through the Bank, including banking, mortgage, and investment services, to customers located principally in Davidson, Rockingham, Guilford, Forsyth and New Hanover Counties in NC, and in the surrounding communities. The various products are those generally offered by community banks, and the allocation of resources is based on the overall performance of the Bank, rather than the individual branches or products.
There are no differences between the measurements used in reporting segment information and those used in the Company’s general-purpose financial statements.
Recent accounting pronouncements
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). This Update establishes common fair value measurement and disclosure requirements in GAAP and IFRS through changes in the description and disclosure of fair value measurements, clarification about the application of existing requirements, and changes to particular principles for measuring fair value or for disclosing information about those measurements. This guidance became effective during the first interim period beginning after December 15, 2011. The application of this Update did not have a material effect on our consolidated financial position or consolidated results of operations.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income. This Update requires companies to present the total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Presentation of comprehensive income in the statement of changes in shareholders’ equity is no longer acceptable. This Update does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income, the option for an entity to present components of other comprehensive income net or before related tax effects, or how earnings per share is calculated or presented. This Update became effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted the new disclosure requirements in its Quarterly Report on Form 10-Q for the period ended March 31, 2012.
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This Update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and requires the entity to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional detail about those amounts. This Update does not change the current requirements for reporting net income or other comprehensive income in the financial statements and will not have a material effect on our consolidated financial position or consolidated results of operations. For pubic companies, this Update applies to all reporting periods presented, including interim periods, and becomes effective prospectively for reporting periods beginning after December 15, 2012. The Company will adopt the new disclosure requirements in its Quarterly Report on Form 10-Q for the period ended March 31, 2013.
Reclassification
Certain items for 2011 and 2010 have been reclassified to conform to the 2012 presentation. Such reclassifications had no effect on net income, total assets or shareholders’ equity as previously reported.
Note 2 - Restriction on cash and due from banks
The Bank maintains required reserve balances with the Federal Reserve Bank of Richmond. The amounts of these reserve balances were $0 at December 31, 2012 and $25,000 at December 31, 2011.
Note 3 - Investment securities
Investment securities at December 31 consist of the following (in thousands):
All securities were classified as available for sale as of each date presented.
During 2012 and 2011, the Company’s investment strategy has focused on corporate bonds in order to take advantage of higher yield potential compared to other available investment alternatives and to supplement earning asset growth. All corporate bond investments are investment grade, as determined by S&P and Moody’s credit ratings.
The aggregate cost of the Company’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $7,685,000 at December 31, 2012. Because of the redemption provisions of this stock, the Company estimates that the fair value equals the cost of this investment and that it is not impaired.
The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2012 and 2011. There were 16 securities in an unrealized loss position at December 31, 2012, compared to 34 securities in an unrealized loss position at December 31, 2011. The unrealized losses relate to debt securities that have incurred fair value reductions due to higher market interest rates since the securities were purchased. The unrealized losses are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Since none of the unrealized losses are material relative to the specific securities and do not relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and the Company has the intent and ability to hold until recovery, none of the securities are deemed to be other than temporarily impaired.
Declines in the fair value of available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other than temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost.
As of December 31, 2012, management does not intend to sell any of the securities classified as available for sale in the table above which have unrealized losses and believes that it is not likely that we will have to sell any such securities before a recovery of cost given the Company’s current liquidity position. The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe such securities are other than temporarily impaired due to reasons of credit quality.
The amortized cost and estimated market value of debt securities at December 31, 2012, by contractual maturities, are shown in the accompanying schedule. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands).
A recap of the maturities of held to maturity securities follows (in thousands):
A recap of the maturities and sales of available for sale securities follows (in thousands):
During 2012, the Company sold $6,721,000 of investments for a gain of $3,000. During 2011, the Company sold $39,209,000 of investments for a gain of $2,026,000. The investments sold by the Company in 2011 consisted of shorter-duration, odd-lot mortgage backed securities and certain corporate bonds. Investment securities with a book value of $82,147,000 were sold during 2010, for a gain of $3,637,000, to reposition the investment portfolio and reduce the Company’s exposure to municipalities.
Investment securities with amortized costs of approximately $94,612,000 and $79,211,000 and market values of approximately $97,419,000 and $82,048,000 as of December 31, 2012 and 2011, respectively, were pledged to secure public deposits and for other purposes. The Bank has obtained $50,000,000 in letters of credit, which are used in lieu of securities to pledge against public deposits.
Note 4 - Loans
Loans are summarized as follows (in thousands):
As of December 31, 2012 and December 31, 2011, loans totaling approximately $478,002,000 and $506,449,000, respectively, were pledged to secure the lines of credit with the FHLB and Federal Reserve Bank.
Nonperforming assets are summarized as follows (in thousands):
(1) Loans restructured in a previous year without an interest rate concession or forgiveness of debt that are performing in accordance with their modified terms.
Nonperforming assets include nonaccrual loans, accruing loans contractually past due 90 days or more, restructured loans, and real estate acquired in settlement of loans.
Commitments to lend additional funds to borrowers whose loans have been restructured are not material at December 31, 2012 or 2011.
The aging of loans is summarized in the following table (in thousands):
Loans specifically identified and individually evaluated for impairment totaled $16.4 million and $32.6 million at December 31, 2012 and December 31, 2011, respectively. Included in these balances were $7.2 million and $20.0 million, respectively, of loans classified as troubled debt restructurings (“TDRs”). A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. For loans classified as TDRs, the Company further evaluates the loans as performing or nonperforming. Nonperforming TDRs originally classified as nonaccrual are able to be reclassified as accruing if, subsequent to restructure, they experience six consecutive months of payment performance according to the restructured terms.
Modifications of terms for loans and their inclusion as TDRs are based on individual facts and circumstances. Loan modifications that are included as TDRs may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral or forgiveness of principal payments, regardless of the period of the modification. The loans included in all loan classes as TDRs at December 31, 2012 had either an interest rate modification or a deferral of one or more principal payments, which the Company considers are concessions. All loans designated as TDRs were modified due to financial difficulties experienced by the borrower. At December 31, 2012, the Company had $1,220,000 of TDRs which were restructured in a previous year without an interest rate concession or forgiveness of debt and are performing in accordance with their modified terms and are therefore excluded from nonperforming status.
The Company monitors the performance of modified loans on an ongoing basis. Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual, and if a loan is on accrual at the time of the modification, it generally stays on accrual. A modified loan will be reclassified to nonaccrual if the loan becomes 90 days delinquent or other weaknesses are observed which make collection of principal and interest unlikely. A loan on nonaccrual may be reclassified to accrual status following an evaluation and having experienced at least six consecutive months of payment performance in accordance with the restructured terms. All TDRs are considered impaired.
The total number of loans that are TDRs and the total outstanding recorded investment in TDRs as of December 31 for the three years 2012, 2011, and 2010 are reflected in the table below (dollars in thousands):
The following table provides information about TDRs identified during the current period (in thousands, except number of contracts):
A TDR is considered to be in default if it is 90 days or more past due at the end of any month during the reporting period.
The following table provides information about TDRs restructured in the previous twelve months that subsequently defaulted during the stated periods (in thousands, except number of contracts):
Interest is not typically accrued on impaired loans, as they are normally in nonaccrual status. However, interest is accrued on performing TDRs, and interest may be accrued in certain circumstances on nonperforming TDRs, such as those that have an interest rate concession but are otherwise performing. Interest income on performing or nonperforming accruing TDRs is recognized consistent with any other accruing loan. When a loan goes into nonaccrual status, any accrued interest is reversed out of interest income. If a nonaccrual loan is later returned to accruing status, future interest income is recognized on a method that approximates the effective yield to maturity based on the recorded amount of the loan. There are $3.8 million in TDRs at December 31, 2012 that are considered impaired and are accruing. The following table shows interest income recognized and received on these TDRs for the twelve months ended December 31, 2012 (in thousands):
The Bank’s policy for impaired loan accounting subjects all loans to impairment recognition except for large groups of smaller balance homogeneous loans such as credit card, residential mortgage and consumer loans. The Bank generally considers loans 90 days or more past due and all nonaccrual loans to be impaired.
Impaired loans individually evaluated for impairment and related information are summarized in the following tables (in thousands):
Impaired, nonperforming and other classified loans are summarized in the following table (in thousands):
The balance in the allowance for credit losses and the recorded investment in loans by portfolio segment and based on the reserving method for the years ended December 31, 2012 and 2011 were as follows:
The Bank’s policy for calculating and assigning specific reserves is applicable to all loans except for groups of smaller balance homogeneous loans such as credit card, residential mortgage and consumer loans in which impairment is collectively evaluated. The Bank generally considers loans 90 days or more past due and all nonaccrual loans to be impaired.
Management follows a loan review program designed to evaluate the credit risk in its loan portfolio. Sample selection is a combination of random selection and targeted selection based on total credit exposure and identified risk factors. The Internal Loan Review Department consists of qualified personnel knowledgeable in lending practices, bank policies and procedures and relevant laws and regulations. Internal Loan Review along with lending personnel utilize a system of nine risk grades in assessing and identifying the risk in the loan portfolio. The nine risk grades are exceptional risk, standard risk, high special risk, special risk, pre-watch, special mention, substandard, doubtful, and loss. Through this loan review process, the Bank maintains an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for credit losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as pass, special mention, substandard, or doubtful as described below, and reserves are allocated based on management’s judgment and historical experience. The Management Credit Committee, consisting of the Chief Credit Officer, Chief Commercial Credit Officer, Senior Credit Officers, and the Loan Review Manager perform a monthly high level review of new and renewed production. An external loan review is conducted by a third party vendor in a series of three reviews annually.
Pass - These loans are loans that have been assigned to one of the first five risk grades: exceptional risk, standard risk, high special risk, special risk, or pre-watch.
Special Mention - These loans have potential weaknesses, which may, if not corrected or reversed, weaken the bank's credit position at some future date. The loans may not show problems as yet due to the borrower(s)’ apparent ability to service the debt, but special circumstances surround the loans of which the bank and management should be aware. This category may also include loans where repayment has not been satisfactory, where constant attention is required to maintain a set repayment schedule, or where terms of a loan agreement have been violated but the borrower still appears to have sufficient financial strength to avoid a lower rating. It also includes new loans that significantly depart from established loan policy and loans to weak borrowers with a strong guarantor.
Substandard - These are loans whose full final collectability may not appear to be a matter for serious doubt, but which nevertheless have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and require close supervision by management, such as unprofitable and/or undercapitalized businesses, inability to generate sufficient cash flow for debt reduction, deterioration of collateral and special problems arising from the particular condition of an industry. It also includes workout loans on a liquidation basis when a loss is not expected.
Doubtful - These are loans that have all the weakness inherent in one graded substandard with the added provision that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and value, highly questionable. In addition, the extent of the potential loss may not be currently determinable. Most of these loans are considered impaired.
The following table summarizes, by internally assigned risk grade, the risk grade for loans for which the Bank has assigned a risk grade (in thousands):
Loans with a risk grade of substandard or doubtful are components of classified loans. Additionally, non risk graded residential, home equity, and consumer loans in nonaccrual status of $4,605,000 and $9,851,000 as of December 31, 2012 and December 31, 2011, respectively, are components of classified loans.
The process of determining the allowance for credit losses is driven by the risk grade system and the loss experience on non risk graded homogeneous types of loans. The Bank’s allowance for credit losses is calculated and determined, at a minimum, each fiscal quarter end. The allowance for credit losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio. In determining the allowance for credit losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in the Bank’s market areas. For loans determined to be impaired, the impairment is based on discounted expected cash flows using the loan’s initial effective interest rate or the fair value of the collateral (less selling costs) for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to recognize changes to the allowance based on their judgments about information available to them at the time of their examinations. Loans are charged off when in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance. The Credit Management Committee of the Board of Directors has responsibility for oversight.
Management believes the allowance for credit losses of $26.6 million at December 31, 2012 is adequate to cover probable inherent losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus, there can be no assurance that credit losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting future operating results of the Bank.
Performing classified loans are loans graded substandard, doubtful and loss with total credit exposure of less than $500,000 and not evaluated on an individual basis for impairment. However, the Bank closely monitors such loans as a result of their elevated risk profile. The balance of these performing classified loans decreased to $26.5 million at December 31, 2012 from $88.0 million at December 31, 2011. These loans, while exhibiting signs of weakness, continue to perform pursuant to stated terms and conditions and therefore do not have specifically identified expected losses. Approximately 75% of the loans in this category are identified as commercial and industrial or income producing commercial real estate, which management assigns a lower probability of default and/or loss given default. The allowance for credit losses associated with such loans was $2.2 million at December 31, 2012, which was based on a model that uses probability of default, and expected loss in the event of default, to determine expected losses within a given group of loans. This model incorporates 20 quarters of historical loss data into the calculation of the allowance. In the event that adequate historical loss data is not available for a particular risk grade, relevant industry data will be used to determine an appropriate reserve allowance.
An analysis of the changes in the allowance for credit losses follows (in thousands):
Note 5 - Premises and equipment
The following is a summary of premises and equipment (in thousands):
Depreciation and amortization expense amounting to $2,796,000, $3,044,000 and $3,792,000, for the years ended December 31, 2012, 2011, and 2010, respectively, is included in occupancy expense and furniture and equipment expense in the consolidated statements of income.
Note 6 - Deposits
The aggregate amount of certificates of deposit of $100,000 or more was approximately $172,675,000 and $169,768,000 at December 31, 2012 and 2011, respectively. The accompanying table presents the scheduled maturities of total time deposits at December 31, 2012 (in thousands).
Note 7 - Short-term borrowings and long-term debt
The following is a schedule of short-term borrowings and long-term debt (in thousands, except percentages):
At December 31, 2012, the Bank had a $342,520,000 line of credit with the FHLB under which $163,000,000 was used. The amounts used consist of $113,000,000 in regular FHLB advances and a $50,000,000 letter of credit which the Bank uses as collateral securing deposits from municipalities. This line of credit is secured with FHLB stock, investment securities, qualifying residential one to four family first mortgage loans, qualifying multi-family first mortgage loans, qualifying commercial real estate loans, and qualifying home equity lines of credit and second mortgage loans. Based upon collateral pledged, as of December 31, 2012, the borrowing capacity under this line was $258,345,000, with $95,345,000 million available to be borrowed. In addition to the credit line at the FHLB, the Bank has borrowing capacity at the Federal Reserve Bank totaling $7,748,000, and has federal funds lines of $25,000,000, of which there were no borrowings outstanding at December 31, 2012.
Federal funds purchased represent unsecured overnight borrowings from other financial institutions by the Bank. Retail repurchase agreements represent short-term borrowings by the Bank, with overnight maturities collateralized by securities issued by the United States Government or its agencies.
The Bank sold securities under an agreement to repurchase (a “wholesale repurchase agreement”) in 2006. This $21,000,000 transaction has a maturity date in 2016, became callable after one year, and has quarterly calls thereafter at a fixed rate of 4.03%. The investment securities serving as collateral for this borrowing had a market value of approximately $26,572,000 at December 31, 2012. In 2007, the Bank entered into a $15,000,000 wholesale repurchase agreement, which was repaid in June, 2011.
FNB Financial Services Capital Trust I, a Delaware statutory trust (the “Trust,” wholly owned by the Company), issued and sold in a private placement, on August 26, 2005, $25,000,000 of the Trust’s floating rate preferred securities, with a liquidation amount of $1,000 per preferred security, bearing a variable rate of interest per annum, reset quarterly, equal to 3 month LIBOR plus 1.46% (the “Preferred Securities”) and a maturity date of September 30, 2035. The Preferred Securities became callable after five years. Interest payment dates are March 30, June 30, September 30 and December 31 of each year. The Preferred Securities are fully and unconditionally guaranteed on a subordinated basis by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. The entire proceeds from the sale by the Trust to the holders of the Preferred Securities was combined with the entire proceeds from the sale by the Trust to the Company of its common securities (the “Common Securities”), and was used by the Trust to purchase $25,774,000 in principal amount of the Floating Rate Junior Subordinated Notes (the “Junior Subordinated Notes”) of the Company. The Company has not included the Trust in the consolidated financial statements. Currently, regulatory capital rules allow trust preferred securities to be included as a component of regulatory capital for the Company.
The maturities of short-term borrowings and long-term debt at December 31, 2012, is as follows (in thousands):
Note 8 - Other assets and other liabilities
The components of other assets and liabilities at December 31 are as follows (in thousands):
Note 9 - Income taxes
The components of income tax expense (benefit) for the years ended December 31 are as follows (in thousands):
During the third quarter 2012, the Company recorded material writedowns and losses on the disposition or resolution of problem assets, which resulted in a material pre-tax net loss for the year. The Company is in a cumulative pre-tax loss position for the three year period ended December 31, 2012, which constitutes significant negative evidence in the context of evaluating deferred tax assets for realizability as prescribed by ASC Topic 740.
ASC Topic 740 requires that the realizability of the deferred tax asset and evaluation of the need for a valuation allowance consider all positive and negative evidence to form a conclusion as to whether the realization of the deferred tax asset is more likely than not. The Company must also assign weight to the various forms of evidence, based upon the ability to verify the evidence.
Management has evaluated the realizability of the recorded deferred tax assets at December 31, 2012. This evaluation included a review of all available evidence, including recent historical financial performance and expected near-term levels in net interest margin, nonperforming assets, operating expenses, earnings and other factors. It also included a current forecast of performance for 2013 as well as projections for several years based on management’s expectations of performance. It further included the consideration of the items that have given rise to the deferred tax assets, as well as tax planning strategies. Management has concluded that, in addition to a $1.1 million portion of contribution carryforwards which begin expiring in 2013, and a portion of state economic loss carryforwards, an additional $10.0 million valuation allowance is necessary. Management also concluded that the utilization of the remaining deferred tax asset was more likely than not.
The significant components of deferred tax assets at December 31 are as follows (in thousands):
Federal net operating loss carryforwards of $2,325,000, $27,601,000, $13,129,000 and $30,483,000 expire in 2028, 2029, 2030 and 2032 respectively. State net economic loss carryforwards of $997,000, $10,081,000, $21,420,000, $9,985,000, $2,628,000 and $27,742,000 expire in 2022 through 2027, respectively.
The provision for income taxes differs from that computed by applying the federal statutory rate of 35% as indicated in the following analysis (in thousands, except percentages):
The Company’s federal and state income tax returns through 2009 have been examined and settled. The Company does not have any material uncertain tax positions.
Note 10 - Commitments and contingent liabilities
The minimum annual lease commitments under noncancelable operating leases in effect at December 31, 2012, are as follows (in thousands):
Payments for all operating leases amounted to approximately $1,708,000, $1,676,000 and $1,863,000 for the years ended December 31, 2012, 2011, and 2010, respectively.
The Company’s consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities are commitments to extend credit and standby letters of credit. A summary of the contractual amounts of the Bank’s exposure to off-balance sheet risk at December 31 is as follows (in thousands):
The Bank’s exposure to credit loss in the event of nonperformance by the counter party is equal to the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Note 11 - Related party transactions
The Bank had loans outstanding to officers and directors and their affiliated entities during each of the past two years. Such loans were made substantially on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers, and, at the time that they were made, did not involve more than the normal risks of collectibility. The following table summarizes the transactions for the past two years (in thousands):
Note 12 - Other operating expenses
The components of other operating expense for the years ended December 31, 2012, 2011 and 2010 are as follows (in thousands):
Note 13 - Stock-based compensation
The Company recorded $159,000 of total stock-based compensation expense during 2012, compared to $142,000 in 2011 and $79,000 in 2010, or $0.01 or less per diluted share in each year. The stock-based compensation expense is calculated on a ratable basis over the vesting periods of the related stock options or restricted stock units. This expense had no impact on the Company’s reported cash flows. The stock-based compensation expense is reported under personnel expense in the consolidated statements of income.
To determine the amounts recorded in the financial statements, the fair value of each stock option is estimated on the date of the grant using the Black-Scholes option-pricing model. For restricted stock units, the fair value is considered to be the market price on the date the restricted stock unit is granted.
As of December 31, 2012, there was $595,000 of total unrecognized compensation expense related to stock options and restricted stock units. This expense will be fully amortized by December 31, 2015.
As of December 31, 2012, 229,420 restricted stock units granted to certain senior officers were outstanding. For 121,616 of these restricted stock units, the fair value of each of the restricted stock units is $3.89; for 9,710 of these restricted stock units, the fair value of each of the restricted stock units is $4.10; for 88,094 of these restricted stock units, the fair value of each of the restricted stock units is $5.15; and for 10,000 of these restricted stock units, the fair value of each of the restricted stock units is $2.18, which was the closing price of the Company’s common stock on the dates they were granted.
As of December 31, 2012, the Company’s Compensation Committee administered the Company’s five stock-based compensation plans, each of which was approved by the shareholders.
Three of these plans have expired, and while there are options outstanding that have not yet expired, no new awards may be granted thereunder. One of the active plans, which will expire in 2014, has 750,000 shares of common stock authorized for issuance to plan participants in the form of stock options, restricted stock, restricted stock units, performance units and other stock-based awards. The other active plan, which will expire in 2016, has 535,000 shares of common stock authorized for issuance to plan participants in the form of stock options, rights to receive restricted shares of common stock and/or performance units. At December 31, 2012, a total of 961,480 shares were available for future grants under these two plans.
The following is a summary of stock option activity and related information for the years ended December 31:
The following is a summary of information on outstanding and exercisable stock options at December 31, 2012:
The following is a summary of restricted stock unit activity and related information for the years ended December 31:
Note 14 - Net income (loss) per share
The following is a reconciliation of the numerator and denominator of basic and diluted net income (loss) per share of common stock (in thousands, except share data):
The calculation of diluted net income (loss) per share for 2012 excludes the effect of normally dilutive restricted stock units of 41,116, warrant of 759,749, and mandatorily convertible preferred stock of 1,101,191 as these were antidilutive as a result of the Company’s net loss for 2012. On December 31, 2012, there were 529,825 options that were antidilutive since the exercise price exceeded the average market price for the year.
For the year ended December 31, 2011, there were 658,465 options that were antidilutive since the exercise price exceeded the average market price for the year, and there were dilutive restricted stock units of 98,094 and warrant of 819,102. For the year ended December 31, 2010, there were 821,767 options that were antidilutive since the exercise price exceeded the average market price for the year, and there were dilutive restricted stock units of 10,000 restricted and warrant of 431,812. For both 2011 and 2010, the effect of the dilutive restricted stock units and warrant are reflected in the table above.
See Note 19 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K for a description of the warrant.
Note 15 - Parent company only
The Company’s principal asset is its investment in its subsidiary, the Bank. The Company’s principal source of income is dividends and management fees received from the Bank. The following presents condensed financial information of the Company:
Income derived from management and service fees from subsidiary reported in 2011 includes $1,154,000 for prior years.
Note 16 - Employee benefit plans
The Company has three curtailed defined benefit retirement plans:
·A pension plan;
·A supplemental executive retirement plan (“SERP”) covering certain executive and former executive officers; and
·A retiree health benefit plan, which provides partial health insurance benefits for certain early retired employees.
The disclosures presented represent combined information for all of the employee benefit plans. The retiree health benefit plan is not a material part of the aggregate information.
The pension plan, the retiree health benefit plan and the SERP provide for benefits to be paid to eligible employees at retirement based primarily upon years of service with the Company and a percentage of qualifying compensation during the employee’s final years of employment. Contributions to the pension plan are based upon the projected unit credited actuarial funding method and comply with the funding requirements of the Employee Retirement Income Security Act. Contributions prior to the curtailments were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Plan assets consist primarily of cash and cash equivalents, U.S. government securities, and other securities. The following tables outline the changes in these pension obligations, assets and funded status for the years ended December 31, 2012 and 2011, and the assumptions and components of net periodic pension cost for the two and three years in the period ended December 31, 2012 (dollars in thousands):
Target asset allocations are established based on periodic evaluations of risk/reward under various economic scenarios and with varying asset class allocations. The near-term and long-term impact on obligations and asset values are projected and evaluated for funding and financial accounting implications. Actual allocation and investment performance is reviewed quarterly. The current target allocation ranges, along with the actual allocation as of December 31, 2012, are included in the accompanying table.
The fair value of the Company’s pension plan assets at December 31, 2012 and 2011 by asset category are reflected in the following table. The fair value hierarchy descriptions used to measure these plan assets are identified in Note 18 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
The assumed expected return on assets considers the current level of expected returns on risk-free investments (primarily government bonds), the historical level of risk premium associated with the other asset classes in the portfolio and the expectation for future returns of each asset class. The expected return of each asset class is weighted based on the target allocation to develop the expected long-term rate of return on assets. This resulted in the selection of the 8.25% rate used in 2010, 2011, 2012 and to be used for 2013. The required contributions for 2012 were approximately $1,087,000, and the required contributions for 2013 are expected to be approximately $1,031,000. The expected benefit payments for the next ten years are as follows: (1) 2013 - $1,556,000, (2) 2014 - $1,553,000, (3) 2015 - $1,571,000, (4) 2016 - $1,622,000, (5) 2017 - $1,783,000, and (6) 2018 through 2022 - $9,392,000.
The Company also has a separate contributory 401(k) savings plan covering substantially all employees. The 401(k) savings plan allows eligible employees to contribute up to a fixed percentage of their compensation, with the Bank matching a portion of each employee’s contribution. The Bank’s contributions were $751,000 for 2012, $756,000 for 2011 and $792,000 for 2010. The 401(k) savings plan contribution expense is reported under personnel expense in the consolidated statements of income.
A deferred compensation plan allows the directors of the Company to defer compensation. Each plan participant makes an annual election to either receive that year’s compensation or to defer receipt until his or her death, disability or retirement. The deferred compensation balances of this plan are maintained in a rabbi trust. The balances in the trust at December 31, 2012 and 2011 were $4,748,000 and $4,051,000, respectively. In addition, the Company has an inactive Director Deferred Compensation Plan that acquired shares of the Company’s common stock in the open market. These shares are held in a trust at cost, as a component of shareholders’ equity, until distributed.
Note 17 - Regulatory matters
The primary source of funds for dividends that may be paid by the Company to its shareholders is dividends received from the Bank plus cash on hand of $53.9 million as of December 31, 2012. Dividends paid by the Company and the Bank may be limited by minimum capital requirements imposed by banking regulators. At December 31, 2012, the Bank was restricted from paying dividends to the Company unless it received advance approval from the FDIC and the North Carolina Commissioner of Banks (the “Commissioner”). This restriction was removed in February of 2013.
The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that as of December 31, 2012, both the Company and the Bank met all capital adequacy requirements to which they are subject.
The most recent notification from the FDIC categorized the Bank as “well capitalized” under the Regulatory Framework for Prompt Corrective Action. There are no conditions or events since that notification that management believes have changed the Bank’s category. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the accompanying table (dollars in thousands).
Banking regulations restrict the amount of deferred income tax assets that may be recognized for purposes of calculating regulatory capital ratios. At December 31, 2012, $13.0 million of the Company’s deferred income tax assets were deducted from regulatory capital. This amount, which is principally comprised of the future tax benefit associated with net operating loss carry-forwards, when fully utilized would add 0.81% to the total risk-based capital ratio.
Note 18 - Fair value of financial instruments
The following methods and assumptions were used to estimate the fair value for each class of the Company’s financial instruments.
Cash and cash equivalents. The carrying amounts for cash and due from banks approximate fair value because of the short maturities of those instruments.
Investment securities. The fair value of investment securities is based on quoted prices in active markets for identical assets, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities, corresponding to the “significant other observable inputs” definition of GAAP. The fair value of equity investments in the restricted stock of the FHLB equals the carrying value based on the redemption provisions.
Loans.	The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value.
Deposits. The fair value of noninterest-bearing demand deposits and NOW, savings, and money market deposits are the amounts payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.
Federal funds purchased and retail repurchase agreements. The carrying value of federal funds purchased and retail repurchase agreements are considered to be a reasonable estimate of fair value.
Wholesale repurchase agreements and other borrowings. The fair values of these liabilities are estimated using the discounted values of the contractual cash flows. The discount rate is estimated using the rates currently in effect for similar borrowings.
Accrued interest. The carrying amounts of accrued interest approximate fair value.
Financial instruments with off-balance sheet risk. The carrying value of financial instruments with off-balance sheet risk is considered to approximate fair value, since a large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value. The various financial instruments are disclosed in Note 10 in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Impaired loans. The fair value of impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral, less selling and other handling costs, for certain collateral dependent loans less specific reserves.
The estimated fair values of financial instruments for the years ending December 31 (in thousands):
The fair value estimates are made at a specific point in time based on relevant market and other information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
The table below presents the assets measured at fair value on a recurring basis categorized by the level of inputs used in the valuation of each asset (in thousands):
The table below presents the reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (level 3) during 2012 and 2011 (in thousands):
The table below presents the assets measured at fair value on a nonrecurring basis categorized by the level of inputs used in the valuation of each asset (in thousands):
The fair value of loans secured by real estate is determined by appraisals or by alternative evaluations, such as tax evaluations. The fair value of loans not secured by real estate is based on the present value of expected future cash flows. The fair value of loans may also be determined by sales contracts in hand or settlement agreements.
Note 19 - Capital Transactions
On November 1, 2012, the Company entered into securities purchase agreements with select investors. On November 30, 2012, the capital raise was executed through a private placement of two series of mandatorily convertible preferred stock for an aggregate of $56.3 million. Expenses incurred in the offering of $4.1 million were deducted from paid-in capital. At the Special Meeting of Shareholders on February 20, 2013, shareholders approved the conversion of up to 422,456 shares of Series B Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock (the “Series B Preferred Stock”) and up to 140,217 shares of Series C Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock (the “Series C Preferred Stock) into 9,601,273 shares of voting Class A Common Stock and 3,186,750 shares of nonvoting Class B Common Stock, respectively, at a purchase price of $4.40 per share.
Pursuant to the Capital Purchase Program (the “CPP”), on December 12, 2008, the Company issued and sold to the U.S. Department of the Treasury (the “U.S. Treasury”) (i) 52,372 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 2,567,255 shares of common stock at an exercise price of $3.06 per share for an aggregate purchase price of $52,372,000 in cash. The Warrant may be exercised by the U.S. Treasury at any time before it expires on December 12, 2018. Subject to the approval of the federal banking regulators, the Series A Preferred Stock may be redeemed in whole or in part, at any time and from time to time. Once an institution notifies the U.S. Treasury that it would like to repay its investment, the U.S. Treasury must permit repayment subject to consultation with the federal banking regulators. All such redemptions will be at 100% of the issue price, plus any accrued and unpaid dividends. The fair value of the Warrant of $1,497,000 was estimated on the date of the grant using the Black-Scholes option-pricing model. The holders of the Series A Preferred Stock are entitled to receive cumulative dividends of 5 percent for the first five years and 9 percent thereafter.
Note 20 - Sale of Virginia operations
On May 20, 2011, the Bank sold its Harrisonburg, Virginia operations, which included deposits of approximately $48.8 million and loans of approximately $73.0 million at book value. The Bank also sold its branch in Harrisonburg, as well as a parcel of land located in Waynesboro, Virginia. An impairment charge of $339,000 was recorded during the fourth quarter of 2010 for the expected loss on the sale of the real property. A gain of $90,000 was recorded on the sale of the real property when the sale closed in the second quarter of 2011.
Note 21 - Subsequent Events
At the Special Meeting of Shareholders on February 20, 2013, shareholders approved the conversion of up to 422,456 shares of Series B Preferred Stock and up to 140,217 shares of Series C Preferred Stock into Class A Common Stock and Class B Common Stock, respectively, at a conversion rate of $4.40 per share. Articles of Amendment filed with the North Carolina Secretary of State on February 21, 2013, created a new class of nonvoting common stock designated “Class B Common Stock,” and redesignated the Company’s existing common stock as “Class A Common Stock.” The Class A Common Stock and the Class B Common Stock each have no par value per share. As a result, on February 22, 2013, the Series B Preferred Stock was converted into 9,601,262 shares of voting Class A Common Stock, and the Series C Preferred Stock was converted into 3,186,748 shares of nonvoting Class B Common Stock.
Item 9.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s management, including its CEO, CFO, and Chief Accounting Officer (“CAO”), evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2012. Based upon that evaluation, the Company’s CEO, CFO and CAO each concluded that as of December 31, 2012, the end of the period covered by this Annual Report on Form 10-K, the Company effectively maintained disclosure controls and procedures.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s CEO, CFO and CAO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Management has made a comprehensive review, evaluation and assessment of the Company’s internal control over financial reporting as of December 31, 2012. In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control -Integrated Framework. Based on this assessment, management believes that, as of December 31, 2012, the Company’s internal control over financial reporting is effective. In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, management makes the following assertions:
•
Management has implemented a process to monitor and assess both the design and operating effectiveness of internal control over financial reporting.
•
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
Management of the Company has evaluated, with the participation of the Company’s CEO, CFO, and CAO, changes in the Company’s internal control over financial reporting during the fourth quarter of 2012. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the fourth quarter that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B.Other Information
Effective January 23, 2013, the Company's non-qualified deferred compensation plan was amended to permit the immediate participation in the plan by a director who is appointed to fill a Board vacancy until the next duly called election of directors by the Company’s shareholders. In general, the plan requires a newly elected director to wait until the January 1 coincident with or immediately following his or her election as a director. A copy of the Third Amendment to the NewBridge Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management is attached hereto as Exhibit 10.38 and incorporated herein by reference.
PART III
Item10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
(a) Directors and Executive Officers - The information required by this Item regarding directors, nominees and executive officers of the Company is set forth in the Proxy Statement under the sections captioned “Proposal 1 - Election of Directors,” “Executive Officers of the Company,” and “Board Committees - Audit Committee,” which sections are incorporated herein by reference.
(b) Section 16(a) Compliance - The information required by this Item regarding compliance with Section 16(a) of the Exchange Act is set forth in the Proxy Statement under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance,” which section is incorporated herein by reference.
(c) Audit Committee - The information required by this Item regarding the Company’s Audit Committee, including the Audit Committee Financial Expert, is set forth in the Company’s Proxy Statement under the sections captioned “Board Committees - Audit Committee” and “Board Committees - Audit Committee Report,” which sections are incorporated herein by reference.
(d) Code of Ethics - The information required by this Item regarding the Company’s code of ethics is set forth in the Proxy Statement under the section captioned “Code of Business Conduct and Ethics,” which section is incorporated herein by reference.
Item 11.
Item 11.EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Proxy Statement under the sections captioned “Compensation Discussion and Analysis,” “Grants of Plan-Based Awards,” “Outstanding Equity Awards at Fiscal Year-End,” “Option Exercises and Stock Vested,” “ Pension Benefits,” “Non-qualified Deferred Compensation,” “Potential Payments Upon Termination or Change in Control,” “Director Compensation,” “Directors’ Fees and Practices,” “Board Committees - Compensation Committee Interlocks and Insider Participation” and “Board Committees - Compensation Committee Report,” which sections are incorporated herein by reference.
Item 12.
Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is set forth in the Proxy Statement under the sections captioned “Security Ownership of Certain Beneficial Owners” and “How Much Common Stock do our Directors and Executive Officers Own?” and in Item 5 of this Annual Report on Form 10-K, which sections and Item are incorporated herein by reference.
Item 13.
Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is set forth in the Proxy Statement under the sections captioned “Proposal 1 - Election of Directors,” “Certain Relationships and Related Transactions,” “Board Committees,” “Board Committees - Compensation Committee Interlocks and Insider Participation,” and “Board Committees - Related Party Matters,” which sections are incorporated herein by reference.
Item 14.
Item 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is set forth in the Proxy Statement under the section captioned “Audit Fees Paid to Independent Auditor,” which section is incorporated herein by reference.
PART IV
Item 15.
Item 15.Exhibits and Financial Statement Schedules
(a)(1)	Financial Statements. The following financial statements and supplementary data are included in Item 8 of this report.
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to Consolidated Financial Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below.
(b) The exhibits to the Form 10-K begin on 98 of this Report.
(c) See 15(a)(2) above.
Exhibit Index
Exhibit No.
Description
3.1
Articles of Incorporation, and amendments thereto, incorporated by reference to Exhibit 4.1 of the Registration Statement on Form S-8, filed with the SEC on May 16, 2001 (SEC File No. 333-61046).
3.2
Articles of Merger of FNB with and into LSB, including amendments to the Articles of Incorporation, as amended, incorporated by reference to Exhibit 3.4 of the Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, filed with the SEC on November 9, 2007 (SEC File No. 000-11448).
3.3
Amended and Restated Bylaws adopted by the Board of Directors on August 17, 2004 and amended on July 23, 2008 (with identified Bylaw approved by the shareholders) incorporated by reference to Exhibit 3.3 of the Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, filed with the SEC on May 8, 2009 (SEC File No. 000-11448).
3.4
Articles of Amendment, filed with the North Carolina Department of the Secretary of State on December 12, 2008, incorporated herein by reference to Exhibit 4.1 of the Current Report on Form 8-K filed with the SEC on December 12, 2008 (SEC File No. 000-11448).
3.5
Articles of Amendment to Designate the Terms of the Series B Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock and Series C Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock, incorporated herein by reference to Exhibit 3.1 of the Current Report on Form 8-K filed with the SEC on November 30, 2012 (SEC File No. 000-11448).
3.6
Articles of Amendment, incorporated herein by reference to Exhibit 3.1 of the Current Report on Form 8-K filed with the SEC on February 21, 2013 (SEC File No. 000-11448).
4.1
Amended and Restated Trust Agreement, regarding Trust Preferred Securities, dated August 23, 2005, incorporated herein by reference to Exhibit 4.02 of the Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed with the SEC (SEC File No. 000-13086).
4.2
Guarantee Agreement, regarding Trust Preferred Securities, dated August 23, 2005, incorporated herein by reference to Exhibit 4.03 of the Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed with the SEC (SEC File No. 000-13086).
4.3
Indenture, regarding Trust Preferred Securities, dated August 23, 2005, incorporated herein by reference to Exhibit 4.04 of the Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed with the SEC (SEC File No. 000-13086).
4.4
Form of Certificate for the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, incorporated herein by reference to Exhibit 4.2 of the Current Report on Form 8-K filed with the SEC on December 12, 2008 (SEC File No. 000-11448).
4.5
Warrant for Purchase of Shares of Common Stock issued by Bancorp to the United States Department of the Treasury on December 12, 2008, incorporated herein by reference to Exhibit 4.3 of the Current Report on Form 8-K filed with the SEC on December 12, 2008 (SEC File No. 000-11448).
4.6
Certificate of Designation for the Series B Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock, and Series C Mandatorily Convertible Adjustable Rate Cumulative Perpetual Preferred Stock, incorporated herein by reference to Exhibit 4.1 of the Current Report on Form 8-K filed with the SEC on November 30, 2012 (SEC File No. 000-11448).
4.7
Certificate of Designation for the Class B Common Stock, incorporated herein by reference to Exhibit 4.1 of the Current Report on Form 8-K filed with the SEC on February 21, 2013 (SEC File No. 000-11448).
4.8
Specimen certificate of Class A Common Stock, no par value.
10.1
Benefit Equivalency Plan of FNB Southeast, effective January 1, 1994, incorporated herein by reference to Exhibit 10 of the Quarterly Report on Form 10-QSB for the fiscal quarter ended June 30, 1995, filed with the SEC (SEC File No. 000-13086).*
10.2
1994 Director Stock Option Plan, incorporated herein by reference to Exhibit 4 of the Registration Statement on Form S-8 filed with the SEC on July 15, 1994 (SEC File No. 33-81664).*
10.3
1996 Omnibus Stock Incentive Plan, incorporated herein by reference to Exhibit 10.2 of the Annual Report on Form 10-K for the year ended December 31, 1995, filed with the SEC on March 28, 1996 (SEC File No. 000-11448).*
10.4
Omnibus Equity Compensation Plan, incorporated herein by reference to Exhibit 10(B) of the Annual Report on Form 10-KSB40 for the fiscal year ended December 31, 1996, filed with the SEC on March 31, 1997 (SEC File No. 000-13086).*
10.5
Amendment to Benefit Equivalency Plan of FNB Southeast, effective January 1, 1998, incorporated herein by reference to Exhibit 10.16 of the Annual Report on Form 10-K for the fiscal year ended December 31, 1998, filed with the SEC on March 25, 1999 (SEC File No. 000-13086).*
10.6
Amendment Number 1 to 1996 Omnibus Stock Incentive Plan, incorporated herein by reference to Exhibit 4.5 of the Registration Statement on Form S-8, filed with the SEC on May 16, 2001 (SEC File No. 333-61046).*
10.7
Long Term Stock Incentive Plan for certain senior management employees of FNB Southeast, incorporated herein by reference to Exhibit 10.10 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2002, filed with the SEC on March 27, 2003 (SEC File No. 000-13086).*
10.8
Form of Stock Option Award Agreement for a Director adopted under LSB Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC on December 23, 2004 (SEC File No. 000-11448).*
10.9
Form of Incentive Stock Option Award Agreement for an Employee adopted under LSB Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the SEC on December 23, 2004 (SEC File No. 000-11448).*
10.10
Form of Amendment to the applicable Grant Agreements under the 1996 Omnibus Stock Incentive Plan, incorporated herein by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the SEC on April 15, 2005 (SEC File No. 000-11448).*
10.11
Form of Amendment to the Incentive Stock Option Award Agreement for an Employee adopted under LSB Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.3 of the Current Report on Form 8-K filed with the SEC on April 15, 2005 (SEC File No. 000-11448).*
10.12
Restated Form of Director Fee Deferral Agreement adopted under LSB Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on December 23, 2005 (SEC File No. 000-11448).*
10.13
Form of Stock Appreciation Rights Award Agreement adopted under LSB Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 99.2 of the Current Report on Form 8-K filed with the SEC on December 23, 2005 (SEC File No. 000-11448).*
10.14
FNB Amended and Restated Directors Retirement Policy, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on August 3, 2007 (SEC File No. 000-11448).*
10.15
Amendment to the FNB Directors and Senior Management Deferred Compensation Plan Trust Agreement among Regions Bank d/b/a/ Regions Morgan Keegan Trust, FNB Southeast and FNB, dated July 31, 2007, incorporated herein by reference to Exhibit 99.2 of the Current Report on Form 8-K filed with the SEC on August 3, 2007 (SEC File No. 000-11448).*
10.16
Directors and Senior Management Deferred Compensation Plan Trust Agreement between FNB Southeast and Morgan Trust Company, incorporated herein by reference to Exhibit 99.7 of the Current Report on Form 8-K filed with the SEC on March 14, 2008 (SEC File No. 000-11448).*
10.17
Second Amendment to the Directors and Senior Management Deferred Compensation Plan and Directors Retirement Policy Trust Agreement among Regions Bank d/b/a/ Regions Morgan Keegan Trust, Bancorp and the Bank, which is incorporated by reference to Exhibit 99.8 of the current Report on Form 8-K filed with the SEC on March 14, 2008 (SEC File No. 000-11448). *
10.18
Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on March 14, 2008 (SEC File No. 000-11448).*
10.19
First Amendment to the Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management, incorporated herein by reference to Exhibit 99.10 of the Current Report on Form 8-K filed with the SEC on March 14, 2008 (SEC File No. 000-11448).*
10.20
Bancorp Amended and Restated Long Term Stock Incentive Plan, formerly the “FNB Long Term Stock Incentive Plan” (the “2006 Omnibus Plan”), incorporated herein by reference to Exhibit 10.27 of the Quarterly Report on Form 10-Q filed with the SEC on May 9, 2008 (SEC File No. 000-11448).*
10.21
Amended and Restated Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.44 of the Quarterly Report on Form 10-Q filed with the SEC on August 11, 2008 (SEC File No. 000-11448).*
10.22
Form of Restricted Stock Award Agreement adopted under the Amended and Restated Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.45 of the Quarterly Report on Form 10-Q filed with the SEC on August 11, 2008 (SEC File No. 000-11448).*
10.23
Letter Agreement, dated December 12, 2008, between Bancorp and the United States Department of the Treasury, with respect to the issuance and sale of the Fixed Rate Cumulative Perpetual Preferred Stock, Series A and the Warrant, incorporated herein by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC on December 12, 2008 (SEC File No. 000-11448).
10.24
Excessive and Luxury Expenditure Policy of Bancorp and the Bank, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on September 9, 2009 (SEC File No. 000-11448).
10.25
Employment and Change of Control Agreement among Bancorp, the Bank and David P. Barksdale, dated January 12, 2012, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on January 30, 2012 (SEC File No. 000-11448).*
10.26
Employment and Change of Control Agreement among Bancorp, the Bank and Ramsey K. Hamadi, dated March 2, 2012, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on March 2, 2012 (SEC File No. 000-11448).*
10.27
Second Amendment to the Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management, effective January 11, 2012, incorporated herein by reference to Exhibit 10.33 of the Annual Report on Form 10-K filed with the SEC on March 22, 2012.*
10.28
Third Amendment to the Trust Agreement for the Directors and Senior Management Deferred Compensation Plan and Directors Retirement Policy, effective March 5, 2012, incorporated herein by reference to Exhibit 10.34 of the Annual Report on Form 10-K filed with the SEC on March 22, 2012.*
10.29
Appointment of Successor Trustee under the Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management dated March 5, 2012, incorporated herein by reference to Exhibit 10.35 of the Annual Report on Form 10-K filed with the SEC on March 22, 2012.*
10.30
Second Form of Restricted Stock Award Agreement adopted under the Amended and Restated comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.36 of the Annual Report on Form 10-K filed with the SEC on March 22, 2012.*
10.31
Third Form of Restricted Stock Award Agreement adopted under the Amended and Restated Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.37 of the Annual Report on Form 10-K filed with the SEC on March 22, 2012.*
10.32
Fourth Form of Restricted Stock Award Agreement adopted under the Amended and Restated Comprehensive Equity Compensation Plan for Directors and Employees, incorporated herein by reference to Exhibit 10.38 of the Annual Report on Form 10-K filed with the SEC on March 22, 2012.*
10.33
Employment and Change of Control Agreement among Bancorp, the Bank and Pressley A. Ridgill, executed September 9, 2009, and effective January 1, 2013, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on September 5, 2012 (SEC File No. 000-11448).*
10.34
Form of Securities Purchase Agreement, dated November 1, 2012, between Bancorp and certain investors, incorporated herein by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC on November 1, 2012 (SEC File No. 000-11448).
10.35
Form of Registration Rights Agreement, dated November 1, 2012, between Bancorp and certain investors, incorporated herein by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the SEC on November 1, 2012 (SEC File No. 000-11448).
10.36
Employment and Change of Control Agreement among Bancorp, the Bank and William W. Budd, Jr., executed February 8, 2013, and effective March 5, 2013, incorporated herein by reference to Exhibit 99.1 of the Current Report on Form 8-K filed with the SEC on February 11, 2013 (SEC File No. 000-11448).*
10.37
Employment and Change of Control Agreement among Bancorp, the Bank and Robin S. Hager, executed February 8, 2013, and effective August 1, 2013, incorporated herein by reference to Exhibit 99.2 of the Current Report on Form 8-K filed with the SEC on February 11, 2013 (SEC File No. 000-11448).*
10.38
Third Amendment to the Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management, effective January 23, 2013.*
21.1
Schedule of Subsidiaries.
23.1
Consent of Grant Thornton LLP.
31.1
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1
Certification Pursuant to the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009.
99.2
Certification Pursuant to the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009.
101.1
Financial Statements filed in XBRL format.
* Management contract and compensatory arrangements.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NEWBRIDGE BANCORP
Date: March 20, 2013 By: /s/ Pressley A. Ridgill
Pressley A. Ridgill,
President and Chief Executive 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.
Signature
Capacity
Date
/s/ pressley a. ridgill
President, Chief Executive Officer, Director
March 20, 2013
Pressley A. Ridgill
(Principal Executive Officer)
Senior Executive Vice President, Chief
/s/ ramsey k. hamadi
Financial Officer
March 20, 2013
Ramsey K. Hamadi
(Principal Financial Officer)
Senior Vice President, Chief Accounting
/s/ richard m. cobb
Officer, Controller
March 20, 2013
Richard M. Cobb
(Principal Accounting Officer)
/s/ michael s. albert
Chairman of the Board
March 20, 2013
Michael S. Albert
/s/ Barry Z. Dodson
Vice Chairman of the Board
March 20, 2013
Barry Z. Dodson
/s/ j. david branch
Director
March 20, 2013
J. David Branch
/s/ c. arnold britt
Director
March 20, 2013
C. Arnold Britt
/s/ robert c. clark
Director
March 20, 2013
Robert C. Clark
/s/ Alex A. Diffey, jr.
Director
March 20, 2013
Alex A. Diffey, Jr.
/s/ Donald P. Johnson
Director
March 20, 2013
Donald P. Johnson
/s/ Joseph H. Kinnarney
Director
March 20, 2013
Joseph H. Kinnarney
Signature
Capacity
Date
/s/ robert F. Lowe
Director
March 20, 2013
Robert F. Lowe
/s/ mary e. rittling
Director
March 20, 2013
Mary E. Rittling
/s/ E. Reid Teague
Director
March 20, 2013
E. Reid Teague
/s/ john f. watts
Director
March 20, 2013
John F. Watts
/s/ g. alfred webster
Director
March 20, 2013
G. Alfred Webster
/s/ Kenan C. Wright
Director
March 20, 2013
Kenan C. Wright
/s/ julius s. young, jr.
Director
March 20, 2013
Julius S. Young, Jr.
EXHIBIT INDEX
Exhibit
Description
4.8
Specimen certificate of Class A Common Stock, no par value.
10.38
Third Amendment to the Bancorp Non-Qualified Deferred Compensation Plan for Directors and Senior Management, effective January 23, 2013.
21.1
Schedule of Subsidiaries.
23.1
Consent of Grant Thornton LLP.
31.1
Certification of Pressley A. Ridgill.
31.2
Certification of Ramsey K. Hamadi.
32.1
Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350
99.1
Certification Pursuant to the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009.
99.2
Certification Pursuant to the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009.
101.1
Financial Statements submitted in XBRL format.