UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.

 

FORM 10-Q

 

(Mark One)

 

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
  OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2014

 

OR

 

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
  THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from _________to_________

 

Commission File Number 000-49757

 

FIRST RELIANCE BANCSHARES, INC.

(Exact name of small business issuer as specified in its charter)

 

South Carolina 80-0030931
(State or other jurisdiction of
incorporation or organization) 		(I.R.S. Employer
Identification No.)

  

2170 West Palmetto Street

Florence, South Carolina 29501

(Address of principal executive
offices, including zip code)

 

(843) 656-5000

(Issuer’s telephone number, including area code)

 

 

 

State the number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicable date:

 

4,569,895 shares of common stock, par value $0.01 per share, as of April 30, 2014

 

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

x  Yes  ¨ No

 

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

Yes  x No ¨

 

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

 

Large accelerated filer ¨     Accelerated filer  o     Non-accelerated filer  o     Smaller reporting company  x

(Do not check if a smaller reporting company)

 

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

 

 
 

 

INDEX

 

    Page No.
PART I. FINANCIAL INFORMATION
     
Item 1. Financial Statements  
     
  Condensed Consolidated Balance Sheets - March 31, 2014 (Unaudited) and December 31, 2013 3
     
  Condensed Consolidated Statements of Operations Three months ended March 31, 2014 and 2013 (Unaudited) 4
     
  Condensed Consolidated Statements of Comprehensive Income (Loss) Three months ended March 31, 2014 and 2013 (Unaudited) 5
     
  Condensed Consolidated Statements of Shareholders’ Equity Three months ended March 31, 2014 and 2013 (Unaudited) 6
     
  Condensed Consolidated Statements of Cash Flows Three months ended March 31, 2014 and 2013 (Unaudited) 7
     
  Notes to Condensed Consolidated Financial Statements (Unaudited) 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
     
Item 4. Controls and Procedures 40
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 41
     
Item 1A.Risk Factors 41
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
     
Item 6. Exhibits 41

 

 
 

 

FIRST RELIANCE BANCSHARES, INC. 

Condensed Consolidated Balance Sheets

 

    March 31,     December 31,  
    2014     2013  
    (Unaudited)     (Audited)  
Assets                
Cash and cash equivalents:                
Cash and due from banks   $ 3,368,635     $ 3,548,974  
Interest-bearing deposits with other banks     17,877,291       14,698,851  
Total cash and cash equivalents     21,245,926       18,247,825  
                 
Time deposits in other banks     101,309       101,207  
                 
Securities available-for-sale     11,253,414       12,144,843  
Securities held-to-maturity (Estimated fair value of $35,933,179 and $36,951,934 at March 31, 2014 and December 31, 2013, respectively)     35,643,920       36,951,934  
Nonmarketable equity securities     1,142,400       1,594,900  
Total investment securities     48,039,734       50,691,677  
                 
Mortgage loans held for sale     937,278       2,248,252  
                 
Loans receivable     239,634,692       238,502,131  
Less allowance for loan losses     (2,802,823 )     (2,894,153 )
Loans, net     236,831,869       235,607,978  
                 
Premises, furniture and equipment, net     24,131,418       24,333,616  
Accrued interest receivable     954,180       1,129,881  
Other real estate owned     7,236,115       8,932,634  
Cash surrender value life insurance     13,029,218       12,945,693  
Other assets     1,152,482       1,169,368  
Total assets   $ 353,659,529     $ 355,408,131  
                 
Liabilities and Shareholders’ Equity                
Liabilities                
Deposits                
Noninterest-bearing transaction accounts   $ 66,652,989     $ 65,576,524  
Interest-bearing transaction accounts     52,101,388       46,046,043  
Savings     85,751,801       86,247,410  
Time deposits $100,000 and over     38,426,451       39,934,745  
Other time deposits     42,361,720       44,610,301  
Total deposits     285,294,349       282,415,023  
Securities sold under agreement to repurchase     5,386,566       4,876,118  
Advances from Federal Home Loan Bank     17,000,000       23,000,000  
Junior subordinated debentures     10,310,000       10,310,000  
Accrued interest payable     636,622       587,649  
Other liabilities     2,635,661       2,126,597  
Total liabilities     321,263,198       323,315,387  
                 
Shareholders’ Equity                
Preferred stock                
Series A cumulative perpetual preferred stock - 15,349 shares issued and outstanding at March 31, 2014 and December 31, 2013     15,179,709       15,145,597  
Series B cumulative perpetual preferred stock - 767 shares issued and outstanding at March 31, 2014 and December 31, 2013     767,000       769,894  
Common stock, $0.01 par value; 20,000,000 shares authorized, 4,569,895 and 4,568,695 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively     45,699       45,687  
Capital surplus     30,611,309       30,609,281  
Treasury stock, at cost, 29,846 shares at March 31, 2014 and December 31, 2013     (201,686 )     (201,686 )
Nonvested restricted stock     (21,774 )     (32,138 )
Retained deficit     (14,132,769 )     (14,447,907 )
Accumulated other comprehensive income     148,843       204,016  
Total shareholders’ equity     32,396,331       32,092,744  
Total liabilities and shareholders’ equity   $ 353,659,529     $ 355,408,131  

 

See notes to condensed consolidated financial statements

 

- 3 -
 

 

FIRST RELIANCE BANCSHARES, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

 

    Three Months Ended  
    March 31,  
    2014     2013  
Interest income                
Loans, including fees   $ 3,273,679     $ 3,471,204  
Investment securities                
Taxable     287,981       347,984  
Nontaxable     28,571       -  
Other interest income     11,902       26,343  
Total     3,602,133       3,845,531  
                 
Interest expense                
Time deposits     249,119       604,663  
Other deposits     33,333       73,711  
Other interest expense     81,480       121,537  
Total     363,932       799,911  
                 
Net interest income     3,238,201       3,045,620  
                 
Provision for loan losses     -       -  
                 
Net interest income after provision for loan losses     3,238,201       3,045,620  
                 
Noninterest income                
Service charges on deposit accounts     383,375       413,315  
Gain on sale of mortgage loans     201,240       293,569  
Income from bank owned life insurance     83,525       85,040  
Other charges, commissions and fees     258,614       241,925  
Gain on sale of securities available-for-sale     5,321       -  
Other non-interest income     73,709       83,649  
Total     1,005,784       1,117,498  
                 
Noninterest expenses                
Salaries and benefits     1,812,735       1,928,709  
Occupancy expense     367,030       358,087  
Furniture and equipment expense     414,449       295,515  
Other operating expenses     1,303,415       1,567,386  
Total     3,897,629       4,149,697  
                 
Income before taxes     346,356       13,421  
                 
Income tax     -       -  
                 
Net income     346,356       13,421  
                 
Preferred stock dividends     209,120       249,248  
                 
Deemed dividends on preferred stock resulting from net accretion of discount and amortization of premium     31,218       43,900  
                 
Net income (loss) available to common shareholders   $ 106,018     $ (279,727 )
                 
Average common shares outstanding, basic     4,569,122       4,094,866  
Average common shares outstanding, diluted     4,649,502       4,094,866  
                 
Income (loss) per common share:                
Basic   $ 0.02     $ (0.07 )
Diluted     0.02       (0.07 )

 

See notes to condensed consolidated financial statements

 

- 4 -
 

 

FIRST RELIANCE BANCSHARES, INC.
Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

    Three Months Ended  
    March 31,  
    2014     2013  
             
Net income from operations   $ 346,356     $ 13,421  
                 
Other comprehensive income (loss), net of tax:                
Securities available-for-sale                
Unrealized holding losses arising during the period     (64,972 )     (252,025 )
Income tax benefit     (22,090 )     (31,246 )
Net of income taxes     (42,882 )     (220,779 )
                 
Reclassification adjustment for gains (loss) realized in net income from operations     5,321       -  
Income tax expense     1,809       -  
Net of income taxes     3,512       -  
                 
Other-than-temporary impairment on available-for-sale securities     -       (70,000 )
Income tax benefit     -       (8,678 )
Net of income taxes     -       (61,322 )
                 
Other comprehensive loss attributable to securities available-for-sale     (46,394 )     (159,457 )
                 
Securities held-to-maturity                
Amortization of net unrealized gains capitalized on securities transferred from available-for-sale     (13,302 )     -  
Income tax benefit     (4,523 )     -  
Net of income taxes     (8,779 )     -  
                 
Other comprehensive loss     (55,173 )     (159,457 )
                 
Comprehensive income (loss)   $ 291,183     $ (146,036 )

 

See notes to condensed consolidated financial statements 

 

- 5 -
 

 

FIRST RELIANCE BANCSHARES, INC.

Condensed Consolidated Statements of Shareholders’ Equity

For the Three Months Ended March 31, 2014 and 2013

(Unaudited)

 

                                        Accumulated        
                                        Other        
                            Nonvested     Retained     Comprehensive        
    Preferred     Common     Capital     Treasury     Restricted     Earnings     Income        
    Stock     Stock     Surplus     Stock     Stock     (Deficit)     (Loss)     Total  
Balance, December 31, 2012   $ 18,199,743     $ 40,949     $ 27,991,132     $ (182,234 )   $ (123,466 )   $ (6,207,116 )   $ 1,478,919     $ 41,197,927  
                                                                 
Net income                                             13,421               13,421  
                                                                 
Changes in unrealized gains and losses on securities                                                     (159,457 )     (159,457 )
                                                                 
Accretion of Series A Preferred stock discount     47,970                                       (47,970 )             -  
                                                                 
Amortization of Series B Preferred stock premium     (4,070 )                                     4,070               -  
                                                                 
Net Change in Restricted Stock             4       (735 )             39,770                       39,039  
                                                                 
Purchase of treasury stock                             (1,210 )                             (1,210 )
                                                                 
Balance, March 31, 2013   $ 18,243,643     $ 40,953     $ 27,990,397     $ (183,444 )   $ (83,696 )   $ (6,237,595 )   $ 1,319,462     $ 41,089,720  
                                                                 
Balance, December 31, 2013   $ 15,915,491     $ 45,687     $ 30,609,281     $ (201,686 )   $ (32,138 )   $ (14,447,907 )   $ 204,016     $ 32,092,744  
                                                                 
Net income                                             346,356               346,356  
                                                                 
Changes in unrealized gains and losses on securities                                                     (55,173 )     (55,173 )
                                                                 
Accretion of Series A Preferred stock discount     34,112                                       (34,112 )             -  
                                                                 
Amortization of Series B Preferred stock premium     (2,894 )                                     2,894               -  
                                                                 
Amortization of nonvested restricted stock                                     10,364                       10,364  
                                                                 
Issuance of common stock             12       2,028                                       2,040  
                                                                 
Balance, March 31, 2014   $ 15,946,709     $ 45,699     $ 30,611,309     $ (201,686 )   $ (21,774 )   $ (14,132,769 )   $ 148,843     $ 32,396,331  

 

See notes to condensed consolidated financial statements

 

- 6 -
 

 

FIRST RELIANCE BANCSHARES, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

    Three Months Ended  
    March 31,  
    2014     2013  
             
Cash flows from operating activities:                
Net income   $ 346,356     $ 13,421  
Adjustments to reconcile net income to net cash provided by operating activities:                
Depreciation and amortization expense     242,654       226,360  
Gain on sale of securities available-for-sale     (5,321 )     -  
(Gain) loss on sale of other real estate owned     (112,594 )     24,340  
Impairment loss on available-for-sale securities     -       70,000  
Discount accretion and premium amortization     41,118       78,908  
Disbursements for mortgage loans held for sale     (5,682,944 )     (5,781,617 )
Proceeds from sale of mortgage loans held for sale     6,993,918       8,518,513  
Decrease in interest receivable     175,701       63,508  
Increase in interest payable     48,973       30,882  
Increase for cash surrender value of life insurance     (83,525 )     (85,040 )
Amortization of deferred compensation on restricted stock     10,364       39,039  
(Increase) decrease in other assets     (16,500 )     157,334  
Increase in other liabilities     537,486       204,011  
Net cash provided by operating activities     2,495,686       3,559,659  
                 
Cash flows from investing activities:                
Net (increase) decrease in loans receivable     (1,235,891 )     3,133,351  
Purchases of securities available-for-sale     (5,153,110 )     -  
Maturities of securities available-for-sale     1,269,650       4,667,566  
Maturities of securities held-to-maturity     667,981       -  
Sales of securities available-for-sale     5,295,529       -  
Increase in time deposits in other banks     (102 )     (100,153 )
Decrease in nonmarketable equity securities     452,500       242,400  
Sales of other real estate owned     1,821,113       635,534  
Purchases of premises and equipment     (7,069 )     (37,929 )
Net cash provided by investing activities     3,110,601       8,540,769  
                 
Cash flows from financing activities:                
Net increase in demand deposits, interest-bearing transaction accounts and savings accounts     6,636,201       2,197,497  
Net decrease in certificates of deposit and other time deposits     (3,756,875 )     (16,345,580 )
Net increase in securities sold under agreements to repurchase     510,448       200,176  
Net decrease in a dvances from Federal Home Loan Bank     (6,000,000 )     -  
Issuance of common stock     2,040       -  
Purchase of treasury stock     -       (1,210 )
Net cash used by financing activities     (2,608,186 )     (13,949,117 )
                 
Net increase (decrease) in cash and cash equivalents     2,998,101       (1,848,689 )
                 
Cash and cash equivalents, beginning     18,247,825       38,062,903  
                 
Cash and cash equivalents, end   $ 21,245,926     $ 36,214,214  
                 
Cash paid during the period for:                
Income taxes   $ -     $ -  
Interest     314,959       769,029  
                 
Supplemental noncash investing and financing activities:                
Foreclosures on loans transferred to other real estate owned   $ 12,000     $ 444,910  
Net change in unrealized losses on investment securities     (55,173 )     (159,457 )

 

See notes to condensed consolidated financial statements

 

- 7 -
 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

Note 1 - Basis of Presentation

 

First Reliance Bancshares, Inc. (the “Company”) was incorporated to serve as a bank holding company for its subsidiary, First Reliance Bank (the “Bank”). First Reliance Bank was incorporated on August 9, 1999 and commenced business on August 16, 1999. The principal business activity of the Bank is to provide banking services to domestic markets, principally in Florence, Lexington, and Charleston Counties in South Carolina. The Bank is a state-chartered commercial bank, and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”).

 

The accompanying condensed consolidated financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they are condensed and omit certain disclosures that would appear in audited annual consolidated financial statements. The consolidated financial statements as of March 31, 2014 and for the interim periods ended March 31, 2014 and 2013 are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation. The consolidated financial information as of December 31, 2013 has been derived from the audited consolidated financial statements as of that date. For further information, refer to the consolidated financial statements and the notes included in First Reliance Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Note 2 - Recently Issued Accounting Pronouncements

 

The following is a summary of recent authoritative pronouncements: – First Quarter

 

In January 2014, the Financial Accounting Standards Board (the “FASB”) amended the Receivables - Troubled Debt Restructurings by Creditors subtopic of the Codification to address the reclassification of consumer mortgage loans collateralized by residential real estate upon foreclosure. The amendments clarify the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The amendments also outline interim and annual disclosure requirements. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Note 3 - Reclassifications

 

Certain captions and amounts in the financial statements in the Company’s Form 10-Q for the quarter ended March 31, 2013 were reclassified to conform to the March 31, 2014 presentation.

 

Note 4 - Investment Securities

 

The amortized cost and estimated fair values of securities available-for-sale were:

                         
    Amortized     Gross Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
March 31, 2014                                
Mortgage-backed securities   $ 8,450,875     $ 35,043     $ 13,833     $ 8,472,085  
Corporate bonds     2,771,515       -       20,186       2,751,329  
Equity security     30,000       -       -       30,000  
Total   $ 11,252,390     $ 35,043     $ 34,019     $ 11,253,414  
                                 
December 31, 2013                                
Mortgage-backed securities   $ 9,277,577     $ 87,635     $ 46,579     $ 9,318,633  
Corporate bonds     2,765,950       30,260       -       2,796,210  
Equity security     30,000       -       -       30,000  
Total   $ 12,073,527     $ 117,895     $ 46,579     $ 12,144,843  

 

- 8 -
 

 

The amortized cost and estimated fair values of securities held-to-maturity were:

                         
    Amortized     Gross Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
March 31, 2014                                
U.S. Government sponsored agencies   $ 6,912,687     $ 90,591     $ 114,576     $ 6,888,702  
Mortgage-backed securities     25,346,867       630,243       184,657       25,792,453  
Municipals     3,159,870       92,154       -       3,252,024  
      35,419,424     $ 812,988     $ 299,233     $ 35,933,179  
Unamortized capitalization of net unrealized gains on securities transferred from available-for-sale     224,496                          
Total   $ 35,643,920                        
                                 
December 31, 2013                                
U.S. Government sponsored agencies   $ 7,146,409     $ 80,707     $ 156,131     $ 7,070,985  
Mortgage-backed securities     26,404,573       537,133       210,365       26,731,341  
Municipals     3,163,155       17,569       31,116       3,149,608  
      36,714,137     $ 635,409     $ 397,612     $ 36,951,934  
Capitalization of net unrealized gains on securities transferred from available-for-sale     237,797                          
Total   $ 36,951,934                          

 

At December 31, 2013, the Company transferred certain securities to the held-to-maturity category from available-for-sale, since the Company has the ability and management intends to hold these securities to maturity. At the time of the reclassification, the securities were carried at their estimated fair value of $36,951,934, including net unrealized gains of $237,797. The net unrealized gain is being amortized to other comprehensive income (loss) over the life of the underlying securities.

 

The following is a summary of maturities of securities available-for-sale and held-to-maturity as of March 31, 2014. The amortized cost and estimated fair values are based on the contractual maturity dates. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty. Mortgage-backed securities are presented as a separate line, maturities of which are based on expected maturities since paydowns are expected to occur before contractual maturity dates.

 

    Securities     Securities  
    Available-for-Sale     Held-to-Maturity  
    Amortized     Estimated     Amortized     Estimated  
      Cost     Fair Value     Cost     Fair Value  
Due after ten years   $ 2,771,515     $ 2,751,329     $ 9,991,039     $ 10,140,726  
Mortgage-backed securities     8,450,875       8,472,085       25,652,881       25,792,453  
Equity security     30,000       30,000       -       -  
Total   $ 11,252,390     $ 11,253,414     $ 35,643,920     $ 35,933,179  

 

The following table shows gross unrealized losses and fair value of securities available-for-sale, aggregated by investment category, and length of time that individual securities have been in a continuous realized loss position at March 31, 2014 and December 31, 2013.

 

    March 31, 2014     December 31, 2013  
    Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses  
Less Than 12 Months                                
Mortgage-backed securities   $ 1,925,806     $ 13,833     $ 1,999,360     $ 46,579  
Corporate bonds     2,751,329       20,186       -       -  
Total securities available-for-sale   $ 4,677,135     $ 34,019     $ 1,999,360     $ 46,579  

 

- 9 -
 
 

The following table shows gross unrealized losses and fair value of securities held-to-maturity, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2014 and December 31, 2013.

 

    March 31, 2014     December 31, 2013  
    Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses  
Less Than 12 Months                                
U.S. Government sponsored agencies   $ 4,402,949     $ 114,576     $ 4,549,325     $ 156,131  
Mortgage-backed securities     4,889,633       184,657       5,011,313       210,365  
Municipals     -       -       2,037,029       31,116  
Total securities held-to-maturity   $ 9,292,582     $ 299,233     $ 11,597,667     $ 397,612  

 

At March 31, 2014 and December 31, 2013, there were no investment securities that had been in a loss position for twelve months or more.

 

During the first quarter of 2014, gross proceeds from the sale of available-for-sale securities were $5,295,529, resulting in realized gross gains of $39,110 and gross losses of $33,789. There were no sales of investment securities during the first quarter of 2013.

 

Note 5 – Loans Receivable and Allowance for Loan Losses

 

Major classifications of loans receivable are summarized as follows:

 

    March 31,     December 31,  
    2014     2013  
Real estate loans:                
Construction   $ 23,890,521     $ 24,175,347  
Residential:                
Residential 1-4 family     35,761,717       35,873,036  
Multifamily     3,890,201       4,312,057  
Second mortgages     4,077,550       4,245,778  
Equity lines of credit     21,427,102       21,270,126  
Total residential     65,156,570       65,700,997  
Nonresidential     105,861,288       104,378,485  
Total real estate loans     194,908,379       194,254,829  
Commercial and industrial     32,584,523       32,486,848  
Consumer     12,136,195       11,725,319  
Other     5,595       35,135  
Total loans   $ 239,634,692     $ 238,502,131  

 

The Company has pledged certain loans as collateral to secure its borrowings from the Federal Home Loan Bank. The total of loans pledged was $79,515,357 and $76,972,548 at March 31, 2014 and December 31, 2013, respectively.

 

The following is an analysis of the allowance for loan losses by class of loans for the three months ended March 31, 2014 and the year ended December 31, 2013.

 

March 31, 2014

 

          Total              
        Real Estate Loans     Real              
 (Dollars in Thousands)               Non-     Estate           Consumer  
    Total     Construction     Residential     Residential     Loans     Commercial     and Other  
                                     
Beginning balance   $ 2,894     $ 303     $ 1,043     $ 1,382     $ 2,728     $ 65     $ 101  
Provisions     -       (31 )     2       20       (9 )     28       (19 )
Recoveries     111       9       3       89       101       7       3  
Charge-offs     (202 )     (1 )     (3 )     (188 )     (192 )     -       (10 )
Ending balance   $ 2,803     $ 280     $ 1,045     $ 1,303     $ 2,628     $ 100     $ 75  

 

- 10 -
 

 

December 31, 2013

 

                Total              
          Real Estate Loans     Real              
(Dollars in Thousands)                Non-     Estate           Consumer  
    Total     Construction     Residential     Residential     Loans     Commercial     and Other  
Beginning balance   $ 4,167     $ 1,441     $ 951     $ 1,129     $ 3,521     $ 616     $ 30  
Provisions     610       (980 )     903       1,136       1,059       (548 )     99  
Recoveries     455       138       177       35       350       89       16  
Charge-offs     (2,338 )     (296 )     (988 )     (918 )     (2,202 )     (92 )     (44 )
Ending balance   $ 2,894     $ 303     $ 1,043     $ 1,382     $ 2,728     $ 65     $ 101  

 

The following is a summary of loans evaluated for impairment individually and collectively, by class as of March 31, 2014 and December 31, 2013.

 

March 31, 2014

 

Allowance for Loan Losses

 

                            Total              
          Real Estate Loans     Real              
 (Dollars in Thousands)                 Non-     Estate           Consumer  
    Total     Construction     Residential     Residential     Loans     Commercial     and Other  
Allowance                                                        
Evaluated for impairment Individually   $ 561     $ 2     $ 144     $ 369     $ 515     $ 46     $ -  
Collectively     2,242       278       901       934       2,113       54       75  
Allowance for loan losses   $ 2,803     $ 280     $ 1,045     $ 1,303     $ 2,628     $ 100     $ 75  
                                                         
Total Loans                                                        
Evaluated for impairment Individually   $ 15,243     $ 2,456     $ 3,212     $ 8,049     $ 13,717     $ 1,435     $ 91  
Collectively     224,392       21,434       61,945       97,812       181,191       31,150       12,051  
Loans receivable   $ 239,635     $ 23,890     $ 65,157     $ 105,861     $ 194,908     $ 32,585     $ 12,142  

 

December 31, 2013

 

                            Total              
          Real Estate Loans     Real              
(Dollars in Thousands)                 Non-     Estate         Consumer  
  Total     Construction     Residential     Residential     Loans     Commercial     and Other  
Allowance                                                        
Evaluated for impairment Individually   $ 405     $ 2     $ 185     $ 163     $ 350     $ 53     $ 2  
Collectively     2,489       301       858       1,219       2,378       12       99  
Allowance for loan losses   $ 2,894     $ 303     $ 1,043     $ 1,382     $ 2,728     $ 65     $ 101  
                                                         
Total Loans                                                        
Evaluated for impairment Individually   $ 18,160     $ 2,495     $ 3,091     $ 10,998     $ 16,584     $ 1,480     $ 96  
Collectively     220,342       21,680       62,610       93,381       177,671       31,007       11,664  
Loans receivable   $ 238,502     $ 24,175     $ 65,701     $ 104,379     $ 194,255     $ 32,487     $ 11,760  

 

- 11 -
 

 

The Company identifies impaired loans through its normal internal loan review process. Loans on the Company’s problem loan watch list are considered potentially impaired loans. These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected. Loans are not considered impaired if a minimal delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected.

 

The following summarizes the Company’s impaired loans as of March 31, 2014.

 

          Unpaid           Average  
(Dollars in Thousands)   Recorded     Principal     Related     Recorded  
    Investment     Balance     Allowance     Investment  
With no related allowance recorded:                                
Real estate                                
Construction   $ 674     $ 849     $ -     $ 677  
Residential     2,496       3,468       -       2,312  
Nonresidential     6,735       6,938       -       6,391  
Total real estate loans     9,905       11,255       -       9,380  
Commercial     21       27       -       17  
Consumer and other     90       99       -       86  
      10,016       11,381       -       9,483  
                                 
With an allowance recorded:                                
Real estate                                
Construction     1,782       1,782       2       1,799  
Residential     716       750       144       840  
Nonresidential     1,314       1,417       369       3,132  
Total real estate loans     3,812       3,949       515       5,771  
Commercial     1,414       1,484       46       1,441  
Consumer and other     1       1       -       7  
      5,227       5,434       561       7,219  
                                 
Total                                
Real estate                                
Construction     2,456       2,631       2       2,476  
Residential     3,212       4,218       144       3,152  
Nonresidential     8,049       8,355       369       9,523  
Total real estate loans     13,717       15,204       515       15,151  
Commercial     1,435       1,511       46       1,458  
Consumer and other     91       100       -       93  
Total   $ 15,243     $ 16,815     $ 561     $ 16,702  

 

The following summarizes the Company’s impaired loans as of December 31, 2013.

 

          Unpaid           Average  
(Dollars in Thousands)   Recorded     Principal     Related     Recorded  
    Investment     Balance     Allowance     Investment  
With no related allowance recorded:                                
Real estate                                
Construction   $ 680     $ 849     $ -     $ 1,599  
Residential     2,127       2,272       -       3,038  
Nonresidential     6,047       6,365       -       8,187  
Total real estate loans     8,854       9,486       -       12,824  
Commercial     12       18       -       1,131  
Consumer and other     83       91       -       75  
      8,949       9,595       -       14,030  

 

- 12 -
 

 

 

          Unpaid           Average  
(Dollars in Thousands)   Recorded     Principal     Related     Recorded  
    Investment     Balance     Allowance     Investment  
With an allowance recorded:                                
Real estate                                
Construction   $ 1,815     $ 1,815     $ 2     $ 1,777  
Residential     964       999       185       1,299  
Nonresidential     4,951       5,087       163       2,803  
Total real estate loans     7,730       7,901       350       5,879  
Commercial     1,468       1,538       53       606  
Consumer and other     13       14       2       28  
      9,211       9,453       405       6,513  
Total                                
Real estate                                
Construction     2,495       2,664       2       3,375  
Residential     3,091       3,271       185       4,337  
Nonresidential     10,998       11,452       163       10,990  
Total real estate loans     16,584       17,387       350       18,702  
Commercial     1,480       1,556       53       1,737  
Consumer and other     96       105       2       104  
Total   $ 18,160     $ 19,048     $ 405     $ 20,543  

 

Interest income on impaired loans other than nonaccrual loans is recognized on an accrual basis. Interest income on nonaccrual loans is recognized only as collected. For the quarters ended March 31, 2014 and 2013, interest income recognized on nonaccrual loans was $31,086 and $148,728, respectively. If the nonaccrual loans had been accruing interest at their original contracted rates, related income would have been $110,227 and $289,706 for quarters ended March 31, 2014 and 2013, respectively.

 

A summary of current, past due and nonaccrual loans as of March 31, 2014 was as follows:

 

    Past Due     Past Due Over 90 days                    
    30-89     and     Non-     Total           Total  
( Dollars in Thousands )   Days     Accruing     Accruing     Past Due     Current     Loans  
Real estate                                                
Construction   $ -     $ -     $ 475     $ 475     $ 23,415     $ 23,890  
Residential     176       -       1,796       1,972       63,185       65,157  
Nonresidential     -       -       3,986       3,986       101,875       105,861  
Total real estate loans     176       -       6,257       6,433       188,475       194,908  
Commercial     -       -       1,353       1,353       31,232       32,585  
Consumer and other     12       -       79       91       12,051       12,142  
Totals   $ 188     $ -     $ 7,689     $ 7,877     $ 231,758     $ 239,635  

 

A summary of current, past due and nonaccrual loans as of December 31, 2013 was as follows:

 

    Past Due     Past Due Over 90 days                    
( Dollars in Thousands )   30-89     and     Non-     Total           Total  
    Days     Accruing     Accruing     Past Due     Current     Loans  
Real estate                                                
Construction   $ 11     $ -     $ 481     $ 492     $ 23,683     $ 24,175  
Residential     344       -       1,672       2,016       63,685       65,701  
Nonresidential     24       127       5,006       5,157       99,222       104,379  
Total real estate loans     379       127       7,159       7,665       186,590       194,255  
Commercial     3       -       1,393       1,396       31,091       32,487  
Consumer and other     19       8       74       101       11,659       11,760  
Totals   $ 401     $ 135     $ 8,626     $ 9,162     $ 229,340     $ 238,502  

 

Included in the loan portfolio are particular loans that have been modified in order to maximize the collection of loan balances. If, for economic or legal reasons related to the customer’s financial difficulties, the Company grants a concession compared to the original terms and conditions on the loan, the modified loan is classified as a troubled debt restructuring (“TDR”). Concessions can relate to the contractual interest rate, maturity date or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing financial challenges in the current economic environment.

 

- 13 -
 

 

At March 31, 2014 there were 30 loans classified as a TDR totaling $7,274,231. Of the 30 loans, 16 loans totaling $4,564,197 were performing while 14 loans totaling $2,710,034 were not performing. As of December 31, 2013 there were 30 loans classified as TDRs totaling $7,157,230. Of the 30 loans, 16 loans totaling $3,481,589 were performing while 14 loans totaling $3,675,641 were not performing. All of these restructured loans resulted in either extended maturity or lowered rates and were included in the impaired loan balance.

 

The following table provides, by class, the number of loans modified in TDRs during the first quarters of 2014 and 2013.

 

( Dollars in Thousands )   For the Quarter Ended March 31, 2014     For the Quarter Ended March 31, 2013  
                Unpaid                 Unpaid  
    Number     Recorded     Principal     Number     Recorded     Principal  
    of Loans     Investment     Balance     of Loans     Investment     Balance  
Extended maturity                                                
Consumer and other     -     $ -     $ -       1     $ 13     $ 13  
                                                 
Reduced Rate                                                
Real estate - Residential     1       62         62       1       170       170  
Totals     1     $      62     $ 62       2     $ 183     $ 183  

 

The following table provides the number of loans and leases modified in TDRs during the previous 12 months which subsequently defaulted during the quarter ended March 31, 2014 and 2013, respectively, as well as the recorded investments and unpaid principal balances as of March 31, 2014 and 2013. Loans in default are those past due greater than 89 days.

 

( Dollars in Thousands )   For the Quarter Ended March 31, 2014     For the Quarter Ended March 31, 2013  
                Unpaid                 Unpaid  
    Number     Recorded     Principal     Number     Recorded     Principal  
    of Loans     Investment     Balance     of Loans     Investment     Balance  
Reduced Rate                                                
Real estate                                                
Residential     1     $ 62     $ 62       1     $ 170     $ 170  
Nonresidential     -       -       -       1       119       119  
Totals     1     $    62     $    62       2     $ 289     $ 289  

 

All loans modified in TDRs are evaluated for impairment. The nature and extent of impairment of TDRs, including those which have experienced a subsequent default, are considered in determining an appropriate level of allowance for credit losses.

 

Credit Indicators

 

Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt, including, among other factors: current financial information, historical payment experience, credit documentation, public information, and current economic trends. The following definitions are utilized for risk ratings, which are consistent with the definitions used in supervisory guidance:

 

Special Mention - Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

 

Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

 

- 14 -
 

 

As of March 31, 2014, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

                            Total              
          Real Estate Loans     Real              
 (Dollars in Thousands)               Non-     Estate           Consumer  
  Total     Construction     Residential     Residential     Loans     Commercial     and Other  
Pass   $ 196,445     $ 14,565     $ 55,823     $ 84,372     $ 154,760     $ 29,737     $ 11,948  
Special mention     31,032       8,850       5,987       14,695       29,532       1,412       88  
Substandard     12,158       475       3,347       6,794       10,616       1,436       106  
Doubtful     -       -       -       -       -       -       -  
Totals   $ 239,635     $ 23,890     $ 65,157     $ 105,861     $ 194,908     $ 32,585     $ 12,142  

 

As of December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

                            Total              
           Real Estate Loans     Real              
(Dollars in Thousands)       Non-     Estate           Consumer  
  Total     Construction     Residential     Residential     Loans     Commercial     and Other  
Pass   $ 193,839     $ 14,406     $ 56,227     $ 81,891     $ 152,524     $ 29,735     $ 11,580  
Special mention     27,926       9,085       5,904       11,588       26,577       1,271       78  
Substandard     16,737       684       3,570       10,900       15,154       1,481       102  
Doubtful     -       -       -       -       -       -       -  
Totals   $ 238,502     $ 24,175     $ 65,701     $ 104,379     $ 194,255     $ 32,487     $ 11,760  

 

The Company enters into financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by the other parties to the instrument is represented by the contractual notional amount of the instrument. Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments to extend credit as it does for on-balance-sheet instruments. Letters of credit are conditional commitments issued to guarantee a customer’s performance to a third party and have essentially the same credit risk as other lending facilities.

 

Collateral held for commitments to extend credit and standby letters of credit varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties.

 

The following table summarizes the Company’s off-balance sheet financial instruments whose contract amounts represent credit risk at the dates indicated below:

 

    March 31,     December 31,  
    2014     2013  
Commitments to extend credit   $ 35,508,578     $ 34,397,688  
Standby letters of credit     75,000       8,000  

 

Note 6 – Other Real Estate Owned

 

Transactions in other real estate owned (“OREO”) for the three months ended March 31, 2014 and year ended December 31, 2013 are summarized below:

 

    March 31,     December 31,  
    2014     2013  
Beginning balance   $ 8,932,634     $ 15,289,991  
Additions     12,000       4,827,496  
Sales     (1,708,519 )     (6,279,377 )
Write downs     -       (4,905,476 )
Ending balance   $ 7,236,115     $ 8,932,634  

 

- 15 -
 

 

The Company recognized a net gain of $112,594 and a net loss of $24,340 on the sale of OREO for the three months ended March 31, 2014 and 2013, respectively.

 

OREO expense for the three months ended March 31, 2014 and 2013 was $115,286 and $216,265, respectively, which includes gains and losses on sales.

 

Note 7 – Shareholders’ Equity

 

Common Stock – The following is a summary of the changes in common shares outstanding for the three months ended March 31, 2014 and 2013.

 

    Three Months Ended  
    March 31,  
    2014     2013  
             
Common shares outstanding at beginning of the period     4,568,695       4,094,861  
Issuance of common stock     1,200       -  
Issuance of non-vested restricted shares     -       1,245  
Forfeiture of restricted shares     -       (835 )
Common shares outstanding at end of the period     4,569,895       4,095,271  

 

Preferred Stock - On March 6, 2009, the Company completed a transaction with the United States Treasury (the “Treasury”) under the Troubled Asset Relief Program Capital Purchase Program, whereby the Company sold 15,349 shares of its Series A Cumulative Perpetual Preferred Stock (the “Series A Shares”) to the Treasury.  In addition, the Treasury received a warrant to purchase 767 shares of the Company’s Series B Cumulative Perpetual Preferred Stock (the “Series B Shares”), which was immediately exercised for a nominal exercise price. The preferred shares issued to the Treasury qualify as Tier 1 capital for regulatory purposes. On March 1, 2013, the Treasury auctioned the subject securities in a private transaction with unaffiliated third-party investors.

 

The Series A Preferred Stock is a senior cumulative perpetual preferred stock that has a liquidation preference of $1,000 per share, pays cumulative dividends at a rate of 5% per year (approximately $767,000 annually) for the first five years and beginning May 15, 2014, at a rate of 9% per year (approximately $1,381,000 annually). Dividends are payable quarterly. At any time, the Company may, at its option and with regulatory approval, redeem the Series A Preferred Stock at par value plus accrued and unpaid dividends. The Series A Preferred Stock is generally non-voting.

 

The Series B Preferred Stock is a cumulative perpetual preferred stock that has the same rights, preferences, privileges, voting rights and other terms as the Series A Preferred Stock, except that dividends will be paid at the rate of 9% per year and may not be redeemed until all the Series A Preferred Stock has been redeemed. The Series A and Series B Preferred Shares will receive preferential treatment in the event of liquidation, dissolution or winding up of the Company.

 

The Company must request prior approval from the Federal Reserve Bank of Richmond (the “Federal Reserve”) prior to declaring or paying dividends on its common stock or preferred stock, or making scheduled interest payments on its trust-preferred securities. Such approval was not granted by the Federal Reserve for payment of the Company’s dividends and interest payments due and payable in the ten consecutive quarters ended March 31, 2014. Additionally, such approval was not granted for payments due in the second quarter of 2014. Since the Company has not paid the dividend on its Series A and Series B Shares for more than six consecutive quarterly periods, the holders of these shares currently have the right to appoint up to two individuals to the Company’s board of directors. To date, the right to appoint directors has not been exercised by the holders.

 

As of March 31, 2014, dividends in arrears on the Series A and Series B shares totaled $2,091,200.

 

Note 8 – Income Taxes

 

The income tax expense related to the Company’s pretax income for the first quarters of 2014 and 2013 was offset by a reversal of an equal amount of the Company’s valuation allowance related to its deferred tax assets. Therefore, no income tax provision was recorded for the first quarters of 2014 and 2013.

 

Note 9 – Net Income (Loss) Per Common Share

 

Net income (loss) available to common shareholders represents net income (loss) adjusted for preferred dividends including dividends declared, accretions of discounts and amortization of premiums on preferred stock issuances and cumulative dividends related to the current dividend period that have not been declared as of period end. All potential dilutive common shares equivalents were deemed to be anti-dilutive for the quarter ended March 31, 2013, due to the net loss available to common shareholders.

 

- 16 -
 

 

The following is a summary of the net income (loss) per common share calculations for the three months ended March 31, 2014 and 2013.

 

    2014     2013  
Net income (loss) available to common shareholders                
Net income   $ 346,356     $ 13,421  
Preferred stock dividends     209,120       249,248  
Deemed dividends on preferred stock resulting from net accretion of discount and amortization of premium     31,218       43,900  
                 
Net income (loss) available to common shareholders   $ 106,018     $ (279,727 )
                 
Basic net income (loss) per common share:                
Net income (loss) available to common shareholders   $ 106,018     $ (279,727 )
                 
Average common shares outstanding – basic     4,569,122       4,094,866  
                 
Basic income (loss) per common share   $ 0.02     $ (0.07 )
                 
Diluted net income (loss) per common share:                
Net income (loss) available to common shareholders   $ 106,018     $ (279,727 )
                 
Average common shares outstanding – basic     4,569,122       4,094,866  
                 
Dilutive potential common shares     80,380       -  
                 
Average common shares outstanding – diluted     4,649,502       4,094,866  
                 
Diluted net income (loss) per common share   $ 0.02     $ (0.07 )

 

Note 10 - Equity Incentive Plan

 

On January 19, 2006, the Company adopted the 2006 Equity Incentive Plan (the “Plan”), which provides for the granting of dividend equivalent rights options, performance unit awards, phantom shares, stock appreciation rights and stock awards, each of which are subject to such conditions based upon continued employment, passage of time or satisfaction of performance criteria or other criteria as permitted by the plan. The plan, as amended on September 17, 2010, allows the Company to award, subject to approval by the Board of Directors, up to 950,000 shares of stock, to officers, employees, and directors, consultants and service providers of the Company or its affiliates. Awards may be granted for a term of up to ten years from the effective date of grant. Under the Plan, our Board of Directors has sole discretion as to the exercise date of any awards granted. The per-share exercise price of incentive stock awards may not be less than the market value of a share of common stock on the date the award is granted. Any awards that expire unexercised or are canceled become available for re-issuance.

 

The Company can issue the restricted shares as of the grant date either by the issuance of share certificate(s) evidencing restricted shares or by documenting the issuance in uncertificated or book entry form on the Company's stock records. Except as provided by the Plan, the employee does not have the right to make or permit to exist any transfer or hypothecation of any restricted shares. When restricted shares vest, the employee must either pay the Company within two business days the amount of all tax withholding obligations imposed on the Company or make an election pursuant to Section 83(b) of the Internal Revenue Code to pay taxes at grant date.

 

Restricted shares may be subject to one or more objective employment, performance or other forfeiture conditions established by the Plan Committee at the time of grant. The restricted shares will not vest unless the Company’s retained earnings at the end of the fiscal quarter preceding the third anniversary of the restricted share award date are greater than the award value of the restricted shares. Any shares of restricted stock that are forfeited will again become available for issuance under the Plan. An employee or director has the right to vote the shares of restricted stock after grant until they are forfeited. Compensation cost for restricted stock is equal to the market value of the shares at the date of the award and is amortized to compensation expense over the vesting period. Dividends, if any, will be paid on awarded but unvested stock.

 

The Company did not issue any shares of restricted stock, nor were there any forfeitures of restricted stock, during the first quarter of 2014. During the three months ended March 31, 2013 the Company issued 1,245 shares of restricted stock pursuant to the Plan.  The shares cliff vest in three years and are fully vested in 2016, subject to meeting the performance criteria of the Plan. The weighted-average fair value per share of restricted stock issued during the three months ended March 31, 2013 was $1.76.  Compensation cost associated with the issuances was $2,191 for the quarter ended March 31, 2013. During the first quarter of 2013, 835 shares were forfeited, having a weighted average price of $3.50. Shares vested in the first quarters of 2014 and 2013 were 14,827 and 30,229, respectively. Compensation cost amortized to expense for the first quarters of 2014 and 2013 was $10,364 and $39,039, respectively.

 

- 17 -
 

 

The Plan also allows for the issuance of Stock Appreciation Rights ("SARs"). The SARs entitle the participant to receive the excess of (1) the market value of a specified or determinable number of shares of the stock at the exercise date over the fair value at grant date or (2) a specified or determinable price which may not in any event be less than the fair market value of the stock at the time of the award. Upon exercise, the Company can elect to settle the awards using either Company stock or cash. The shares start vesting after five years and vest at 20% per year until fully vested. Compensation cost for SARs is amortized to compensation expense over the vesting period. No SARs were issued during the first quarters of 2014 and 2013.

 

Note 11 – Fair Value Measurements

 

Generally accepted accounting principles (“GAAP”) provide a framework for measuring and disclosing fair value that requires disclosures about the fair value of assets and liabilities recognized in the balance sheet, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).

 

Fair value is defined as the exchange in price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of the lower of cost or market accounting or the writing down of individual assets.

 

The following methods and assumptions were used to estimate the fair value of significant financial instruments:

 

Fair Value Hierarchy

 

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

 

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

 

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

  

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

 

Assets Recorded at Fair Value on a Recurring Basis

 

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

 

Securities Available-for-Sale - Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

 

Loans - The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At March 31, 2014 and December 31, 2013, a significant portion of impaired loans were evaluated based upon the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

 

- 18 -
 

 

Mortgage Loans Held for Sale - The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

 

Other Real Estate Owned - Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charges to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

 

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy at March 31, 2014 and December 31, 2013.

  

    Total     Level 1     Level 2     Level 3  
March 31, 2014                                
Available-for-sale securities:                                
Mortgage-backed securities   $ 8,472,085     $ -     $ 8,472,085     $ -  
Corporate bonds     2,751,329       -       2,751,329       -  
Equity security     30,000       -       30,000       -  
      11,253,414       -       11,253,414       -  
Mortgage loans held for sale (1)     937,278       -       937,278       -  
    $ 12,190,692     $ -     $ 12,190,692     $ -  
                                 
December 31, 2013                                
Available-for-sale securities:                                
Mortgage-backed securities   $ 9,318,633     $ -     $ 9,318,633     $ -  
Corporate bonds     2,796,210       -       2,796,210       -  
Equity security     30,000       -       30,000       -  
      12,144,843       -       12,144,843       -  
Mortgage loans held for sale (1)     2,248,252       -       2,248,252       -  
    $ 14,393,095     $ -     $ 14,393,095     $ -  

 

(1) Carried at the lower of cost or market.

 

There were no liabilities measured at fair value on a recurring basis at March 31, 2014 and December 31, 2013.

 

Assets Recorded at Fair Value on a Nonrecurring Basis

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2014 and December 31, 2013, aggregated by level in the fair value hierarchy within which those measurements fall.

  

    Total     Level 1     Level 2     Level 3  
March 31, 2014                                
Collateral-dependent impaired loans receivable   $ 10,392,155     $ -     $ -     $ 10,392,155  
Other real estate owned     7,236,115       -       -       7,236,115  
Total assets at fair value   $ 17,628,270     $ -     $ -     $ 17,628,270  

 

- 19 -
 

 

    Total     Level 1     Level 2     Level 3  
December 31, 2013                                
Collateral-dependent impaired loans receivable   $ 13,359,438     $ -     $ -     $ 13,359,438  
Other real estate owned     8,932,634       -       -       8,932,634  
Total assets at fair value   $ 22,292,072     $ -     $ -     $ 22,292,072  

 

For level 3 assets measured at fair value on a non-recurring basis as of March 31, 2014 and December 31, 2013, the significant unobservable inputs in the fair value measurements were as follows:

 

          General
    Valuation Technique   Significant Unobservable Inputs   Range
         
Collateral-dependant impaired loans receivable   Appraised Value   Collateral discounts   0-10%
             
Other real estate owned   Appraised Value   Collateral discounts and estimated costs to sell   0-10%

 

 

There were no liabilities measured at fair value on a nonrecurring basis at March 31, 2014 and December 31, 2013.

 

Disclosures about Fair Value of Financial Instruments

 

The following describes the valuation methodologies used by the Company for estimating fair value of financial instruments not recorded at fair value in the balance sheet on a recurring or nonrecurring basis:

 

Cash and Due from Banks and Interest-bearing Deposits with Other Banks - The carrying amount is a reasonable estimate of fair value.

 

Time Deposits in other Banks - The carrying amount is a reasonable estimate of fair value.

 

Securities Held-to-Maturity - The fair values of securities held-to-maturity are based on quoted market prices or dealer quotes. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities

 

Equity Securities - The carrying amount of nonmarketable equity securities is a reasonable estimate of fair value since no ready market exists for these securities.

 

Loans Receivable – For certain categories of loans, such as variable rate loans which are repriced frequently and have no significant change in credit risk, fair values are based on the carrying amounts. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

 

Deposits - The fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date. The fair values of certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates to a schedule of aggregated expected maturities.

 

Securities Sold Under Agreements to Repurchase - The carrying amount is a reasonable estimate of fair value because these instruments typically have terms of one day.

 

Advances From Federal Home Loan Bank - The fair values of fixed rate borrowings are estimated using a discounted cash flow calculation that applies the Company’s current borrowing rate from the Federal Home Loan Bank. The carrying amounts of variable rate borrowings are reasonable estimates of fair value because they can be repriced frequently.

 

Junior Subordinated Debentures - The carrying value of the junior subordinated debentures approximates their fair value since they were issued at a floating rate.

 

Accrued Interest Receivable and Payable - The carrying value of these instruments is a reasonable estimate of fair value.

 

Off-Balance Sheet Financial Instruments - Fair values of off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.

 

- 20 -
 

 

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2014 and December 31, 2013. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

 

                Fair Value Measurements  
                Quoted              
                Prices in              
                Active Markets              
                for Identical     Other     Significant  
                Assets or     Observable     Unobservable  
    Carrying     Fair     Liabilities     Inputs     Inputs  
    Amount     Value     (Level 1)     (Level 2)     (Level 3)  
March 31, 2014                                        
                                         
Financial Assets:                                        
Securities held-to-maturity   $ 35,643,920     $ 35,933,179     $ -     $ 35,933,179     $ -  
Loans receivable     239,634,692       241,656,000       -       -       241,656,000  
                                         
Financial Liabilities:                                        
Certificates of deposit   $ 80,788,171     $ 81,138,000     $ -     $ 81,138,000     $ -  
Advances from Federal Home Loan Bank     17,000,000       17,009,000       -       17,009,000       -  
                                         
December 31, 2013                                        
                                         
Securities held-to-maturity   $ 36,951,934     $ 36,951,934     $ -     $ 36,951,934     $ -  
Loans receivable     238,502,131       240,472,000       -       -       240,472,000  
                                         
Financial Liabilities:                                        
Certificates of deposit   $ 84,545,046     $ 85,081,000     $ -     $ 85,081,000     $ -  
Advances from Federal Home Loan Bank     23,000,000       23,010,000       -       23,010,000       -  

 

Note 12 - Subsequent Events

 

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Unrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred that require accrual or disclosure.

 

- 21 -
 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation

 

The following discussion reviews our results of operations and assesses our financial condition as of and for the periods indicated. You should read the following discussion and analysis in conjunction with the discussion of forward-looking statements and unaudited condensed consolidated financial statements as of and for the three months ended March 31, 2014 and 2013 included elsewhere in this report and the audited consolidated financial statements included our Annual Report on Form 10-K for the year ended December 31, 2013.

 

Cautionary Note Regarding Forward-Looking Statements

 

The statements contained in this report on Form 10-Q that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. We caution readers of this report that such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements.

 

Although we believe that our expectations of future performance are based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from our expectations.

 

These forward-looking statements involve risks and uncertainties and may not be realized due to a variety of factors, including, but not limited to the following:

 

· deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses;

 

· changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments;

 

· the failure of assumptions underlying the establishment of reserves for possible loan losses;

 

· changes in political and economic conditions, including the political and economic effects of the current economic downturn and other major developments, including the ongoing war on terrorism, continued tensions in the Middle East, and the ongoing economic challenges facing the European Union;

 

· changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts its operations, including, without limitation, reduced rates of business formation and growth, commercial and residential real estate development, and real estate prices;

 

· the Company’s ability to comply with any requirements imposed on it or the Bank by their respective regulators, and the potential negative consequences that may result;

 

· the impacts of renewed regulatory scrutiny on consumer protection and compliance led by the Consumer Finance Protection Bureau;

 

· fluctuations in markets for equity, fixed-income, commercial paper and other securities, which could affect availability, market liquidity levels, and pricing;

 

· governmental monetary and fiscal policies, including the undetermined effects of the Federal Reserve’s “Quantitative Easing” program, as well as other legislative and regulatory changes;

 

· changes in capital standards and asset risk-weighting included in promulgated rules to implement the so-called “Basel III” accords;

 

· the risks of changes in interest rates or an unprecedented period of record-low interest rates on the level and composition of deposits, loan demand and the values of loan collateral, securities and interest sensitive assets and liabilities; and

 

· the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone and the Internet.

 

Forward-looking statements speak only as of the date on which they are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made to reflect the occurrence of unanticipated events.

 

- 22 -
 

 

Overview

 

The following discussion describes our results of operations for the quarter ended March 31, 2014 as compared to the quarter ended March 31, 2013 and also analyzes our financial condition as of March 31, 2014 as compared to December 31, 2013.

 

Like most community bank holding companies, we derive the majority of our income from interest received on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings.  Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread. 

 

Due to risks inherent in all loans, we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible.  We maintain this allowance by charging a provision for loan losses against our operating earnings for each period.  We have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.

 

In addition to earning interest on our loans and investments, we earn income through fees and other charges to our customers.  We have also included a discussion of the various components of this non-interest income, as well as our non-interest expense.

 

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements.  We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in our filings with the SEC.

 

Critical Accounting Policies

 

We have adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in the notes to the consolidated financial statements at December 31, 2013 as filed in our Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions we have made, which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on the historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of our judgments and assumptions, actual results could differ from these judgments and estimates which could have a major impact on our carrying values of assets and liabilities and our results of operations.

 

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

 

Regulatory Matters

 

Following an examination of the Bank by the FDIC during the first quarter of 2010, the Bank's Board of Directors agreed to enter into a Memorandum of Understanding (the "Bank MOU") with the FDIC and the South Carolina Board of Financial Institutions (the “SC Board”) that became effective August 19, 2010. Among other things, the Bank MOU provides for the Bank to (i) review and formulate objectives relative to liquidity and growth, including a reduction in reliance on volatile liabilities, (ii) formulate plans for the reduction and improvement in adversely classified assets, (iii) maintain a Tier 1 leverage capital ratio of 8% and continue to be "well capitalized" for regulatory purposes, (iv) continue to maintain an adequate allowance for loan and lease losses, (v) not pay any dividend to the Bank's parent holding company without the approval of the regulators, (vi) review officer performance and consider additional staffing needs, and (vii) provide progress reports and submit various other information to the regulators.

 

In addition, on the basis of the same examination by the FDIC and the SC Board, the Federal Reserve requested that the Company enter into a separate Memorandum of Understanding, which the Company entered into in December 2010 (the "Company MOU"). While this agreement provides for many of the same measures suggested by the Bank MOU, the Company MOU requires that the Company seek pre-approval from the Federal Reserve prior to the declaration or payment of dividends or other interest payments relating to its securities. As a result, until the Company is no longer subject to the Company MOU, it will be required to seek regulatory approval prior to paying scheduled dividends on its preferred stock and on its trust preferred securities, including the Series A and Series B Preferred Shares. This provision will also apply to the Company's common stock, although to date, the Company has not elected to pay dividends on its shares of common stock.

 

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The Federal Reserve approved the scheduled payment of dividends on the Company’s preferred stock and interest payments on the Company’s trust preferred securities for the first three quarters of 2011; however, the Federal Reserve did not approve the Company’s request to pay dividends and interest payments relating to its outstanding classes of preferred stock and trust preferred securities due and payable in the fourth quarter of 2011, and such consent has not been granted thereafter, largely out of deference to the Federal Reserve’s policy statement on dividends.

 

A policy statement published by the Board of Governors of the Federal Reserve System indicates that, as a general matter, it believes the board of directors of a bank holding company should eliminate, defer, or significantly reduce the company’s dividends if:

· the company’s net income available to shareholders for the preceding four quarters is not sufficient to fully fund the dividends;

 

· the prospective rate of earnings retention is not consistent with the company’s capital needs and overall current and prospective financial condition; or

 

· the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.

 

The policy statement notes that a failure to do so could result in a supervisory finding that the organization is operating in an unsafe and unsound manner. We believe that the criteria noted above will be heavily weighted by the Federal Reserve in evaluating any future request by the Company to pay dividends on its Series A Shares and the Series B Shares and interest on its outstanding trust preferred securities. Accordingly, we do not anticipate submitting further approval requests until such time as each of the stated criteria has been met or there are other compelling reasons to believe such a request, if submitted, would be approved.

 

In response to these regulatory matters, the Bank and the Company have taken various actions designed to improve our lending procedures, nonperforming assets, liquidity and capital position and other conditions related to our operations, which are more fully described in turn as part of this discussion. We believe that the successful completion of these initiatives, and the continued improvement of the local economy of the communities we serve, will result in full compliance with our regulatory obligations with the FDIC, the SC Board and the Federal Reserve and position us well for stability and growth over the long term.

 

Effect of Economic Trends

 

Economic conditions, competition and federal monetary and fiscal policies also affect financial institutions. Lending activities are also influenced by regional and local economic factors, such as housing supply and demand, competition among lenders, customer preferences and levels of personal income and savings in our primary market area.

 

Results of Operations

 

Our results of operations for the first quarter of 2014 were $385,745 higher than results achieved in the first quarter of 2013. Specifically, for the first quarter 2014, we realized a net income available to common shareholders of $106,018, or a basic and diluted income per share of $0.02. For the first quarter 2013, we incurred a net loss available to common shareholders of $279,727, or a basic and diluted loss per share of $0.07.

 

Our 2014 operating results were positively impacted by the reduction of $252,068 in our noninterest expenses and an increase of $192,581 in our net interest income. However, our operating results were negatively impacted by the reduction of $111,714 in noninterest income. A detailed discussion of each of these items follows.

 

Income Statement Review

 

Net Interest Income

 

The largest component of our net income is net interest income, which is the difference between the income earned on assets and interest paid on deposits and on the borrowings used to support such assets. Net interest income is determined by the yields earned on our interest-earning assets and the rates paid on interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities. The total interest-earning assets yield rate less the total interest-bearing liabilities rate represents our net interest rate spread.

 

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Net interest income for the first quarter of 2014 was $3,238,201 compared to $3,045,620 for the first quarter of 2013, an increase of $192,581, or 6.32%. The increase is due primarily to the 18.95% decline in the average volume of our interest bearing liabilities, slightly offset by a decline in the average volume of our earning assets of 16.06%. Additionally, we reduced the average rate paid on our interest bearing liabilities by 46 basis points, while we were able to increase the average rate earned on our earning assets by 51 basis points.

 

For the first quarter of 2014, average-earning assets totaled $299,638,201 with an annualized average yield of 4.88% compared to $356,963,528 and 4.37%, respectively, for the first quarter of 2013. Average interest-bearing liabilities totaled $249,959,338 with an annualized average cost of 0.59% for first quarter of 2014 compared to $308,409,906 and 1.05%, respectively, for the first quarter of 2013.

 

Our net interest margin and net interest spread were 4.38% and 4.29%, respectively, for the first quarter of 2014 compared to 3.46% and 3.32%, respectively, for the first quarter of 2013.

 

Because loans often provide a higher yield than other types of earning assets, one of our goals is to maintain our loan portfolio as the largest component of total earning assets. Loans comprised 80.86% and 73.40% of average earning assets at March 31, 2014 and 2013, respectively. Loan interest income for the three months ended March 31 2014 and 2013 was $3,273,679 and $3,471,204, respectively. The annualized average yield on loans was 5.48% and 5.37% for the first quarters of 2014 and 2013, respectively. Average balances of loans decreased to $242,289,822 during the first quarter of 2014, a decrease of $19,734,496 from the average of $262,024,318 during first quarter of 2013. Our loan interest income for the first quarter of 2014 was favorably impacted by the significant reduction of our non-performing loans. At March 31, 2014 our nonaccruing loans totaled $7,688,522 compared to $19,539,884 as of March 31, 2013, a decrease of $11,851,362, or 60.65%. Additional information may be found in the “Rate/Volume Analysis” presented below.

 

Available-for-sale and held-to-maturity investment securities averaged $48,070,625 and $57,969,319 for the first quarters of 2014 and 2013, respectively. Their percentage of average earning assets was relatively the same for both periods, 16.04% for 2014 compared to 16.24% for 2013. Interest earned on these securities totaled $316,552 and $347,984 for the first quarters of 2014 and 2013, respectively, resulting in an annualized average yield of 2.67% and 2.43%, respectively.

 

Our average interest-bearing deposits were $215,923,992 and $282,714,350 for the first quarters of 2014 and 2013, respectively. This represented a decrease of $66,790,358, or 23.62%. Total interest paid on deposits for first quarters of 2014 and 2013 was $282,452 and $678,374, respectively. As our loan demand declined, we concurrently lowered our rates paid for deposits, specifically for time deposits, which is the primary reason that the amount of our average time deposits are $53,289,342, or 38.89%, lower during the first quarter of 2014 than during the same period in 2013.

 

The average balance of our other interest-bearing liabilities was $34,035,346 and $25,695,556 for the first quarters of 2014 and 2013, respectively. This represented an increase of $8,339,790, or 32.46%, which is primarily attributable to the increase of $6,835,658 in our average volume of borrowing from the Federal Home Loan Bank, that replaced our higher cost time deposits. For the first quarter of 2014, the annualized average cost of borrowing from the Federal Home Land Bank was 0.43%, while the average rate paid on time deposits was 1.21% for this period.

 

The following table sets forth, for the periods indicated, certain information related to our average balance sheet and our average yields on assets and average costs of liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from the daily balances throughout the periods indicated.

 

    Average Balances, Income and Expenses, and Rates  
Period ended March 31,   2014     2013     2012  
    Average     Income/     Yield/     Average     Income/     Yield/     Average     Income/     Yield/  
(Dollars in thousands)   Balance     Expense     Rate     Balance     Expense     Rate     Balance     Expense     Rate  
Assets                                                                        
Earning assets:                                                                        
Loans (1)   $ 242,290     $ 3,274       5.48 %   $ 262,024     $ 3,471       5.37 %   $ 303,831     $ 4,400       5.82 %
Securities, taxable     44,922       288       2.60       57,969       348       2.43       66,157       465       2.82  
Securities, nontaxable     3,148       28       3.61       -       -       0.00       20,155       197       3.93  
Other earning assets     9,278       12       0.52       36,970       27       0.30       39,732       27       0.28  
Total earning assets     299,638       3,602       4.88       356,963       3,846       4.37       429,875       5,089       4.76  
Non-earning assets     48,546                       55,168                       58,599                  
Total assets   $ 348,184                     $ 412,131                     $ 488,474                  

 

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    Average Balances, Income and Expenses, and Rates  
Period ended March 31,   2014     2013     2012  
    Average     Income/     Yield/     Average     Income/     Yield/     Average     Income/     Yield/  
(Dollars in thousands)   Balance     Expense     Rate     Balance     Expense     Rate     Balance     Expense     Rate  
Liabilities and Shareholders' Equity                                                                        
Interest-bearing deposits:                                                                        
Transaction accounts   $ 46,462     $ 9       0.08 %   $ 43,956     $ 14       0.13 %   $ 42,449     $ 32       0.31 %
Savings and money market accounts     85,721       25       0.12       101,728       60       0.24       120,732       122       0.41  
Time deposits     83,741       249       1.21       137,030       605       1.79       201,244       1,052       2.10  
Total interest-bearing deposits     215,924       283       0.53       282,714       679       0.97       364,425       1,206       1.33  
                                                                         
Other interest-bearing liabilities:                                                                        
Federal Home Loan Bank borrowing     17,835       19       0.43       11,000       64       2.36       13,000       66       2.04  
Junior subordinated debentures     10,310       60       0.58       10,310       56       0.54       10,310       63       0.61  
Other     5,890       2       0.14       4,386       1       0.09       470       -       0.10  
Total other interest-bearing Liabilities     34,035       81       0.97       25,696       121       1.91       23,780       129       2.18  
                                                                         
Total interest-bearing liabilities     249,959       364       0.59       308,410       800       1.05       388,205       1,335       1.38  
Noninterest-bearing deposits     63,080                       60,799                       55,929                  
Other liabilities     2,883                       1,901                       2,695                  
Shareholders' equity     32,262                       41,021                       41,645                  
                                                                         
Total liabilities and equity   $ 348,184                     $ 412,131                     $ 488,474                  
                                                                         
Net interest income/interest spread           $ 3,238       4.29 %           $ 3,046       3.32 %           $ 3,754       3.38 %
                                                                         
Net yield on earning assets                     4.38 %                     3.46 %                     3.51 %

 

(1) Includes mortgage loans held for sale and nonaccruing loans

 

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume.  The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

 

Three Months Ended March 31,   2014 Compared to 2013     2013 Compared to 2012  
    Due to increase (decrease) in     Due to increase (decrease) in  
(Dollars in thousands)   Volume     Rate     Total     Volume     Rate     Total  
Interest income:                                                
Loans   $ (269 )   $ 70     $ (199 )   $ (595 )   $ (334 )   $ (929 )
Securities, taxable     (83 )     23       (60 )     (55 )     (62 )     (117 )
Securities, tax exempt     -       29       29       (98 )     (98 )     (196 )
Other earning assets     (27 )     13       (14 )     (3 )     1       (2 )
Total interest income     (379 )     135       (244 )     (751 )     (493 )     (1,244 )
                                                 
Interest expense:                                                
Interest-bearing deposits                                                
Interest-bearing transaction accounts     1       (6 )     (5 )     1       (20 )     (19 )
Savings and money market accounts     (8 )     (27 )     (35 )     (17 )     (45 )     (62 )
Time deposits     (194 )     (162 )     (356 )     (306 )     (142 )     (448 )
Total interest-bearing deposits     (201 )     (195 )     (396 )     (322 )     (207 )     (529 )
                                                 
Other interest-bearing liabilities:                                                
Federal Home Loan Bank borrowings     25       (70 )     (45 )     (11 )     9       (2 )
Junior subordinated debentures     -       4       4       -       (6 )     (6 )
Other     1       -       1 )     1       -       1  
Total other interest-bearing liabilities     26       (66 )     (40 )     (10 )     3       (7 )
                                                 
Total interest expense     (175 )     (261 )     (436 )     (332 )     (204 )     (536 )
                                                 
Net interest income   $ (204 )   $ 396     $ 192     $ (419 )   $ (289 )   $ (708 )

  

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Provision and Allowance for Loan Losses

 

We have developed policies and procedures for evaluating the overall quality of our credit portfolio and the timely identification of potential problem credits. On a quarterly basis, our Board of Directors reviews and approves the appropriate level for the allowance for loan losses based upon management’s recommendations, the results of our internal monitoring and reporting system, and an analysis of economic conditions in our market. The objective of management has been to fund the allowance for loan losses at a level greater than or equal to our internal risk measurement system for loan risk.

 

Additions to the allowance for loan losses, which are expensed as the provision for loan losses on our statement of operations, are made periodically to maintain the allowance at an appropriate level based on management’s analysis of the potential risk in the loan portfolio. Loan losses and recoveries are charged or credited directly to the allowance. The amount of the provision is a function of the level of loans outstanding, the level of nonperforming loans, historical loan loss experience, the amount of loan losses actually charged against the reserve during a given period, and current and anticipated economic conditions.

 

The allowance represents an amount which management believes will be adequate to absorb inherent losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on regular evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in our lending policies and procedures, changes in the local and national economy, changes in volume or type of credits, changes in the volume or severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.

 

More specifically, in determining our allowance for loan losses, we regularly review loans for specific and impaired reserves based on the appropriate impairment assessment methodology. Pooled reserves are determined using historical loss trends measured over a four-quarter average applied to risk rated loans grouped by Federal Financial Institutions Examination Council (“FFIEC”) call code and segmented by impairment status. The pooled reserves are calculated by applying the appropriate historical loss ratio to the loan categories. Impaired loans greater than a minimum threshold established by management are excluded from this analysis. The sum of all such amounts determines our pooled reserves. In line with our peer group, we review historical losses over four quarters, which results in a provision estimate responsive to current economic conditions. The historical loss factors utilized in our model have been updated as of the end of the fourth quarter 2014 to reflect losses realized through the end of fourth quarter 2013.

 

As we mention above, we track our portfolio and analyze loans grouped by FFIEC call code categories. The first step in this process is to risk grade each loan in the portfolio based on one common set of parameters. These parameters include items like debt-to-worth ratio, liquidity of the borrower, net worth, experience in a particular field and other factors such as underwriting exceptions. Weight is also given to the relative strength of any guarantors on the loan.

 

After risk grading each loan, we then segment the portfolio by FFIEC call code groupings, separating out substandard and impaired loans.  The remaining loans are grouped into “performing loan pools.”  The loss history for each performing loan pool is measured over a specific period of time to create a loss factor. The relevant look back period is determined by management, regulatory guidance, and current market events.  The loss factor is then applied to the pool balance and the reserve per pool calculated.  Loans deemed to be substandard but not impaired are segregated and a loss factor is applied to this pool as well.  Loans are segmented based upon sizes as smaller impaired loans are pooled and a loss factor applied, while larger impaired loans are assessed individually using the appropriate impairment measuring methodology.  Finally, five qualitative factors are utilized to assess economic and other trends not currently reflected in the loss history. These factors include concentration of credit across the portfolio, the experience level of management and staff, effects of changes in risk selection and underwriting practice, industry conditions and the current economic and business environment.  A quantitative value is assigned to each of the five factors, which is then applied to the performing loan pools. Negative trends in the loan portfolio increase the quantitative values assigned to each of the qualitative factors and, therefore, increase the reserve.  For example, as general economic and business conditions decline, this qualitative factor’s quantitative value will increase, which will increase the reserve requirement for this factor.  Similarly, positive trends in the loan portfolio, such as improvement in general economic and business conditions, will decrease the quantitative value assigned to this qualitative factor, thereby decreasing the reserve requirement for this factor.  These factors are reviewed and updated by our management committee on a regular basis to arrive at a consensus for our qualitative adjustments.

 

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Periodically, we adjust the amount of the allowance based on changing circumstances. We recognize loan losses to the allowance and add subsequent recoveries back to the allowance for loan losses. In addition, on a quarterly basis, we informally compare our allowance for loan losses to various peer institutions; however, we recognize that allowances will vary, as financial institutions are unique in the make-up of their loan portfolios and customers, which necessarily creates different risk profiles and risk weighting of qualitative factors for the institutions. We would only consider further adjustments to our allowance for loan losses based on this peer review if our allowance was significantly different from our peer group. To date, we have not made any such adjustment. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period, especially considering the overall economic weakness in many of our market areas due to a slow recovery from the recent downturn.

 

Various regulatory agencies review our allowance for loan losses through their periodic examinations, and they may require additions to the allowance for loan losses based on their judgment and assumptions about the economic condition of our market and the loan portfolio at the time of their examinations. Our losses will undoubtedly vary from our estimates, and it is possible that charge-offs in future periods will exceed the allowance for loan losses as estimated at any point in time.

 

As of March 31, 2014 and 2013, the allowance for loan losses was $2,802,823 and $4,198,520, respectively, a decrease of $1,395,697, or 33.20%, from the 2013 allowance, reflecting significant reductions in practically all categories of our problem loans. As a percentage of total loans, the allowance for loan losses was 1.17% and 1.64% at March 31, 2014 and 2013, respectively. See the discussion regarding the provision expense and “Activity in the Allowance for Loan Losses” below for additional information regarding our asset quality and loan portfolio.

 

For the first quarters of 2014 and 2013, we did not record a provision for loan losses. Our analysis of the allowance for loan losses as of March 31, 2014, revealed that our overall loss rates have been stabilizing over the past several allowance calculations and that our credit exposure is phasing out in the Myrtle Beach market and the Charleston market, which were particularly hard-hit by the downturn in real estate markets. Additionally, not having to record a provision for loan losses is reflective of our success in aggressively reducing our exposure in these markets and the volume of high-risk construction loans on our books.

 

We believe the allowance for loan losses at March 31, 2014, is adequate to meet potential loan losses inherent in the loan portfolio and, as described earlier, to maintain the flexibility to adjust the allowance should our local economy and loan portfolio either improve or decline in the future.

 

Noninterest Income

 

For the first quarter of 2014 compared to first quarter 2013, noninterest income decreased $111,714, or 10.10%. The decrease is due primarily to the following. During the first half of 2013, the U.S. economy experienced historically low mortgage rates, which resulted in a high volume of homeowners choosing to refinance their existing mortgages. However, during latter half of 2013, mortgage interest rates began to rise, resulting in a decrease in the number of refinanced mortgages. This led to the $92,329 decline in the gain on the sale of mortgage loans for the first quarter of 2014.

 

Noninterest Expenses

 

For the quarters ended March 31, 2014 and 2013, noninterest expense totaled $3,897,629 and $4,149,697, respectively, a decrease of $252,068, or 6.07%.

 

The expense for salaries and benefits was $1,812,735 and $1,928,709 for the first quarters of 2014 and 2013, respectively. By improving operating efficiencies, we were able to reduce the expense for this category by $115,974, or 6.01%

 

Furniture and equipment expense for the first quarters of 2014 and 2013 was $414,449 and $295,515, respectively, for an increase of $118,934. The increase is related to data processing refunds received in the first quarter of 2013 for prior year service interruptions and lost income.

 

Other operating expenses for first quarter of 2014 were $263,971, or 16.84% lower than experienced in for the first quarter of 2013. For the first quarters of 2014 and 2013, other operating expenses were $1,303,415 and $1,567,386, respectively. A detailed explanation for the significant changes in this expense category follows.

 

1. Professional fees were higher for the first quarter of 2014 as a result of legal fees relating to litigation arising in the ordinary course of our business as well defending a lawsuit filed by certain clients of the Schurlknight and Rivers Law Firm (“S&R”), which was a customer of the Bank.

 

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2. OREO expenses for the first quarter of 2014 were $100,979 lower than the first quarter of 2013. The decrease is attributable to the net gain/loss recognized on the sale of OREO properties that are included in OREO expenses. For the first quarter of 2014 we realized a net gain of $112,594, while for the first quarter of 2013 we realized a net loss of $24,340.

 

3. During the first quarter of 2013, we recorded a $70,000 impairment loss on our equity security that was purchased for $100,000. In the first quarter of 2014, there was no impairment loss.

 

4. The cost of our FDIC insurance assessments for the first quarter of 2014 declined $59,426, largely because we successfully reduced the average volume of our higher cost time deposits.

 

Income Taxes

 

The income tax expense related to our pretax income for the first quarters of 2014 and 2013 was offset by a reversal of an equal amount in our valuation allowance related to our deferred tax assets. Therefore no income tax provision was required for the first quarters of 2014 and 2013.

 

Balance Sheet Review

 

General

At March 31, 2014, we had total assets of $353.7 million, consisting principally of $240.6 million in loans, $48.0 million in investments, and $21.2 million in cash and due from banks.  Our liabilities at March 31, 2014, totaled $321.3 million, which consisted principally of $285.3 million in deposits, $17.0 million in FHLB advances, and $15.7 million in other borrowings. At March 31, 2014, our shareholders’ equity was $32.4 million.

 

At December 31, 2013, we had total assets of $355.4 million, consisting principally of $240.8 million in loans, $50.7 million in investments, and $18.2 million in cash and due from banks. Our liabilities at December 31, 2013 totaled $323.3 million, consisting principally of $282.4 million in deposits, $23.0 million in FHLB advances, and $15.2 million in other borrowings. At December 31, 2013, our shareholders' equity was $32.1 million.

 

Investment Securities

 

The investment securities portfolio, which is also a component of our total earning assets, consists of securities available-for-sale, securities held-to-maturity and nonmarketable equity securities.

 

Securities Available-for-Sale - At March 31, 2014, our investment in available-for-sale securities was $11,253,414. This is $891,429, or 7.34%, lower than our investment of $12,144,843 in available-for-sale securities at December 31, 2013. These securities are carried at their estimated fair value.

 

Securities Held-to-Maturity - At March 31, 2014 and December 31, 2013, securities held-to-maturity were $35,643,920 and $36,951,934, respectively, a decrease of $1,308,014, or 3.54%. These securities are carried at amortized cost, including the net unrealized gain in available-for-sale-securities that were reclassified as held-to-maturity on December 31, 2013. The net unrealized gain is being amortized to other comprehensive income over the life of the underlying securities. The net unrealized gain included in the amortized cost at March 31, 2014 and December 31, 2013, was $224,496 and $237,797, respectively. We intend to hold these securities to maturity and have the ability to do so.

 

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The amortized costs and the estimated fair value of our securities available-for-sale and held-to-maturities at March 31, 2014 and December 31, 2013 are shown in the following tables.

 

Available-for-Sale

 

    March 31, 2014     December 31, 2013  
    Amortized     Estimated     Amortized     Estimated  
    Cost     Fair Value     Cost     Fair Value  
Mortgage-backed securities   $ 8,450,875     $ 8,472,085     $ 9,277,577     $ 9,318,633  
Corporate bonds     2,771,515       2,751,329       2,765,950       2,796,210  
Equity security     30,000       30,000       30,000       30,000  
Total   $ 11,252,390     $ 11,253,414     $ 12,073,527     $ 12,144,843  

 

Held-to-Maturity

    March 31, 2014     December 31, 2013  
    Amortized     Estimated     Amortized     Estimated  
    Cost     Fair Value     Cost     Fair Value  
Government sponsored enterprises   $ 6,912,687     $ 6,888,702     $ 7,146,409     $ 7,070,985  
Mortgage-backed securities     25,346,867       25,792,453       26,404,573       26,731,341  
Municipals     3,159,870       3,252,024       3,163,155       3,149,608  
Total     35,419,424     $ 35,933,179       36,714,137     $ 36,951,934  
Capitalization of net unrealized gains on securities transferred from available-for-sale     224,496               237,797          
Total   $ 35,643,920             $ 36,951,934          

 

At March 31, 2014, there were no securities available-for-sale or securities held-to-maturity that had been in a loss position for twelve months or more.

 

Distribution and Yields

 

Contractual maturities and yields on our securities available-for-sale and held-to-maturity at March 31, 2014 are shown in the following tables. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities are presented separately, maturities of which are based on expected maturities since paydowns are expected to occur before contractual maturity dates.

 

Available-for-Sale (1)

    Due after  
    ten years  
(Dollars in thousands)   Amount     Yield  
Corporate bonds   $ 2,751       0.54 %

 

(1) Excludes mortgage-backed securities totaling $8,472,085 with a yield of 2.58% and an equity security in the amount $30,000.

 

Held-to-Maturity (2)

 

    Due after  
    ten years  
(Dollars in thousands)   Amount     Yield  
U.S. Government sponsored agencies   $ 6,845       3.24 %
Municipals     3,146       4.20  
Total   $ 9,991       3.53 %

 

(2) Excludes mortgage-backed securities totaling $25,653 with a yield of 3.19%.

 

Nonmarketable Equity Securities – Nonmarketable equity securities are recorded at their original cost since no ready market exists for these securities. At March 31, 2014 and December 31, 2013, nonmarketable equity securities consisted of Federal Home Loan Bank and Community Bankers Bank stock, which are recorded at their original cost of $1,084,300 and $58,100, respectively and $1,536,800 and $58,100, respectively. These securities are held primarily as a pre-requisite for accessing liquidity sources provided by the issuers of these securities.

 

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Loans

 

Loans, including loans held for sale, are the largest category of earning assets and typically provide higher yields than the other types of earning assets. Associated with the higher loan yields are the inherent credit and liquidity risks, which we attempt to control and counterbalance. Loans averaged $242,289,822 during the first quarter of 2014 compared to $262,024,318 during the first quarter of 2013, a decrease of $19,734,496, or 7.53%. From March 31, 2013 to March 31, 2014, we charged off loans totaling approximately $2,374,000 and foreclosed on loans totaling approximately $4,395,000, whereby the loan balances were transferred to other real estate owned. The remainder of this decrease was the result of the economic downturn in our markets and worldwide deleveraging that caused the volume of new loan customers and average loan balances carried by current customers to decrease. At March 31, 2014, total loans were $240,571,970 compared to $240,750,383 at December 31, 2013, a decrease of $174,413, or 0.07%. Excluding loans held for sale, loans were $239,634,692 at March 31, 2014, compared to $238,502,131 at December 31, 2013, an increase of $1,132,561, or 0.47%. This increase is mainly attributable to the rise of $1,482,803 in our nonresidential loans, which includes commercial loans secured by real estate. During the latter part of 2013, we renewed our emphasis on marketing commercial loan products to small business owners.

 

The following table summarizes the composition of our loan portfolio at March 31, 2014 and December 31, 2013.

 

    March 31,     % of     December 31,     % of  
    2014     Total     2013     Total  
Mortgage loans on real estate                                
Construction   $ 23,890,521       9.97 %   $ 24,175,347       10.14 %
Residential 1-4 family     35,761,717       14.92       35,873,036       15.04  
Multifamily     3,890,201       1.62       4,312,057       1.81  
Second mortgages     4,077,550       1.70       4,245,778       1.78  
Equity lines of credit     21,427,102       8.94       21,270,126       8.92  
Total residential     65,156,570       27.18       65,700,997       27.55  
Nonresidential     105,861,288       44.18       104,378,485       43.76  
Total real estate loans     194,908,379       81.33       194,254,829       81.45  
Commercial and industrial     32,584,523       13.60       32,486,848       13.62  
Consumer     12,136,195       5.06       11,725,319       4.92  
Other, net     5,595       0.01       35,135       0.01  
Total loans   $ 239,634,692       100.00 %   $ 238,502,131       100.00 %

 

In the context of this discussion, a “real estate mortgage loan” is defined as any loan, other than a loan for construction purposes, secured by real estate, regardless of the purpose of the loan.  It is common practice for financial institutions in our market area to obtain a mortgage on the borrower’s real estate when possible, in addition to any other available collateral.  This real estate collateral is taken as security to reinforce the likelihood of the ultimate repayment of the loan and tends to increase management’s willingness to make real estate loans and, to that extent, also tends to increase the magnitude of the real estate loan portfolio component.

 

The largest component of our loan portfolio is real estate mortgage loans. At March 31, 2014, real estate mortgage loans totaled $194,908,379 and represented 81.33% of the total loan portfolio, compared to $194,254,829, or 81.45%, at December 31, 2013. This represents an increase of $653,550, or 0.34%, from the December 31, 2013 balance.

 

Residential mortgage loans totaled $65,156,570 at March 31, 2014, and represented 27.18% of the total loan portfolio, compared to $65,700,997 and 27.55% respectively, at December 31, 2013.  Residential real estate loans consist of first and second mortgages on single or multi-family residential dwellings.

 

Nonresidential mortgage loans, which include commercial loans and other loans secured by multi-family properties and farmland, totaled $105,861,288 at March 31, 2014, compared to $104,378,485 at December 31, 2013.  This represents an increase of $1,482,803, or 1.42%, from the December 31, 2013 balance. These loans represented 44.18% and 43.76% of the total loans at March 31, 2014 and December 31, 2013, respectively.

 

Real estate construction loans were $23,890,521 and $24,175,348 at March 31, 2014 and December 31, 2013, respectively, and represented 9.97% and 10.14% of the total loan portfolio, respectively. From December 31, 2013 to March 31, 2014, these loans declined $284,827, or 1.18%.

 

Currently, the demand for real estate loans in our market area is weak, largely because of a slow recovery from the recent recession that affected many businesses and individuals in our market area.

 

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Commercial and industrial loans increased $97,675, or 0.30%, to $32,584,523 at March 31, 2014, from $32,486,848 at December 31, 2013. The increase is attributable to our renewed emphasis on marketing commercial loan products to small business owners. At March 31, 2014 and December 31, 2013, commercial and industrial loans represented 13.60% and 13.62%, respectively, of the total loan portfolio.

 

Our loan portfolio is also comprised of consumer and other loans that totaled $12,141,790 and $11,760,454 at March 31, 2014 and December 31, 2013, respectively, and represented 5.07% and 4.93%, respectively, of the total loan portfolio. From December 31, 2013 to March 31, 2014, our consumer and other loans have increased by $381,336, resulting primarily from the implementation of several marketing programs designed to increase consumer borrowings.

 

Our loan portfolio reflects the diversity of our markets.  The economies of our markets contain elements of medium and light manufacturing, higher education, regional health care, and distribution facilities. We expect our local economy to remain stable; however, due to the slow economic recovery in some of our markets, we do not expect any material growth in our loan portfolio in the near future. We do not engage in foreign lending.

 

Maturities and Sensitivity of Loans to Changes in Interest Rates

 

The information in the following tables is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity.  Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity.  Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

 

The following table summarizes loan maturity distribution by type and related interest rate characteristics at March 31, 2014.

 

          Over              
          One Year              
    One Year or     Through     Over Five        
( Dollars in thousands )   Less     Five Years     Years     Total  
                         
Real estate   $ 46,059     $ 123,239     $ 25,610     $ 194,908  
Commercial and industrial     16,883       15,506       196       32,585  
Consumer and other     1,670       7,921       2,551       12,142  
    $ 64,612     $ 146,666     $ 28,357     $ 239,635  
Loans maturing after one year with:                                
Fixed interest rates                           $ 129,281  
Floating interest rates                             45,742  
                            $ 175,023  

 

Allowance for Loan Losses

 

The following table summarizes the allocation of the allowance for loan losses at March 31, 2014 and December 31, 2013.

 

    March 31,     % of     December 31,     % of  
(Dollars in thousands)   2014     Total     2013     Total  
Real estate loans                                
Construction   $ 280       9.99 %   $ 303       10.47 %
Residential     1,045       37.28       1,043       36.04  
Nonresidential     1,303       46.49       1,382       47.75  
Total real estate loans     2,628       93.76       2,728       94.26  
Commercial and industrial     100       3.57       65       2.25  
Consumer and other     75       2.67       101       3.49  
Total loans   $ 2,803       100.00 %   $ 2,894       100.00 %

 

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Activity in the Allowance for Loan Losses

 

The following table summarizes the activity related to our allowance for loan losses for the three months ended March 31, 2014 and 2013.

 

    Three Months Ended  
    March 31,  
(Dollars in thousands)   2014     2013  
Balance, January 1,   $ 2,894     $ 4,167  
Loans charged off:                
Real estate – Construction     1       7  
Real estate – Residential     3       95  
Real estate – Nonresidential     188       48  
Total real estate loans     192       150  
Commercial and industrial     -       3  
Consumer and other     10       13  
Total loan losses     202       166  
                 
Recoveries of previous loan losses:                
Real estate – Construction     9       78  
Real estate – Residential     3       90  
Real estate – Nonresidential     89       -  
Total real estate loans     101       168  
Commercial and industrial     7       28  
Consumer and other     3       2  
Total recoveries     111       198  
Net charge-offs (recoveries)     91       (32 )
Provision for loan losses     -       -  
Balance, March 31,   $ 2,803     $ 4,199  
                 
Total loans outstanding, end of period   $ 239,635     $ 256,710  
                 
Allowance for loan losses to loans outstanding     1.17 %     1.64 %

 

Risk Elements in the Loan Portfolio

 

The following table shows the nonperforming assets, percentages of net charge-offs, and the related percentage of allowance for loan losses for the three months ended March 31, 2014 and 2013.

 

    March 31,  
(Dollars in thousands)   2014     2013  
Loans over 90 days past due and still accruing   $ -     $ 544  
Loans on nonaccrual:                
Real Estate Construction     475       2,288  
Real Estate Residential     1,796       3,454  
Real Estate Nonresidential     3,986       11,908  
Total real estate loans     6,257       17,650  
Commercial     1,353       1,808  
Consumer     79       82  
Total nonaccrual loans     7,689       19,540  
Total of nonperforming loans     7,689       20,084  
Other nonperforming assets     7,236       15,075  
Total nonperforming assets   $ 14,925     $ 35,159  
                 
Percentage of nonperforming assets to total assets     4.20 %     8.70 %
Percentage of nonperforming loans to total loans     3.21 %     7.82 %
Allowance for loan losses as a percentage of non-performing loans     36.45 %     20.91 %

 

Loans over 90 days past due and still accruing – At March 31, 2014 and 2013, loans over 90 days past due and still accruing interest totaled $0 and $544,017, respectively. This improvement was achieved primarily by aggressively monitoring past due loans.

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Nonaccruing loans – At March 31, 2014 and 2013, loans totaling $7,688,522 and $19,539,884, respectively, were in nonaccrual status. The improvement in nonaccrual loans was due primarily to charge-offs, foreclosures, and repayments. Generally, loans are placed on nonaccrual status if principal or interest payments become 90 days past due and/or we deem the collectibility of the principal and/or interest to be doubtful.  Once a loan is placed in nonaccrual status, all previously accrued and uncollected interest is reversed against interest income. Interest income on nonaccrual loans is recognized on a cash basis when the ultimate collectability is no longer considered doubtful.  Loans are returned to accrual status when the principal and interest amounts contractually due are brought current and future payments are reasonably assured. For the first quarters of 2014 and 2013, interest income recognized on nonaccrual loans was $31,086 and $148,728, respectively. If the nonaccrual loans had been accruing interest at their original contracted rates, related income would have been $110,227 and $289,706 for quarters ended March 31, 2014 and 2013, respectively. All nonaccruing loans at March 31, 2014 and 2013 were included in our classification of impaired loans at those dates.

 

Restructured loans - In situations where, for economic or legal reasons related to a borrower’s financial difficulties, a concession to the borrower is granted that we would not otherwise consider, the related loan is classified as a TDR. The restructuring of a loan may include the transfer of real estate collateral, either through the pledge of additional properties by the borrower or through a transfer to the Bank in lieu of foreclosures. Restructured loans may also include the borrower transferring to the Bank receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan, a modification of the loan terms, or a combination of the above.

 

At March 31, 2014 there were 30 loans classified as a TDR totaling $7,274,231. Of the 30 loans, 16 loans totaling $4,564,197 were performing while 14 loans totaling $2,710,034 were not performing. As of March 31, 2013 there were 51 loans classified as a TDR totaling $13,062,003. Of the 51 loans, 17 loans totaling $5,533,207 were performing while 34 loans totaling $7,528,795 were not performing. From March 31, 2013 to March 31, 2014, TDR loans decreased by $5,787,772 due to charge-offs, foreclosures and repayments. All restructured loans resulted in either extended maturity or lowered rates and were included in the impaired loan balance.

 

Impaired loans - At March 31, 2014, we had impaired loans totaling $15,242,612, as compared to $26,613,230 at March 31, 2013. The improvement in impaired loans in the first quarter of 2014 compared to the same period in 2013 was primarily attributable to the reduction of high-risk construction loans on our books and the phasing out of our credit exposure in the Myrtle Beach and Charleston markets, which were particularly hard hit by the downturn in real estate markets in 2013. At March 31, 2014, there were 9 borrowers that accounted for approximately 70.09% of the total amount of the impaired loans at that date. These loans were primarily commercial real estate loans located in the following South Carolina areas: 53% in the Coastal area, 22% in the Columbia area and 25% in the Florence area.  Impaired loans, as a percentage of total loans, were 6.36% at March 31, 2014 as compared 9.98% at March 31, 2013.

 

During the quarter ended March 31, 2014, the average investment in impaired loans was approximately $16,702,000 as compared to $26,739,000 during the quarter ended March 31, 2013. Impaired loans with a specific allocation of the allowance for loan losses totaled $5,227,045 and $7,729,196 at March 31, 2014 and 2013, respectively. The amount of the specific allocation at March 31, 2014 and 2013 was $560,661 and $405,265, respectively.

 

The downturn in the real estate market that began in 2008 and continued into the first quarter of 2014 has resulted in an increase in loan delinquencies, defaults and foreclosures; however, we believe these trends are stabilizing as the liquidation prices for our OREO has stabilized for vertical construction, indicating some stabilization of demand for that product.  In some cases, the current economic downturn has resulted in a significant impairment to the value of our collateral and limits our ability to sell the collateral upon foreclosure at its appraised value. There is also risk that downward trends could continue at a higher pace.  If real estate values further decline, it is also more likely that we would be required to increase our allowance for loan losses.

 

On a quarterly basis, we analyze each loan that is classified as impaired during the period to determine the potential for possible loan losses. This analysis is focused upon determining the then current estimated value of the collateral, local market condition, and estimated costs to foreclose, repair and resell the property. The net realizable value of the property is then computed and compared to the loan balance to determine the appropriate amount of specific reserve for each loan.

 

Other nonperforming assets - Other nonperforming assets consist of OREO that was acquired through foreclosure.  OREO is carried at fair market value minus estimated costs to sell. Current appraisals are obtained at time of foreclosure and write-downs, if any, charged to the allowance for loan losses as of the date of foreclosure.  On a regular basis , we reevaluate our OREO properties for impairment.  Along with gains and losses on disposal, expenses to maintain such assets and subsequent changes in the valuation allowance are included in other noninterest expense.

 

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As of March 31, 2014, we had OREO properties totaling $7,236,115, geographically located in the following South Carolina areas – 63.00% in the Coastal area, 8.21% in the Columbia area and 28.79% in the Florence area.  The combined nature of these properties is 92.83% commercial and 7.17% residential and other. We are diligently trying to dispose of our OREO properties; however, the relatively low demand in many of these market segments affects our ability to do so in a timely manner without experiencing additional losses.  This is especially true for properties consisting of raw land.

 

From March 31, 2013 to March 31, 2014, OREO decreased $7,838,912, or 52.00%. During this period, sales and write downs were $7,328,022 and $4,905,476, respectively, while properties acquired through foreclosures totaled $4,394,586.

 

The write downs noted in the previous paragraph were primarily the result of an extensive marketing analysis of our OREO properties that we made during the fourth quarter of 2013, taking into consideration our experience as to the time required to sell OREO properties, the volume of OREO properties held by other banks in our market area, and the deeply discounted prices being offered for the purchase of OREO properties. As a result of this analysis, we increased our write downs by $3,500,000 for estimated future losses on the sale on our OREO properties.

 

OREO expense for the three months ended March 31, 2014 and 2013 was $115,286 and $216,265, respectively, which includes a net gain of $112,594 and a net loss of $24,340 on sales, respectively.

 

Deposits and Other Interest-Bearing Liabilities

 

Average interest-bearing liabilities decreased $58,450,568, or 18.95%, to $249,959,338 for the first quarter of 2014, from $308,409,906 for the comparable 2013 period. This decrease is primarily attributable to the significant reduction in our average interest-bearing deposits.

 

Deposits - For the quarters ended March 31, 2014 and 2013, average total deposits were $279,004,035 and $343,513,855, respectively, which is a decrease of $66,790,353, or 19.44%. As our loan demand declined, we concurrently lowered our rates paid for deposits, specifically for time deposits, which is the primary reason that the amount of our average time deposits are $53,289,342, or 38.89%, lower during the first quarter of 2014 than during the same period in 2013. At March 31, 2014 and December 31, 2013, total deposits were $285,294,349 and $282,415,023, respectively, a decrease of $2,879,326, or 1.02%.

 

Average interest-bearing deposits decreased $66,790,358, or 23.62%, to $215,923,992 for the quarter ended March 31, 2014, from $282,714,350 for the quarter ended March 31, 2013.

 

The average balance of non-interest bearing deposits increased $2,280,538, or 3.75%, to $63,080,043 for the three months ended March 31, 2014, from $60,799,505 for the three months ended March 31, 2013.

 

The following table shows the average balance amounts and the average rates paid on deposits held by us for the three months ended March 31, 2014 and 2013.

 

    2014     2013  
    Average     Average     Average     Average  
    Amount     Rate     Amount     Rate  
Non-interest bearing demand deposits   $ 63,080,043       0.00 %   $ 60,799,505       0.00 %
Interest bearing demand deposits     46,462,181       0.08       43,955,905       0.13  
Savings accounts     85,720,561       0.12       101,727,853       0.24  
Time deposits     83,741,250       1.21       137,030,592       1.79  
Total   $ 279,004,035       0.41 %   $ 343,513,855       0.80 %

 

Core deposits, which exclude time deposits of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $246,867,898 and $242,480,278 at March 31, 2014 and December 31, 2013, respectively. As of March 31, 2014 and December 31, 2013, our core deposits were 86.53% and 85.86% of total deposits, respectively. Overall, we have placed a high priority on securing low-cost local deposits over other, more costly, funding sources in the current low-rate environment.

 

Included in time deposits of $100,000 and over, at March 31, 2014 and December 31, 2013, are brokered time deposits of $23,005,000. In accordance with our asset/liability management strategy, we do not intend to renew or replace the brokered deposits outstanding at March 31, 2014, when they mature.

 

Deposits, and particularly core deposits, have been our primary source of funding and have enabled us to meet successfully both our short-term and long-term liquidity needs. We anticipate that such deposits will continue to be our primary source of funding in the future. Our loan-to-deposit ratio was 84.00% and 84.45% on March 31, 2014 and December 31, 2013, respectively.

 

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The maturity distribution of our time deposits of $100,000 or more at March 31, 2014 is set forth in the following table:

 

    March 31,  
    2014  
Three months or less   $ 12,553,720  
Over three through twelve months     13,793,015  
Over one year through three years     11,692,887  
Over three years     386,829  
Total   $ 38,426,451  

 

Approximately 68.56% of our time deposits of $100,000 or more had scheduled maturities within one year. Large certificate of deposit customers tend to be extremely sensitive to interest rate levels, making these deposits less reliable sources of funding for liquidity planning purposes than core deposits. We expect most certificates of deposit with maturities less than one year to be renewed upon maturity. However, there is the possibility that some certificates may not be renewed. We believe that, should these certificates of deposit not be renewed, the impact would be minimal on our operations and liquidity due to the availability of other funding sources.

 

Other Borrowings - Other borrowings at March 31, 2014 and December 31, 2013, consist of the following:

 

    March 31,     December 31,  
    2014     2013  
Securities sold under agreements to repurchase   $ 5,386,566     $ 4,876,118  
Advances from Federal Home Loan Bank     17,000,000       23,000,000  
Junior subordinated debentures     10,310,000       10,310,000  

 

Securities sold under agreements to repurchase mature on a one to seven day basis. These agreements are secured by U.S. government agency securities. Advances from the Federal Home Loan Bank mature at different periods, as discussed in the footnotes to the financial statements, and are secured by our one to four family residential mortgage loans and our investment in the Federal Home Loan Bank stock. The junior subordinated debentures mature on November 23, 2035 and have an interest rate of LIBOR plus 1.83%.

 

Capital Resources

 

Total shareholders' equity at March 31, 2014 and December 31, 2013 was $32.4 million and $32.1 million, respectively. The $0.3 million increase during the first three months of 2014 resulted mainly from our net income of $0.3 million.

 

The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the three months ended March 31, 2014 and 2013. While we have not paid a cash dividend on our common stock since our inception, the Company has declared and paid dividends on its outstanding shares of preferred stock, and made quarterly interest payments on its trust-preferred securities as agreed. Under the terms of the Company MOU, the terms of which are more fully described as part of “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Regulatory Matters,” the Company must request prior approval from the Federal Reserve prior to declaring or paying dividends on its common stock or preferred stock, or making scheduled interest payments on its trust-preferred securities. The Federal Reserve approved the scheduled payment of dividends on the Company’s preferred stock and interest payments on the Company’s trust preferred securities for the first three quarters of 2011; however, the Federal Reserve did not approve the Company’s request to pay dividends and interest payments relating to its outstanding classes of preferred stock and trust preferred securities due and payable in the fourth quarter of 2011, and such consent has not been granted thereafter, largely out of deference to the Federal Reserve’s policy statement on dividends.

 

    Three Months Ended  
    March 31,  
    2014     2013  
Return on average assets     0.40 %     0.01 %
Return on average equity     4.35       0.13  
Average equity to average assets ratio     9.27       9.95  

 

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The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Currently, the Bank MOU requires that the Bank maintain a Tier 1 leverage ratio of 8%, and our other regulatory capital ratios at such levels so as to be considered well capitalized for regulatory purposes. We continue to be in full compliance with this requirement of the Bank MOU. Additional discussion of the Bank MOU is included above as part of “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Regulatory Matters.”

 

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%.  Tier 1 capital of the Company consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for-sale, minus certain intangible assets.  The Company’s Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 capital and 8% for total risk-based capital; under the provisions of the Bank MOU the Bank will be required to maintain a Tier 1 leverage ratio of 8% and a total risk-based capital ratio of 10%.  However, as the Company has less than $500 million in assets, its activities and regulatory capital structure are de-emphasized pursuant to the Federal Reserve's Small Bank Holding Company Policy Statement, with all significant business activities attributed to the Bank by the Company's regulators.

 

The Company and the Bank are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%. All others are subject to maintaining ratios 1% to 2% above the minimum.

 

The Company and the Bank were each considered to be “well capitalized” for regulatory purposes at March 31, 2014 and December 31, 2013.

 

The following table shows the regulatory capital ratios for the Company and the Bank at March 31, 2014 and December 31, 2013.

 

    March 31, 2014     December 31, 2013  
    Holding           Holding        
    Company     Bank     Company     Bank  
                         
Total capital (to risk-weighted assets)     15.93 %     14.55 %     15.75 %     14.35 %
Tier 1 capital (to risk-weighted assets)     14.94 %     13.56 %     14.73 %     13.34 %
Leverage or Tier 1 capital (to total average assets)     12.21 %     11.08 %     11.78 %     10.67 %

 

In July 2013, the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency each approved final rules to implement the Basel III regulatory capital reforms, among other changes required by the Dodd-Frank Act. The rules will apply to all national and state banks, such as the Bank, and savings associations and most bank holding companies and savings and loan holding companies, which we collectively refer to herein as “covered banking organizations.” Bank holding companies with less than $500 million in total consolidated assets, such as the Company, are not subject to the final rules, nor are savings and loan holding companies substantially engaged in commercial activities or insurance underwriting. The framework requires covered banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, taking into account the impact of risk. The approved rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% as well as a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4% for all banking institutions. In terms of quality of capital, the final rules emphasize common equity Tier 1 capital and implement strict eligibility criteria for regulatory capital instruments. The final rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity. The requirements in the rules begin to phase in on January 1, 2015 for covered banking organizations such as the Bank. The requirements in the rules will be fully phased in by January 1, 2019. The ultimate impact of the new capital standards on the Bank is currently being reviewed.

 

Effect of Inflation and Changing Prices

 

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements.  Rather, our financial statements have been prepared on a historical cost basis in accordance with generally accepted accounting principles.

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Unlike most industrial companies, the assets and liabilities of financial institutions such as our bank subsidiary are primarily monetary in nature. Therefore, interest rates have a more significant effect on our performance than do the general rate of inflation and of goods and services. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. As discussed previously in "Management’s Discussion and Analysis - Rate/Volume Analysis," we seek to manage the relationships between interest sensitive-assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation .

 

Off-Balance Sheet Risk

 

Through our operations, we have made contractual commitments to extend credit in the ordinary course of business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At March 31, 2014, we had issued commitments to extend credit of $35.9 million and standby letters of credit of $0.1 million through various types of commercial lending arrangements. Approximately $31.8 million of these commitments to extend credit had variable rates.

 

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2014.

 

                After                    
          After One     Three                    
    Within     Through     Through     Within     Greater        
  One     Three     Twelve     One     Than        
( Dollars in Thousands )   Month     Months     Months     Year     One Year     Total  
Unused commitments to extend credit   $ 1,565     $ 1,246     $ 11,232     $ 14,043     $ 21,465     $ 35,508  
Standby letters of credit     -       -       75       75       -       75  
Totals   $ 1,565     $ 1,246     $ 11,307     $ 14,118     $ 21,465     $ 35,583  

 

Market Risk

 

Market risk is the risk of loss from adverse changes in market prices and rates and principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities.  Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.  Our finance committee monitors and considers methods of managing exposure to interest rate risk.  We have both an internal finance committee consisting of senior management and directors that meets at various times during each quarter and a management finance committee that meets weekly as needed.  The finance committees are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

 

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity "gap," which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time.  Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability.  Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.  We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive. We were liability sensitive during the year ended December 31, 2013 and during the three months ended March 31, 2014. As of March 31, 2014, we expect to be liability sensitive for the next nine months because a majority of our deposits reprice over a 12-month period. Approximately 33% of our loans were variable rate loans at March 31, 2014. The ratio of cumulative gap to total earning assets after 12 months was a negative 44.69% because $137.0 million more liabilities will reprice in a 12-month period than assets. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally.  For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

 

Liquidity and Interest Rate Sensitivity

 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss and the ability to raise additional funds by increasing liabilities.  Liquidity management involves monitoring our sources and use of funds in order to meet our day-to-day cash flow requirements while maximizing profits.  Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control.  For example, the timing of maturities of securities in our investment portfolio is fairly predictable and is subject to a high degree of control at the time investment decisions are made.  However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

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At March 31, 2014, our liquid assets, consisting of cash and cash equivalents amounted to $21.2 million, or 6.01% of total assets.  Our investment securities, excluding nonmarketable securities, at March 31, 2014, amounted to $46.9 million, or 13.26% of total assets.  Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.  However, $15.5 million of these securities were pledged as collateral to secure public deposits and borrowings as of March 31, 2014.  At December 31, 2013, our liquid assets, consisting of cash and cash equivalents, amounted to $18.2 million, or 5.13% of total assets.  Our investment securities, excluding nonmarketable securities, at December 31, 2013 amounted to $49.1 million, or 13.81% of total assets.  Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.  However, $17.2 million of these securities were pledged as collateral to secure public deposits and borrowings as of December 31, 2013.

 

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity.  For the near future, it is our intention to reduce the use of wholesale funding to fund loan demand, instead relying on lower-cost funding sources, particularly core deposits.  We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings.  In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. At March 31, 2014, we had a $5.6 million unused line of credit with the Federal Reserve and had sufficient unpledged securities that would have allowed us to borrow an additional $31.3 million from the Federal Reserve. Also, as member of the Federal Home Loan Bank of Atlanta, (the “FHLB”), we can make applications for borrowings that can be made for leverage purposes.  The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from them. We have an available line to borrow funds from the FHLB up to 30% of the Bank’s total assets, which provide additional available funds of $106.4 million at March 31, 2014.  At that date the Bank had drawn $17.0 million on this line.  Finally, we had available at March 31, 2014 an unsecured line of credit, which was unused, to purchase up to $10.0 million of federal funds from an unrelated correspondent institution.  We believe that the sources described above will be sufficient to meet our future liquidity needs.

 

The Company is largely dependent upon dividends from the Bank as a source of cash.  The Bank MOU restricts the ability of the Bank to declare and pay dividends to the Company.  The Company MOU requires the Company to obtain approval of the Federal Reserve prior to declaring dividends.  The Federal Reserve did not approve the Company’s request to pay dividends and interest payments relating to its outstanding classes of preferred stock and trust preferred securities due and payable in the fourth quarter of 2011, and such consent has not been granted thereafter, largely out of deference to the Federal Reserve’s policy statement on dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Regulatory Matters” for additional information relating to the Company MOU.

 

Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates . We have both an internal finance committee consisting of senior management that meets at various times during each quarter and a management finance committee that meets weekly as needed.  The finance committees are responsible for maintaining the level of interest rate sensitivity of our interest-sensitive assets and liabilities within board-approved limits.

 

Interest Sensitivity Analysis

 

The following table sets forth information regarding our rate sensitivity as of March 31, 2014, for each of the time intervals indicated. The information in the table may not be indicative of our rate sensitivity position at other points in time.  In addition, the maturity distribution indicated in the table may differ from the contractual maturities of the earning assets and interest-bearing liabilities presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.

 

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The following table sets forth our interest rate sensitivity March 31, 2014.

 

                After           Greater        
          After One     Three           Than One        
    Within     Through     Through     Within     Year or        
  One     Three     Twelve     One     Non-        
( Dollars in Thousands )   Month     Months     Months     Year     Sensitive     Total  
Assets                                                
Interest-earning assets                                                
Interest-bearing deposits in other banks   $ 17,877     $ -     $ -     $ 17,877     $ -     $ 17,877  
Time Deposits in other banks     -       -       101       101       -       101  
Loans (1)     20,582       12,761       32,206       65,549       175,023       240,572  
Securities - taxable     -       -       -       -       43,752       43,752  
Securities - nontaxable     -       -       -       -       3,146       3,146  
Nonmarketable securities     1,142       -       -       1,142       -       1,142  
Total earning assets     39,601       12,761       32,307       84,669       221,921       306,590  
                                                 
Liabilities                                                
Interest-bearing liabilities                                                
Interest-bearing deposits:                                                
Demand deposits     52,101       -       -       52,101       -       52,101  
Savings deposits     85,752       -       -       85,752       -       85,752  
Time deposits     17,518       7,801       36,138       61,457       19,331       80,788  
Total interest-bearing deposits     155,371       7,801       36,136       199,310       19,331       218,641  
Federal Home Loan Bank advances     -       -       17,000       17,000       -       17,000  
Junior subordinated debentures     -       -       -       -       10,310       10,310  
Repurchase agreements     5,387       -       -       5,387       -       5,387  
Total interest-bearing liabilities     160,758       7,801       53,138       221,697       29,641       251,338  
Period gap   $ (121,157 )   $ 4,960     $ (20,831 )   $ (137,028 )   $ 192,280          
                                                 
Cumulative gap   $ (121,157 )   $ (116,197 )   $ (137,028 )   $ (137,028 )   $ 55,252          
                                                 
Ratio of cumulative gap to total earning assets     (39.52 )%     (37.90 )%     (44.69 )%     (44.69 )%     18.02 %        

 

(1) Including mortgage loans held for sale

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

See "Market Risk" and "Liquidity and Interest Rate Sensitivity" in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for quantitative and qualitative disclosures about market risk, which information is incorporated herein by reference.

 

Item 4. Controls and Procedures

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”).  Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

 

Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all errors and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

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Based upon their controls evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective at a reasonable assurance level.

 

There have been no changes in our internal controls over financial reporting during our first fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Part II - Other Information

 

Item 1. Legal Proceedings

 

There are no material, pending legal proceedings to which the Company or its subsidiary is a party or of which any of their property is the subject.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

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

 

(a) Not applicable.

 

(b) Not applicable.

 

Item 6. Exhibits

 

Exhibit    
Number   Exhibit
10.1   Waiver of Benefits, dated December 30, 2013, by and among F.R. Saunders, Jr., the Company and the Bank
10.2   Waiver of Benefits, dated December 30, 2013, by and among Jeffrey A. Paolucci, the Company and the Bank
10.3   Waiver of Benefits, dated December 30, 2013, by and among Thomas C. Ewart, Sr., the Company and the Bank
10.4   Employment Agreement, dated as of April 23, 2003, by and between Thomas C. Ewart, Sr. and the Bank (1)
31.1   Certification pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended.
31.2   Certification pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended.
32.1   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.
32.2   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101   Interactive Data Files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 in XBRL.  Pursuant to Regulation 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

__________

(1) Incorporated by reference from the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2003.

 

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SIGNATURE

 

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

 

  FIRST RELIANCE BANCSHARES, INC.
     
Date:  May 13, 2014 By: /s/ F.R. SAUNDERS, JR.
    F. R. Saunders, Jr.
    President & Chief Executive Officer
    (Principal Executive Officer)
     
Date:  May 13, 2014 By: /s/ JEFFERY A. PAOLUCCI
    Jeffery A. Paolucci
    Senior Vice President and Chief Financial Officer
    (Principal Financial Officer)

 

- 42 -

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