ECBE Ecb Bancorp (MM)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended September 30, 2011

or

 

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

For the transition period from             to             

Commission File No. 0-24753

 

 

ECB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina		56-2090738
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Post Office Box 337, Engelhard, North Carolina 27824

(Address of principal executive offices) (Zip Code)

(252) 925-5501

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     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 (Section 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 definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

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

On November 10, 2011, there were 2,849,841 outstanding shares of Registrant’s common stock.

 

 

 

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Table of Contents

 

Index		Begins on Page
Part 1 – Financial Information
Item 1.        Financial Statements:
Consolidated Balance Sheets at September 30, 2011 (unaudited) and December 31, 2010			3
Consolidated Results of Operations for Three and Nine Months Ended September  30, 2011 and 2010 (unaudited)			4
Consolidated Statements of Changes in Shareholders’ Equity for Nine Months Ended September  30, 2011 and 2010 (unaudited)			5
Consolidated Statements of Cash Flows for Nine Months Ended September 30, 2011 and 2010 (unaudited)			6
Notes to Consolidated Financial Statements			7
Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations			38
Item 3.         Quantitative and Qualitative Disclosures About Market Risk			55
Item 4.        Controls and Procedures			55
Part II – Other Information
Item 1.        Legal Proceedings			56
Item 1A.    Risk Factors			56
Item 2.         Unregistered Sales of Equity Securities and Use of Proceeds			56
Item 3.        Defaults upon Senior Securities			56
Item 4.        Removed and Reserved			56
Item 5.        Other Information			56
Item 6.        Exhibits			56
Signatures			57
Exhibit Index			58
Certifications

 

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ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

September 30, 2011 (unaudited) and December 31, 2010

(Dollars in thousands, except per share data)

 

		September 30, 2011				December 31, 2010*
Assets
Non-interest bearing deposits and cash		$	13,123			$	11,731
Interest bearing deposits			61				20
Overnight investments			4,055				8,415
Total cash and cash equivalents			17,239				20,166
Investment securities
Available-for-sale, at market value (cost of $325,023 and $275,883 at September 30, 2011 and December 31, 2010, respectively)			327,066				273,229
Loans held for sale			2,338				4,136
Loans			521,626				567,631
Allowance for loan losses			(12,214	)			(13,247	)
Loans, net			509,412				554,384
Real estate and repossessions acquired in settlement of loans, net			6,223				4,536
Federal Home Loan Bank common stock, at cost			3,768				4,571
Bank premises and equipment, net			26,137				26,636
Accrued interest receivable			4,972				5,243
Bank owned life insurance			11,676				8,954
Other assets			14,864				18,014
Total		$	923,695			$	919,869
Liabilities and Shareholders’ equity
Deposits
Demand, noninterest bearing		$	123,783			$	104,932
Demand, interest bearing			257,115				262,977
Savings			46,879				29,938
Time			368,832				388,094
Total deposits			796,609				785,941
Accrued interest payable			630				631
Short-term borrowings			13,528				11,509
Long-term obligations			25,500				34,500
Other liabilities			4,180				6,394
Total liabilities			840,447				838,975
Shareholders’ equity
Preferred stock, Series A			17,412				17,288
Common stock, par value $3.50 per share			9,974				9,974
Capital surplus			25,868				25,852
Warrants			878				878
Retained earnings			27,946				28,554
Accumulated other comprehensive income (loss)			1,170				(1,652	)
Total shareholders’ equity			83,248				80,894
Total		$	923,695			$	919,869
Common shares outstanding			2,849,841				2,849,841
Common shares authorized			10,000,000				10,000,000
Preferred shares outstanding			17,949				17,949
Preferred shares authorized			2,000,000				2,000,000

 

*	Derived from audited consolidated financial statements.

 

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ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Results of Operations

For the three and nine months ended September 30, 2011 and 2010 (unaudited)

(Dollars in thousands, except per share data)

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Interest income:
Interest and fees on loans		$	7,096			$	7,640			$	21,782			$	23,062
Interest on investment securities:
Interest exempt from federal income taxes			106				385				351				1,337
Taxable interest income			1,961				1,949				6,061				5,519
Dividend income			9				6				27				40
Other interest income			17				2				38				9
Total interest income			9,189				9,982				28,259				29,967
Interest expense:
Deposits:
Demand accounts			511				406				1,573				1,045
Savings			85				25				212				52
Time			1,751				2,347				5,352				7,248
Short-term borrowings			73				66				215				183
Long-term obligations			146				161				471				434
Total interest expense			2,566				3,005				7,823				8,962
Net interest income			6,623				6,977				20,436				21,005
Provision for loan losses			1,028				3,863				6,231				8,643
Net interest income after provision for loan losses			5,595				3,114				14,205				12,362
Noninterest income:
Service charges on deposit accounts			836				842				2,429				2,558
Other service charges and fees			410				470				984				1,168
Mortgage origination fees			255				351				1,033				856
Net gain on sale of securities			998				2,030				1,882				3,471
Income from bank owned life insurance			74				75				222				223
Other operating (expense) income			(5	)			32				(12	)			58
Total noninterest income			2,568				3,800				6,538				8,334
Noninterest expenses:
Salaries			2,737				2,548				8,127				7,193
Retirement and other employee benefits			638				740				2,098				2,182
Occupancy			528				480				1,533				1,384
Equipment			550				589				1,622				1,542
Professional fees			240				187				782				686
Supplies			49				45				178				165
Telephone			179				147				537				487
FDIC insurance			236				355				763				1,033
Other outside services			94				123				437				351
Net cost of real estate and repossessions acquired in settlement of loans			645				112				742				493
Other operating expenses			1,643				1,053				3,621				3,017
Total noninterest expenses			7,539				6,379				20,440				18,533
Income before income taxes			624				535				303				2,163
Income tax expense (benefit)			97				(5	)			(285	)			179
Net income			527				540				588				1,984
Preferred stock dividends			225				225				673				673
Accretion of discount			42				42				124				124
Income (loss) available to common shareholders		$	260			$	273			($	209	)		$	1,187
Net income (loss) per share - basic		$	0.09			$	0.10			($	0.07	)		$	0.42
Net income (loss) per share - diluted		$	0.09			$	0.10			($	0.07	)		$	0.42
Weighted average shares outstanding - basic			2,849,841				2,849,841				2,849,841				2,849,511
Weighted average shares outstanding - diluted			2,849,841				2,849,841				2,849,841				2,849,554

 

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ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity

Nine months ended September 30, 2011 and 2010 (unaudited)

(Dollars in thousands, except per share data)

 

		Preferred stock, Series A				Common Stock								Common stock warrants				Capital surplus				Retained earnings				Accumulated other comprehensive income				Comprehensive income				Total
						Number				Amount
Balance January 1, 2010		$	17,122				2,847,881			$	9,968			$	878			$	25,803			$	29,555			$	1,049							$	84,375
Unrealized gain, net of income tax expense of $ 1,563																											2,497			$	2,497				2,497
Net income																							1,984								1,984				1,984
Total comprehensive income																														$	4,481
Stock based compensation																			28																28
Stock options exercised							1,960				6								13																19
Preferred stock accretion			124																				(124	)											—
Cash dividends on preferred stock																							(673	)											(673	)
Cash dividends ($0.21 per share)																							(598	)											(598	)
Balance September 30, 2010		$	17,246				2,849,841			$	9,974			$	878			$	25,844			$	30,144			$	3,546							$	87,632

 

		Preferred stock, Series A				Common Stock								Common stock warrants				Capital surplus				Retained earnings				Accumulated other comprehensive income				Comprehensive income				Total
						Number				Amount
Balance January 1, 2011		$	17,288				2,849,841			$	9,974			$	878			$	25,852			$	28,554			$	(1,652	)						$	80,894
Unrealized gain, net of income tax expense of $ 1,808																											2,889			$	2,889				2,889
Post retirement health insurance benefit adjustment, net of income tax benefit of $ 42																											(67	)			(67	)			(67	)
Net income																							588								588				588
Total comprehensive income																														$	3,410
Stock based compensation																			16																16
Preferred stock accretion			124																				(124	)											—
Cash dividends on preferred stock																							(673	)											(673	)
Cash dividends ($0.14 per share)																							(399	)											(399	)
Balance September 30, 2011		$	17,412				2,849,841			$	9,974			$	878			$	25,868			$	27,946			$	1,170							$	83,248

 

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ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Nine months ended September 30, 2011 and 2010 (unaudited)

(Dollar amounts in thousands)

 

		Nine months ended September 30,
		2011				2010
Cash flows from operating activities:
Net income		$	588			$	1,984
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			1,071				999
Amortization of premium on investment securities, net			2,245				1,284
Provision for loan losses			6,231				8,643
Gain on sale of securities			(1,882	)			(3,471	)
Stock based compensation			16				28
Decrease (increase) in accrued interest receivable			271				(209	)
Impairment of real estate and repossessions acquired in settlement of loans			515				206
Loss on sale of real estate and repossessions acquired in settlement of loans			101				272
Income from Bank owned life insurance			(222	)			(223	)
Originations of mortgage loans held for sale			(40,860	)			(18,485	)
Proceeds from sale of loans held for sale			42,658				16,382
Decrease in other assets			1,384				266
Decrease in accrued interest payable			(1	)			(139	)
Decrease in other liabilities, net			(2,323	)			(859	)
Net cash provided by operating activities			9,792				6,678
Cash flows from investing activities:
Proceeds from sales of investment securities classified as available-for-sale			112,587				96,858
Proceeds from maturities of investment securities classified as available-for-sale			35,684				36,981
Purchases of investment securities classified as available-for-sale			(197,774	)			(152,456	)
Redemption of Federal Home Loan Bank common stock			803				367
Purchases of premises and equipment			(572	)			(1,169	)
Proceeds from disposal of real estate and repossessions acquired in settlement of loans and real estate held for sale			2,156				2,357
Purchases of life insurance			(2,500	)			—
Net loan repayments (disbursements)			34,282				(5,436	)
Net cash used by investing activities			(15,334	)			(22,498	)
Cash flows from financing activities:
Net increase in deposits			10,668				35,862
Net increase (decrease) in borrowings			(6,981	)			4,124
Dividends paid to common shareholders			(399	)			(917	)
Dividends paid on preferred stock			(673	)			(673	)
Net proceeds from issuance of common stock			—				19
Net cash provided by financing activities			2,615				38,415
(Decrease) increase in cash and cash equivalents			(2,927	)			22,595
Cash and cash equivalents at beginning of period			20,166				17,811
Cash and cash equivalents at end of period		$	17,239			$	40,406
Cash paid during the period:
Interest		$	7,824			$	9,101
Taxes			163				746
Supplemental disclosures of noncash financing and investing activities:
Cash dividends declared but not paid		$	—			$	199
Unrealized gains on available-for-sale securities, net of deferred taxes			2,889				2,497
Transfer from loans to real estate and repossessions acquired in settlement of loans			4,459				3,043
Transfer from long-term to short-term borrowings			9,000				6,500
Transfer from investments to other assets			—				250
Transfer from real estate and repossessions acquired in settlement of loans to bank premises and equipment			—				398

See accompanying notes to consolidated financial statements.

 

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ECB BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(1) Basis of Presentation

The consolidated financial statements include the accounts of ECB Bancorp, Inc. (“Bancorp”) and its wholly-owned subsidiary, The East Carolina Bank (the “Bank”) (Bancorp and the Bank collectively referred to hereafter as the “Company”). The Bank has one wholly-owned subsidiary, ECB Financial Services, Inc., which formerly provided courier services to the Bank but is currently inactive. All intercompany transactions and balances are eliminated in consolidation. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and the reported amounts of income and expenses for the periods presented. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and retirement plan costs. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties held as collateral for loans. Our retirement plans and other post-retirement benefit costs are actuarially determined based on assumptions on the discount rate, estimated future return on plan assets and the health care cost trend rate.

All adjustments considered necessary for a fair presentation of the results for the interim periods presented have been included (such adjustments are normal and recurring in nature). The notes to consolidated financial statements in Bancorp’s annual report on Form 10-K as of December 31, 2010 should be referenced when reading these unaudited interim consolidated financial statements. Operating results for the period ended September 30, 2011, are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Reclassification

Certain reclassifications have been made to the prior period’s financial statements to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.

Loans

Loans are generally stated at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs. Loan origination fees net of certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual life of the related loans using the level-yield method.

Impaired loans are defined as those which management believes it is probable we will not collect all amounts due according to the contractual terms of the loan agreement.

Interest on loans is recorded based on the principal amount outstanding. The Company ceases accruing interest on loans (including impaired loans) when, in management’s judgment, the collection of interest appears doubtful or the loan is past due 90 days or more. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Management may return a loan classified as nonaccrual to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms over an extended period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Allowance for Loan Losses

The allowance for loan losses (AFLL) is established through provisions for losses charged against income. Loan amounts deemed to be uncollectible are charged against the AFLL, and subsequent recoveries, if any, are credited to the allowance. The AFLL represents management’s estimate of the amount necessary to absorb estimated probable losses in the loan portfolio. Management’s periodic evaluation of the adequacy of the allowance is based on individual loan reviews, past loan loss experience, economic conditions in the Company’s market areas, the fair value and adequacy of underlying collateral, and the growth and loss attributes of the loan portfolio. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. Thus, future changes to the AFLL may be necessary based on the impact of changes in loan loss experience, the fair value and adequacy of underlying collateral, the growth and loss attributes of the loan portfolio and economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s AFLL. Such agencies may require the Company to recognize adjustments to the AFLL based on their judgments about information available to them at the time of their examination.

 

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In evaluating the allowance for loan losses, the Company prepares an analysis of its current loan portfolio through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

During the third quarter of 2011, the following circumstances occurred which represent the primary factors contributing to a reduction in the AFLL:

 

•

We experienced a significant decline in the outstanding balance of construction and land development as well as commercial and industrial loans. Additionally, the overall risk grade of the remaining loans within these segments has improved. Given the significance of historical loss rates attributable to these loan segments, the declining loan balances and improved average risk grades had a substantial impact on our general reserves, effectively lowering them by approximately 16 basis points, or $769 thousand, as compared to our prior quarter end.

 

•

Consistent with each quarterly reporting period, management also evaluated the AFLL model’s unallocated internal and external factor percentages. As the Bank has continued to strengthen certain internal controls of the credit function, specific internal factors were scored to ensure they were consistent with improved Bank policies and procedures. The impact of these modifications increased our general reserves by approximately 14 basis points, or $690 thousand as compared to our prior quarter end.

 

•

During the quarter, management conducted an impairment migration study using the Bank’s historical data from the preceding two years. From this study we determined that our years to impairment AFLL model assumption should be reduced in all but two of our loan segments. This analysis provided statistical support for the refinement of this assumption and effectively lowered our general reserves by approximately 47 basis points, or $2.3 million, after considering the net effect of the prior two points above, as compared to our prior quarter end.

Management’s migration study was supplemented by an independent study of the allowance model. During the third quarter of 2011, the Bank also employed an independent specialist to perform a loss migration analysis on the Bank’s loan portfolio in order to provide additional statistical data and validation for the Bank’s AFLL modeling process. That analysis provided the Bank with useful data regarding its loss migration history and mean level of loss history given our credit migration, and served as an independent validation of our overall allowance position at period end. Management and the Board of Directors have evaluated the impact of these AFLL model updates and determined that the allowance represents an amount necessary to absorb estimated probable losses in the loan portfolio.

Historical loss calculations for each homogeneous risk group are based on a three year average loss ratio calculation with the most recent quarter’s loss history included in the model. The impact is to more quickly recognize and increase the loss history in a respective grouping. For those groups with little or no loss history, management increases the historical factor through a positive adjustment to more accurately represent current economic conditions and their probable impact on that particular loan group.

Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and on their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. Most loans risk rated “substandard”, “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Some smaller loans risk rated “substandard”, “doubtful” and “loss” with balances less than $100 thousand are not removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

A portion of the Bank’s allowance for loan losses is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the portion determined through general qualitative and quantitative internal and external factors, the general portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. While the Company believes that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Unsecured loans are charged-off in full against the Company’s allowance for loan losses as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal. Included in the write-down is the estimated expense to liquidate the property and typically an additional allowance for the foreclosure discount.

Subsequent Events

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the consolidated financial statements were issued.

A special meeting of the shareholders of the Company was held on October 12, 2011. At this meeting the shareholders approved amending the Company’s Articles of Incorporation to increase the number of its authorized shares of common stock from 10,000,000 to 50,000,000 and authorized 2,000,000 shares of a new class of mandatorily convertible non-voting common stock. The shareholders also approved the Company’s 2011 Equity Plan and the issuance of shares of the Company’s common stock to certain institutional investors in a private placement offering pursuant to the terms of a Securities Purchase Agreement, dated as of June 30, 2011 and amended and restated as of September 9, 2011, and related documents.

 

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(2) Net Income Per Share

Basic net income per share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. For purposes of basic net income per share, restricted stock is considered “contingently issuable” and is not included in the weighted average number of common shares outstanding.

Diluted net income per share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Restricted stock is considered outstanding for purposes of diluted net income per share. The amount of compensation cost attributed to future services and not yet recognized is considered “proceeds” using the treasury stock method. Restricted stock had no dilutive effect on earnings per share for the nine or three-month periods ended September 30, 2011 and September 30, 2010.

In computing diluted net income per share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate diluted net income per share for the Company. Diluted weighted average shares outstanding did not increase for the nine and three months ended September 30, 2011 as there was no dilutive impact of options for the periods. For the nine months ended September 30, 2010, diluted weighted average shares outstanding increased by 43 due to the dilutive impact of options. Stock options had no impact on diluted weighted average shares for the three months ended September 30, 2010. For the nine month period ending September 30, 2011, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department and 28,513 options were not included in the computation of diluted earnings per share as the effect would have been anti-dilutive. For the three month period ending September 30, 2011, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department and 28,513 options were not included in the computation of diluted earnings per share because the exercise price exceeded the average market price of the Company’s stock for that period. There were 28,513 options outstanding for both the nine and three months ended September 30, 2010, that were not included in the computation of diluted net income per share because the exercise price was above the average market value of the Company’s stock for the periods. As of September 30, 2010, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department was not included in the computation of net income per share for either the nine or three-month period because its exercise price exceeded the average market price of the company’s stock for the periods.

 

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The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income (Loss) Per Share for the nine months ended September 30.

 

		Nine months ended September 30, 2011 (dollars in thousands, except per share data)
		Income (Numerator)				Shares (Denominator)				Per Share Amount
Basic net loss per share		$	(209	)			2,849,841			$	(0.07	)
Effect of dilutive securities			—				—
Diluted net loss per share		$	(209	)			2,849,841			$	(0.07	)

 

		Nine months ended September 30, 2010 (dollars in thousands, except per share data)
		Income (Numerator)				Shares (Denominator)				Per Share Amount
Basic net income per share		$	1,187				2,849,511			$	0.42
Effect of dilutive securities			—				43
Diluted net income per share		$	1,187				2,849,554			$	0.42

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Share for the three months ended September 30.

 

		Three months ended September 30, 2011 (dollars in thousands, except per share data)
		Income (Numerator)				Shares (Denominator)				Per Share Amount
Basic net income per share		$	260				2,849,841			$	0.09
Effect of dilutive securities			—				—
Diluted net income per share		$	260				2,849,841			$	0.09

 

		Three months ended September 30, 2010 (dollars in thousands, except per share data)
		Income (Numerator)				Shares (Denominator)				Per Share Amount
Basic net income per share		$	273				2,849,841			$	0.10
Effect of dilutive securities			—				—
Diluted net income per share		$	273				2,849,841			$	0.10

 

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(3) Comprehensive Income

Comprehensive income is defined as the change in equity during a period for non-owner transactions and is divided into net income and other comprehensive income. Other comprehensive income includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. The components of comprehensive income for the periods presented are as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
		(Dollars in thousands)
Net income		$	527				540			$	588			$	1,984
Other comprehensive income:
Unrealized gains on available for sale securities arising during the period			2,332				2,990				6,579				7,531
Tax expense			(898	)			(1,150	)			(2,533	)			(2,899	)
Reclassification to realized gains			(998	)			(2,030	)			(1,882	)			(3,471	)
Tax expense			384				780				725				1,336
Defined benefit pension adjustment			—				—				(109	)			—
Tax benefit			—				—				42				—
Total other comprehensive income			820				590				2,822				2,497
Total comprehensive income		$	1,347			$	1,130			$	3,410			$	4,481

 

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(4) Recent Accounting Pronouncements

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

In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company is required to include these disclosures in its interim and annual consolidated financial statements. See Note 7.

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011, FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present.

Disclosures related to TDRs under ASU 2010-20 have been presented in Note 7.

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the consolidated financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments will be effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the consolidated financial statements.

The Comprehensive Income topic of the ASC was amended by ASU 2011-05 in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity. The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The amendments will be applicable to the Company on January 1, 2012 and will be applied retrospectively.

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

 

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(5) Investment Securities

The following is a summary of the securities portfolio by major classification:

 

		September 30, 2011
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
		(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises and FFCB bonds		$	14,180			$	349			$	—			$	14,529
Obligations of states and political subdivisions			10,861				592				—				11,453
Mortgage-backed securities			154,388				2,401				(88	)			156,701
SBA-backed securities			112,844				554				(197	)			113,201
Corporate bonds			32,750				30				(1,598	)			31,182
		$	325,023			$	3,926			$	(1,883	)		$	327,066

 

		December 31, 2010
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
		(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises and FFCB bonds		$	25,466			$	183			$	(868	)		$	24,781
Obligations of states and political subdivisions			12,818				240				(80	)			12,978
Mortgage-backed securities			150,850				837				(1,597	)			150,090
SBA-backed securities			57,362				258				(767	)			56,853
Corporate bonds			29,387				77				(937	)			28,527
		$	275,883			$	1,595			$	(4,249	)		$	273,229

 

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Gross realized gains and losses on sales of securities for the three and nine-month periods ended September 30, 2011 and September 30, 2010 were as follows:

 

			$0,000,000				$0,000,000
		Nine months ended September 30, (Dollars in thousands)
		2011				2010
Gross realized gains		$	1,987			$	3,519
Gross realized losses			(105	)			(48	)
Net realized gains		$	1,882			$	3,471

 

			$0,000,				$0,000,
		Three months ended September 30, (Dollars in thousands)
		2011				2010
Gross realized gains		$	1,016			$	2,062
Gross realized losses			(18	)			(32	)
Net realized gains		$	998			$	2,030

Analysis of Certain Investments in Debt and Equity Securities for Other Than Temporary Impairment

The following tables set forth the amount of unrealized losses at September 30, 2011 and December 31, 2010 (that is, the amount by which cost or amortized cost exceeds fair value), and the related fair value of investments with unrealized losses, none of which are considered to be other-than-temporarily impaired. The tables are segregated into investments that have been in a continuous unrealized-loss position for less than 12 months from those that have been in a continuous unrealized-loss position for 12 months or longer.

 

		September 30, 2011
		Less Than 12 Months								12 Months or longer								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
		(Dollars in thousands)
Mortgage-backed securities		$	23,213			$	88			$	—			$	—			$	23,213			$	88
SBA-backed securities			42,846				197				—				—				42,846				197
Corporate bonds			22,948				1,187				1,588				411				24,536				1,598
Total		$	89,007			$	1,472			$	1,588			$	411			$	90,595			$	1,883

 

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		December 31, 2010
		Less Than 12 Months								12 Months or longer								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
		(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds		$	17,410			$	868			$	—			$	—			$	17,410			$	868
Obligations of states and political subdivisions			3,548				80				—				—				3,548				80
Mortgage-backed securities			99,549				1,597				—				—				99,549				1,597
SBA-backed securities			31,963				767				—				—				31,963				767
Corporate bonds			20,815				654				1,717				283				22,532				937
Total		$	173,285			$	3,966			$	1,717			$	283			$	175,002			$	4,249

As of September 30, 2011 and December 31, 2010, management concluded that the unrealized losses presented above, which consisted of thirty-seven securities at September 30, 2011 and seventy-nine securities at December 31, 2010, are temporary in nature and the Company has the intent to hold these investments for a time necessary to recover their cost and it is not likely that the Bank would be required to sell prior to recovery. The losses above are on debt securities that have contractual maturity dates and are primarily related to market interest rates. All unrealized losses on investment securities are not considered to be other-than-temporary, because they are related to changes in interest rates, lack of liquidity and demand in the general investment market and do not affect the expected cash flows of the underlying collateral or the issuer. The Bank’s mortgage-backed securities are all backed by government sponsored enterprises or agencies. The Bank does not own any private label mortgage-backed securities.

At September 30, 2011 and December 31, 2010, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company was $3.8 million and $4.6 million, respectively. On August 16, 2011, FHLB paid a dividend for the second quarter of 2011 with an annualized rate of 0.76%. The dividend rate was equal to average three-month LIBOR for the period of April 1, 2011 to June 30, 2011 plus 0.50%, and was applicable to capital stock held during that period. Management believes that its investment in FHLB stock was not other-than-temporarily impaired as of September 30, 2011 or December 31, 2010. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a decrease in the value of the FHLB stock held by the Company.

 

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The aggregate amortized cost and fair value of the available-for-sale securities portfolio at September 30, 2011 by remaining contractual maturity are as follows:

 

		Amortized Cost				Fair Value
		(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds:
Due in five through ten years		$	14,180			$	14,529
Obligations of states and political subdivisions:
Due in one year or less			251				252
Due in one through five years			961				1,038
Due in five through ten years			4,153				4,383
Due after ten years			5,496				5,780
Mortgage-backed securities:
Due in five through ten years			8,152				8,288
Due after ten years			146,236				148,413
SBA-backed securities:
Due in five through ten years			4,967				5,075
Due after ten years			107,877				108,126
Corporate bonds:
Due in one through five years			13,358				13,241
Due in five through ten years			19,392				17,941
Total securities		$	325,023			$	327,066

 

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Securities with an amortized cost of $190.7 million at September 30, 2011 are pledged as collateral. Of this total, securities with an amortized cost of $57.0 million and fair value of $57.5 million are pledged as collateral for FHLB advances.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at December 31, 2010 by remaining contractual maturity are as follows:

 

		Amortized Cost				Fair Value
		(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds:
Due in one through five years		$	2,000			$	1,972
Due in five through ten years			16,108				15,982
Due after ten years			7,358				6,827
Obligations of states and political subdivisions:
Due in one year or less			370				373
Due in one through five years			252				253
Due in five through ten years			5,203				5,354
Due after ten years			6,993				6,998
Mortgage-backed securities:
Due in five through ten years			4,307				4,551
Due after ten years			146,543				145,539
SBA-backed securities:
Due in five through ten years			5,889				5,973
Due after ten years			51,473				50,880
Corporate bonds:
Due in one year through five years			8,779				8,712
Due in five through ten years			17,421				16,767
Due after ten years			3,187				3,048
Total securities		$	275,883			$	273,229

Securities with an amortized cost of $212.2 million at December 31, 2010 were pledged as collateral. Of this total, securities with an amortized cost of $52.9 million and fair value of $52.2 million were pledged as collateral for FHLB advances.

 

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(6) Loans

Loans at September 30, 2011 and December 31, 2010 classified by type are as follows:

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Real estate loans:
Construction and land development		$	71,282			$	90,267
Secured by farmland			31,844				26,694
Secured by residential properties			117,691				120,183
Secured by nonfarm, nonresidential properties			211,719				218,028
Consumer installment			5,233				4,096
Credit cards and related plans			2,229				2,261
Commercial and all other loans:
Commercial and industrial			44,185				60,242
Loans to finance agricultural production			20,902				28,217
All other loans			16,639				17,863
			521,724				567,851
Less deferred fees and costs, net			98				220
		$	521,626			$	567,631
Included in the above:
Nonaccrual loans		$	20,741			$	15,896
Restructured loans 1			7,877				6,193

 

1.	Restructured loans include loans restructured and still accruing. There were $3,387 in restructured loans included in nonaccrual total. The Company is not committed to advance additional funds on restructured loans.

The Company, through its normal lending activity, originates and maintains loans receivable that are substantially concentrated in the Eastern region of North Carolina, where its offices are located. The Company’s policy calls for collateral or other forms of repayment assurance to be received from the borrower at the time of loan origination. Such collateral or other form of repayment assurance is subject to changes in economic value due to various factors beyond the control of the Company, and such changes could be significant.

At September 30, 2011 and December 31, 2010, included in real estate loans were loans collateralized by owner-occupied residential real estate of approximately $57.7 million and $55.5 million, respectively.

Loans with a book value of approximately $27.2 million at September 30, 2011 are pledged as eligible collateral for FHLB advances. Loans with a book value of approximately $30.1 million at December 31, 2010 were pledged as eligible collateral for FHLB advances.

 

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(7) Credit Quality of Loans and Allowance for Loan Losses

An analysis of the allowance for loan losses for the three and nine months ended September 30, 2011, and September 30, 2010 follows:

 

		For the Three Months Ended								For the Nine Months Ended
		September 30, 2011				September 30, 2010				September 30, 2011				September 30, 2010
		(Dollars in thousands)
Beginning balance		$	15,448			$	10,462			$	13,247			$	9,725
Provision for loan losses			1,028				3,863				6,231				8,643
Recoveries			88				170				234				243
Loans charged off			(4,350	)			(1,308	)			(7,498	)			(5,424	)
Ending balance		$	12,214			$	13,187			$	12,214			$	13,187

 

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The following tables summarize the balances by loan category of the allowance for loan losses with changes arising from charge-offs, recoveries and provision expense for the nine months ending September 30, 2011, three months ending September 30, 2011 and for the year ending December 31, 2010:

Allowance for Loan Losses

As of and for the Nine Months Ended September 30, 2011

 

Allowance for Credit Losses		Real Estate Construction and Land Development				Real Estate Secured by Farmland				Real Estate Secured by Residential Properties				Real Estate Secured by Nonfarm Nonresidential				Consumer Installment				Credit Cards and Related Plans				Commercial and Industrial				Loans to Finance Agricultural Production				All Other Loans				General Qualitative & Quantitative Portion				Total
		(Dollars in thousands)
Beginning balance		$	6,168			$	28			$	3,450			$	1,007			$	12			$	21			$	882			$	18			$	139			$	1,522			$	13,247
Charge-offs			(4,327	)			—				(941	)			(1,594	)			(18	)			(108	)			(338	)			—				(172	)			—				(7,498	)
Recoveries			9				—				7				43				4				1				84				—				86				—				234
Provisions			2,553				(12	)			149				2,067				17				305				215				109				178				650				6,231
Ending Balance		$	4,403			$	16			$	2,665			$	1,523			$	15			$	219			$	843			$	127			$	231			$	2,172			$	12,214
Ending Balance: individually evaluated for impairment		$	940			$	—			$	1,059			$	999			$	—			$	200			$	510			$	—			$	—			$	—			$	3,708
Ending Balance: collectively evaluated for impairment		$	3,463			$	16			$	1,606			$	524			$	15			$	19			$	333			$	127			$	231			$	2,172			$	8,506
Loans
Ending Balance		$	71,174			$	31,782			$	117,824			$	211,479			$	5,354			$	2,231			$	44,201			$	20,910			$	16,671			$	—			$	521,626
Ending Balance: individually evaluated for impairment		$	12,567			$	—			$	7,678			$	9,755			$	—			$	200			$	1,363			$	—			$	—			$	—			$	31,563
Ending Balance: collectively evaluated for impairment		$	58,607			$	31,782			$	110,146			$	201,724			$	5,354			$	2,031			$	42,838			$	20,910			$	16,671			$	—			$	490,063

Allowance for Loan Losses

As of and for the Three Months Ended September 30, 2011

 

Allowance for Credit Losses		Real Estate Construction and Land Development				Real Estate Secured by Farmland				Real Estate Secured by Residential Properties				Real Estate Secured by Nonfarm Nonresidential				Consumer Installment				Credit Cards and Related Plans				Commercial and Industrial				Loans to Finance Agricultural Production				All Other Loans				General Qualitative & Quantitative Portion				Total
		(Dollars in thousands)
Beginning balance		$	7,467			$	33			$	4,239			$	1,132			$	30			$	188			$	622			$	15			$	174			$	1,548			$	15,448
Charge-offs			(2,410	)			—				(237	)			(1,551	)			(3	)			(99	)			—				—				(50	)			—				(4,350	)
Recoveries			3				—				5				43				2				—				6				—				29				—				88
Provisions			(657	)			(17	)			(1,342	)			1,899				(14	)			130				215				112				78				624				1,028
Ending Balance		$	4,403			$	16			$	2,665			$	1,523			$	15			$	219			$	843			$	127			$	231			$	2,172			$	12,214
Ending Balance: individually evaluated for impairment		$	940			$	—			$	1,059			$	999			$	—			$	200			$	510			$	—			$	—			$	—			$	3,708
Ending Balance: collectively evaluated for impairment		$	3,463			$	16			$	1,606			$	524			$	15			$	19			$	333			$	127			$	231			$	2,172			$	8,506
Loans
Ending Balance		$	71,174			$	31,782			$	117,824			$	211,479			$	5,354			$	2,231			$	44,201			$	20,910			$	16,671			$	—			$	521,626
Ending Balance: individually evaluated for impairment		$	12,567			$	—			$	7,678			$	9,755			$	—			$	200			$	1,363			$	—			$	—			$	—			$	31,563
Ending Balance: collectively evaluated for impairment		$	58,607			$	31,782			$	110,146			$	201,724			$	5,354			$	2,031			$	42,838			$	20,910			$	16,671			$	—			$	490,063

 

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Allowance for Loan Losses

As of and for the Year Ended December 31, 2010

 

Allowance for Credit Losses		Real Estate Construction and Land Development				Real Estate Secured by Farmland				Real Estate Secured by Residential Properties				Real Estate Secured by Nonfarm Nonresidential				Consumer Installment				Credit Cards and Related Plans				Commercial and Industrial				Loans to Finance Agricultural Production				All Other Loans				General Qualitative & Quantitative Portion				Total
		(Dollars in thousands)
Beginning balance		$	4,623			$	25			$	2,383			$	541			$	23			$	13			$	523			$	16			$	169			$	1,409			$	9,725
Charge-offs			(5,977	)			—				(2,022	)			(213	)			(54	)			(11	)			(1,191	)			—				(277	)			(—	)			(9,745	)
Recoveries			111				—				19				—				7				1				19				—				130				—				287
Provisions			7,411				3				3,070				679				36				18				1,531				2				117				113				12,980
Ending Balance		$	6,168			$	28			$	3,450			$	1,007			$	12			$	21			$	882			$	18			$	139			$	1,522			$	13,247
Ending Balance: individually evaluated for impairment		$	803			$	—			$	916			$	546			$	—			$	—			$	102			$	—			$	—			$	—			$	2,367
Ending Balance: collectively evaluated for impairment		$	5,365			$	28			$	2,534			$	461			$	12			$	21			$	780			$	18			$	139			$	1,522			$	10,880
Loans
Ending Balance		$	90,145			$	26,661			$	120,278			$	217,709			$	4,209			$	2,261			$	60,238			$	28,215			$	17,915			$	—			$	567,631
Ending Balance: individually evaluated for impairment		$	15,940			$	—			$	6,103			$	3,812			$	—			$	—			$	397			$	—			$	—			$	—			$	26,252
Ending Balance: collectively evaluated for impairment		$	74,205			$	26,661			$	114,175			$	213,897			$	4,209			$	2,261			$	59,841			$	28,215			$	17,915			$	—			$	541,379

 

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Loans are closely monitored by management for changes in quality. This monitoring includes assessing the appropriateness of the credit quality indicator in relation to the risk of the loan. Management uses the following indicators to grade the risk of each loan based on a system of eight possible ratings.

Pass: Include loans that are risk rated one through three. The primary source of repayment for pass loans is very likely to be sufficient, with secondary sources readily available; strong financial position; minimal risk; profitability, liquidity and capitalization are better than industry norms.

Weak Pass: Include loans that are risk rated four. The asset quality for weak pass assets is generally acceptable. Primary source of loan repayment is acceptable and secondary sources are likely to be realized, if needed; acceptable business credit, but borrowers operations, cash flow, or financial condition evidence more than average risk; requires above average levels of supervision and attention from Loan Officer. The source of increased risk has been identified, can be effectively managed/corrected, and the increased risk is not significant to warrant a more severe rating.

Special Mention : Include loans that are risk rated five. A special mention asset is considered to be high risk due to potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard : Include loans that are risk rated six through eight. Loans rated as substandard are considered to be very high risk. A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Some loans that are substandard do not meet the definition of an impaired loan and therefore are not deemed impaired.

The following tables present loans as of September 30, 2011 and December 31, 2010 classified by risk type:

Credit Quality Indicators

As of September 30, 2011

 

		Pass				Weak Pass				Special Mention				Substandard				Total
		(Dollars in thousands)
Real Estate—Construction and Land Development Loans		$	28,042			$	23,173			$	6,289			$	13,670			$	71,174
Real Estate—Secured by Farmland			23,724				4,500				3,558				—				31,782
Real Estate—Secured by Residential Properties			61,587				36,253				10,989				8,995				117,824
Real Estate—Secured by Nonfarm Nonresidential			94,931				79,452				23,191				13,905				211,479
Consumer Installment			3,438				1,587				228				101				5,354
Credit Cards and Related Plans			1,160				670				111				290				2,231
Commercial and Industrial			22,938				17,516				1,899				1,848				44,201
Loans to Finance Agriculture Production			14,735				3,829				2,346				—				20,910
All Other Loans			5,912				10,735				22				2				16,671
Total		$	256,467			$	177,715			$	48,633			$	38,811			$	521,626

 

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Credit Quality Indicators

As of December 31, 2010

 

		Pass				Weak Pass				Special Mention				Substandard				Total
		(Dollars in thousands)
Real Estate—Construction and Land Development Loans		$	35,356			$	27,978			$	9,466			$	17,345			$	90,145
Real Estate—Secured by Farmland			17,869				6,294				2,495				3				26,661
Real Estate—Secured by Residential Properties			64,457				43,364				3,469				8,988				120,278
Real Estate—Secured by Nonfarm Nonresidential			94,208				96,287				20,107				7,107				217,709
Consumer Installment			2,466				1,460				265				18				4,209
Credit Cards and Related Plans			1,211				869				89				92				2,261
Commercial and Industrial			33,416				22,805				3,292				725				60,238
Loans to Finance Agriculture Production			18,346				7,230				2,639				—				28,215
All Other Loans			8,442				9,341				119				13				17,915
Total		$	275,771			$	215,628			$	41,941			$	34,291			$	567,631

The following tables summarize the past due loans by category as of September 30, 2011 and December 31, 2010:

Past Due Loans

As of September 30, 2011

 

		30-59 Days Past Due				60-89 Days Past Due				Greater than 89 Days				Total Past Due				Current				Total
		(Dollars in thousands)
Real Estate Construction and Land Development		$	99			$	—			$	8,537			$	8,636			$	62,538			$	71,174
Real Estate Secured by Farmland			—				—				—				—				31,782				31,782
Real Estate Secured by Residential Properties			2,248				682				1,841				4,771				113,053				117,824
Real Estate Secured by Nonfarm Nonresidential			1,490				1,850				3,492				6,832				204,647				211,479
Consumer Installment			3				6				—				9				5,345				5,354
Credit Cards and Related Plans			1				—				200				201				2,030				2,231
Commercial and Industrial			42				—				253				295				43,906				44,201
Loans to Finance Agricultural Production			—				—				—				—				20,910				20,910
All Other Loans			26				—				—				26				16,645				16,671
Total		$	3,909			$	2,538			$	14,323			$	20,770			$	500,856			$	521,626

 

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Past Due Loans

As of December 31, 2010

 

		30-59 Days Past Due				60-89 Days Past Due				Greater than 90 Days				Total Past Due				Current				Total
		(Dollars in thousands)
Real Estate Construction and Land Development		$	2,997			$	929			$	9,627			$	13,553			$	76,592			$	90,145
Real Estate Secured by Farmland			—				—				—				—				26,661				26,661
Real Estate Secured by Residential Properties			251				389				2,526				3,166				117,112				120,278
Real Estate Secured by Nonfarm Nonresidential			545				—				919				1,464				216,245				217,709
Consumer Installment			35				6				5				46				4,163				4,209
Credit Cards and Related Plans			3				—				—				3				2,258				2,261
Commercial and Industrial			111				19				553				683				59,555				60,238
Loans to Finance Agricultural Production			—				—				—				—				28,215				28,215
All Other Loans			22				4				—				26				17,889				17,915
Total		$	3,964			$	1,347			$	13,630			$	18,941			$	548,690			$	567,631

 

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The following tables summarize impaired loans as of September 30, 2011 and December 31, 2010. The recorded investment balance includes the loan balance, deferred fees that have yet to be recognized and accrued interest. The deferred fees that have yet to be recognized are not material amounts. At September 30, 2011, $14.0 million of the recorded investment in impaired loans were loans that were written down through partial charge-offs of $8.9 million. At December 31, 2010, $11.8 million of the recorded investment in impaired loans were loans that were written down through partial charge-offs of $7.3 million.

Impaired Loans

 

		Balance at September 30, 2011												Nine Months Ended September 30, 2011								Three Months Ended September 30, 2011
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
		(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development		$	9,766			$	15,847			$	—			$	8,009			$	98			$	8,389			$	32
Real Estate Secured by Farmland			—				—				—				—				—				—				—
Real Estate Secured by Residential Properties			3,546				3,880				—				3,858				58				3,881				21
Real Estate Secured by Nonfarm Nonresidential			5,779				7,245				—				2,220				47				3,626				25
Consumer Installment			—				—				—								—								—
Credit Cards and Related Plans			—				—				—				—				—				—				—
Commercial and Industrial			413				650				—				359				10				344				3
Loans to Finance Agricultural Production			—				—				—				—				—				—				—
All Other Loans			—				—				—				—				—				—				—
Total impaired loans with no related allowance		$	19,504			$	27,622			$	—			$	14,446			$	213			$	16,240			$	81
With an allowance recorded:
Real Estate Construction and Land Development		$	2,807			$	3,478			$	940			$	7,449			$	91			$	5,935			$	22
Real Estate Secured by Farmland			—				—				—				—				—				—				—
Real Estate Secured by Residential Properties			4,138				4,135				1,059				4,064				62				4,367				24
Real Estate Secured by Nonfarm Nonresidential			3,983				4,046				999				3,889				82				5,178				35
Consumer Installment			—				—				—				—				—				—				—
Credit Cards and Related Plans			200				200				200				200				7				200				2
Commercial and Industrial			958				951				510				601				17				995				9
Loans to Finance Agricultural Production			—				—				—				—				—				—				—
All Other Loans			—				—				—				—				—				—				—
Total impaired loans with related allowance recorded		$	12,086			$	12,810			$	3,708			$	16,203			$	259			$	16,675			$	92
Total
Construction and Land Development		$	12,573			$	19,325			$	940			$	15,458			$	189			$	14,324			$	54
Residential			7,684				8,015				1,059				7,922				120				8,248				45
Commercial			11,133				12,892				1,509				7,069				156				10,143				72
Consumer			200				200				200				200				7				200				2
Total impaired loans		$	31,590			$	40,432			$	3,708			$	30,649			$	472			$	32,915			$	173

 

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Impaired Loans

As of December 31, 2010

 

		Recorded Investment				Unpaid Principal Balance				Related Allowance
		(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development		$	9,212			$	13,354			$	—
Real Estate Secured by Farmland			—				—				—
Real Estate Secured by Residential Properties			2,700				2,972				—
Real Estate Secured by Nonfarm Nonresidential			1,029				1,097				—
Consumer Installment			—				—				—
Credit Cards and Related Plans			—				—				—
Commercial and Industrial			218				217				—
Loans to Finance Agricultural Production			—				—				—
All Other Loans			—				—				—
Total impaired loans with no related allowance		$	13,159			$	17,640			$	—
With an allowance recorded:
Real Estate Construction and Land Development		$	6,771			$	9,497			$	803
Real Estate Secured by Farmland			—				—				—
Real Estate Secured by Residential Properties			3,411				3,405				915
Real Estate Secured by Nonfarm Nonresidential			2,794				2,784				546
Consumer Installment			—				—				—
Credit Cards and Related Plans			—				—				—
Commercial and Industrial			179				199				102
Loans to Finance Agricultural Production			—				—				—
All Other Loans			—				—				—
Total impaired loans with related allowance recorded		$	13,155			$	15,885			$	2,366
Total
Construction and Land Development		$	15,983			$	22,851			$	803
Residential			6,111				6,377				915
Commercial			4,220				4,297				648
Consumer			—				—				—
Total impaired loans		$	26,314			$	33,525			$	2,366

The following table presents nonaccrual loans as of September 30, 2011 and December 31, 2010 by loan category:

Nonaccrual Loans

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Real Estate Construction and Land Development		$	9,817			$	10,839
Real Estate Secured by Farmland			—				—
Real Estate Secured by Residential Properties			4,630				3,268
Real Estate Secured by Nonfarm Nonresidential			5,797				1,231
Consumer Installment			—				5
Credit Cards and Related Plans			200				—
Commercial and Industrial			297				553
Loans to Finance Agricultural Production			—				—
All Other Loans			—				—
Total		$	20,741			$	15,896

 

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For the three and nine months ended September 30, 2011 the following table presents a breakdown of the types of concessions made by loan class. The recorded investment balances presented are balances at the time of concessions.

Troubled Debt Restructurings

 

		Three Months ended September 30, 2011												Nine Months ended September 30, 2011
		Number of Loans				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment				Number of Loans				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
										(Dollars in thousands)
Below market interest rate:
Real Estate Secured by Residential Properties			—			$	—			$	—				1			$	219			$	219
Real Estate Secured by Nonfarm Nonresidential			—				—				—				1				1,145				1,145
Credit Cards and Related Plans			—				—				—				1				33				33
Total below market interest rate			—			$	—			$	—				3			$	1,397			$	1,397
Extended payment terms:
Real Estate Construction and Land Development			—			$	—			$	—				1			$	56			$	56
Real Estate Secured by Residential Properties			—				—				—				3				1,549				1,549
Real Estate Secured by Nonfarm Nonresidential			3				918				918				3				918				918
Commercial and Industrial			2				227				227				2				227				227
Total Extended Payment Terms			5			$	1,145			$	1,145				9			$	2,750			$	2,750
Forgiveness of principal:
Real Estate Construction and Land Development			—			$	—			$	—				10			$	925			$	860
Total forgiveness of principal			—			$	—			$	—				10			$	925			$	860
Total			5			$	1,145			$	1,145				22			$	5,072			$	5,007

 

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The following table presents the successes and failures of the types of modifications within the previous nine months as of September 30, 2011. The recorded investment balances presented are as of September 30, 2011.

 

		Paid in Full								Paying as Restructured								Converted to Non-accrual								Foreclosure/Default
		Number of Loans				Recorded Investment				Number of Loans				Recorded Investment				Number of Loans				Recorded Investment				Number of Loans				Recorded Investment
		(Dollars in thousands)
Below market interest rate			—			$	—				3			$	1,395				—			$	—				—			$	—
Extended payment terms			—				—				8				2,588				1				166				—				—
Forgiveness of principal			—				—				—				—				10				828				—				—
Total			—				—				11			$	3,983				11				994				—				—

Of the loans listed above only one loan in the amount of $166 thousand converted to non-accrual during the three months ended September 30, 2011. There were no loans that were restructured during the three or nine months ending on September 30, 2011 that were ninety days or more past due and therefore had a payment default.

Loans which management identifies as impaired generally will be nonperforming loans or restructured loans (also known as “troubled debt restructurings” or “TDR’s”). As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered troubled debt restructurings (TDRs) under the amended guidance. The Company identified no loans as TDRs which the allowance for loan losses had previously been measured under a general allowance methodology.

(8) Postretirement Benefits

The Company has a postretirement benefit plan whereby the Company pays postretirement health care benefits for certain of its retirees that have met minimum age and service requirements. Net periodic postretirement benefit cost for the nine- and three-month periods ended September 30, 2011 and 2010 includes the following components.

 

		Nine months ended September 30, (Dollars in thousands)
		2011				2010
Components of net periodic cost:
Service cost		$	6			$	3
Interest cost			27				32
Prior service cost			—				(6	)
Net periodic postretirement benefit cost		$	33			$	29

 

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		Three months ended September 30, (Dollars in thousands)
		2011				2010
Components of net periodic cost:
Service cost		$	2			$	1
Interest cost			9				11
Prior service cost			—				(2	)
Net periodic postretirement benefit cost		$	11			$	10

The Company expects to contribute $43 thousand to its postretirement benefit plan in 2011. No contributions were made in the first nine months of 2011. For additional information related to the plan, refer to the Company’s Form 10-K for the year ended December 31, 2010.

 

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(9) Fair Value Of Financial Instruments

Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at September 30, 2011 and December 31, 2010:

 

		September 30, 2011								December 31, 2010
		Carrying Value				Estimated Fair Value				Carrying Value				Estimated Fair Value
		(Dollars in thousands)
Financial assets:
Cash and cash equivalents		$	17,239			$	17,239			$	20,166			$	20,166
Investment securities			327,066				327,066				273,229				273,229
FHLB stock			3,768				3,768				4,571				4,571
Accrued interest receivable			4,972				4,972				5,243				5,243
Net loans			509,412				501,923				554,384				550,614
Loans held for sale			2,338				2,338				4,136				4,136
Financial liabilities:
Deposits		$	796,609			$	804,049			$	785,941			$	790,105
Short-term borrowings			13,528				13,528				11,509				11,509
Accrued interest payable			630				630				631				631
Long-term obligations			25,500				26,340				34,500				34,954

The fair value of net loans is based on estimated 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. This does not include consideration of liquidity that market participants would use to value such loans. The estimated fair values of deposits and long-term obligations at September 30, 2011 and December 31, 2010 are based on estimated cash flows discounted at market interest rates. The carrying values of other financial instruments, including various receivables and payables, approximate fair value. The fair value of off-balance sheet financial instruments is considered immaterial. These off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

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 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 use of option pricing models, discounted cash flow models and similar techniques.

 

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The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities 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 lower of cost or market accounting or write-downs of individual assets.

There were no changes to the techniques used to measure fair value during the period.

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

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, 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.

Mortgage Banking Activity

The Company enters into interest rate lock commitments and commitments to sell mortgages. At September 30, 2011, the amount of fair value associated with these interest rate lock commitments was $96 thousand, which is included in other assets. At December 31, 2010, the amount of fair value associated with these interest rate lock commitments was $101 thousand, which was included in other assets. Forward loan sale commitments have been deemed insignificant for both periods.

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 losses 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 agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2011, the majority of the total impaired loans were evaluated based on 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 impaired 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 impaired loan as nonrecurring Level 3.

Real Estate and Repossessions Acquired in Settlement of Loans

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged 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.

 

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Assets recorded at fair value on a recurring basis

 

September 30, 2011		Total				Level 1				Level 2				Level 3
		(Dollars in thousands)
Investment Securities Available-for-Sale
Government-sponsored enterprises and FFCB bonds		$	14,529			$	—			$	14,529			$	—
Obligations of states and political subdivisions			11,453				—				11,453				—
Mortgage-backed securities			156,701				25,109				131,592				—
SBA-backed securities			113,201				113,201				—				—
Corporate bonds			31,182				4,994				23,100				3,088
Total Securities		$	327,066			$	143,304			$	180,674			$	3,088
Interest rate lock commitments		$	96			$	—			$	—			$	96
Total assets at fair value		$	327,162			$	143,304			$	180,674			$	3,184

Assets recorded at fair value on a recurring basis

 

December 31, 2010		Total				Level 1				Level 2				Level 3
		(Dollars in thousands)
Investment Securities Available-for-Sale
Government-sponsored enterprises and FFCB bonds		$	24,781			$	—			$	24,781			$	—
Obligations of states and political subdivisions			12,978				—				12,978				—
Mortgage-backed securities			150,090				4,200				145,890				—
SBA-backed securities			56,853				55,422				1,431				—
Corporate bonds			28,527				—				26,811				1,716
Total Securities		$	273,229			$	59,622			$	211,891			$	1,716
Interest rate lock commitments		$	101			$	—			$	—			$	101
Total assets at fair value		$	273,330			$	59,622			$	211,891			$	1,817

 

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Assets recorded at fair value on a nonrecurring basis

 

September 30, 2011		Total				Level 1				Level 2				Level 3
		(Dollars in thousands)
Impaired Loans
Real estate—construction and land development		$	10,962			$	—			$	4,320			$	6,642
Real estate—secured by residential properties			4,510				—				3,251				1,259
Real estate—secured by nonfarm nonresidential properties			5,500				—				3,488				2,012
Commercial and industrial			630				—				36				594
Total impaired loans		$	21,602			$	—			$	11,095			$	10,507
Real estate and repossessions acquired in settlement of loans
Total real estate and repossessions acquired in settlement of loans		$	6,223			$	—			$	4,517			$	1,706
Total assets at fair value		$	27,825			$	—			$	15,612			$	12,213

 

December 31, 2010		Total				Level 1				Level 2				Level 3
		(Dollars in thousands)
Impaired Loans
Real estate—construction and land development		$	11,077			$	—			$	3,027			$	8,050
Real estate—secured by residential properties			3,834				—				3,666				168
Real estate—secured by nonfarm nonresidential properties			2,550				—				2,467				83
Commercial and industrial			77				—				—				77
Total impaired loans		$	17,538			$	—			$	9,160			$	8,378
Real estate and repossessions acquired in settlement of loans
Real estate and repossessions acquired in settlement of loans		$	4,536			$	—			$	2,277			$	2,259
Total assets at fair value		$	22,074			$	—			$	11,437			$	10,637

 

 

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As of September 30, 2011 there were $3.9 million of Level 2 investment securities available for sale that were reported as Level 1 as of December 31, 2010. The bond was transferred from Level 1 to Level 2 during the year of 2011 because the December 31, 2010 pricing was based on the Company’s actual trade for the security at initial purchase while the September 30, 2011 pricing was through a pricing system.

During the first nine months of 2011 there were no investment securities transferred in or out of Level 3. During the first nine months of 2010, there was one Level 3 investment security that was transferred to Level 2 given that the September 30, 2010 valuation was based on a third party market valuation that was based on quoted prices for similar instruments in active markets versus the December 31, 2009 valuation which was based on assumptions not observable in the market. The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and nine month periods of 2011 and the first nine months of 2010.

 

		Corporate Bonds				Interest Rate Lock Commitments				Total
		(Dollars in thousands)
Balance, December 31, 2010		$	1,716			$	101			$	1,817
Total gains or losses (realized/unrealized):
Included in earnings			—				(31	)			(31	)
Included in other comprehensive income			(225	)			—				(225	)
Purchases, issuances, and settlements			—				—				—
Transfers in to/out of Level 3			—				—				—
Balance, June 30, 2011		$	1,491			$	70			$	1,561
Total gains or losses (realized/unrealized):
Included in earnings			—				26				26
Included in other comprehensive income			97				—				97
Purchases, issuances, and settlements			1,500				—				1,500
Transfers in to/out of Level 3			—				—				—
Balance, September 30, 2011		$	3,088			$	96			$	3,184

 

		Government- sponsored enterprises and FFCB bonds				Corporate Bonds				Total
		(Dollars in thousands)
Balance, December 31, 2009		$	2,480			$	1,871			$	4,351
Total gains or losses (realized/unrealized):
Included in earnings			—				—				—
Included in other comprehensive income			—				(70	)			(70	)
Purchases, issuances, and settlements											—
Transfers in to/out of Level 3			(2,480	)			—				(2,480	)
Balance, September 30, 2010		$	—			$	1,801			$	1,801

 

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(10) U.S. Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program

On January 16, 2009, we issued Series A Preferred Stock in the amount of $17,949,000 and a warrant to purchase 144,984 shares of our common stock to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The Series A Preferred Stock qualifies as Tier 1 capital for purposes of regulatory capital requirements and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Prior to January 16, 2012, unless we have redeemed all of this preferred stock or the U.S. Treasury has transferred all of this preferred stock to a third party, the consent of the U.S. Treasury will be required for us to, among other things, increase our common stock dividend above $0.1825 per share or repurchase our common stock except in limited circumstances. In addition, until the U.S. Treasury ceases to own our securities sold under the TARP Capital Purchase Program, the compensation arrangements for our senior executive officers must comply in all respects with the U.S. Emergency Economic Stabilization Act of 2008 and the rules and regulations thereunder.

(11) Regulatory Matters

Bancorp’s and the Bank’s actual capital ratios for purposes of bank regulatory capital guidelines are presented in the following table:

 

		Ratio required to be well capitalized under prompt corrective action provisions				Minimum ratio required for capital adequacy purposes				Bancorp’s Ratio				Bank’s Ratio
As of September 30, 2011:
Tier 1 Capital (to Average Assets)		³	5.00	%		³	3.00	%			8.34	%			8.34	%
Tier 1 Capital (to Risk Weighted Assets)		³	6.00	%		³	4.00	%			12.59				12.59
Total Capital (to Risk Weighted Assets)		³	10.00	%		³	8.00	%			13.85				13.85
As of December 31, 2010:
Tier 1 Capital (to Average Assets)		³	5.00	%		³	3.00	%			8.66	%			8.66	%
Tier 1 Capital (to Risk Weighted Assets)		³	6.00	%		³	4.00	%			12.08				12.08
Total Capital (to Risk Weighted Assets)		³	10.00	%		³	8.00	%			13.34				13.34
As of September 30, 2010:
Tier 1 Capital (to Average Assets)		³	5.00	%		³	3.00	%			8.79	%			6.85	%
Tier 1 Capital (to Risk Weighted Assets)		³	6.00	%		³	4.00	%			12.38				9.65
Total Capital (to Risk Weighted Assets)		³	10.00	%		³	8.00	%			13.64				10.91

 

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During April 2011, the Bank’s Board of Directors adopted a resolution at the request of the Federal Deposit Insurance Corporation to the effect that the Bank, through its management, will take various actions designed to address issues related to the Bank’s operations. The Resolution provides that, among other things, the Bank will (1) establish and continue to maintain an adequate reserve for loan losses, and review the adequacy of the reserve with the Board prior to each quarter-end and make appropriate provisions to the reserve; (2) in order to maintain sufficient capital levels, establish and document a prudent policy regarding cash dividends the Bank pays to Bancorp, document an analysis of amounts to be paid by each quarter-end prior to payment, and not pay any cash dividend to Bancorp without seeking the prior approval of the FDIC and N.C. Commissioner of Banks; (3) implement various recommendations regarding risk management policies and practices for the Bank’s funds management and investment functions; (4) provide for the internal audit program to include a review and coverage of activities sufficient to determine compliance with the Bank’s policies, applicable laws and regulations and sound banking principles, and identification of audit personnel who periodically report directly to the Board; (5) correct or eliminate various credit administration weaknesses and establish an effective credit administration function, and ascertain that all necessary supporting documentation is obtained and evaluated before loans are extended; and (6) correct violations of and ensure further compliance with applicable laws, rules and regulations.

The Bank has complied with the necessary actions in all aspects of the board resolution.

(12) Security Purchase Agreement

On June 30, 2011, the Company entered into a Securities Purchase Agreement with certain institutional investors to issue $75 million in 4,687,500 common shares under a private placement at $16 per share. It will also issue warrants to the investors with five-year terms that are convertible into common stock at an exercise price of $8 per share. The amount of common shares subject to exercise under the warrants will equal 25% of the number of shares to be issued to the investors in the offering. The completion of the transaction is subject to regulatory approval but is expected to close in the fourth quarter.

On September 9, 2011, the Company entered into a First Amended and Restated Securities Purchase Agreement (the “Amended Agreement”) pursuant to which one additional institutional investor agreed to purchase common stock in the Offering and one other Investor agreed to increase their respective investments in the Company. As a result, the aggregate size of the Offering was increased to $79.7 million and the number of common shares to be issued increased to 4,981,250.

The Company intends to use the proceeds of the offering to support future operational growth and to redeem the preferred stock and associated warrants that were issued under the TARP Capital Purchase Program. The proceeds will also be used to improve capital for other general corporate purposes.

(13) Entry Into a Definitive Material Agreement.

On July 14, 2011, ECB Bancorp, Inc. announced that its subsidiary, The East Carolina Bank (the “Bank”), has entered into a definitive agreement (the “Agreement”) with The Bank of Hampton Roads (“Hampton Roads”) under which the Bank will acquire five banking offices of Hampton Roads, located in Cary, Chapel Hill, Plymouth and Raleigh, North Carolina. Of the five offices to be acquired, two will be sold at their fair market value and the three other offices will be leased. The Bank has also agreed to purchase three parcels of unimproved real property in Chapel Hill and Raleigh, North Carolina, each at their fair market value, and assume the lease for one parcel of unimproved real property in Durham, North Carolina, in each case for future branch development.

 

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The Agreement provides that the Bank will assume approximately $195 million of deposit liabilities, which includes the deposit liabilities from the Branches as well as deposit liabilities from two additional Hampton Roads branch offices in Roper and Wilmington, North Carolina. The Bank will pay an aggregate 2.4% deposit premium on the deposit liabilities it assumes.

The Bank will not be assuming any brokered deposits, deposit accounts associated with lines of credit, self-directed individual retirement accounts or certain other deposit liabilities in the transaction. Under the agreement, the Bank will purchase the personal property, furniture, fixtures, leasehold improvements and equipment located at the Branches. Management is in the process of evaluating the accounting treatment of the transaction.

Completion of the transaction is subject to receipt of required regulatory approvals and satisfaction of other customary closing conditions.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this Report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risk factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available through our Internet website at www.myecb.com or directly through the Commission’s website at www.sec.gov. Forward-looking statements in this Report may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, (a) the necessary approval required for the private placement and assumption of deposits may not be obtained or may not be obtained on the terms expected or on the schedule that we anticipate, and other closing conditions for such transactions may not be satisfied (b) pressures on our earnings, capital and liquidity resulting from current and future conditions in the credit and equity markets, (c) continued or unexpected increases in credit losses in our loan portfolio, (d) continued adverse conditions in the economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (e) the financial success or changing strategies of our customers, (f) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect our business, (g) changes in the interest rate environment and the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, (h) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively against other financial institutions in our banking markets; (i) weather and similar conditions, particularly the effect of hurricanes on our banking and operations facilities and on our customers and the communities in which we do business; and (j) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements in this Report are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and we do not intend, to update these forward-looking statements.

Executive Summary

ECB Bancorp, Inc. is a bank holding company headquartered in Engelhard, North Carolina. Our wholly owned subsidiary, The East Carolina Bank (the “Bank”), is a state-chartered community bank that was founded in 1919. For the purpose of this discussion, “we,” “us” and “our” refers to the Bank and the bank holding company as a single, consolidated entity unless the context otherwise indicates.

As of September 30, 2011, we had consolidated assets of approximately $923.7 million, total loans of approximately $521.6 million, total deposits of approximately $796.6 million and shareholders’ equity of approximately $83.2 million. For the three months ended September 30, 2011, we had income available to common shareholders of $260 thousand, or $0.09 basic and diluted earnings per share, compared to income available to common shareholders of $273 thousand, or $0.10 basic and diluted earnings per share for the three months ended September 30, 2010. For the nine months ended September 30, 2011, we had net loss attributable to common shareholders of $209 thousand or $0.07 basic and diluted loss per share, compared to income available to common shareholders of $1.2 million or $0.42 basic and diluted earnings per share for the nine months ended September 30, 2010.

 

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Critical Accounting Policies

Our significant accounting policies are set forth in Note 1 to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. Of these significant accounting policies, we consider our policy regarding the allowance for loan losses to be our most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. We have developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements. Additional information concerning our allowance for loan losses and related matters is contained in the discussion under the caption “Asset Quality”.

Comparison of the Results of Operations for the Three- and Nine-Month Periods Ended September 30, 2011 and 2010

The following table summarizes components of income and expense and the changes in those components for the three- and nine-month periods ended September 30, 2011 as compared to the same periods in 2010.

Condensed Consolidated Results of Operations

(Dollars in thousands)

 

		For the Three Months Ended September  30, 2011				Changes from the Prior Year								For the Nine Months Ended September 30, 2011				Changes from the Prior Year
						Amount				%								Amount				%
Total interest income		$	9,189			$	(793	)			(7.9	)		$	28,259			$	(1,708	)			(5.7	)
Total interest expense			2,566				(439	)			(14.6	)			7,823				(1,139	)			(12.7	)
Net interest income			6,623				(354	)			(5.1	)			20,436				(569	)			(2.7	)
Provision for loan losses			1,028				(2,835	)			(73.4	)			6,231				(2,412	)			(27.9	)
Net interest income after
Provision for loan losses			5,595				2,481				79.7				14,205				1,843				14.9
Noninterest income			2,568				(1,232	)			(32.4	)			6,538				(1,796	)			(21.6	)
Noninterest expense			7,539				1,160				18.2				20,440				1,907				10.3
Income before income taxes			624				89				16.6				303				(1,860	)			(86.0	)
Income tax provision (benefit)			97				102				(2,040	)			(285	)			(464	)			(259.2	)
Net income			527				(13	)			(2.4	)			588				(1,396	)			(70.4	)
Preferred stock dividend and accretion of discount			267				—				—				797				—				—
Net income (loss) available to common shareholders		$	260			$	(13	)			(4.8	)		$	(209	)		$	(1,396	)			(117.6	)

 

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Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. Net interest income for the three months ended September 30, 2011 was $6.6 million, a decrease of $354 thousand or 5.1% when compared to net interest income of $7.0 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, net interest income was $20.4 million, a decrease of $569 thousand or 2.7% when compared to net interest income of $21.0 million for the same period in 2010.

The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and interest-bearing liabilities and the various rate spreads between our interest-earning assets and our interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.

Interest income decreased $793 thousand or 7.9% for the three months ended September 30, 2011 compared to the same three months of 2010. Interest income decreased $1.7 million or 5.7% for the nine months ended September 30, 2011 compared to the same nine months in 2010. The decreases for the three and nine months ended September 30, 2011 are due to the decreases in the rates earned on our average earning assets and a decrease in the volume of these earning assets. The tax-equivalent yield on average earning assets decreased 45 basis points for the quarter ended September 30, 2011 to 4.24% from 4.69% for the same period in 2010. For the first nine months of 2011, the yield on average earning assets, on a tax-equivalent basis, decreased 43 basis points to 4.46% compared to 4.89% for the nine months ended September 30, 2010. Management attributes the decrease in the yield on our earning assets to the continued low level of market interest rates. Yields on our taxable securities decreased approximately 54 and 62 basis points for the three- and nine-month periods ending September 30, 2011, respectively, as compared to the same periods last year as the volume of securities has increased with lower yielding securities and previously held securities sold, called or matured have been replaced with lower yielding securities.

Our average cost of funds during the third quarter of 2011 was 1.39%, a decrease of 25 basis points when compared to 1.64% for the third quarter of 2010. Average rates paid on bank certificates of deposit decreased 30 basis points from 2.07% for the quarter ended September 30, 2010 to 1.77% for the quarter ended September 30, 2011, while our average cost of borrowed funds decreased 3 basis points during the third quarter of 2011 compared to the same period in 2010. Total interest expense decreased $439 thousand or 14.6% during the third quarter of 2011 compared to the same period in 2010, primarily the result of decreased market rates paid on these liabilities. For the nine months ended September 30, 2011, our cost of funds was 1.43%, a decrease of 25 basis points when compared to 1.68% for the same period in 2010. Average rates paid on bank certificates of deposit decreased 24 basis points from 2.08% to 1.84% for the first nine months of 2011, while our cost of borrowed funds decreased 18 basis points compared to the same period a year ago. Total interest expense decreased $1.1 million or 12.7% during the nine months of 2011 compared to the same period in 2010, primarily the result of decreased market rates paid on these liabilities. The volume of average interest-bearing liabilities increased approximately $14.6 million for the nine months of 2011 compared with the same period in 2010.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest bearing deposits in earning assets.

Our annualized net interest margin, on a tax-equivalent basis, for the three months ended September 30, 2011 was 3.06% compared to 3.31% in the third quarter of 2010, while our net interest spread decreased 20 basis points during the same period. For the nine months ended September 30, 2011, our net interest margin, on a tax-equivalent basis, was 3.24% compared to 3.46% in the first nine months of 2010 while our net interest spread decreased 18 basis points.

Average interest-bearing liabilities, as a percentage of interest-earning assets, for the quarters ended September 30, 2011 and 2010 were 84.6% and 84.5%, respectively. For the nine months ended September 30, 2011, average interest-bearing liabilities as a percentage of interest-earning assets were 85.6% compared to 85.2% for the nine months ended September 30, 2010.

 

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Average Consolidated Balance Sheets and Net Interest Analysis Fully on Tax-Equivalent Basis

For the three months ended

 

		September 30, 2011												September 30, 2010
		Average Balance				Yield/ Rate(5)				Income/ Expense				Average Balance				Yield/ Rate(5)				Income/ Expense
		(Dollars in thousands)
Assets
Loans—net (1)		$	522,486				5.39	%		$	7,096			$	564,526				5.37	%		$	7,640
Taxable securities			302,011				2.59	%			1,970				247,596				3.13	%			1,955
Non-taxable securities (2)			10,863				5.87	%			161				38,220				6.06	%			583
Other investments			29,147				0.23	%			17				10,013				0.08	%			2
Total interest-earning assets			864,507				4.24	%		$	9,244				860,355				4.69	%		$	10,180
Cash and due from banks			14,775												11,955
Bank premises and equipment, net			26,343												25,622
Other assets			35,385												27,433
Total assets		$	941,010											$	925,365
Liabilities and Shareholders’ Equity
Interest-bearing deposits		$	690,380				1.35	%		$	2,347			$	684,890				1.61	%		$	2,778
Short-term borrowings			14,287				2.03	%			73				18,351				1.43	%			66
Long-term obligations			26,978				2.15	%			146				23,812				2.68	%			161
Total interest-bearing liabilities			731,645				1.39	%			2,566				727,052				1.64	%			3,005
Non-interest-bearing deposits			121,741												108,111
Other liabilities			5,288												1,792
Shareholders’ equity			82,336												88,410
Total liabilities and Shareholders’ equity		$	941,010											$	925,365
Net interest income and net interest margin (FTE) (3)							3.06	%		$	6,678								3.31	%		$	7,175
Interest rate spread (FTE) (4)							2.85	%											3.05	%

 

(1)	Average loans include non-accruing loans, net of allowance for loan losses and loans held for sale.

(2)	Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable-equivalent adjustments were $55 thousand and $198 thousand for periods ended September 30, 2011 and 2010, respectively.

(3)	Net interest margin is computed by dividing net interest income by average total earning assets.

(4)	Interest rate spread equals the average yield on total earning assets minus the average rate paid on total interest-bearing liabilities.

(5)	Annualized

 

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For the nine months ended

 

		September 30, 2011												September 30, 2010
		Average Balance				Yield/ Rate(5)				Income/ Expense				Average Balance				Yield/ Rate(5)				Income/ Expense
		(Dollars in thousands)
Assets
Loans—net (1)		$	533,250				5.46	%		$	21,782			$	566,824				5.44	%		$	23,062
Taxable securities			285,005				2.86	%			6,088				213,564				3.48	%			5,559
Non-taxable securities (2)			11,681				6.09	%			532				44,461				6.09	%			2,026
Other investments			21,876				0.23	%			38				14,129				0.09	%			9
Total interest-earning assets			851,812				4.46	%		$	28,440				838,978				4.89	%		$	30,656
Cash and due from banks			13,423												11,395
Bank premises and equipment, net			26,596												25,321
Other assets			35,363												27,032
Total assets		$	927,194											$	902,726
Liabilities and Shareholders’ Equity
Interest-bearing deposits		$	684,901				1.39	%		$	7,137			$	677,946				1.65	%		$	8,345
Short-term borrowings			15,056				1.91	%			215				17,113				1.43	%			183
Long-term obligations			29,075				2.17	%			471				19,384				2.99	%			434
Total interest-bearing liabilities			729,032				1.43	%			7,823				714,443				1.68	%			8,962
Non-interest-bearing deposits			111,563												101,202
Other liabilities			5,5526												708
Shareholders’ equity			81,073												86,373
Total liabilities and Shareholders’ equity		$	927,194											$	902,726
Net interest income and net interest margin (FTE) (3)							3.24	%		$	20,617								3.46	%		$	21,694
Interest rate spread (FTE) (4)							3.03	%											3.21	%

 

(1)	Average loans include non-accruing loans, net of allowance for loan losses and loans held for sale.

(2)	Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable-equivalent adjustments were $181 thousand and $689 thousand for periods ended September 30, 2011 and 2010, respectively.

(3)	Net interest margin is computed by dividing net interest income by average total earning assets.

(4)	Interest rate spread equals the average yield on total earning assets minus the average rate paid on total interest-bearing liabilities.

(5)	Annualized

The following table presents the relative impact on net interest income of average outstanding balances (volume) of earning assets and interest-bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

 

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Change in Interest Income and Expense on Tax Equivalent Basis

For the three months ended September 30, 2011 compared to 2010

Increase (Decrease) in interest income and expense due to changes in:

 

		2011 compared to 2010
		Volume(1)				Rate(1)				Net
		(Dollars in thousands)
Loans		$	(570	)		$	26			$	(544	)
Taxable securities			392				(377	)			15
Non-taxable securities (2)			(411	)			(11	)			(422	)
Other investments			7				8				15
Interest income			(582	)			(354	)			(936	)
Interest-bearing deposits			20				(451	)			(431	)
Short-term borrowings			(18	)			25				7
Long-term obligations			19				(34	)			(15	)
Interest expense			21				(460	)			(439	)
Net interest income		$	(603	)		$	106			$	(497	)

 

(1)	The combined rate/volume variance for each category has been allocated equally between rate and volume variances.

(2)	Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable-equivalent adjustments were $55 thousand and $198 thousand for periods ended September 30, 2011 and 2010, respectively.

For the nine months ended September 30, 2011 compared to 2010

Increase (Decrease) in interest income and expense due to changes in:

 

		2011 compared to 2010
		Volume(1)				Rate(1)				Net
		(Dollars in thousands)
Loans		$	(1,369	)		$	89			$	(1,280	)
Taxable securities			1,693				(1,164	)			529
Non-taxable securities (2)			(1,493	)			(1	)			(1,494	)
Other investments			9				20				29
Interest income			(1,160	)			(1,056	)			(2,216	)
Interest-bearing deposits			79				(1,287	)			(1,208	)
Short-term borrowings			(26	)			58				32
Long-term obligations			187				(150	)			37
Interest expense			240				(1,379	)			(1,139	)
Net interest income		$	(1,400	)		$	323			$	(1,077	)

 

(1)	The combined rate/volume variance for each category has been allocated equally between rate and volume variances.

(2)	Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable-equivalent adjustments were $181 thousand and $689 thousand for periods ended September 30, 2011 and 2010, respectively.

 

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Provision for Loan Losses

The provision for loan losses charged to operations during the three and nine months ended September 30, 2011 was $1.0 million and $6.2 million, respectively. The provision for loan losses charged to operations during the three and nine months ended September 30, 2010 was $3.9 million and $8.6 million, respectively. The decreases for both periods were mainly due to changes made to our allowance model related to years to impairment. During the third quarter ended on September 30, 2011 the estimation of years to impairment for most homogeneous loan groups were reduced in the allowance model from two years to one year to reflect actual historic calculations. The Bank had net charge-offs of $4.3 million for the quarter ended September 30, 2011 compared to net charge-offs of $1.1 million during the third quarter of 2010. For the nine-month periods ended September 30, 2011 and 2010, the Bank had net charge-offs of $7.3 million and $5.2 million, respectively. We use the results of our allowance for loan loss model to estimate the dollar amount of provision expense needed to maintain the adequacy of our allowance for loan losses. Our management analyzes the adequacy of the allowance on a monthly basis and adjustments to the provision expense are made as necessary. Additional information regarding our allowance for loan losses is contained in the discussion under the caption “Asset Quality.”

Noninterest Income

Noninterest income, principally charges and fees assessed for the use of our services, is a significant contributor to net income. The following table presents the components of noninterest income for the three- and nine-month periods ended September 30, 2011 and 2010.

 

		For the Three Months Ended September 30, 2011				Changes from the Prior Year								For the Nine Months Ended September 30, 2011				Changes from the Prior Year
						Amount				%								Amount				%
		(Dollars in thousands)
Service charges on deposit accounts		$	836			$	(6	)			(0.7	)		$	2,429			$	(129	)			(5.0	)
Other service charges and fees			410				(60	)			(12.8	)			984				(184	)			(15.8	)
Mortgage origination fees			255				(96	)			(27.4	)			1,033				177				20.7
Net gain on sale of securities			998				(1,032	)			(50.8	)			1,882				(1,589	)			(45.8	)
Income from bank owned life insurance			74				(1	)			(1.3	)			222				(1	)			(0.4	)
Other operating expense			(5	)			(37	)			(115.6	)			(12	)			(70	)			(120.7	)
Total noninterest income		$	2,568			$	(1,232	)			(32.4	)		$	6,538			$	(1,796	)			(21.6	)

Noninterest income decreased $1.2 million or 32.4% to $2.6 million for the third quarter of this year compared to $3.8 million for the same period in 2010. For the nine months ended September 30, 2011 noninterest income decreased $1.8 million or 21.6% to $6.5 million compared to $8.3 million for the same period in 2010. The decrease in noninterest income in the third quarter of 2011 as compared to the same quarter of 2010 is primarily due to a decrease in net gain on sale of securities of $1.0 million. The year to date decrease in noninterest income is also primarily the result of a decrease in net gain on the sale of securities of $1.8 million. Service charges on deposit accounts decreased $6 thousand and $129 thousand, respectively, for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 mainly due to a decrease in overdraft protection fees. Other service charges and fees decreased $60 thousand and $184 thousand, respectively, for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. The primary reason for the decrease is that brokerage investment service fees and gain on mortgage commitments were down during both periods. Mortgage loan origination fees decreased $96 thousand and increased $177 thousand, respectively, for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. The increase is mainly because we established a correspondent bank platform for our mortgage department near the end of the first quarter of 2010 and we began originating loans in our name and selling them in the secondary market. This change fully impacted the nine months ending on September 30, 2011 but had less of an impact on the prior year periods.

 

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Noninterest Expense

Noninterest expense increased 18.2% and 10.3%, respectively, for the three and nine months ended September 30, 2011, as compared to the same periods in 2010. The following table presents the components of noninterest expense for the three and nine months ended September 30, 2011 and dollar and percentage changes from the prior year.

 

		For the Three Months Ended September 30, 2011				Changes from the Prior Year								For the Nine Months Ended September 30, 2011				Changes from the Prior Year
						Amount				%								Amount				%
		(Dollars in thousands)
Salaries		$	2,737			$	189				7.4			$	8,127			$	934				13.0
Retirement and other employee benefits			638				(102	)			(13.8	)			2,098				(84	)			(3.8	)
Occupancy			528				48				10.0				1,533				149				10.8
Equipment			550				(39	)			(6.6	)			1,622				80				5.2
Professional fees			240				53				28.3				782				96				14.0
Supplies			49				4				8.9				178				13				7.9
Telephone			179				32				21.8				537				50				10.3
FDIC deposit insurance			236				(119	)			(33.5	)			763				(270	)			(26.1	)
Other outside services			94				(29	)			(23.6	)			437				86				24.5
Net cost of real estate and repossessions acquired in settlement of loans			645				533				475.9				742				249				50.5
Other operating expenses			1,643				590				56.0				3,621				604				20.0
Total noninterest expenses		$	7,539			$	1,160				18.2			$	20,440			$	1,907				10.3

Salary expense for the three and nine months ended September 30, 2011 increased $189 thousand and $934 thousand, respectively, compared to the same prior year periods. The increase is primarily the result of additions made to personnel including personnel associated with a new branch opened in December 2010. The increase also includes general cost of living and merit increases.

Employee related benefits expense for the three and nine months ended September 30, 2011 decreased $102 thousand and $84 thousand, respectively, compared to the same prior year periods. The decrease is mainly associated with a decrease in supplemental employee retirement plan expense. As of September 30, 2011, we had 246 full time equivalent employees and operated 25 full service banking offices and one mortgage loan origination office.

Occupancy expense for the three and nine months ended September 30, 2011 increased $48 thousand and $149 thousand, respectively, compared to the same prior year periods. The increases are related to expenses associated with the new branch that was opened in December 2010 and an increase in building repairs and maintenance expense.

Equipment expense for the three and nine months ended September 30, 2011 decreased $39 thousand and increased $80 thousand, respectively, compared to the same prior year periods. The increase for the nine month period is mainly the result of increases in depreciation and equipment rental expenses.

Professional fees, which include consulting, audit and legal fees, increased $53 thousand for the three months ended September 30, 2011 compared to the same period of 2010, and increased $96 thousand when compared on a year to date basis to the prior year period. Consulting expense during the third quarter decreased $4 thousand and, on a year to date basis, consulting expense decreased $18 thousand in 2011 when compared to the same period in 2010. Audit and accounting fees in the third quarter of 2011 increased $16 thousand from the prior year period, and for the nine-month period ended September 30, 2011 audit fees increased $25 thousand over the prior year nine-month period. Legal expense during the third quarter increased $42 thousand and, on a year to date basis, legal expense increased $89 thousand in 2011 when compared to the same period in 2010.

 

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FDIC deposit insurance expenses decreased $119 thousand for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. For the nine-month period ended September 30, 2011, FDIC deposit insurance expense decreased $270 thousand over the nine-month period ended September 30, 2010. The decreases for both the three- and nine-month periods were due to a change made by the FDIC in its assessment calculations.

Other outside services expense for the three and nine months ended September 30, 2011 decreased $29 thousand and increased $86 thousand, respectively, compared to the same prior year periods. The increase for the nine month period is related to additional services acquired and an increase in cost of existing services.

Net cost of real estate and repossessions acquired in the settlement of loans expense for the three and nine months ended September 30, 2011 increased $533 thousand and $249 thousand, respectively, compared to the same prior year periods. The increases are mainly related to write-downs on one residential property and one construction and land development property that occurred in the third quarter or 2011.

Other operating expenses for the three and nine months ended September 30, 2011 increased $590 thousand and $604 thousand, respectively, compared to the same prior year periods. The increases are mainly related to increases in advertising, core processing services, and expenses related to branch acquisition.

Income Taxes

Income tax expense for the three months ended September 30, 2011 was $97 thousand compared to an income tax benefit of $5 thousand for the three months ended September 30, 2010, resulting in effective tax rates of 15.5% and (0.9)%, respectively. The effective tax rate was higher for the three months ended September 30, 2011 compared to the same period in 2010 mainly due to a decrease in interest income exempt from federal income taxes. For the nine-month period ending September 30, 2011, there was a tax benefit of $285 thousand compared to an income tax expense of $179 thousand for the same period of 2010, which resulted in effective tax rates of (94.1)% and 8.3%, respectively. The effective tax rate was lower for the nine months ended September 30, 2011 compared to the same period in 2010 due to a larger percentage of tax exempt income to taxable income during the nine months ended September 30, 2011.

Financial Condition

Balance Sheet

Our total assets were $923.7 million at September 30, 2011, $919.9 million at December 31, 2010 and $932.2 million at September 30, 2010. For the twelve months ended September 30, 2011, our loans declined $53.4 million or 9.3% while our deposits grew by approximately $6.0 million or 0.8%. Year-over-year, our earning assets decreased by $18.6 million primarily through a decline in our loans. For the nine months ended September 30, 2011, our loans outstanding decreased $46.0 million and deposits increased by $10.7 million.

Loans

As of September 30, 2011, total loans had decreased to $521.6 million, down 8.1% from total loans of $567.6 million at December 31, 2010 and down 9.3% from total loans of $575.0 million at September 30, 2010. The decline in loans year-over-year and for the nine months ending September 30, 2011 can be attributed to continued weak economic conditions.

Asset Quality

At September 30, 2011, our allowance for loan losses as a percentage of loans was 2.34%, up from 2.29% at September 30, 2010 and up from 2.33% at December 31, 2010. The increase in part reflects the increase in our historical loss rate as our charge-offs have increased during the past two years. Also, the increase reflects the recognition of additional loans identified as being impaired. The increase was partially offset by changes made to the allowance model as discussed below. In evaluating the allowance for loan losses, we prepare an analysis of our current loan portfolio through the use of historical loss rates, homogeneous risk analysis grouping that include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

During the third quarter of 2011, the following circumstances occurred which represent the primary factors contributing to a reduction in the AFLL:

 

•

We experienced a significant decline in the outstanding balance of construction and land development as well as commercial and industrial loans. Additionally, the overall risk grade of the remaining loans within these segments has improved. Given the significance of historical loss rates attributable to these loan segments, the declining loan balances and improved average risk grades had a substantial impact on our general reserves, effectively lowering them by approximately 16 basis points, or $769 thousand, as compared to our prior quarter end.

 

•

Consistent with each quarterly reporting period, management also evaluated the AFLL model’s unallocated internal and external factor percentages. As the Bank has continued to strengthen certain internal controls of the credit function, specific internal factors were scored to ensure they were consistent with improved Bank policies and procedures. The impact of these modifications increased our general reserves by approximately 14 basis points, or $690 thousand as compared to our prior quarter end.

 

•

During the quarter, management conducted an impairment migration study using the Bank’s historical data from the preceding two years. From this study we determined that our years to impairment AFLL model assumption should be reduced in all but two of our loan segments. This analysis provided statistical support for the refinement of this assumption and effectively lowered our general reserves by approximately 47 basis points, or $2.3 million, after considering the net effect of the prior two points above, as compared to our prior quarter end.

Management’s migration study was supplemented by an independent study of the allowance model. During the third quarter of 2011, the Bank also employed an independent specialist to perform a loss migration analysis on the Bank’s loan portfolio in order to provide additional statistical data and validation for the Bank’s AFLL modeling process. That analysis provided the Bank with useful data regarding its loss migration history and mean level of loss history given our credit migration, and served as an independent validation of our overall allowance position at period end. Management and the Board of Directors have evaluated the impact of these AFLL model updates and determined that the allowance represents an amount necessary to absorb estimated probable losses in the loan portfolio.

 

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Historical loss calculations for each homogeneous risk group are based on a three year average loss ratio calculation with the most recent quarter’s loss history included in the model. The impact is to more quickly recognize and increase the loss history in a respective grouping. For those groups with little or no loss history, management increases the historical factor through a positive adjustment to more accurately represent current economic conditions and their probable impact on that particular loan group.

 

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Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. Most loans risk rated “substandard”, “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Some smaller loans risk rated “substandard”, “doubtful” and “loss” with balances less than $100 thousand are not removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

A portion of the Bank’s allowance for loan losses is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the portion determined through general qualitative and quantitative internal and external factors, the general portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. While we believe that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Unsecured loans are charged-off in full against the Bank’s allowance for loan losses as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended, or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisals. Included in the write-down is the estimated expense to liquidate the property and, typically, an additional allowance for the foreclosure discount.

 

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Net charge-offs for the first nine months of 2011 totaled $7.3 million compared to net charge-offs of $5.2 million during the first nine months of 2010. The provision for loan losses charged to operations for the nine months ended September 30, 2011 and 2010 was $6.2 million and $8.6 million, respectively. The following table presents an analysis of the changes in the allowance for loan losses for the nine months ended September 30, 2011 and 2010.

Analysis of Changes in Allowance for Loan Losses

 

		For the nine months
		Ended September 30,
		2011				2010
		(Dollars in thousands)
Total loans outstanding at end of period-gross		$	521,626			$	575,003
Average loans outstanding-gross		$	546,225			$	576,497
Allowance for loan losses at beginning of period		$	13,247			$	9,725
Total charge-offs			(7,498	)			(5,424	)
Total recoveries			234				243
Net charge offs			(7,264	)			(5,181	)
Provision for loan losses			6,231				8,643
Allowance for loan losses at end of period		$	12,214			$	13,187

 

			$000				$000
		For the nine months
		Ended September 30,
		2011				2010
Ratios
Annualized net charge-offs to average loans during the period			1.77	%			1.20	%
Allowance for loan losses to loans at period end			2.34	%			2.29	%
Allowance for loan losses to nonperforming loans at period end			42.7	%			63.9	%
Allowance for loan losses to impaired loans at period end			38.7	%			37.9	%

The ratio of annualized net charge-offs to average loans increased to 1.77% at September 30, 2011 from 1.20% at September 30, 2010 mainly due to an increase in real estate related charge-offs. The increase in the allowance for loan losses to loans to 2.34% at September 30, 2011 from 2.29% at September 30, 2010 reflects the increase in our historical loss rate as our charge-offs have increased during the past two years. Also, the increase reflects the recognition of additional loans identified as being impaired. The increase was partially offset by changes made to the allowance model as discussed under the caption “Asset Quality”. The ratio of our allowance for loan losses to nonperforming loans decreased to 42.7% as of September 30, 2011 compared to 63.9% as of September 30, 2010.

Construction, land and development (“CLD”) loans make up 13.6% of the Bank’s loan portfolio. This sector of the economy has been particularly impacted by declines in housing activity and has had a disproportionate impact on the Bank’s credit quality. The table below shows trends of CLD loans, along with ratios relating to their relative credit quality.

 

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		CLD Loans								All Other Loans								Total Loans
		Balance				% of Total				Balance				% of Total
		(Dollars in thousands)
Balances at September 30, 2011		$	71,174				13.6	%		$	450,452				86.4	%		$	521,626
Impaired loans			12,567				39.8	%			18,996				60.2	%			31,563
Allocated Reserves			4,403				41.1	%			6,301				59.9	%			10,704
YTD Net Charge-offs			4,318				59.4	%			2,946				40.6	%			7,264
Nonperforming loans (NPL)			11,445				40.0	%			17,173				60.0	%			28,618
NPL as % of loans			16.1	%							3.8	%							5.5	%

While balances of CLD loans make up 13.6% of the Bank’s loan portfolio at September 30, 2011, they represent 39.8% and 59.4% of the Bank’s impaired loans and YTD net charge-offs, respectively. CLD loans represent 40.0% of the Bank’s nonperforming loans and 41.1% of the Bank’s allocated reserves are allocated to CLD loans.

Nonperforming Assets

The following table summarizes our nonperforming assets at the dates indicated.

 

		September 30, 2011				December 31, 2010
		(Dollars in thousands)
Non-accrual loans		$	20,741			$	15,896
Restructured loans			7,877				6,193
Other real estate owned & repossessions			6,223				4,536
Total		$	34,841			$	26,625

Nonperforming assets consist of loans not accruing interest, loans past due ninety days and still accruing interest, restructured debt, and real estate acquired in settlement of loans and other repossessed collateral. It is our policy to place loans on non-accrual status when any portion of principal or interest becomes 90 days past due, or earlier if full collection of principal and interest becomes doubtful. When loans are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments received thereafter are applied as a reduction to the remaining principal balance so long as doubt exists as to the ultimate collection of the principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when the collectability of principal or interest is no longer doubtful. Nonperforming assets were $34.8 million and $26.6 million, or 3.77% and 2.89% of total assets, at September 30, 2011 and December 31, 2010, respectively. On September 30, 2011, our nonperforming loans (consisting of non-accruing and restructured loans) amounted to approximately $28.6 million compared to $22.1 million as of December 31, 2010. The increase in nonperforming loans was mainly due to increases in nonaccrual real estate loans secured by non-farm non-residential properties. We had $6.2 million in other real estate owned and repossessions at September 30, 2011 compared to $4.5 million at December 31, 2010. The increase is mainly due to additional foreclosures on construction and land development loans.

Loans Considered Impaired

We review our nonperforming loans and other groups of loans based on loan size or other factors for impairment. At September 30, 2011, we had loans totaling $31.6 million (which includes $27.7 million in nonperforming loans) which were considered to be impaired compared to $26.3 million at December 31, 2010. As discussed under the caption “Asset Quality”, loans are considered impaired if, based on current information, circumstances or events, it is probable that the Bank will not collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. However, treating a loan as impaired does not necessarily mean that we expect to incur a loss on that loan, and our impaired loans include loans that currently are performing in accordance with their terms. For example, if we believe it is probable that a loan will be collected, but not according to its original agreed upon payment schedule, we may treat that loan as impaired even though we expect that the loan will be repaid or collected in full. As indicated in the table below, when we believe a loss is probable on a non-collateral dependent impaired loan, a portion of our reserve is allocated to that probable loss. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on a current independent appraisal.

 

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The following table sets forth the number and volume of loans, net of previous charge-offs, that were considered impaired, and their associated reserve allocation, if any, at September 30, 2011. Twenty-three non-accrual loans with a total balance of approximately $799 thousand and four restructured loans with a balance of $164 thousand were not removed from their homogeneous group and individually analyzed for impairment because their individual loan balances were less than $100 thousand.

 

		Number of Loans				Loan Balances Outstanding				Allocated Reserves
		(Dollars in millions)
Non-accrual loans			62			$	20.0			$	1.1
Restructured loans			14				7.7				1.8
Total nonperforming loans			76			$	27.7			$	2.9
Other impaired loans with allocated reserves			11				3.7				0.8
Other impaired loans without allocated reserves			2				0.2				—
Total impaired loans			89			$	31.6			$	3.7

Investment Securities and Other Assets

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. We use two categories to classify our securities: “held-to-maturity” and “available-for-sale.” Currently, none of our investments are classified as held-to-maturity. While we have no plans to liquidate a significant amount of our securities, the securities classified as available-for-sale may be sold to meet liquidity needs should management deem it to be in our best interest.

Our investment securities totaled $327.1 million at September 30, 2011, $273.2 million at December 31, 2010 and $263.9 million at September 30, 2010. Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are not otherwise needed to satisfy loan demand. Investable funds not otherwise utilized are temporarily invested as federal funds sold or as interest-bearing balances at other banks, the level of which is affected by such considerations as near-term loan demand and liquidity needs.

At September 30, 2011, the securities portfolio had unrealized net gains of approximately $2.0 million, which are reported in accumulated other comprehensive income on the consolidated statement of changes in shareholders’ equity, net of tax. Our securities portfolio at September 30, 2011 consisted of U.S. government sponsored agencies, collateralized mortgage obligations (CMOs), mortgage-backed securities (MBS), corporate bonds and tax-exempt municipal securities.

We currently have the ability to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. As of September 30, 2011, our aggregate amortized cost of securities we held from certain individual issuers exceeded 10% of our common shareholders’ equity. As of September 30, 2011 the amortized cost and market value of the securities from such issuers were as follows:

 

		Amortized Cost				Market Value
		(Dollars in thousands)
Federal National Mortgage Corporation		$	100,138			$	101,610
Federal Home Loan Mortgage Corporation			37,327				37,769
Goldman Sachs Group			7,383				7,108
Government National Mortgage Association			21,923				22,390
Morgan Stanley			7,473				7,052
Small Business Administration			112,844				113,201

At September 30, 2011, we held $11.7 million in bank owned life insurance, compared to $9.0 million and $8.9 million at December 31, 2010 and September 30, 2010, respectively.

 

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Deposits and Other Borrowings

Deposits

Deposits totaled $796.6 million as of September 30, 2011 compared to deposits of $785.9 million at December 31, 2010 and up 0.8% compared to deposits of $790.6 million at September 30, 2010. We attribute our deposit growth during the twelve months ended September 30, 2011 mainly to an increase in Rewards Checking and Savings accounts and an increase in noninterest bearing demand accounts. We believe that we can improve our core deposit funding by improving our branching network and providing more convenient opportunities for customers to bank with us.

Other Borrowings

Short-term borrowings include sweep accounts and advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) having maturities of one year or less. Our short-term borrowings totaled $13.5 million at September 30, 2011, compared to $11.5 million on December 31, 2010, a net increase of $2.0 million.

The following table details the maturities and rates of our borrowings from the FHLB, as of September 30, 2011.

 

Borrow Date

Type

Principal

Term

Rate

Maturity

(Dollars in thousands)

February 29, 2008

Fixed rate

$

5,000

4 years

3.18

%

February 29, 2012

March 12, 2008

Fixed rate

2,000

4 years

3.25

March 12, 2012

March 12, 2008

Fixed rate

7,500

5 years

3.54

March 12, 2013

August 17, 2010

Fixed rate

3,000

4 years

1.49

August 18, 2014

August 17, 2010

Fixed rate

4,500

5 years

1.85

August 17, 2015

August 17, 2010

Fixed rate

2,500

6 years

2.21

August 17, 2016

August 20, 2010

Fixed rate

2,000

3 years

1.09

August 20, 2013

August 20, 2010

Fixed rate

3,000

4 years

1.48

August 20, 2014

August 20, 2010

Fixed rate

3,000

5 years

1.83

August 20, 2015

September 1, 2010

Fixed rate

2,000

2 years

0.66

September 4, 2012

Total Borrowings:

$

34,500

Composite rate:

2.34

%

Long-Term Obligations

Long-term obligations consist of advances from FHLB with maturities greater than one year. Our long-term borrowing from the FHLB totaled $25.5 million on September 30, 2011, compared to $34.5 million of FHLB advances on both December 31, 2010 and September 30, 2010. The decrease of $9.0 million in long-term FHLB advances as of September 30, 2011 from December 31, 2010, is the result of FHLB advances being reclassified to short-term borrowings because the current time to maturity is less than a year.

Liquidity

Liquidity refers to our continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) lines for the purchase of federal funds from other banks; (d) lines of credit established at the FHLB, less existing advances; and (e) our investment securities portfolio. All our debt securities are of investment grade quality and, if the need arises, can be promptly liquidated on the open market or pledged as collateral for short-term borrowing.

Consistent with our general approach to liquidity management, loans and other assets of the Bank are funded primarily using local core deposits, retail repurchase agreements and the Bank’s capital position. To date, these core funds, supplemented by FHLB advances, institutional deposits obtained through the internet and brokered deposits, have been adequate to fund loan demand in our market areas, while maintaining the desired level of immediate liquidity and an investment securities portfolio available for both immediate and secondary liquidity purposes. It is anticipated that funding sources in the future will include continued use of brokered deposits and institutional deposits obtained through the Internet.

 

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We are a member of the FHLB. Membership, along with a blanket collateral commitment of our one-to-four family residential mortgage loan portfolio, as well as our commercial real estate loan portfolio, provided us the ability to draw up to $184.7 million, $184.0 million and $186.4 million of advances from the FHLB at September 30, 2011, December 31, 2010 and September 30, 2010, respectively. At September 30, 2011, we had outstanding FHLB advances totaling $34.5 million compared to $42.5 million for both December 31, 2010 and September 30, 2010.

As a requirement for membership, we invest in stock of the FHLB in the amount of 1% of our outstanding residential loans or 5% of our outstanding advances from the FHLB, whichever is greater. That stock is pledged as collateral for any FHLB advances drawn by us. At September 30, 2011, we owned 37,675 shares of the FHLB’s $100 par value capital stock, compared to 45,708 and 47,494 shares at December 31, 2010 and September 30, 2010, respectively. No ready market exists for such stock, which is carried at cost.

We also had unsecured federal funds lines in the aggregate amount of $46.0 million available to us at September 30, 2011 under which we can borrow funds to meet short-term liquidity needs. At September 30, 2011, we had no borrowings outstanding under these federal funds lines. Another source of funding is loan participations sold to other commercial banks (in which we retain the servicing rights). We believe that our liquidity sources are adequate to meet our operating needs.

Net cash provided by operations during the nine months ended September 30, 2011 totaled $9.8 million, compared to net cash provided by operations of $6.7 million for the same period in 2010. Net cash used in investing activities decreased to $15.3 million for the nine months ended September 30, 2011, as compared to $22.5 million for the same period in 2010. Net cash provided by financing activities was $2.6 million for the first nine months of 2011, compared to net cash provided of $38.4 million for the same period in 2010. Cash and cash equivalents at September 30, 2011 were $17.2 million compared to $40.4 million at September 30, 2010.

As discussed in Note 11, during April 2011, the Bank’s Board of Directors adopted a resolution at the request of the Federal Deposit Insurance Corporation to the effect that, among other things, the Bank will not pay any cash dividend to us without the approval of the FDIC and N.C. Commissioner of Banks. Dividends we receive from the Bank are our primary source of funds with which we can pay dividends on our outstanding common and preferred stock. As a result, if the Bank’s regulators declined to permit the Bank to dividend funds to us, we would be unable to pay dividends on our common and preferred stock.

Capital Resources

Shareholders’ Equity

As of September 30, 2011, our total shareholders’ equity was $83.2 million (consisting of common shareholders’ equity of $65.8 million and preferred stock of $17.4 million) compared with total shareholders’ equity of $80.9 million as of December 31, 2010 (consisting of common shareholders’ equity of $63.6 million and preferred stock of $17.3 million). Common shareholders’ equity increased by approximately $2.2 million to $65.8 million at September 30, 2011 from $63.6 million at December 31, 2010. We generated net income of $588 thousand, experienced an increase in net unrealized gains on available-for-sale securities of $2.9 million, recognized a decrease of $67 thousand to the post retirement benefit plan and stock based compensation of $16 thousand on incentive stock awards. During the first nine months of 2011, we declared cash dividends of $399 thousand or $0.14 on our common shares and we declared dividends and recorded accretion of discount of $673 thousand on preferred shares.

We are subject to various regulatory capital requirements administered by our federal banking regulators. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by these regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines involving quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by the FDIC to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (each as defined in the regulations). As a bank holding company, we also are subject, on a consolidated basis, to the capital adequacy guidelines of the Federal Reserve Board. The capital requirements of the Federal Reserve Board are similar to those of the FDIC governing the Bank. As of September 30, 2011, we and the Bank met all capital adequacy requirements to which we are subject.

As of September 30, 2011, we experienced an increase in our risk-weighted capital ratios when compared to the periods ending September 30, 2010 and December 31, 2011. This increase is primarily due to a decrease in risk-weighted assets.

On June 30, 2011, the Company entered into a Securities Purchase Agreement with certain institutional investors to issue $75 million in 4,687,500 common shares under a private placement at $16 per share. It will also issue warrants to the investors with five-year terms that are convertible into common stock at an exercise price of $8 per share. The amount of common shares subject to exercise under the warrants will equal 25% of the number of shares to be issued to the investors in the offering. The completion of the transaction is subject to regulatory and shareholder approvals but is expected to close in the fourth quarter.

 

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On September 9, 2011, the Company entered into a First Amended and Restated Securities Purchase Agreement (the “Amended Agreement”) pursuant to which one additional institutional investor agreed to purchase common stock in the Offering and one other Investor agreed to increase their respective investments in the Company. As a result, the aggregate size of the Offering was increased to $79.7 million and the number of common shares to be issued increased to 4,981,250.

The Company intends to use the proceeds of the offering to support future operational growth and to redeem the preferred stock and associated warrants that were issued under the TARP Capital Purchase Program. The proceeds will also be used to improve capital for other general corporate purposes.

 

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Based on the most recent notification from the FDIC, the Bank is well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.

Our and the Bank’s actual capital ratios are presented in the following table:

 

		Ratio required to be well capitalized under prompt corrective action provisions				Minimum ratio required for capital adequacy purposes				Our Ratio				Bank’s Ratio
As of September 30, 2011:
Tier 1 Capital (to Average Assets)		³	5.00	%		³	3.00	%			8.34	%			8.34	%
Tier 1 Capital (to Risk Weighted Assets)		³	6.00	%		³	4.00	%			12.59				12.59
Total Capital (to Risk Weighted Assets)		³	10.00	%		³	8.00	%			13.85				13.85
As of December 31, 2010:
Tier 1 Capital (to Average Assets)		³	5.00	%		³	3.00	%			8.66	%			8.66	%
Tier 1 Capital (to Risk Weighted Assets)		³	6.00	%		³	4.00	%			12.08				12.08
Total Capital (to Risk Weighted Assets)		³	10.00	%		³	8.00	%			13.34				13.34
As of September 30, 2010:
Tier 1 Capital (to Average Assets)		³	5.00	%		³	3.00	%			8.79	%			6.85	%
Tier 1 Capital (to Risk Weighted Assets)		³	6.00	%		³	4.00	%			12.38				9.65
Total Capital (to Risk Weighted Assets)		³	10.00	%		³	8.00	%			13.64				10.91

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

Our market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of our asset/liability management function.

Management does not believe there has been any significant change in the overall analysis of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis prepared and presented in conjunction with the Form 10-K Annual Report for the fiscal year ended December 31, 2010.

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that we are able to record, process, summarize and report in a timely manner the information required to be disclosed in reports we file under the Exchange Act.

We review our disclosure controls and procedures, including our internal control over financial reporting, on an ongoing basis and may from time to time make changes aimed at enhancing their effectiveness. In connection with the above evaluation of our disclosure controls and procedures, no change in our internal control over financial reporting was identified that occurred during the quarterly period ended September 30, 2011, and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

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, 2010, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K referred to above 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

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Removed and Reserved

Item 5. Other Information

None.

Item 6. Exhibits

An Exhibit Index listing exhibits that are being filed or furnished with, or incorporated by reference into, this Report appears immediately following the signature page and is incorporated herein by reference.

 

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SIGNATURES

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.

 

		ECB BANCORP, INC .         (Registrant)
Date: November 14, 2011		By:		/s/    A. Dwight Utz
				A. Dwight Utz
				(President & CEO)
Date: November 14, 2011		By:		/s/    Thomas M. Crowder
				Thomas M. Crowder
				(Executive Vice President & CFO)

 

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EXHIBIT INDEX

 

Exhibit Number		Description
10.01		Securities Purchase Agreement (incorporated by reference from Exhibits to Registrant’s Current Report on Form 8-K dated June 30, 2011 and filed on July 7, 2011)
10.02		First Amended and Restated Securities Purchase Agreement (incorporated by reference from Exhibits to Registrant’s Current Report on Form 8-K dated and filed on September 9, 2011)
10.03		Registration Rights Agreement (incorporated by reference from Exhibits to Registrant’s Current Report on Form 8-K dated June 30, 2011 and filed on July 7, 2011)
10.04		Purchase and Assumption Agreement between The Bank of Hampton Roads and The East Carolina Bank (incorporated by reference from Exhibits to Registrant’s Current Report of Form 8-K dated July 14, 2011 and filed on July 15, 2011)
31.01		Certification of Chief Executive Officer required by Rule 13a-14(a) (furnished herewith)
31.02		Certification of Chief Financial Officer required by Rule 13a-14(a) (furnished herewith)
32.01		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)
32.02		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)
101.1		Interactive Data File (submitted herewith)

 

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