Quarterly Report (10-q)

Table of Contents

 

 

United States

Securities and Exchange Commission

Washington, DC 20549

 

 

FORM 10-Q

 

 

(Mark one)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2013

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 number: 001-35279

 

 

ASB BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina		45-2463413
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

 

11 Church Street, Asheville, North Carolina		28801
(Address of principle executive offices)		(Zip code)

[phone]

(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 Securities Exchange Act of 1934 during the preceding twelve 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 ninety 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 (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files)    Yes   x     No   ¨

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

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨   (Do not check if a smaller reporting company)		Smaller reporting company		¨

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

There were 5,305,323 shares of Common Stock, par value $0.01 per share, issued and outstanding as of April 30, 2013.

 

 

 

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ASB BANCORP, INC.

FORM 10-Q

Table of Contents

 

				Begins on Page
Part I.		Financial Information
Item 1.		Financial Statements
		Consolidated Balance Sheets (Unaudited) At March 31, 2013 and December 31, 2012			1
		Consolidated Statements of Income (Unaudited) For the Three Months Ended March 31, 2013 and 2012			2
		Consolidated Statements of Comprehensive Income (Loss) (Unaudited) For the Three Months Ended March 31, 2013 and 2012			3
		Consolidated Statement of Changes in Stockholders’ Equity (Unaudited) For the Three Months Ended March 31, 2013			4
		Consolidated Statements of Cash Flows (Unaudited) For the Three Months Ended March 31, 2013  and 2012			5
		Notes to Consolidated Financial Statements (Unaudited)			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			45
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			63
Item 4.		Controls and Procedures			65
Part II.		Other Information
Item 1.		Legal Proceedings			65
Item 1A.		Risk Factors			65
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			66
Item 3.		Defaults Upon Senior Securities			67
Item 4.		Mine Safety Disclosures			67
Item 5.		Other Information			67
Item 6.		Exhibits			67
Signatures					68

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ASB BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (Unaudited)

 

 

(dollars in thousands, except par values)		March 31, 2013				December 31, 2012*
Assets
Cash and due from banks		$	7,400			$	10,361
Interest-earning deposits with banks			42,921				37,029
Total cash and cash equivalents			50,321				47,390
Securities available for sale (amortized cost of $255,050 at March 31, 2013 and $235,605 at December 31, 2012)			257,324				238,736
Securities held to maturity (estimated fair value of $5,041 at March 31, 2013 and $5,182 at December 31, 2012)			4,556				4,649
Investment in Federal Home Loan Bank stock, at cost			3,131				3,429
Loans held for sale			11,603				9,759
Loans receivable (net of deferred loan fees of $421 at March 31, 2013 and $410 at December 31, 2012)			395,540				387,721
Allowance for loan losses			(8,553	)			(8,513	)
Loans receivable, net			386,987				379,208
Premises and equipment, net			13,184				13,306
Foreclosed real estate (net of loss reserves of $3,140 at March 31, 2013 and $3,114 at December 31, 2012)			18,128				19,411
Deferred income tax assets, net			5,443				5,450
Securities sold but not settled			—				21,260
Other assets			6,845				6,756
Total assets		$	757,522			$	749,354
Liabilities
Noninterest-bearing deposits		$	68,420			$	65,295
Interest-bearing deposits			521,206				513,004
Total deposits			589,626				578,299
Overnight and short-term borrowings			618				411
Federal Home Loan Bank advances			50,000				50,000
Accounts payable and other liabilities			9,845				9,115
Total liabilities			650,089				637,825
Stockholders’ Equity
Preferred stock, $0.01 par value; 10,000,000 shares authorized; none issued			—				—
Common stock, $0.01 par value; 60,000,000 shares authorized; 5,305,323 shares issued at March 31, 2013 and 5,584,551 shares issued at December 31, 2012			53				56
Additional paid-in capital			49,598				53,994
Retained earnings			69,310				68,570
Accumulated other comprehensive loss, net of tax			(3,581	)			(3,067	)
Unearned Employee Stock Ownership Plan (ESOP) shares			(4,003	)			(4,080	)
Unearned equity incentive plan shares			(3,601	)			(3,601	)
Stock-based deferral plan shares			(343	)			(343	)
Total stockholders’ equity			107,433				111,529
Total liabilities and stockholders’ equity		$	757,522			$	749,354

 

*	Derived from audited consolidated financial statements.

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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ASB BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

 

		Three Months Ended March 31,
(dollars in thousands, except per share data)		2013				2012
Interest and dividend income
Loans, including fees		$	4,600			$	5,100
Securities			1,085				1,368
Other earning assets			61				71
Total interest and dividend income			5,746				6,539
Interest expense
Deposits			632				1,317
Overnight and short-term borrowings			1				1
Federal Home Loan Bank advances			484				601
Total interest expense			1,117				1,919
Net interest income			4,629				4,620
Provision for loan losses			112				598
Net interest income after provision for loan losses			4,517				4,022
Noninterest income
Mortgage banking income			588				327
Deposit and other service charge income			631				747
Income from debit card services			355				303
Gain (loss) on sale of investment securities			(7	)			502
Other noninterest income			321				79
Total noninterest income			1,888				1,958
Noninterest expenses
Salaries and employee benefits			2,687				2,868
Occupancy expense, net			535				544
Foreclosed property expenses			116				63
Data processing fees			652				626
Federal deposit insurance premiums			156				167
Advertising			131				162
Professional and outside services			199				257
Other noninterest expenses			844				879
Total noninterest expenses			5,320				5,566
Income before income tax provision			1,085				414
Income tax provision			345				130
Net income		$	740			$	284
Net income per common share – Basic		$	0.15			$	0.06
Net income per common share – Diluted		$	0.15			$	0.06

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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ASB BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

 

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
Comprehensive Income (Loss)
Net income		$	740			$	284
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale:
Reclassification of securities losses (gains) recognized in net income			7				(502	)
Deferred income tax (benefit) expense			(2	)			201
Gains (losses) arising during the period			(865	)			(474	)
Deferred income tax benefit			346				188
Unrealized holding gains (losses) adjustment, net of tax			(514	)			(587	)
Defined Benefit Pension Plans:
Net periodic pension cost			335				(177	)
Net pension gain (loss)			(335	)			177
Deferred income tax benefit			—				—
Defined benefit pension plan adjustment, net of tax			—				—
Total other comprehensive income (loss)			(514	)			(587	)
Comprehensive income (loss)		$	226			$	(303	)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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ASB BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

 

 

(dollars in thousands)		Three Months Ended March 31, 2013
Common stock
December 31, 2012		$	56
Repurchase of common stock			(3	)
March 31, 2013		$	53
Additional paid-in capital
December 31, 2012		$	53,994
Repurchase of common stock			(4,611	)
ESOP shares allocated			51
Stock-based compensation expense			164
March 31, 2013		$	49,598
Retained earnings
December 31, 2012		$	68,570
Net income			740
March 31, 2013		$	69,310
Accumulated other comprehensive income (loss), net of tax
December 31, 2012		$	(3,067	)
Other comprehensive loss			(514	)
March 31, 2013		$	(3,581	)
Unearned ESOP shares
December 31, 2012		$	(4,080	)
ESOP shares allocated			77
March 31, 2013		$	(4,003	)
Unearned equity incentive plan shares
December 31, 2012		$	(3,601	)
March 31, 2013		$	(3,601	)
Stock-based deferral plan shares
December 31, 2012		$	(343	)
March 31, 2013		$	(343	)
Total stockholders’ equity
December 31, 2012		$	111,529
Repurchase of common stock			(4,614	)
Net income			740
Other comprehensive loss			(514	)
ESOP shares allocated			128
Stock-based compensation expense			164
March 31, 2013		$	107,433

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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ASB BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
Operating Activities
Net income		$	740			$	284
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			112				598
Provision for loss on foreclosed properties			59				33
Depreciation			290				288
Loss (gain) on sale of foreclosed real estate			(65	)			37
Deferred income tax expense			351				78
Net amortization of premiums on securities			1,381				666
Loss (gain) on sale of investment securities			7				(502	)
Net accretion of deferred fees on loans			(27	)			(37	)
Mortgage loans originated for sale			(34,577	)			(19,912	)
Proceeds from sale of mortgage loans			33,321				19,811
Gain on sale of mortgage loans			(588	)			(327	)
ESOP compensation expense			128				94
Stock-based compensation expense			164				—
Decrease in income tax receivable			9				2,554
Decrease in interest receivable			163				183
Net change in other assets and liabilities			221				452
Net cash provided by operating activities			1,689				4,300
Investing Activities
Purchases of securities available for sale			(32,076	)			(64,938	)
Proceeds from sales of securities available for sale			20,950				35,274
Proceeds from maturities and/or calls of securities available for sale			1,000				6,000
Principal repayments on mortgage-backed and asset-backed securities			10,893				10,264
Redemption (purchase) of FHLB stock			298				(13	)
Net decrease (increase) in loans receivable			(7,904	)			13,779
Capitalized expenses of foreclosed real estate			(5	)			—
Net proceeds from sales of foreclosed real estate			1,334				1,091
Purchases of premises and equipment			(168	)			(227	)
Net cash provided by (used in) investing activities			(5,678	)			1,230

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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ASB BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited)

 

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
Financing Activities
Net increase in deposits		$	11,327			$	2,006
Net proceeds from repurchase agreements			207				226
Stock-based deferral plan shares purchased			—				(2	)
Common stock repurchased			(4,614	)			—
Net cash provided by financing activities			6,920				2,230
Net increase in cash and cash equivalents			2,931				7,760
Cash and cash equivalents at beginning of period			47,390				72,327
Cash and cash equivalents at end of period		$	50,321			$	80,087
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest on deposits, advances and other borrowings		$	1,119			$	1,921
Income taxes			—				2,494
Non-cash investing and financing transactions:
Transfers from loans to foreclosed real estate		$	40			$	2,171
Security purchases in the process of settlement			248				3,441
Change in unrealized gain on securities available for sale			(858	)			(976	)
Change in deferred income taxes resulting from other comprehensive income			344				389

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These interim financial statements do not contain all necessary disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for a complete set of financial statements and, therefore, should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Annual Report on Form 10-K of ASB Bancorp, Inc. filed with the Securities and Exchange Commission (the “SEC”) on March 15, 2013. These financial statements were prepared on a basis consistent with the audited consolidated financial statements previously referenced and include all normal and recurring adjustments that management believes are necessary in order to conform to GAAP. The results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or any other future period.

Organization – ASB Bancorp, Inc. (the “Parent”) was incorporated on May 12, 2011 by Asheville Savings Bank, S.S.B. (the “Bank”) to be the Bank’s holding company upon completion of the Bank’s conversion from the mutual to stock form of organization.

The Bank is headquartered in Asheville, North Carolina and provides mortgage, consumer and commercial banking services primarily in Buncombe, Henderson, McDowell, Transylvania, and Madison counties in North Carolina. The Bank is regulated by the Office of the North Carolina Commissioner of Banks (“NCCoB”) and the Federal Deposit Insurance Corporation (“FDIC”). The Company is regulated by the Board of Governors of the Federal Reserve System (the “FRB”) and the NCCoB.

Principles of Consolidation – The consolidated financial statements include the accounts of the Parent and its wholly owned subsidiary, the Bank (collectively, the “Company”). The Bank has two wholly owned subsidiaries, Appalachian Financial Services, Inc., which has on occasion managed the Bank’s real estate acquired through debt default but is currently inactive, and Wenoca, Inc., which serves as the Bank’s trustee regarding deeds of trust. Both subsidiaries are organized as North Carolina corporations. For purposes of the consolidated financial statements, all significant intercompany accounts and transactions have been eliminated. The accounting and reporting policies of the Company conform to GAAP.

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Investment Securities – Realized gains and losses on sales of investment securities are recognized at the time of sale (“trade date”) based upon the specific identification method.

Interest income includes amortization of purchase premiums and discounts. Realized gains and losses are derived from the amortized cost of the security sold. Declines in the fair value of held to maturity and available for sale debt securities below their cost that are deemed to be other than temporary because of credit risk impairment are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other issues, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) the intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (iv) whether it is more likely than not that the Company will be required to sell the investment prior to a recovery.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans – Loans that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized fees and costs on originated loans. The net amount of nonrefundable loan origination fees and certain direct costs associated with the lending processes are deferred and amortized to interest income over the contractual lives of the loans.

Loan Segments and Classes

The Bank’s portfolio segments and classes within those segments are subject to risks that could have an adverse impact on the credit quality of the loan portfolio. Management has identified the risks described below as significant risks that are generally similar among the loan segments and classes.

Commercial loan segment

The Bank’s commercial loans are centrally underwritten based primarily on the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. The Bank’s commercial lenders and underwriters work to understand the borrower’s businesses and management experiences. The majority of the Bank’s commercial loans are secured by collateral, so collateral values are important to the transaction. In commercial loan transactions where the principals or other parties provide personal guarantees, the Bank’s commercial lenders and underwriters analyze the relative financial strength and liquidity of each guarantor. Risks that are common to the Bank’s commercial loan classes include general economic conditions, demand for the borrowers’ products and services, the personal circumstances of the principals, and reductions in collateral values.

In addition to these common risks for the Bank’s commercial loans, the various commercial loan classes also have certain risks specific to them.

Commercial construction and land development loans are highly dependent on the supply and demand for commercial real estate in the Bank’s markets as well as the demand for the newly constructed residential homes and lots being developed by the Bank’s commercial loan customers. Prolonged deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for the Bank’s commercial borrowers.

Commercial mortgage and commercial and industrial loans are primarily dependent on the ability of the Bank’s commercial loan customers to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. To the extent that a borrower’s actual business results significantly underperform the original projections, the ability of that borrower to service the Bank’s loan on a basis consistent with the contractual terms may be at risk. While these loans and leases are generally secured by real property, personal property, or business assets such as inventory or accounts receivable, it is possible that the liquidation of the collateral will not fully satisfy the obligation.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Other commercial real estate loans consist primarily of loans secured by multifamily housing. The primary risk associated with multifamily loans is the ability of the income producing property that collateralizes the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in the borrower having to provide rental rate concessions to achieve adequate occupancy rates.

Non-commercial loan segment

The Bank underwrites its non-commercial loans using automated credit scoring and analysis tools. These credit scoring tools take into account factors such as payment history, credit utilization, length of credit history, types of credit currently in use, and recent credit inquiries. To the extent that the loan is secured by collateral, the value of the collateral is also evaluated. Common risks to each class of non-commercial loans include general economic conditions within the Bank’s markets, such as unemployment and potential declines in collateral values, and the personal circumstances of the borrowers.

In addition to these common risks for the Bank’s non-commercial loans, various non-commercial loan classes may also have certain risks specific to them.

Residential mortgage and non-commercial construction and land development loans are to individuals and are typically secured by 1-4 family residential property, undeveloped land, and partially developed land in anticipation of pending construction of a personal residence. Significant and rapid declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the current market value of the collateral. Recent declines in value have led to unprecedented levels of foreclosures and losses within the banking industry. Non-commercial construction and land development loans can experience delays in completion and cost overruns that exceed the borrower’s financial ability to complete the project. Such cost overruns can result in foreclosure of partially completed and unmarketable collateral.

Revolving mortgage loans are often secured by second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values. A substantial decline in collateral value could render the Bank’s second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies and disputes with first lien holders that may further weaken collateral positions. Further, the open-end structure of these loans creates the risk that customers may draw on the lines in excess of the collateral value if there have been significant declines since origination.

Consumer loans include loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Credit Quality Indicators

Loans are monitored for credit quality on a recurring basis and the composition of the loans outstanding by credit quality indicator is provided below.

Loan credit quality indicators are developed through review of individual borrowers on an ongoing basis, although certain non-commercial loans, including residential mortgage, revolving mortgage and consumer loans, are evaluated upon origination and are reevaluated upon a change in delinquency status. Most commercial loans are evaluated at least annually with more frequent evaluation of more severely criticized loans or leases. The indicators represent the rating for loans as of the date presented based on the most recent assessment performed. These credit quality indicators are defined as follows:

Pass – A pass rated asset is not adversely classified because it does not display any of the characteristics for adverse classification.

Special mention – A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, such potential weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention assets are not adversely classified and do not warrant adverse classification.

Substandard – A substandard asset is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets classified as substandard generally have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. These assets are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Doubtful – An asset classified doubtful has all the weaknesses inherent in an asset classified substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions, and values.

Loss – Assets classified loss are considered uncollectible and of such little value that their continuing to be carried as an asset is not warranted. This classification is not necessarily equivalent to no potential for recovery or salvage value, but rather that it is not appropriate to defer a full write-off even though partial recovery may be effected in the future.

Allowance for Loan Losses – The allowance for loan losses is management’s estimate of probable credit losses that are inherent in the Bank’s loan portfolios at the balance sheet date. The allowance increases when the Bank provides for loan losses through charges to operating earnings and when the Bank recovers amounts from loans previously written down or charged off. The allowance decreases when the Bank writes down or charges off loans amounts that are deemed uncollectible.

Management determines the allowance for loan losses based on periodic evaluations that are inherently subjective and require substantial judgment because the evaluations require the use of material estimates that are susceptible to significant change. The Bank generally uses two allowance methodologies that are primarily based on management’s determination as to whether or not a loan is considered to be impaired.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Commercial loans, as well as non-commercial loans that are classified as substandard and secured by real estate, are evaluated for impairment on a loan-by-loan basis and are considered impaired when it is probable, based on current information, that the borrower will be unable to pay contractual interest or principal as required by the loan agreement. Loans that experience insignificant payment delays and payment shortfalls are not necessarily considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment history, and the amount of the shortfall relative to the principal and interest owed. Loans that are deemed to be troubled debt restructurings are also included as impaired loans. Impaired loans are measured at their estimated fair value based on either the value of the loan’s expected future cash flows discounted at the loan’s effective interest rate or on the collateral value, net of the estimated costs of disposal, if the loan is collateral dependent. For loans considered impaired, an individual allowance for loan losses is recorded when the loan principal balance exceeds the estimated fair value.

For loans not considered impaired, management determines the allowance for loan losses based on estimated loss percentages that are determined by and applied to the various classes of loans that comprise the segments of the Bank’s loan portfolio. The estimated loss percentages by loan class are based on a number of factors that include by class (i) average historical losses over the past three years, (ii) levels and trends in delinquencies, impairments, and net charge-offs, (iii) trends in the volume and direction of loan balances within that class, terms, and concentrations, (iv) trends in interest rates, (v) effects of changes in the Bank’s risk tolerance, underwriting standards, lending policies, procedures, and practices, and (vi) national and local business and economic conditions.

Future material adjustments to the allowance for loan losses may be necessary due to changing economic conditions or declining collateral values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses and may require the Bank to make adjustments to the allowance for loan losses based upon judgments that differ significantly from those of management.

Nonperforming Assets – Nonperforming assets can include loans that are past due 90 days or more and continue to accrue interest, loans on which interest is not being accrued, and foreclosed real estate.

Loans Past Due 90 Days or More, Nonaccruing, Impaired, or Restructured – The Bank’s policies related to when loans are placed on nonaccruing status conform to guidelines prescribed by bank regulatory authorities. Generally, the Bank suspends the accrual of interest on loans (i) that are maintained on a cash basis because of the deterioration of the financial condition of the borrower, (ii) for which payment in full of principal or interest is not expected, or (iii) on which principal or interest has been in default for a period of 90 days or more, unless the loan is both well secured and in the process of collection. While a loan is on nonaccruing status, the Bank recognizes interest income only to the extent cash payments are received in excess of collection of the principal outstanding on the loan. Loans are returned to accruing status when all principal and interest amounts contractually due are brought current and concern no longer exists as to the future collectability of principal and interest, which is generally confirmed when the loan demonstrates performance for six consecutive months or payment cycles.

 

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1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

A troubled debt restructuring (“TDR”) occurs when a borrower is experiencing financial difficulty and the Bank grants a concession it would not otherwise consider to provide the borrower relief from one or more of the contractual loan conditions. Concessions that the Bank might consider include the allowance of interest-only payments on more than a temporary basis, the reduction of interest rates, the extension of the loan term, the forgiveness of principal, or a combination of these. The Bank might require additional collateral or additional guarantors as conditions to modifying loans as TDRs.

The Bank might consider modifying both accruing or nonaccruing loans as TDRs. When a modification includes a reduction of principal that resulted from a partial charge off of the loan, the Bank typically accounts for the TDR as a nonaccruing loan.

The Bank classifies TDRs as impaired loans and evaluates the need for an allowance for loan loss on a loan-by-loan basis consistent with its evaluation of impaired loans that have not been modified as TDRs. An allowance is based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the underlying collateral less any selling costs, if the loan is deemed to be collateral dependent.

The Bank’s policy for recognition of interest income on loans considered to be impaired, including restructured loans, is the same as its interest income recognition policy for loans not considered to be impaired.

Loan Charge-offs – The Bank charges off loan balances, in whole or in part, when available, verifiable, and documentable information confirms that specific loans, or portions of specific loans, are uncollectible or unrecoverable. For unsecured loans, losses are confirmed when it can be determined that the borrower, or any guarantor, is unwilling or unable to pay the amounts as agreed. When the borrower, or any guarantors, are unwilling or unable to pay the amounts as agreed on a loan secured by collateral and any recovery is dependent upon the sale of the collateral, the loan is deemed to be collateral dependent. Repayments or recoveries for collateral dependent loans are directly affected by the value of the collateral at liquidation. As such, loan repayment can be affected by factors that influence the amount recoverable, the timing of the recovery, or a combination of the two. Such factors include economic conditions that affect the markets in which the loan or its collateral is sold, bankruptcy, repossession and foreclosure laws, and consumer banking regulations. Losses are also confirmed when the loan, or a portion of the loan, is classified as loss resulting from loan reviews conducted by the Bank.

Charge-offs of loans in the commercial loan segment are recognized when the uncollectibility of the loan balance and the inability to recover sufficient value from the sale of any collateral securing the loan is confirmed. The uncollectibility of the loan balance is evidenced by the inability of the commercial borrower to generate cash flows sufficient to repay the loan as agreed causing the loan to become delinquent. For collateral dependent commercial loans, the Bank determines the fair value of the collateral based on appraisals, current market conditions, and estimated costs to sell the collateral. For collateral dependent commercial loans where the loan balance, including any accrued interest, net deferred fees or costs, and unamortized premiums or discounts, exceeds the fair value of the collateral securing the loan, the deficiency is identified as unrecoverable, is deemed to be a confirmed loss, and is charged off.

 

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1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Charge-offs of loans in the non-commercial loan segment are generally confirmed and recognized in a manner similar to loans in the commercial loan segment. Secured non-commercial loans that are identified as uncollectible and are deemed to be collateral dependent are confirmed as loss to the extent the fair value of the collateral is insufficient to recover the loan balance. Closed-end consumer loans that become 120 cumulative days past due and open-end consumer loans that become 180 cumulative days past due are charged off to the extent that the fair value of any collateral, less estimated costs to sell the collateral, is insufficient to recover the loan balance. Closed-end and open-end loans secured by residential real estate that become 180 days past due are charged off to the extent that the fair value of the residential real estate securing the loan, less estimated costs to sell the collateral, is insufficient to recover the loan balance. Loans determined to be fraudulent are charged off within 90 days of discovery. Loans to borrowers in bankruptcy are subject to modification by the bankruptcy court and are charged off to the extent that the fair value of any collateral securing the loan, less estimated costs to sell the collateral, is insufficient to recover the loan balance, unless the Bank expects repayment is likely to occur. Such loans are charged off within 60 days of the receipt of notification from a bankruptcy court or when the loans become 120 days past due, whichever is shorter.

Foreclosed Real Estate – Foreclosed real estate consists of real estate and other assets acquired as a result of customers’ loan defaults. Foreclosed real estate is stated at the lower of the related loan balance or the fair value of the property net of the estimated costs of disposal with a charge to the allowance for loan losses upon foreclosure. Any write-downs subsequent to foreclosure are charged against operating earnings. To the extent recoverable, costs relating to the development and improvement of property are capitalized, whereas those costs relating to holding the property are charged to expense.

Comprehensive Income – Comprehensive income is defined as the change in equity of an enterprise during a period from transactions and other events and circumstances from non-owner sources and, accordingly, includes both net income and amounts referred to as other comprehensive income (“OCI”). The items of other comprehensive income are included in the Consolidated Statements of Comprehensive Income (Loss). The accumulated balance of other comprehensive income is included in the equity section of the Consolidated Balance Sheets. The Company’s components of accumulated other comprehensive income include unrealized gains and/or losses on investment securities classified as available for sale and certain changes in the Company’s benefit obligations under its retirement plans. The Company adjusts the level of accumulated comprehensive income related to its retirement plans on an annual basis, consistent with the receipt of its annual actuarial studies.

The changes in the components of the Company’s accumulated other comprehensive loss, net of income taxes, were as follows:

 

		Three Months Ended March 31, 2013
		Beginning				OCI Before				Amount				Net				Ending
(dollars in thousands)		Balance				Reclassification				Reclassified				OCI				Balance
Unrealized gain (loss) on securities		$	1,879			$	(519	)		$	5			$	(514	)		$	1,365
Benefit plan liability			(4,946	)			221				(221	)			—				(4,946	)
Accumulated other comprehensive loss, net of tax		$	(3,067	)		$	(298	)		$	(216	)		$	(514	)		$	(3,581	)

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

The Company’s reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2013 were as follows:

 

(dollars in thousands)
Details about Accumulated Other Comprehensive Income Components		Amount Reclassified from Accumulated Other Comprehensive Income				Affected Line Item in the Statement Where Net Income Is Presented
Reclassification of securities losses (gains) recognized in net income		$	7			Gain (loss) on sale of investment securities
Deferred income tax (benefit) expense			(2	)		Income tax provision
		$	5			Net of tax
Amortization of defined benefit pension items:
Prior service cost (credit)		$	(18	)
Net loss			164
Curtailment credit			(481	)
Net periodic pension benefit			(335	)		Salaries and employee benefits
Deferred income tax (benefit) expense			114			Income tax provision
Total reclassifications for the period		$	(221	)		Net of tax

Income Taxes – The establishment of provisions for federal and state income taxes is a complex area of accounting, which involves the use of significant judgments and estimates in applying relevant tax statutes. The Company is subject to audit by federal and state tax authorities, the results of which may produce tax liabilities that differ from the Company’s tax estimates and provisions. The Company continually evaluates its exposure to possible tax assessments arising from audits and it records its estimate of possible exposure based on current facts and circumstances. The Parent and the Bank have entered into a formal agreement that will allow them, if so elected, to file consolidated federal and state income tax returns, where permitted, and each to pay its respective share of income taxes due.

Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. When uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset may be reduced by a valuation allowance. The amount of any valuation allowance established is based upon an estimate of the deferred tax asset that is more likely than not to be recovered. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.

 

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1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

A significant portion of the recorded deferred tax assets relate to a loan loss allowance on which the realization of income tax benefits is dependent on the Bank’s ability to generate future taxable income. Because of this dependency, the Bank’s management considered the need for a valuation allowance, but determined there was sufficient positive evidence to support their conclusion not to record a valuation allowance. The positive evidence that led the Bank’s management to conclude that the income tax benefits of the Bank’s deferred tax assets would be realized included (1) the Bank has a sustained history of generating taxable income and realizing the income tax benefits of its deferred tax assets and income tax credits, (2) the Bank’s management believes that, based on certain credit quality indicators, the credit quality issues that resulted in the 2010 net loss and caused the net operating loss carry forward and deferred tax asset related to the loan loss allowance have improved somewhat, (3) the Bank generated pretax income in 2011, (4) the Bank’s management is aware of one or more strategies that, if implemented, could generate future taxable income, and (5) the net operating loss carry forward does not expire in the near term and the Bank has not experienced expiring loss carry forwards in its past. The Bank’s loss carry forward periods under applicable federal and North Carolina income tax laws are 20 years and 15 years, respectively, with remaining loss carry forward periods of 18 years and 13 years, respectively.

The Bank includes interest and penalties related to income tax liabilities in noninterest expense. The Bank’s tax filings for the years ended December 31, 2008 through 2011 are currently open to audit under statutes of limitations by the Internal Revenue Service and the North Carolina Department of Revenue.

Pension Plan – The Bank has two noncontributory, defined benefit pension plans. The Bank recognizes the overfunded or underfunded status of the plans as an asset or liability in its consolidated statement of financial position and recognizes changes in the funded status in the year in which the change occurs through comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. GAAP also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position and to include additional disclosure in the notes to financial statements about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation.

Employee Stock Ownership Plan (“ESOP”) – In connection with the mutual-to-stock conversion on October 11, 2011, the Bank established an ESOP for the benefit of all of its eligible employees. Full-time employees of the Bank who have been credited with at least 1,000 hours of service during a 12-month period and who have attained age 21 are eligible to participate in the ESOP. Shares allocated under the ESOP vest at the rate of 20% per year of service beginning with the completion of two years of service and fully vest upon the completion of six years of service. The Bank anticipates it will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable to the Company over a period of 15 years.

 

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1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Unallocated ESOP shares are not considered outstanding (including for the calculation of net income per common share as discussed below) and are shown as a reduction of stockholders’ equity. Dividends on unallocated ESOP shares, if paid, are considered to be compensation expense. The Company recognizes compensation cost equal to the fair value of the ESOP shares during the periods in which they are committed to be released. The fair value of the annual share allocations is recorded on a monthly basis with fair value determined by calculating the average closing stock price for each day during the month. To the extent that the fair value of the Company’s ESOP shares differs from the cost of such shares, the difference is recognized in stockholders’ equity. The Company recognizes a tax deduction equal to the cost of the shares released. Because the ESOP is internally leveraged through a loan from the Company to the ESOP, the loan receivable by the Company from the ESOP is not reported as an asset nor is the debt of the ESOP shown as a liability in the consolidated financial statements.

Equity Incentive Plan – The Company issued restricted stock and stock options under the 2012 Equity Incentive Plan during the first quarter of 2013 to key officers and outside directors. In accordance with the requirements of ASC 718, Compensation – Stock Compensation, the Company uses a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured based on the fair value of the award as of the grant date and recognized over the vesting period.

Net Income Per Common Share – Where presented, basic net income per common share is the Company’s net income available to common stockholders, which represents net income less dividends paid or payable to preferred stock shareholders, if any, divided by the weighted average number of common shares outstanding during the period. In calculating the weighted average number of common shares outstanding, shares held by the ESOP are not considered to be outstanding until they are committed to be released for allocation. Also, the weighted average of unvested restricted shares are not considered outstanding until the shares vest.

For diluted income per common share, net income available to common shareholders is divided by the weighted average number of common shares issued and outstanding for each period plus amounts representing the dilutive effect of stock options and restricted stock, as well as any adjustment to income that would result from the assumed issuance. The effects of restricted stock and stock options are excluded from the computation of diluted income per common share in periods in which the effect would be antidilutive. Potential common shares that might be issued by the Company relate solely to outstanding stock options and restricted stock and are determined using the treasury stock method.

 

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1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Net income per common share has been computed based on the following:

 

		Three Months Ended March 31,
(dollars in thousands, except per share data)		2013				2012
Numerator:
Net income		$	740			$	284
Denominator:
Weighted average common shares issued			5,461,536				5,584,551
Less: Weighted average unvested restricted shares			223,382				—
Less: Weighted average unallocated ESOP shares			404,157				435,512
Weighted average common shares used to compute net income per common share – Basic			4,833,997				5,149,039
Add: Effect of dilutive securities			198				—
Weighted average common shares used to compute net income per common share – Diluted			4,834,195				5,149,039
Net income per common share – Basic		$	0.15			$	0.06
Net income per common share – Diluted		$	0.15			$	0.06

Reclassifications – Certain reclassifications have been made to the financial statements of the prior periods presented to conform to the current period presentation. The reclassifications had no effect on net income, net income per share, or stockholders’ equity as previously reported.

 

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1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Recent Accounting Pronouncements

Accounting Standards Update ASU 2011-11 – In December, 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities , in an effort to improve comparability between U.S. GAAP and IFRS financial statements with regard to the presentation of offsetting assets and liabilities on the statement of financial position arising from financial and derivative instruments, and repurchase agreements. The ASU establishes additional disclosures presenting the gross amounts of recognized assets and liabilities, offsetting amounts, and the net balance reflected in the statement of financial position. Descriptive information regarding the nature and rights of the offset must also be disclosed. The amendments are effective for annual reporting periods beginning on or after January 1, 2013. The adoption of the new guidance did not have an impact on the Company’s financial statements.

Accounting Standards Update ASU 2012-02 – In July, 2012, the FASB issued ASU 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment, which amends the guidance in ASC 350-30 on testing indefinite-lived intangible assets, other than goodwill, for impairment. The FASB amended the impairment testing requirements by allowing an entity to perform a qualitative impairment assessment before calculating the fair value of the asset. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of the new guidance did not have an impact on the Company’s financial statements.

Accounting Standards Update ASU 2012-03 – In August, 2012, the FASB issued ASU 2012-03, Technical Amendments and Corrections to SEC Sections, which amends a number of SEC sections in the FASB Accounting Standards Codification as a result of (1) the issuance of SAB 114, (2) the issuance of SEC Final Rule 33-9250, and (3) corrections related to ASU 2010-22. ASU 2012-03 is effective for all entities upon issuance. The adoption of the new guidance did not have a significant impact on the Company’s financial statements.

Accounting Standards Update ASU 2013-02 – In February, 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income (AOCI). The ASU is intended to help entities improve the transparency of changes in other comprehensive income (OCI) and items reclassified out of AOCI in their financial statements. It does not amend any existing requirements for reporting net income or OCI in the financial statements. Both public and nonpublic entities that report items of OCI are affected by the ASU. ASU 2013-02 is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2012. Early adoption is permitted. The amendments in the ASU should be applied prospectively. Other than the addition of the required disclosures, the adoption of the new guidance did not have an impact on the Company’s financial statements.

 

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2. INVESTMENT SECURITIES

Securities Available for Sale – The maturities, amortized cost, unrealized gains, unrealized losses and fair values of securities available for sale are as follows:

 

Type and Maturity Group		Amortized				Unrealized				Unrealized				Fair
(dollars in thousands)		Cost				Gains				Losses				Value
March 31, 2013
U.S. Government Sponsored Entity (GSE) and agency securities due -
After 1 year but within 5 years		$	9,544			$	212			$	(10	)		$	9,746
After 5 years but within 10 years			2,383				3				(8	)			2,378
Asset-backed securities issued by the Small Business Administration (SBA)			66,573				1,606				(55	)			68,124
Residential mortgage-backed securities issued by GSE’s (1)			123,724				1,246				(425	)			124,545
State and local government securities due -
After 5 years but within 10 years			8,223				339				(26	)			8,536
After 10 years			43,888				399				(1,030	)			43,257
Mutual funds			715				23				—				738
Total		$	255,050			$	3,828			$	(1,554	)		$	257,324
December 31, 2012
U.S. Government Sponsored Entity (GSE) and agency securities due -
After 1 year but within 5 years		$	10,609			$	232			$	(16	)		$	10,825
After 5 years but within 10 years			1,416				6				—				1,422
Asset-backed securities issued by the Small Business Administration (SBA)			69,088				1,387				(64	)			70,411
Residential mortgage-backed securities issued by GSE’s (1)			105,598				1,386				(297	)			106,687
State and local government securities due -
After 5 years but within 10 years			7,613				388				(6	)			7,995
After 10 years			40,570				529				(442	)			40,657
Mutual funds			711				28				—				739
Total		$	235,605			$	3,956			$	(825	)		$	238,736

 

(1)

Residential mortgage-backed securities were issued by United States government sponsored entities including the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, or Government National Mortgage Association. The Company held no private label residential mortgage-backed securities at March 31, 2013 and December 31, 2012 or during the periods then ended.

 

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2. INVESTMENT SECURITIES (Continued)

 

Securities Held to Maturity – The maturities, amortized cost, unrealized gains, unrealized losses and fair values of securities classified as held to maturity are as follows:

 

Type and Maturity Group		Amortized				Unrealized				Unrealized				Fair
(dollars in thousands)		Cost				Gains				Losses				Value
March 31, 2013
U.S. GSE and agency securities due -
After 1 year but within 5 years		$	1,062			$	142			$	—			$	1,204
Residential mortgage-backed securities issued by GSE’s (1)			1,074				75				—				1,149
State and local government securities due -
After 5 years but within 10 years			952				129				—				1,081
After 10 years			1,468				139				—				1,607
Total		$	4,556			$	485			$	—			$	5,041
December 31, 2012
U.S. GSE and agency securities due -
After 5 years but within 10 years		$	1,065			$	144			$	—			$	1,209
Residential mortgage-backed securities issued by GSE’s (1)			1,166				83				—				1,249
State and local government securities due -
After 5 years but within 10 years			951				141				—				1,092
After 10 years			1,467				165				—				1,632
Total		$	4,649			$	533			$	—			$	5,182

 

(1)

Residential mortgage-backed securities were issued by United States government sponsored entities including the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, or Government National Mortgage Association. The Company held no private label residential mortgage-backed securities at March 31, 2013 and December 31, 2012 or during the periods then ended.

 

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2. INVESTMENT SECURITIES (Continued)

 

The following tables show investment gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2013 and December 31, 2012. The total number of securities with unrealized losses at March 31, 2013 and December 31, 2012 were 71 and 54, respectively. The unrealized losses relate to debt securities that have incurred fair value reductions due to higher market interest rates since the securities were purchased. The unrealized losses are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Management has the intent to hold securities with unrealized losses until a recovery of the market value occurs. Management has determined that it is more likely than not that the Company will not be required to sell any of the securities with unrealized losses prior to a recovery of market value sufficient to negate the unrealized loss. Management has analyzed the creditworthiness of the underlying issuers and determined that the Company will collect all contractual cash flows, therefore all impairment is considered to be temporary.

 

		March 31, 2013
		Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		value				losses				value				losses				value				losses
Securities Available for Sale
US GSE and agency		$	4,221			$	(18	)		$	—			$	—			$	4,221			$	(18	)
Asset-backed SBA			6,315				(55	)			—				—				6,315				(55	)
Residential mortgage-backed GSE (1)			52,134				(425	)			—				—				52,134				(425	)
State and local government			32,813				(1,056	)			—				—				32,813				(1,056	)
Total temporarily impaired securities		$	95,483			$	(1,554	)		$	—			$	—			$	95,483			$	(1,554	)

 

(1)

Residential mortgage-backed securities were issued by United States government sponsored entities including the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, or Government National Mortgage Association. The Company held no private label residential mortgage-backed securities at March 31, 2013 and December 31, 2012 or during the periods then ended.

 

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2. INVESTMENT SECURITIES (Continued)

 

		December 31, 2012
		Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		value				losses				value				losses				value				losses
Securities Available for Sale
US GSE and agency		$	1,984			$	(16	)		$	—			$	—			$	1,984			$	(16	)
Asset-backed SBA			13,381				(63	)			390				(1	)			13,771				(64	)
Residential mortgage-backed GSE (1)			35,995				(297	)			—				—				35,995				(297	)
State and local government			24,018				(448	)			—				—				24,018				(448	)
Total temporarily impaired securities		$	75,378			$	(824	)		$	390			$	(1	)		$	75,768			$	(825	)

 

(1)

Residential mortgage-backed securities were issued by United States government sponsored entities including the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, or Government National Mortgage Association. The Company held no private label residential mortgage-backed securities at March 31, 2013 and December 31, 2012 or during the periods then ended.

Investment securities pledged as collateral follow:

 

(dollars in thousands)		March 31, 2013				December 31, 2012
Pledged to Federal Reserve Discount Window		$	11,644			$	3,301
Pledged to repurchase agreements for commercial customers			819				922

Interest income from taxable and tax-exempt securities recognized in interest and dividend income follow:

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
Interest income from taxable securities		$	767			$	1,260
Interest income from tax-exempt securities			318				108
Total interest income from securities		$	1,085			$	1,368

 

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2. INVESTMENT SECURITIES (Continued)

 

Proceeds and realized gains and losses from sales of securities recognized in net income follow:

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
Proceeds from sales of securities		$	20,950			$	35,274
Realized gains (losses) from sales of securities			(7	)			502

3. LOANS RECEIVABLE

Loans receivable by segment and class follow:

 

(dollars in thousands)		March 31, 2013				December 31, 2012
Commercial:
Commercial construction and land development		$	6,075			$	5,161
Commercial mortgage			146,689				138,804
Commercial and industrial			10,369				11,093
Total commercial			163,133				155,058
Non-commercial:
Non-commercial construction and land development			3,885				3,729
Residential mortgage			163,893				163,571
Revolving mortgage			46,853				48,221
Consumer			18,197				17,552
Total non-commercial			232,828				233,073
Total loans receivable			395,961				388,131
Less: Deferred loan fees			(421	)			(410	)
Total loans receivable net of deferred loan fees			395,540				387,721
Less: Allowance for loan losses			(8,553	)			(8,513	)
Loans receivable, net		$	386,987			$	379,208

 

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3. LOANS RECEIVABLE (Continued)

 

Loans receivable by segment, class, and grade follow:

 

						Special																Total
(dollars in thousands)		Pass				Mention				Substandard				Doubtful				Loss*				Loans
March 31, 2013
Commercial:
Commercial construction and land development		$	5,476			$	447			$	152			$	—			$	—			$	6,075
Commercial mortgage			121,925				23,848				916				—				—				146,689
Commercial and industrial			8,038				1,950				381				—				—				10,369
Total commercial			135,439				26,245				1,449				—				—				163,133
Non-commercial:
Non-commercial construction and land development			3,885				—				—				—				—				3,885
Residential mortgage			151,860				9,700				2,333				—				—				163,893
Revolving mortgage			43,477				2,651				725				—				—				46,853
Consumer			17,523				548				126				—				—				18,197
Total non-commercial			216,745				12,899				3,184				—				—				232,828
Total loans receivable		$	352,184			$	39,144			$	4,633			$	—			$	—			$	395,961
December 31, 2012
Commercial:
Commercial construction and land development		$	4,516			$	450			$	195			$	—			$	—			$	5,161
Commercial mortgage			117,046				21,231				527				—				—				138,804
Commercial and industrial			10,239				694				160				—				—				11,093
Total commercial			131,801				22,375				882				—				—				155,058
Non-commercial:
Non-commercial construction and land development			3,729				—				—				—				—				3,729
Residential mortgage			151,617				9,797				2,153				—				4				163,571
Revolving mortgage			45,140				2,294				787				—				—				48,221
Consumer			16,722				683				147				—				—				17,552
Total non-commercial			217,208				12,774				3,087				—				4				233,073
Total loans receivable		$	349,009			$	35,149			$	3,969			$	—			$	4			$	388,131

 

*	Items included in the “Loss” column were fully reserved.

 

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3. LOANS RECEIVABLE (Continued)

 

Loans receivable by segment, class, and delinquency status follow:

 

		Past Due
(dollars in thousands)		31-89 Days				90 Days or More				Total				Current				Total Loans
March 31, 2013
Commercial:
Commercial construction and land development		$	—			$	—			$	—			$	6,075			$	6,075
Commercial mortgage			984				389				1,373				145,316				146,689
Commercial and industrial			195				204				399				9,970				10,369
Total commercial			1,179				593				1,772				161,361				163,133
Non-commercial:
Non-commercial construction and land development			—				—				—				3,885				3,885
Residential mortgage			3				830				833				163,060				163,893
Revolving mortgage			192				—				192				46,661				46,853
Consumer			246				18				264				17,933				18,197
Total non-commercial			441				848				1,289				231,539				232,828
Total loans receivable		$	1,620			$	1,441			$	3,061			$	392,900			$	395,961
December 31, 2012
Commercial:
Commercial construction and land development		$	16			$	40			$	56			$	5,105			$	5,161
Commercial mortgage			393				—				393				138,411				138,804
Commercial and industrial			135				114				249				10,844				11,093
Total commercial			544				154				698				154,360				155,058
Non-commercial:
Non-commercial construction and land development			—				—				—				3,729				3,729
Residential mortgage			875				808				1,683				161,888				163,571
Revolving mortgage			203				60				263				47,958				48,221
Consumer			492				28				520				17,032				17,552
Total non-commercial			1,570				896				2,466				230,607				233,073
Total loans receivable		$	2,114			$	1,050			$	3,164			$	384,967			$	388,131

 

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3. LOANS RECEIVABLE (Continued)

 

The recorded investment in loans, by segment and class, that are not accruing interest or are 90 days or more past due and still accruing interest follows:

 

		March 31, 2013								December 31, 2012
(dollars in thousands)		Nonaccruing				Past Due 90 Days or More and Still Accruing				Nonaccruing				Past Due 90 Days or More and Still Accruing
Commercial:
Commercial construction and land development		$	—			$	—			$	40			$	—
Commercial mortgage			389				—				—				—
Commercial and industrial			204				—				114				—
Total commercial			593				—				154				—
Non-commercial:
Residential mortgage			830				—				808				—
Revolving mortgage			95				—				155				—
Consumer			30				—				34				—
Total non-commercial			955				—				997				—
Total loans receivable		$	1,548			$	—			$	1,151			$	—

 

The Bank services loans for Habitat for Humanity of Western North Carolina as an in kind donation. The balances of these loans were $13.3 million at March 31, 2013 and December 31, 2012.

 

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4. ALLOWANCE FOR LOAN LOSSES

An analysis of the allowance for loan losses by segment follows:

 

		Three Months Ended March 31, 2013
(dollars in thousands)		Commercial				Non- Commercial				Total
Balance at beginning of period		$	4,860			$	3,653			$	8,513
Provision for loan losses			172				(60	)			112
Charge-offs			—				(105	)			(105	)
Recoveries			10				23				33
Balance at end of period		$	5,042			$	3,511			$	8,553

 

		Three Months Ended March 31, 2012
(dollars in thousands)		Commercial				Non- Commercial				Total
Balance at beginning of period		$	6,625			$	4,002			$	10,627
Provision for loan losses			482				116				598
Charge-offs			(571	)			(145	)			(716	)
Recoveries			16				37				53
Balance at end of period		$	6,552			$	4,010			$	10,562

 

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4. ALLOWANCE FOR LOAN LOSSES (Continued)

 

Ending balances of loans and the related allowance, by segment and class, follow:

 

		Allowance for Loan Losses												Total Loans Receivable
		Loans												Loans
		Individually												Individually
		Evaluated				Loans								Evaluated				Loans
		for				Collectively								for				Collectively
(dollars in thousands)		Impairment				Evaluated				Total				Impairment				Evaluated				Total
March 31, 2013
Commercial:
Commercial construction and land development		$	12			$	213			$	225			$	142			$	5,933			$	6,075
Commercial mortgage			670				3,617				4,287				4,036				142,653				146,689
Commercial and industrial			84				446				530				357				10,012				10,369
Total commercial			766				4,276				5,042				4,535				158,598				163,133
Non-commercial:
Non-commercial construction and land development			—				208				208				—				3,885				3,885
Residential mortgage			138				1,665				1,803				2,938				160,955				163,893
Revolving mortgage			107				966				1,073				198				46,655				46,853
Consumer			—				427				427				—				18,197				18,197
Total non-commercial			245				3,266				3,511				3,136				229,692				232,828
Total loans receivable		$	1,011			$	7,542			$	8,553			$	7,671			$	388,290			$	395,961
December 31, 2012
Commercial:
Commercial construction and land development		$	14			$	146			$	160			$	184			$	4,977			$	5,161
Commercial mortgage			633				3,477				4,110				3,673				135,131				138,804
Commercial and industrial			84				506				590				375				10,718				11,093
Total commercial			731				4,129				4,860				4,232				150,826				155,058
Non-commercial:
Non-commercial construction and land development			—				243				243				—				3,729				3,729
Residential mortgage			150				1,691				1,841				2,836				160,735				163,571
Revolving mortgage			114				1,009				1,123				208				48,013				48,221
Consumer			—				446				446				—				17,552				17,552
Total non-commercial			264				3,389				3,653				3,044				230,029				233,073
Total loans receivable		$	995			$	7,518			$	8,513			$	7,276			$	380,855			$	388,131

 

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4. ALLOWANCE FOR LOAN LOSSES (Continued)

 

Impaired loans and the related allowance, by segment and class, follow:

 

						Recorded Investment
		Unpaid				With a				With No								Related
		Principal				Recorded				Recorded								Recorded
(dollars in thousands)		Balance				Allowance				Allowance				Total				Allowance
March 31, 2013
Commercial:
Commercial construction and land development		$	142			$	142			$	—			$	142			$	12
Commercial mortgage			4,036				3,510				526				4,036				670
Commercial and industrial			735				239				118				357				84
Total commercial			4,913				3,891				644				4,535				766
Non-commercial:
Residential mortgage			3,084				1,567				1,371				2,938				138
Revolving mortgage			200				198				—				198				107
Total non-commercial			3,284				1,765				1,371				3,136				245
Total impaired loans		$	8,197			$	5,656			$	2,015			$	7,671			$	1,011
December 31, 2012
Commercial:
Commercial construction and land development		$	225			$	144			$	40			$	184			$	14
Commercial mortgage			3,673				3,146				527				3,673				633
Commercial and industrial			748				249				126				375				84
Total commercial			4,646				3,539				693				4,232				731
Non-commercial:
Residential mortgage			2,978				1,747				1,089				2,836				150
Revolving mortgage			211				208				—				208				114
Total non-commercial			3,189				1,955				1,089				3,044				264
Total impaired loans		$	7,835			$	5,494			$	1,782			$	7,276			$	995

 

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4. ALLOWANCE FOR LOAN LOSSES (Continued)

 

The average recorded investment in impaired loans and interest income recognized on impaired loans follows:

 

		Three Months Ended								Three Months Ended
		March 31, 2013								March 31, 2012
		Average				Interest				Average				Interest
		Recorded				Income				Recorded				Income
(dollars in thousands)		Investment				Recognized				Investment				Recognized
Commercial:
Commercial construction and land development		$	156			$	2			$	16,153			$	2
Commercial mortgage			3,786				44				2,500				8
Commercial and industrial			362				1				504				—
Total commercial			4,304				47				19,157				10
Non-commercial:
Non-commercial construction and land development			—				—				78				—
Residential mortgage			2,906				25				4,362				29
Revolving mortgage			201				1				336				1
Total non-commercial			3,107				26				4,776				30
Total loans receivable		$	7,411			$	73			$	23,933			$	40

 

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4. ALLOWANCE FOR LOAN LOSSES (Continued)

 

The following table summarizes the Bank’s recorded investment in TDRs before and after their modifications during the period indicated. The Bank restructured three loans during the three months ended March 31, 2013. The payment terms on one loan was extended during the three months ended March 31, 2013 and the Bank reduced the interest rate below market levels on two loans during the three months ended March 31, 2013.

 

		Three Months Ended March 31, 2013												Three Months Ended March 31, 2012
(dollars in thousands)		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
Below market interest rate
Non-commercial:
Residential mortgage			2			$	147			$	147				3			$	897			$	897
Total non-commercial			2				147				147				3				897				897
Total			2			$	147			$	147				3			$	897			$	897
Extended payment terms
Commercial:
Commercial construction and land development			—			$	—			$	—				1			$	234			$	234
Commercial mortgage			1				89				89				—				—				—
Total commercial			1				89				89				1				234				234
Total			1			$	89			$	89				1			$	234			$	234
Total			3			$	236			$	236				4			$	1,131			$	1,131

There were no loans modified as TDRs within the preceding 12 months that stopped performing during the three months ended March 31, 2013 and March 31, 2012.

 

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4. ALLOWANCE FOR LOAN LOSSES (Continued)

 

In the determination of the allowance for loan losses, management considers TDRs on commercial loans, and the subsequent nonperformance in accordance with their modified terms, by measuring impairment loan-by-loan based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

The Bank’s loans that were considered to be troubled debt restructurings follow:

 

(dollars in thousands)		March 31, 2013				December 31, 2012
Nonperforming restructured loans		$	116			$	114
Performing restructured loans			5,254				5,065
Total		$	5,370			$	5,179

5. BENEFIT PLANS

Defined Benefit Plans – In January 2013, the Board of Directors amended the Bank’s Qualified and Non-qualified pension plans, effective March 31, 2013, to curtail or eliminate benefits under the plans for services to be performed in future periods. During the three months ended March 31, 2013, pension expense was decreased by a $481,000 one-time credit resulting from the curtailment of benefits for future service.

Net periodic benefit cost related to defined benefit plans included the following components for the periods indicated:

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
Non-Qualified Defined Benefit Plan
Components of Net Periodic Benefit Costs
Service cost		$	—			$	1
Interest cost			10				15
Amortization of prior service cost (credit)			(3	)			(3	)
Amortization of net loss			9				6
Curtailment credit			(31	)			—
Net periodic benefit cost		$	(15	)		$	19
Qualified Defined Benefit Plan
Components of Net Periodic Benefit Costs
Service cost		$	—			$	55
Interest cost			226				298
Expected return on plan assets			(246	)			(302	)
Amortization of prior service cost (credit)			(15	)			(21	)
Amortization of net loss			155				128
Curtailment credit			(450	)			—
Net periodic benefit cost		$	(330	)		$	158

 

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5. BENEFIT PLANS (Continued)

 

Employee Stock Ownership Plan – In conjunction with the Parent’s initial public offering, the Bank established an ESOP to provide eligible employees the opportunity to own Parent stock. The Parent provided a loan to the ESOP in the amount of $4,468,000, which was used to purchase 446,764 shares of the Parent’s common stock at a price of $10.00 per share in the Parent’s initial public offering. The loan bears a fixed interest rate of 3.25% and provides for annual payments of interest and principal over the 15 year term of the loan.

The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account until released for allocation to the participants, as principal and interest payments are made by the ESOP to the Parent.

Shares released are allocated to each eligible participant based on the ratio of each such participant’s compensation, as defined in the ESOP, to the total compensation of all eligible plan participants. Forfeited shares shall be reallocated among other participants in the Plan. At the discretion of the Bank, cash dividends, when paid on allocated shares, will be distributed to participants’ accounts or used to repay the principal and interest on the ESOP loan used to acquire Parent stock on which dividends were paid. Cash dividends on unallocated shares will be used to repay the outstanding debt of the ESOP.

Shares held by the ESOP include the following:

 

		March 31, 2013
Allocated ESOP shares			38,737
ESOP shares committed to be released			7,739
ESOP shares distributed			(41	)
Unallocated ESOP shares			400,288
Total ESOP shares			446,723
Fair value of unallocated ESOP shares (dollars in thousands)		$	6,801

As ESOP shares are earned by the participants, the Company recognizes compensation expense equal to the fair value of the earned ESOP shares during the periods in which they become committed to be released.

Total expense recognized in connection with the ESOP was as follows:

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012
ESOP expense		$	128			$	94

 

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5. BENEFIT PLANS (Continued)

 

2012 Equity Incentive Plan - The Company’s 2012 Equity Incentive Plan (the “2012 Equity Incentive Plan”) provides for awards of restricted stock and stock options to key officers and outside directors. Cost recognized under the 2012 Equity Incentive Plan is based on the fair value of restricted stock and stock option awards on their grant date. The maximum number of shares that may be awarded under the plan is 781,837 shares, including 223,382 for restricted stock shares and 558,455 shares for stock options.

Shares of common stock granted under the 2012 Equity Incentive Plan may be issued from authorized but unissued shares or, in the case of restricted stock awards, may be awarded with shares purchased on the open market. During 2012, the Company purchased the 223,382 shares of its common stock at a total cost of $3.6 million, or an average of $16.12 per share, through an independent trustee to fulfill anticipated restricted stock awards. The share-based awards granted under the 2012 Equity Incentive Plan have some similar characteristics, except some awards have been granted in restricted stock and other awards have been granted in stock options. Therefore, the following disclosures have been disaggregated for the restricted stock awards and the stock option grants under the plan due to their dissimilar characteristics.

Share-based compensation expense related to restricted stock and stock options recognized for the three months ended March 31, 2013 was $164,000.

The table below presents restricted stock award activity for the three months ended March 31, 2013:

 

		Restricted Stock Awards				Weighted Average Grant Date Fair Value
Unvested restricted shares at December 31, 2012			—			$	—
Granted			223,382				15.71
Vested			—				—
Forfeited			—				—
Unvested restricted shares at March 31, 2013			223,382			$	15.71

At March 31, 2013, unrecognized compensation expense adjusted for expected forfeitures was $3.0 million related to restricted stock. The weighted-average period over which compensation cost related to unvested awards is expected to be recognized was 4.85 years at March 31, 2013. No restricted stock awards were vested at March 31, 2013.

 

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5. BENEFIT PLANS (Continued)

 

The table below presents stock option activity for the three months ended March 31, 2013:

 

(dollars in thousands, except per share data)		Stock Options Available for Granting				Stock Options Outstanding				Weighted Average Exercise Price				Remaining Contractual Life (years)				Aggregate Intrinsic Value
Balance at December 31, 2012			558,455				—			$	—
Granted			(467,000	)			467,000				15.71				10.00
Exercised			—				—				—
Forfeited			8,000				(8,000	)			15.71
Expired			—				—				—
Balance at March 31, 2013			99,455				459,000			$	15.71				9.85			$	587
Options exercisable at March 31, 2013							—			$	—

The fair value of each option award is estimated on the date of the grant using the Black-Scholes option pricing model. The Company granted 467,000 options during the quarter ended March 31, 2013 with a fair value of $4.79 per option. The risk-free interest rate is based on a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. The expected term of the options is based on a calculated average life using the “simplified method” defined in and permitted by SEC Staff Accounting Bulletin No. 110 for newly public companies. Because the Company is a newly public company, expected volatility is estimated based on the previous 6.5 years trading history for an aggregate of six composite indexes of U.S. Banks and Thrifts of similar size. The expected dividend yield is based upon current yield on date of grant. Expected forfeitures are estimated at 5.63% based on the Company’s aggregate annual turnover rate for directors, executives and senior managers over the past 6.5 years because the Company has no forfeiture history. The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options granted to directors and officers in the quarter ended March 31, 2013.

 

		Three Months Ended March 31, 2013
Expected life in years			6.5 years
Expected stock price volatility			27.54	%
Expected dividend yield			0.00	%
Risk-free interest rate			1.26	%

At March 31, 2013, the Company had $1.8 million of unrecognized compensation expense related to stock options. The period over which compensation cost related to unvested stock options was 4.85 years at March 31, 2013. No options were vested at March 31, 2013.

 

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6. COMMITMENTS AND CONTINGENCIES

Loan Commitments – The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recorded in the accompanying consolidated balance sheets. Such financial instruments are recorded when they are funded.

The Bank’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making such commitments as it does for instruments that are included in the balance sheet.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial real estate.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit.

 

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6. COMMITMENTS AND CONTINGENCIES (Continued)

 

The Bank’s commitments to extend or originate credit and under standby letters of credit follow:

 

(dollars in thousands)		March 31, 2013				December 31, 2012
Financial instruments whose contract amounts represent credit risk:
Commitments to extend or originate credit		$	131,995			$	144,733
Commitments under standby letters of credit			881				156
Total		$	132,876			$	144,889

Concentrations of Credit Risk – The Bank’s primary market area consists of Buncombe, Henderson, McDowell, Transylvania and Madison counties of North Carolina. The majority of the Bank’s loans are residential mortgage loans and commercial real estate loans. The Bank’s policy generally will allow residential mortgage loans up to 80% of the value of the real estate that is pledged as collateral or up to 95% with private mortgage insurance and commercial real estate loans up to 85% of the value of the real estate that serves as collateral to secure the loan.

Interest Rate Risk – The Bank’s profitability depends to a large extent on its net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings. Like most financial institutions, the Bank’s interest income and interest expense are significantly affected by changes in market interest rates and other economic factors beyond its control. The Bank’s interest-earning assets consist primarily of long-term, fixed-rate mortgage loans, adjustable rate mortgage loans and investments that typically adjust more slowly to changes in interest rates than its interest-bearing liabilities, which are primarily term deposits. Accordingly, the Bank’s earnings are usually adversely affected during periods of rising interest rates and positively impacted during periods of declining interest rates. However, based on the results of the Bank’s interest rate risk simulation model, which management believes accurately reflects the extraordinary stress currently existing in the financial markets with respect to potential margin compression resulting from the Bank’s difficulty in reducing its cost of funds further in this competitive pricing environment, the Bank’s earnings may well be adversely affected if interest rates decline further. Such a decline in rates could result from, among other things, the Federal Reserve Board’s purchase of government securities and/or mortgage-backed securities in an effort to further stimulate the economy. Accordingly, the Bank is currently the beneficiary of a stable rate environment and is carefully monitoring, through its Asset/Liability management process, the competitive landscape related to interest rates as well as various economic indicators in order to optimally position the Bank in terms of changes in interest rates.

Litigation – The Bank is periodically involved in legal actions in the normal course of business. The Bank is not a party to any pending legal proceedings that the Bank’s management believes would have a material adverse effect on the Bank’s financial condition, results of operations, or cash flows.

Investment Commitments – During 2012, the Bank indicated its intent to enter into an agreement to invest $2.0 million as a limited partner in a Small Business Investment Company. The Bank invested $150,000 of its investment commitment in the first quarter of 2013. This investment is recognized using the cost method and is included in “other assets” on the balance sheet.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS

FASB ASC Topic 820: Fair Value Measurements and Disclosures (“FASB ASC Topic 820”) requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed below. The estimated fair value amounts shown below have been determined by the Bank using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Bank could realize in a current market exchange. The use of different market assumptions and/or valuation methodologies could have a material effect on the estimated fair value amounts.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no highly liquid market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.

The fair value estimates presented below are based on pertinent information available to management as of March 31, 2013 and December 31, 2012. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the dates presented herein and, therefore, current estimates of fair value may differ significantly from the amounts presented.

The fair value measurement and disclosure guidance contained in FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.

Level 1

The fair values of Level 1 assets are determined by quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury debt securities.

Level 2

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency mortgage-backed debt securities, SBA asset-backed securities, securities issued by state and local governments, and corporate debt securities.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS (Continued)

 

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments, loans receivable held for investment, accrued interest receivable and payable, time deposits, repurchase agreements, and FHLB advances.

The methodologies for estimating fair values of financial assets and financial liabilities were determined as discussed below. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest, Federal Home Loan Bank Stock and demand deposits.

Investment Securities – Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is primarily based upon quoted prices of like or similar securities, 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. The fair values of investments in mutual funds are determined by quoted prices and are included as recurring Level 1 assets. The fair values of investments in securities issued by U.S. GSE’s, asset-backed securities issued by the SBA, residential mortgage-backed securities issued by U.S. GSE’s, and securities issued by state and local governments 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 and are included as recurring Level 2 assets.

Loans Held for Sale – Loans held for sale are residential mortgages carried at the lower of cost or market value. The market values of loans held for sale are based on what mortgage buyers are currently offering on a “best efforts” basis to buy the loans. As such, mortgages held for sale are classified as nonrecurring Level 2 assets.

Loans Receivable – For variable rate loans, carrying value is a reasonable estimate of fair value. For fixed rate loans, fair values are estimated based on discounted future cash flows using the current interest rates at which loans with similar terms would be made to borrowers of similar credit quality. Valuation adjustments are made for credit risk, which are represented by the allowance for loan losses, but do not include adjustments for illiquidity or other market risks.

The Bank 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 in accordance with the accounting guidance contained in FASB ASC Topic 310: Receivables (“FASB ASC Topic 310”). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value, or 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. Substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with the fair value measurement and disclosure guidance contained in FASB ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS (Continued)

 

When the fair value of the collateral is based on an observable market price or a current appraised value, the impaired loan is recorded as nonrecurring Level 2 assets. 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 Bank records the impaired loan as nonrecurring Level 3 assets.

Accrued Interest Receivable and Payable – The carrying amount is a reasonable estimate of fair value.

Deferred Compensation Assets – Assets include debt and equity securities that are traded in an active exchange market. Fair values are obtained from quoted prices in active markets for identical assets.

Demand and Savings Deposits – By definition, the carrying values are equal to the fair values.

Time Deposits and Repurchase Agreements – Fair value of fixed maturity certificates of deposit is estimated using the FHLB Rate Curve for similar remaining maturities. Fair value of repurchase agreements is estimated using the borrowing rate for overnight borrowings.

Federal Home Loan Bank Advances – The fair value of Federal Home Loan Bank advances is estimated using the rates currently offered for advances of similar remaining maturities.

Deferred Compensation Liabilities – Fair values are measured based on the fair values of the related deferred compensation assets.

Defined Benefit Plan Assets – The Nonqualified Defined Benefit Plan had no plan assets because it was not funded. The assets of the Qualified Defined Benefit Plan, which are invested in interest-bearing depository accounts and money market, debt and equity security mutual funds, are included at fair value in the Qualified Plan’s separate financial statements. Fair value measurement is based upon quoted prices of like or similar securities. The fair values of the Plan’s investments in interest-bearing depository accounts and money market, debt and equity security mutual funds are determined by quoted prices and are included as recurring Level 1 assets.

Foreclosed Properties – Foreclosed properties are measured and recorded at the lower of cost or estimated fair value. The fair value of foreclosed properties is measured using the current appraised value of the property less the estimated expenses necessary to sell the property. Foreclosed properties are classified as nonrecurring Level 3 assets.

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS (Continued)

 

The estimated fair values and carrying amounts of financial instruments follow:

 

		Fair Value Measurement Using																Total Carrying Amount  in Balance Sheet
(dollars in thousands)		Level 1				Level 2				Level 3				Estimated Fair Value
March 31, 2013
Financial assets:
Cash and cash equivalents		$	50,321			$	—			$	—			$	50,321			$	50,321
Securities available for sale			738				256,586				—				257,324				257,324
Securities held to maturity			—				5,041				—				5,041				4,556
Investments in FHLB stock			—				—				3,131				3,131				3,131
Loans held for sale			—				11,777				—				11,777				11,603
Loans receivable, net			—				—				391,707				391,707				386,987
Accrued interest receivable			—				—				2,601				2,601				2,601
Deferred compensation assets			1,159				—				—				1,159				1,159
Financial liabilities:
Demand deposits			—				—				398,338				398,338				398,338
Time deposits			—				—				191,936				191,936				191,288
Repurchase agreements			—				—				616				616				618
Federal Home Loan Bank Advances			—				—				56,487				56,487				50,000
Deferred compensation liabilities			1,159				—				—				1,159				1,159
Accrued interest payable			—				—				129				129				129
Financial instruments whose contract amounts represent credit risk:
Commitments to extend or originate credit			—				—				—				—				—
Commitments under standby letters of credit			—				—				—				—				—

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS (Continued)

 

		Fair Value Measurement Using																Total Carrying Amount  in Balance Sheet
(dollars in thousands)		Level 1				Level 2				Level 3				Estimated Fair Value
December 31, 2012
Financial assets:
Cash and cash equivalents		$	47,390			$	—			$	—			$	47,390			$	47,390
Securities available for sale			739				237,997				—				238,736				238,736
Securities held to maturity			—				5,182				—				5,182				4,649
Investments in FHLB stock			—				—				3,429				3,429				3,429
Loans held for sale			—				9,905				—				9,905				9,759
Loans receivable, net			—				—				382,428				382,428				379,208
Accrued interest receivable			—				—				2,764				2,764				2,764
Deferred compensation assets			1,081				—				—				1,081				1,081
Financial liabilities:
Demand deposits			—				—				389,095				389,095				389,095
Time deposits			—				—				189,755				189,755				189,204
Repurchase agreements			—				—				409				409				411
Federal Home Loan Bank Advances			—				—				56,905				56,905				50,000
Deferred compensation liabilities			1,081				—				—				1,081				1,081
Accrued interest payable			—				—				127				127				127
Financial instruments whose contract amounts represent credit risk:
Commitments to extend or originate credit			—				—				—				—				—
Commitments under standby letters of credit			—				—				—				—				—

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS (Continued)

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Below is a table that presents information about certain assets and liabilities measured at fair value on a recurring basis. There were no transfers to or from Levels 1 and 2 during the three months ended March 31, 2013.

 

(dollars in thousands)		Fair Value Measurement Using												Total Carrying Amount in Balance Sheets				Assets/ Liabilities Measured at Fair Value
Description		Level 1				Level 2				Level 3
March 31, 2013
Securities available for sale:
U.S. GSE and agency securities		$	—			$	12,124			$	—			$	12,124			$	12,124
Asset-backed SBA securities			—				68,124				—				68,124				68,124
Residential mortgage-backed securities issued by GSE’s			—				124,545				—				124,545				124,545
State and local government securities			—				51,793				—				51,793				51,793
Mutual funds			738				—				—				738				738
Total		$	738			$	256,586			$	—			$	257,324			$	257,324
Defined benefit plan assets:
Cash and cash equivalents		$	182			$	—			$	—
Money market mutual funds			145				—				—
Debt security mutual funds			14,118				—				—
Equity security mutual funds			3,577				—				—
Total		$	18,022			$	—			$	—
December 31, 2012
Securities available for sale:
U.S. GSE and agency securities		$	—			$	12,247			$	—			$	12,247			$	12,247
Asset-backed SBA securities			—				70,411				—				70,411				70,411
Residential mortgage-backed securities issued by GSE’s			—				106,687				—				106,687				106,687
State and local government securities			—				48,652				—				48,652				48,652
Mutual funds			739				—				—				739				739
Total		$	739			$	237,997			$	—			$	238,736			$	238,736
Defined benefit plan assets:
Cash and cash equivalents		$	5,837			$	—			$	—
Money market mutual funds			225				—				—
Debt security mutual funds			12,095				—				—
Total		$	18,157			$	—			$	—

 

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ASB BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

7. FAIR VALUE MEASUREMENTS (Continued)

 

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

As may be required from time to time, certain assets may be recorded at fair value on a nonrecurring basis in accordance with U.S. GAAP. Assets measured at fair value on a nonrecurring basis are included in the table below.

 

(dollars in thousands)		Fair Value Measurement Using												Total Carrying Amount  in Balance Sheets				Assets/ Liabilities Measured at Fair Value
Description		Level 1				Level 2				Level 3
March 31, 2013
Impaired loans		$	—			$	—			$	5,071			$	5,071			$	5,071
Foreclosed properties			—				—				18,128				18,128				18,128
December 31, 2012
Impaired loans		$	—			$	—			$	4,686			$	4,686			$	4,686
Foreclosed properties			—				—				19,411				19,411				19,411

 

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

A Caution About Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements, which can be identified by the use of words such as “believes,” “expects,” “anticipates,” “estimates” or similar expressions. Forward-looking statements include, but are not limited to:

 

•

statements of our goals, intentions and expectations;

 

•

statements regarding our business plans, prospects, growth and operating strategies;

 

•

statements regarding the quality of our loan and investment portfolios; and

 

•

estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

 

•

general economic conditions, either nationally or in our primary market area, that are worse than expected;

 

•

a continued decline in real estate values;

 

•

changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;

 

•

increased competitive pressures among financial services companies;

 

•

changes in consumer spending, borrowing and savings habits;

 

•

legislative, regulatory or supervisory changes that adversely affect our business;

 

•

adverse changes in the securities markets;

 

•

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board or the Public Company Accounting Oversight Board; and

 

•

the risks outlined in the “Risk Factors” section of our Annual Report on Form 10-K.

Any of the forward-looking statements that we make in this quarterly report and in other public statements we make may later prove incorrect because of inaccurate assumptions, the factors illustrated above or other factors that we cannot foresee. Consequently, no forward-looking statement can be guaranteed.

Except as required by applicable law or regulation, ASB Bancorp, Inc. does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Critical Accounting Policies

During the three-month period ended March 31, 2013, there were no significant changes in critical accounting policies or the application of critical accounting policies as disclosed in the our audited consolidated financial statements and related footnotes for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K.

 

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We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. The following represent our critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to earnings. Management’s estimates of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impaired loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance monthly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect our earnings. See notes 1 and 4 of the notes to the consolidated financial statements included in this quarterly report.

Fair Value of Investments. Securities are characterized as available for sale or held to maturity based on management’s ability and intent regarding such investment at acquisition. On an ongoing basis, management estimates the fair value of its investment securities based on information and assumptions it deems reliable and reasonable, which may be quoted market prices or if quoted market prices are not available, fair values extrapolated from the quoted prices of similar instruments. Based on this information, an assessment must be made as to whether any decline in the fair value of an investment security should be considered as an other than temporary impairment and recorded in noninterest income as a loss on investments. The determination of such impairment is subject to a variety of factors, including management’s judgment and experience. See notes 2 and 7 of the notes to the consolidated financial statements included in this quarterly report.

Deferred Tax Assets. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred tax asset will not be realized. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. A reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. See note 1 of the notes to the consolidated financial statements included in this quarterly report.

 

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Pension Plan. The Company has a noncontributory defined benefit pension plan. This plan is accounted for under the provisions of ASC Topic 715: Compensation-Retirement Benefits, which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. ASC Topic 715 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. Management must make certain estimates and assumptions when determining the projected benefit obligation. These estimates and assumptions include the expected return on plan assets, the rate of compensation increases over time, and the appropriate discount rate to be used in determining the present value of the obligation. The Bank amended its pension plan to curtail or eliminate benefits under the plans for services to be performed in future periods. The amendment resulted in a one-time credit for prior service costs recognized at the time of curtailment and a recurring reduction in periodic costs recognized for obligations under the pension plan. See notes 1 and 5 of the notes to the consolidated financial statements included in this quarterly report.

Valuation of Stock-Based Compensation. The Company accounts for its stock options and restricted stock in accordance with ASC Topic 718: Compensation – Stock Compensation. ASC Topic 718 requires companies to expense the fair value of stock-based compensation. Management uses the Black-Scholes option valuation model and the Intrinsic Value model to estimate the fair value of stock options and restricted stock, respectively. These models require the input of highly subjective assumptions, including expected stock price volatility and option life stipulated for restricted stock awards. These subjective input assumptions materially affect the fair value estimate.

Introduction

This Management’s Discussion and Analysis is provided to help readers understand how we evaluate our financial condition and results of operations. The following discussions are intended to provide a general overview of our financial condition at March 31, 2013 and our operating performance for the three-month period ended March 31, 2013. Readers seeking more in-depth information should read the more detailed discussions below as well as the consolidated financial statements and related notes included under Item 1 of this quarterly report.

All amounts presented are consolidated data unless otherwise specified. Uncertainty and future events could cause changes in accounting estimates that have material effects on the financial position and results of operations in future periods.

 

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Comparison of Financial Condition at March 31, 2013 and December 31, 2012

The following table provides the changes in our significant asset and liability categories at March 31, 2013 compared to December 31, 2012.

 

(dollars in thousands)		March 31, 2013				December 31, 2012				$ change				% change
Interest-earning assets
Interest-earning deposits with banks and overnight and short-term investments		$	42,921			$	37,029			$	5,892				15.9	%
Investment securities			261,880				243,385				18,495				7.6	%
Investments held at cost			3,131				3,429				(298	)			-8.7	%
Loans held for sale			11,603				9,759				1,844				18.9	%
Loans receivable, net of deferred fees			395,540				387,721				7,819				2.0	%
Total interest-earning assets			715,075				681,323				33,752				5.0	%
Non-interest-earning assets
Cash and due from banks			7,400				10,361				(2,961	)			-28.6	%
Allowance for loan losses			(8,553	)			(8,513	)			(40	)			-0.5	%
Premises and equipment, net of accumulated depreciation			13,184				13,306				(122	)			-0.9	%
Foreclosed real estate, net of reserves			18,128				19,411				(1,283	)			-6.6	%
Deferred income tax assets, net of deferred income tax liabilities			5,443				5,450				(7	)			-0.1	%
Securities sold but not settled			—				21,260				(21,260	)			-100.0	%
Other assets			6,845				6,756				89				1.3	%
Total non-interest-earning assets			42,447				68,031				(25,584	)			-37.6	%
Total assets		$	757,522			$	749,354			$	8,168				1.1	%
Interest-bearing liabilities
Interest-bearing deposits		$	521,206			$	513,004			$	8,202				1.6	%
Overnight and short-term borrowings			618				411				207				50.4	%
Federal Home Loan Bank advances			50,000				50,000				—				0.0	%
Total interest-bearing liabilities			571,824				563,415				8,409				1.5	%
Non-interest-bearing liabilities
Non-interest-bearing deposits			68,420				65,295				3,125				4.8	%
Accounts payable and other liabilities			9,845				9,115				730				8.0	%
Total non-interest-bearing liabilities			78,265				74,410				3,855				5.2	%
Total liabilities			650,089				637,825				12,264				1.9	%
Total equity			107,433				111,529				(4,096	)			-3.7	%
Total liabilities and equity		$	757,522			$	749,354			$	8,168				1.1	%
Cash and cash equivalents		$	50,321			$	47,390			$	2,931				6.2	%
Total core deposits (excludes certificate accounts)			398,338				389,095				9,243				2.4	%
Total certificates of deposit			191,288				189,204				2,084				1.1	%
Total deposits			589,626				578,299				11,327				2.0	%
Total funding liabilities			640,244				628,710				11,534				1.8	%

 

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Assets. Total assets increased $8.1 million, or 1.1%, to $757.5 million at March 31, 2013 from $749.4 million at December 31, 2012. Cash and cash equivalents increased $2.9 million, or 6.2%, to $50.3 million at March 31, 2013 from $47.4 million at December 31, 2012. Investment securities increased $18.5 million, or 7.6%, to $261.9 million at March 31, 2013 from $243.4 million at December 31, 2012, primarily due to the reinvestment of proceeds from the sale of investment securities in the fourth quarter of 2012 that settled in the first quarter of 2013. Loans receivable, net of deferred fees, increased $7.8 million, or 2.0%, to $395.5 million at March 31, 2013 from $387.7 million at December 31, 2012 as new loan originations exceeded loan repayments, prepayments, and foreclosures.

Loan originations totaled $75.2 million for the three months ended March 31, 2013 compared to $48.4 million for the three months ended March 31, 2012. Residential mortgage loan originations totaled $41.1 million and residential construction and land development loan originations totaled $3.1 million for the three months ended March 31, 2013 compared to $23.8 million and $3.9 million, respectively, for the comparable period of 2012. Originations of commercial mortgage loans totaled $20.7 million for the three months ended March 31, 2013 compared to $15.0 million for the same period in 2012. Originations of commercial construction and land development loans totaled $2.9 million and $1.1 million for the three-month period ended March 31, 2013 and March 31, 2012, respectively. Commercial and industrial loan originations totaled $2.2 million for the three months ended March 31, 2013 compared to $2.7 million for the three months ended March 31, 2012. Revolving mortgage and consumer loan originations totaled $5.1 million for the three months ended March 31, 2013 compared to $2.0 million for the same period in 2012. The increase in origination activity was offset by $32.0 million in routine loan payments, prepayments, and payoffs and $33.3 million in loan sales for the three months ended March 31, 2013 compared to $42.0 million in routine payments, prepayments, and payoffs and $19.8 million in loan sales for the three months ended March 31, 2012.

Nonperforming assets. Nonperforming assets totaled $19.7 million, or 2.60% of total assets, at March 31, 2013, compared to $20.6 million, or 2.74% of total assets, at December 31, 2012. Nonperforming assets included $1.5 million in nonperforming loans and $18.1 million in foreclosed real estate at March 31, 2013, compared to $1.2 million and $19.4 million, respectively, at December 31, 2012.

Nonperforming loans increased $397,000, or 34.5%, to $1.5 million at March 31, 2013 from $1.2 million at December 31, 2012. The increase in nonperforming loans to March 31, 2013 from December 31, 2012 was primarily attributable to the addition of one loan that stopped performing during the period. At March 31, 2013, nonperforming loans included one commercial mortgage in the amount of $389,000, three commercial and industrial loans that totaled $204,000, ten residential mortgage loans that totaled $830,000, and one home equity loan in the amount of $95,000. As of March 31, 2013, the nonperforming loans had specific reserves of $191,000.

Troubled debt restructurings at March 31, 2013 totaled $5.4 million compared to $5.2 million at December 31, 2012. There were three additions to troubled debt restructurings during the three months ended March 31, 2013. At March 31, 2013, $116,000 of the total $5.4 million of trouble debt restructurings were not performing.

 

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Foreclosed real estate at March 31, 2013 included 14 properties with a total carrying value of $18.1 million compared to 18 properties with a total carrying value of $19.4 million at December 31, 2012. During the three months ended March 31, 2013, there was one new property in the amount of $40,000 added to foreclosed real estate, while five properties totaling $1.3 million were sold, including one with a private mortgage insurance settlement pending. The Bank also added $59,000 in loss provisions.

Liabilities. Total deposits increased $11.3 million, or 2.0%, to $589.6 million at March 31, 2013 from $578.3 million at December 31, 2012. During the three months ended March 31, 2013, the Company continued its focus on core deposit growth, from which it excludes certificates of deposit. Core deposits increased $9.2 million, or 2.4%, to $398.3 million at March 31, 2013 from $389.1 million at December 31, 2012. Non-interest-bearing deposits increased $3.1 million, or 4.7%, to $68.4 million at March 31, 2013 from $65.3 million at December 31, 2012. Over the same period, certificates of deposit increased $2.1 million, or 1.1%, to $191.3 million at March 31, 2013 from $189.2 million at December 31, 2012.

Results of Operations for the Three Months Ended March 31, 2013 and 2012

Overview. Net income was $740,000, or $0.15 per share, for the three months ended March 31, 2013 compared to net income of $284,000, or $0.06 per share, for the three months ended March 31, 2012. Income before income taxes increased $671,000 primarily due to a $486,000 decrease in provision for loan losses, and a $246,000 decrease in total noninterest expenses, which were partially offset by a $70,000 decrease in total noninterest income. A $793,000 decrease in interest and dividend income was offset by a $802,000 decrease in interest expense.

 

		Three Months Ended March 31,
(dollars in thousands)		2013				2012				$ change				% change
Interest and dividend income		$	5,746			$	6,539			$	(793	)			-12.1	%
Interest expense			1,117				1,919				(802	)			-41.8	%
Net interest income			4,629				4,620				9				0.2	%
Provision for loan losses			112				598				(486	)			-81.3	%
Net interest income after provision for loan losses			4,517				4,022				495				12.3	%
Noninterest income			1,888				1,958				(70	)			-3.6	%
Noninterest expense			5,320				5,566				(246	)			-4.4	%
Income before income tax provision			1,085				414				671				162.1	%
Income tax provision			345				130				215				165.4	%
Net income			740				284				456				160.6	%

Net Interest Income. Net interest income was $4.6 million for each of the three-month periods ended March 31, 2013 and March 31, 2012. Total interest and dividend income decreased by $793,000, or 12.1%, to $5.7 million for the three months ended March 31, 2013 compared to $6.5 million for the three months ended March 31, 2012. The decrease in interest and dividend income was primarily a result of a 12 basis point decrease in yields on interest-earning assets, a $31.6 million decrease in average loan balances, and a $20.9 million decrease in the average balances of all other interest-earning assets, including investments. The decline in total interest and dividend income was offset by a $802,000, or 41.8%, decrease in interest expense to $1.1 million for the three months ended March 31, 2013 compared to $1.9 million for the three months ended March 31, 2012. The decrease in interest expense resulted from a 46 basis point reduction in the average rate paid on interest-bearing liabilities and a decline of $48.2 million in the average balances of interest-bearing liabilities, reflecting a fourth quarter 2012 $10.0 million prepayment of a FHLB advance, when comparing the three-month periods.

 

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Interest income on loans decreased $500,000, or 9.8%, to $4.6 million during the three months ended March 31, 2013, primarily due to a $31.6 million, or 7.3%, decrease in average outstanding loans to $399.6 million during the period. Loan originations increased $26.8 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. Residential mortgage loan sales increased $13.5 million, while loan principal repayments decreased $11.3 million to $30.7 million for the three months ended March 31, 2013 from $42.0 million for the three months ended March 31, 2012. The average balance of investment and mortgage-backed securities increased $4.1 million, or 1.6%, to $260.4 million for the three months ended March 31, 2013 compared to $256.3 million for the three months ended March 31, 2012. The increased average balances of investment securities and mortgage-backed securities were primarily due to the reinvestment into securities of proceeds from loan repayments and from sales of foreclosed properties.

The decrease in interest expense of $802,000 was primarily attributable to a decrease in interest expense on interest-bearing deposits, which declined to $632,000 for the three months ended March 31, 2013 from $1.3 million for the comparable three months of 2012 as the average rate paid on interest-bearing deposits declined 46 basis points to 0.50% from 0.96% and average balances of interest-bearing deposits decreased $38.1 million to $512.6 million from $550.7 million for the respective periods. Average borrowings decreased $10.2 million to $50.6 million from $60.8 million for the comparable periods.

Provision for Loan Losses. The provision for loan losses was $112,000 for the three months ended March 31, 2013 compared to $598,000 for the three months ended March 31, 2012. The decrease in the provision was primarily due to a decrease in charge-offs, which were $105,000 for the first three months of 2013 compared to $716,000 million for the first three months of 2012.

Noninterest Income. Noninterest income decreased $70,000 to $1.9 million for the three months ended March 31, 2013 from $2.0 million for the three months ended March 31, 2012. Factors that contributed to the decrease in noninterest income during the 2013 period were decreases of $509,000 in gains on sale of investment securities and $116,000 in service charge income, partially offset by increases of $261,000 in mortgage banking income and $242,000 in other noninterest income, primarily related to an increase of $114,000 in other income from a SBIC investment. The increase in mortgage banking income was attributable to higher volumes of mortgage loans sold. The decrease in deposit and other service charge income was primarily the result of lower deposit overdraft fees.

Noninterest Expense. Noninterest expense decreased $246,000, or 4.4%, to $5.3 million for the three months ended March 31, 2013 compared to $5.6 million for the three months ended March 31, 2012. The primary reasons for the decrease were decreases of $181,000 in salaries and benefits, and $58,000 in professional and outside services, which were partially offset by an increase of $53,000 in foreclosed property expenses. The decrease in salaries and benefits was primarily due to a $481,000 one-time credit to pension expense resulting from the curtailment of benefits for future service, that was partially offset by increases of $164,000 in expenses related to the Bank’s new equity incentive plan and $126,000 in compensation expenses. The increase in foreclosed property expenses related primarily to the increase in the loss provision compared to the prior year.

Income Tax Expense. Income tax expense increased by $215,000 for the three months ended March 31, 2013 compared to the three-month period ended March 31, 2012, primarily due to an increase in pre-tax income. The effective tax rate was 31.80% for the three months ended March 31, 2013 compared to 31.40% for the three months ended March 31, 2012, primarily due to the effect of lower tax-exempt income relative to pre-tax income.

 

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Average Balances and Yields

The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities for the periods presented. Average balances have been calculated using daily balances. Nonaccrual loans are included in average balances only. Loan fees are included in interest income on loans and are not material. The yields on tax exempt loans and municipal investment securities have been calculated on a tax equivalent basis using a federal marginal tax rate of 34%.

 

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		For the Three Months Ended March 31,
		2013												2012
(dollars in thousands)		Average Balance				Interest and Dividends				Yield/ Cost				Average Balance				Interest and Dividends				Yield/ Cost
Assets
Interest-earning deposits with banks		$	43,378			$	41				0.38	%		$	67,892			$	54				0.32	%
Loans receivable			399,645				4,600				4.67	%			431,202				5,100				4.76	%
Investment securities			67,780				371				2.87	%			62,722				323				2.31	%
Mortgage-backed and similar securities			192,657				714				1.50	%			193,644				1,045				2.17	%
Other interest-earning assets			3,406				20				2.38	%			3,873				17				1.77	%
Total interest-earning assets			706,866				5,746				3.36	%			759,333				6,539				3.48	%
Allowance for loan losses			(8,412	)											(10,337	)
Noninterest-earning assets			58,350												43,240
Total assets		$	756,804											$	792,236
Liabilities and equity
NOW accounts		$	141,003				93				0.27	%		$	131,332				164				0.50	%
Money market accounts			152,430				105				0.28	%			138,797				152				0.44	%
Savings accounts			30,551				7				0.09	%			25,357				17				0.27	%
Certificates of deposit			188,619				427				0.92	%			255,204				984				1.55	%
Total interest-bearing deposits			512,603				632				0.50	%			550,690				1,317				0.96	%
Overnight and short-term borrowings			629				1				0.64	%			779				1				0.52	%
Federal Home Loan Bank advances			50,000				484				3.93	%			60,000				601				4.03	%
Total interest-bearing liabilities			563,232				1,117				0.80	%			611,469				1,919				1.26	%
Noninterest-bearing deposits			66,199												53,596
Other noninterest-bearing liabilities			16,844												10,750
Total liabilities			646,275												675,815
Total equity			110,529												116,421
Total liabilities and equity		$	756,804											$	792,236
Net interest income						$	4,629											$	4,620
Interest rate spread											2.56	%											2.22	%
Net interest margin											2.72	%											2.47	%
Average interest-earning assets to average interest-bearing liabilities			125.50	%											124.18	%

 

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Rate/Volume Analysis . The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior period volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior period rate). The net column represents the sum of the volume and rate columns. Changes attributable to changes in both rate and volume have been allocated proportionally based on the absolute dollar amounts of change in each.

 

		Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012
		Increase (Decrease) Due to:
(dollars in thousands)		Volume				Rate				Net
Interest income:
Interest-earning deposits with banks		$	(22	)		$	9			$	(13	)
Loans receivable			(366	)			(134	)			(500	)
Investment securities			27				21				48
Mortgage-backed and similar securities			(5	)			(326	)			(331	)
Other interest-earning assets			(2	)			5				3
Total interest-earning assets			(368	)			(425	)			(793	)
Interest expense:
NOW accounts			11				(82	)			(71	)
Money market accounts			14				(61	)			(47	)
Savings accounts			3				(13	)			(10	)
Certificates of deposit			(216	)			(341	)			(557	)
Total interest-bearing deposits			(188	)			(497	)			(685	)
Overnight and short-term borrowings			—				—				—
Federal Home Loan Bank advances			(97	)			(20	)			(117	)
Total interest-bearing liabilities			(285	)			(517	)			(802	)
Net increase interest income		$	(83	)		$	92			$	9

 

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Risk Management

Overview . Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for on a mark-to-market basis. Other risks that we face are operational risk, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.

Credit Risk Management . Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. We do not offer Alt-A, sub-prime or no-documentation mortgage loans.

When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due, a late notice is sent to the borrower. When the loan becomes 30 days past due, a more formal letter is sent. Between 15 and 30 days past due, telephone calls are also made to the borrower. After 30 days, we regard the borrower in default. At 60 days delinquent, the borrower may be sent a letter from our attorney and we may commence collection proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. Generally, when a consumer loan becomes 60 days past due, we institute collection proceedings and attempt to repossess any personal property that secures the loan. Management informs the board of directors monthly of the amount of loans delinquent more than 30 days, all loans in foreclosure and repossessed property that we own.

Analysis of Non-performing Assets and Classified Assets . We consider repossessed assets and loans that are 90 days or more past due and certain loans that are less than 90 days past due, but that we do not believe we will not be able to collect the full amount of, to be non-performing assets. Loans are generally placed on nonaccrual status when they become 90 days delinquent, or sooner if the facts and circumstances indicate that we will not be able to collect the full amount of the loan, at which time the accrual of interest ceases and accrued interest is reversed and deducted from income. Typically, payments received on a nonaccrual loan are first applied to the outstanding principal balance to the extent that principal is due and then recognized as interest income.

Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. Property acquired through foreclosure is recorded at the lower of its cost or fair market value at the date of foreclosure, net of estimated disposal costs. Any holding costs and declines in fair value after acquisition of the property result in charges against income.

 

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The following table provides information with respect to our non-performing assets at the dates indicated.

 

(dollars in thousands)		March 31, 2013				December 31, 2012				$ change				% change
Nonperforming Loans:
Nonaccruing Loans (1)
Commercial:
Commercial construction and land development		$	—			$	40			$	(40	)			-100.0	%
Commercial mortgage			389				—				389				n/a
Commercial and industrial			204				114				90				78.9	%
Total commercial			593				154				439				285.1	%
Non-commercial:
Residential mortgage			830				808				22				2.7	%
Revolving mortgage			95				155				(60	)			-38.7	%
Consumer			30				34				(4	)			-11.8	%
Total non-commercial			955				997				(42	)			-4.2	%
Total nonaccruing loans (1)			1,548				1,151				397				34.5	%
Total loans past due 90 or more days and still accruing			—				—				—				0.0	%
Total nonperforming loans			1,548				1,151				397				34.5	%
Foreclosed real estate			18,128				19,411				(1,283	)			-6.6	%
Total nonperforming assets			19,676				20,562				(886	)			-4.3	%
Performing troubled debt restructurings (2)			5,254				5,065				189				3.7	%
Performing troubled debt restructurings and total nonperforming assets		$	24,930			$	25,627				(697	)			-2.7	%
Allowance for loan losses		$	8,553			$	8,513
Total loans		$	395,540			$	387,721
Allowance as a percentage of total loans			2.16	%			2.20	%
Allowance as a percentage of nonperforming loans			552.52	%			739.62	%
Total nonperforming loans to total loans			0.39	%			0.30	%
Total nonperforming loans to total assets			0.20	%			0.15	%
Total nonperforming assets to total assets			2.60	%			2.74	%
Performing troubled debt restructurings and total nonperforming assets to total assets			3.29	%			3.42	%

 

(1)	Nonaccruing loans include nonaccruing troubled debt restructurings.

(2)	Performing troubled debt restructurings exclude nonaccruing troubled debt restructurings.

 

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We periodically modify loans by extending loan terms or granting other concessions to help borrowers remain current and avoid foreclosure. These modified loans, also referred to as troubled debt restructurings, totaled $5.4 million at March 31, 2013, compared to $5.2 million at December 31, 2012. The increase during the three months ended March 31, 2013 was mainly the result of three loans totaling $236,000 being restructured during the period. At March 31, 2013, $116,000 of the total $5.4 million of troubled debt restructurings were not performing according to their restructured terms and were included in the nonperforming asset table above as nonaccruing loans.

Interest income that would have been recorded had nonaccruing loans been current according to their original terms amounted to $26,000 for the three-month period ended March 31, 2013, compared to $243,000 for the comparable period of 2012. Interest income of $73,000 related to nonperforming loans was recognized for the three-month period ended March 31, 2013, compared to $40,000 for the same period of 2012.

At March 31, 2013, our nonaccruing loans included the following:

 

•

Commercial Mortgage loans

 

•

One loan secured by a commercial building located in western North Carolina. As of March 31, 2013, the loan was considered impaired and nonaccruing with a remaining balance of $389,000. The Bank established a $62,000 specific reserve in the first quarter of 2013.

 

•

Residential Mortgage loans

 

•

Ten loans to multiple unrelated borrowers on one- to four-family residential properties with an aggregate balance of $830,000 as of March 31, 2013.

At March 31, 2013, our performing troubled debt restructurings included the following:

 

•

Commercial Mortgage Loans

 

•

One loan for the purchase of an existing mobile home park to be used for future development secured by nonowner-occupied commercial real estate located in coastal South Carolina. The loan was modified in the second quarter of 2012, which extended the terms of the loan and required scheduled principal payments. The future performance of the loan is dependent upon the guarantor group’s willingness and ability to service the debt. Such willingness and ability was demonstrated by the fact that, as of March 31, 2013, the loan was a performing troubled debt restructuring with a balance of $3.1 million that matures in May of 2014. As of March 31, 2013, the loan had a specific reserve of $608,000.

 

•

Residential Mortgage Loans

 

•

Nine loans to multiple unrelated borrowers on one- to four-family residential properties with an aggregate balance of $2.0 million as of March 31, 2013.

 

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Foreclosed properties consisted of the following at the dates indicated.

 

		March 31, 2013								December 31, 2012
(dollars in thousands)		Number				Amount				Number				Amount
By foreclosed loan type:
Commercial mortgage			1			$	986				2			$	1,709
Commercial construction and land development			11				16,623				10				16,642
Residential mortgage			2				519				5				944
Residential construction			—				—				1				116
Total			14			$	18,128				18			$	19,411

An analysis of foreclosed real estate follows:

 

(dollars in thousands)		Three Months Ended March 31, 2013
Beginning balance		$	19,411
Transfers from loans			40
Capitalized cost			5
Loss provisions			(59	)
Gain on sale of foreclosed properties			65
Net proceeds from sales of foreclosed properties			(1,334	)
Ending balance		$	18,128

 

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The Bank’s largest foreclosed property resulted from a loan relationship that had an original purpose of constructing a mixed-use retail, commercial office, and residential condominium project located in western North Carolina. As a result of this foreclosure, the Bank acquired (1) 44 of the 48 condominium units in the building including all eight of the retail units, three of which are leased, (2) eight of the eleven commercial office condominiums, three of which were sold by the developer prior to the foreclosure, and (3) 28 of the 29 residential units, one of which was sold by the developer prior to the foreclosure. Following an additional write-down of approximately $630,000 on the loans secured by this collateral in the fourth quarter of 2012, the Bank recorded this foreclosed property in the amount of $9.8 million.

Federal regulations require us to review and classify our assets on a regular basis. In addition, the FDIC and the NCCoB have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets; substandard, doubtful, and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full questionable on the basis of currently existing facts, conditions, and values, and there is a high possibility of loss. Assets classified “loss” are considered uncollectible and of such little value that continued recognition as an asset of the institution is not warranted. The regulations also provide for a “special mention” category, described as assets which do not currently expose an institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving close attention. When we classify an asset as substandard or doubtful we may establish a specific allowance for loan losses. If we classify an asset as loss, we charge off an amount equal to 100% of the portion of the asset classified loss.

The following table shows the aggregate amounts of our classified and special mention assets at the dates indicated.

 

(dollars in thousands)		March 31, 2013				December 31, 2012				$ change				% change
Adversely classified loans:
Substandard		$	4,633			$	3,969			$	664				16.7	%
Loss			—				4				(4	)			-100.0	%
Total adversely classified loans			4,633				3,973				660				16.6	%
Special mention loans			39,144				35,149				3,995				11.4	%
Total classified and special mention loans			43,777				39,122				4,655				11.9	%
Total classified and special mention assets		$	43,777			$	39,122			$	4,655				11.9	%

Other than as disclosed in the above tables and related discussions, there were no other loans where management had serious doubts about the ability of the borrowers to comply with the present loan repayment terms.

At March 31, 2013, substandard loans totaling $4.6 million included $1.5 million in nonaccruing loans that were previously discussed as nonperforming loans. The remaining $3.1 million in performing substandard loans included the following:

 

•

Commercial Mortgage loans

 

•

One loan on commercial retail property located in western North Carolina. As of March 31, 2013, the loan was performing with a total balance of $527,000.

 

•

Residential Mortgage loans

 

•

Twenty-five loans to multiple unrelated borrowers for one- to four-family residential properties with an aggregate balance of $2.1 million as of March 31, 2013.

 

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Classified assets include loans that are classified due to factors other than payment delinquencies, such as lack of current financial statements and other required documentation, insufficient cash flows or other deficiencies, and therefore, are not included as non-performing assets.

At March 31, 2013, special mention loans included the following large impaired loan:

 

•

Commercial Mortgage Loans

 

•

One loan for the purchase of an existing mobile home park to be used for future development secured by nonowner-occupied commercial real estate located in coastal South Carolina. The loan was modified in the second quarter of 2012, which extended the terms of the loan and required scheduled principal payments. The future performance of the loan is dependent upon the guarantor group’s willingness and ability to service the debt. Such willingness and ability was demonstrated by the fact that, as of March 31, 2013, the loan was a performing troubled debt restructuring with a balance of $3.1 million that matures in May of 2014. As of March 31, 2013, the loan had a specific reserve of $608,000.

Liquidity Management . Liquidity is the ability to meet current and future financial obligations of a short- term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the Federal Home Loan Bank of Atlanta. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly adjust our investments in liquid assets based upon our assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on securities and interest-earning deposits we place with other banks; and (iv) the objectives of our asset-liability management policy.

Our most liquid assets are cash and cash equivalents and interest-bearing deposits in other banks. The level of these assets depends on our operating, financing, lending and investing activities during any given period. At March 31, 2013, cash and cash equivalents totaled $50.3 million, including $42.9 million in interest-bearing deposits in other banks, of which $25.2 million was on deposit with the Federal Reserve Bank. Securities totaling $257.3 million classified as available-for-sale provide an additional source of liquidity. In addition, at March 31, 2013, we had the ability to borrow a total of approximately $57.5 million from the Federal Home Loan Bank of Atlanta and approximately $11.1 million from the Federal Reserve Bank’s discount window. At March 31, 2013, we had $50.0 million in Federal Home Loan Bank advances outstanding and $2.0 million in letters of credit to secure public funds deposits.

A significant use of our liquidity is the funding of loan originations. At March 31, 2013, we had $132.0 million in commitments to extend credit outstanding, although we expect that significantly less will ultimately be funded. Certificates of deposit due within one year of March 31, 2013 totaled $101.1 million, or 52.9% of certificates of deposit. We believe the large percentage of certificates of deposit that mature within one year reflects customer hesitancy to invest funds for longer periods due to the continued low interest rate environment and local competitive pressure. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the maturing certificates of deposit. Based on past experience, we believe that a significant portion of our certificates of deposit will remain with us. We believe we have the ability to attract and retain deposits by adjusting the interest rates we offer.

In addition, we believe that our branch network, which is presently comprised of thirteen full-service branch offices located throughout our primary market area, and the general cash flows from our existing lending and investment activities will afford us sufficient long-term liquidity.

 

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The following tables present our contractual obligations as of the dates indicated.

 

						Payments due by period
(dollars in thousands)		Total				Less than One Year				One to Three Years				Three to Five Years				More than Five Years
At March 31, 2013
Long-term debt obligations		$	50,000			$	—			$	—			$	40,000			$	10,000
Operating lease obligations			2,069				362				724				448				535
Total		$	52,069			$	362			$	724			$	40,448			$	10,535
At December 31, 2012
Long-term debt obligations		$	50,000			$	—			$	—			$	40,000			$	10,000
Operating lease obligations			2,159				362				724				523				550
Total		$	52,159			$	362			$	724			$	40,523			$	10,550

Capital Management . We are subject to various regulatory capital requirements administered by the FDIC and the NCCoB, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At March 31, 2013, we exceeded all of our regulatory capital requirements and were considered “well capitalized” under regulatory guidelines.

We strive to manage our capital for maximum shareholder benefit. The capital from our stock offering significantly increased our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes, including the funding of lending activities. Our financial condition and results of operations will be enhanced by the capital from the offering, resulting over time in increased net interest-earning assets and net income. However, the large increase in equity resulting from the capital raised in the offering will, initially, have an adverse impact on our return on equity. To help us better manage our capital, we may consider the use of such tools as continued common share repurchases and the declaration of cash dividends as regulations permit.

 

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The Company and the Bank had the following actual and required regulatory capital amounts as of the periods indicated:

 

										Regulatory Requirements
										Minimum for Capital								Minimum to Be
		Actual								Adequacy Purposes								Well Capitalized
(dollars in thousands)		Amount				Ratio				Amount				Ratio				Amount				Ratio
ASB Bancorp, Inc.
March 31, 2013
Tier I leverage capital		$	109,132				14.36	%		$	30,395				4.00	%		$	37,993				5.00	%
Tier I risk-based capital			109,132				27.42	%			15,918				4.00	%			23,878				6.00	%
Total risk-based capital			114,161				28.69	%			31,837				8.00	%			39,796				10.00	%
December 31, 2012
Tier I leverage capital			112,508				14.69	%			30,632				4.00	%			38,290				5.00	%
Tier I risk-based capital			112,508				27.72	%			16,237				4.00	%			24,356				6.00	%
Tier I risk-based capital			117,638				28.98	%			32,475				8.00	%			40,594				10.00	%
Asheville Savings Bank, S.S.B.
March 31, 2013
Tier I leverage capital		$	91,490				12.27	%		$	29,818				4.00	%		$	37,272				5.00	%
Tier I risk-based capital			91,490				23.08	%			15,858				4.00	%			23,787				6.00	%
Total risk-based capital			96,500				24.34	%			31,716				8.00	%			39,645				10.00	%
NC Savings Bank capital			100,053				13.44	%			37,229				5.00	%			n/a				n/a
December 31, 2012
Tier I leverage capital			90,388				12.06	%			29,983				4.00	%			37,479				5.00	%
Tier I risk-based capital			90,388				22.35	%			16,174				4.00	%			24,262				6.00	%
Total risk-based capital			95,498				23.62	%			32,349				8.00	%			40,436				10.00	%
NC Savings Bank capital			98,914				13.48	%			36,680				5.00	%			n/a				n/a

Off-Balance Sheet Arrangements . In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit and letters of credit.

For the three months ended March 31, 2013 and the year ended December 31, 2012, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk Management . We manage the interest rate sensitivity of our interest-bearing liabilities and interest- earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Our strategy for managing interest rate risk emphasizes: adjusting the maturities of borrowings; adjusting the investment portfolio mix and duration and generally selling in the secondary market substantially all newly originated fixed rate one- to-four-family residential real estate loans. We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of derivative financial instruments.

We have an Asset/Liability Management Committee (“ALCO”) which includes our Board Chair, who is an independent director, and members of management to communicate, coordinate and control all aspects involving asset-liability management. ALCO meets quarterly to establish and monitor the volume, maturities, pricing and mix of assets and funding liabilities with the objective of managing assets and funding liabilities to provide results that are consistent with liquidity, growth, risk limits and profitability goals.

Our goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest and net income.

Interest Rate Risk Analysis . Our profitability depends to a large extent on our net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings. Like most financial institutions, our interest income and interest expense are significantly affected by changes in market interest rates and other economic factors beyond our control. Our interest-earning assets consist primarily of long-term, fixed-rate mortgage loans, adjustable rate mortgage loans and investments that typically adjust more slowly to changes in interest rates than our interest-bearing liabilities, which are primarily term deposits. Accordingly, our earnings are usually adversely affected during periods of rising interest rates and positively impacted during periods of declining interest rates. The recent periods of sustained historically low interest rates have also reduced our net interest margins as we could not lower our cost of interest-bearing liabilities commensurate with the reductions in the yields on our interest-earning assets.

We implement an interest rate risk simulation model to determine our possible adverse exposure to net interest income and economic value of equity due to changes in interest rates, repricing risk, yield curve risk and basis risk. Our internal simulation model evaluates our projected future net interest income and economic value of equity under various interest rate scenarios and applies certain contractual and behavioral assumptions to calculate results in an increasing rate scenario, in a decreasing rate scenario and in a constant rate scenario. The major assumptions applied to our internal simulation model include, but are not limited to, the present value discounting method, calculated and reported rate shock and rate ramp scenarios, key rates, curves and spreads, internal rate restrictions (such as rate floors and caps and teaser rates), prepay and decay tables and interest rate exposure limits.

Based on the results of internal simulation model, which management believes accurately reflects the extraordinary stress currently existing in the financial markets with respect to potential margin compression resulting from our difficulty in reducing our costs of funds further in the current competitive pricing environment, our earnings may be adversely affected if interest rates were to further decline. Such a decline could result from, among other things, the Federal Reserve Board’s purchase of government securities and/or mortgage-backed securities in an effort to further stimulate the national economy. Although the current rate environment remains stable, we continue to carefully monitor, through our Asset/Liability Committee management process, the competitive landscape related to interest rates as well as various economic indicators in order to best position ourselves with respect to changing interest rates.

 

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The following table reflects the estimated effects of changes in interest rates on the present value of our equity and on our projected net interest income over the next twelve months.

 

														Over the Next Twelve Months
		As of March 31, 2013												Ending March 31, 2014
		Present Value of Equity												Projected Net Interest Income
		Market												Net Interest
(dollars in thousands)		Value				$ change				% change				Income				$ change				% change
Change in Rates (in basis points “bp”):
300 bp		$	98,641			$	(21,903	)			-18.17	%		$	18,883			$	284				1.53	%
200			104,715				(15,829	)			-13.13	%			18,407				(192	)			-1.03	%
100			112,551				(7,993	)			-6.63	%			18,432				(167	)			-0.90	%
0			120,544				—				0.00	%			18,599				—				0.00	%
(100)			122,701				2,157				1.79	%			16,849				(1,750	)			-9.41	%

 

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Item 4. Controls and Procedures

The Company’s management has carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act (1) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

Management of the Company has evaluated, with the participation of the Company’s principal executive officer and principal financial officer, changes in the Company’s internal control over financial reporting as defined in Rule 13a-15(e) of the Exchange Act during the quarter ended March 31, 2013. In connection with the above evaluation of the effectiveness of the Company’s disclosure controls and procedures, no changes in its internal control over financial reporting were identified as having occurred during the quarter ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

Item 1A. Risk Factors

For information regarding ASB Bancorp’s risk factors, see “Risk Factors” in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2013. As of March 31, 2013, the risk factors of ASB Bancorp have not changed materially from those disclosed in the Company’s Annual Report on Form 10-K.

 

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

The Company’s purchases of its common stock made during the quarter consisted of stock repurchases under the Company’s approved plan and are set forth in the following table.

 

Total

Maximum

Number

Number of

of Shares

Shares That

Purchased

May Yet be

Total

as Part of

Purchased

Number

Average

Publicly

Under the

of Shares

Price Paid

Announced

Plan or

Purchased

Per Share

Programs

Programs

Period

(a)

(b)

(c)

(d)

January 1 – January 31, 2013

—

—

—

279,228

February 1 – February 28, 2013

220,700

$

16.49

220,700

58,528

March 1 – March 31, 2013

58,528

16.63

58,528

—

Total

279,228

$

16.52

279,228

On October 5, 2012, the Company announced the commencement of a 5% stock repurchase program. Under the plan, the Company could repurchase up to 279,228 shares, or 5% of its common stock outstanding, through open market or privately negotiated transactions. The stock repurchase program was completed during the first quarter of 2013 for a total of 279,228 shares purchased at an average price of $16.52 per share.

The following table sets forth information as of March 31, 2013 regarding shares of our common stock that may be issued upon exercise of options previously granted and currently outstanding under our stock option plans, as well as the number of shares available for the grant of options that had not been granted as of that date.

 

Number of Securities

remaining available for

future issuance under

Number of securities to

Weighted-average

equity compensation

be issued upon exercise

exercise price

plans (excluding

of outstanding options

of outstanding options

securities reflected in

warrants and rights

warrants and rights

column (a)

Plan category

(a)

(b)

(c)

Equity compensation plans approved by security holders

459,000

$

15.71

99,455

Equity compensation plans not approved by security holders

—

N/A

—

Total

459,000

$

15.71

99,455

 

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Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

 

3.1		Articles of Incorporation of ASB Bancorp, Inc. (1)
3.2		Bylaws of ASB Bancorp, Inc. (1)
4.1		Form of Common Stock Certificate of ASB Bancorp, Inc. (1)
10.1		Employment Agreement, dated as of October 18, 2011, by and between ASB Bancorp, Inc., Asheville Savings Bank, S.S.B. and Suzanne S. DeFerie * (2)
10.2		Employment Agreement, dated as of October 18, 2011, by and between ASB Bancorp, Inc., Asheville Savings Bank, S.S.B. and Kirby A. Tyndall * (2)
10.3		Employment Agreement, dated as of October 18, 2011, by and between ASB Bancorp, Inc., Asheville Savings Bank, S.S.B. and David A. Kozak * (2)
10.4		Employment Agreement, dated as of October 18, 2011, by and between ASB Bancorp, Inc., Asheville Savings Bank, S.S.B. and Fred A. Martin * (2)
10.5		Employment Agreement, dated as of December 18, 2012, by and between Asheville Savings Bank, S.S.B. and Vikki D. Bailey * (3)
10.6		Asheville Savings Bank, S.S.B. Change In Control Severance Plan * (4)
10.7		ASB Bancorp, Inc. Stock-Based Deferral Plan * (4)
10.8		ASB Bancorp, Inc. 2012 Equity Incentive Plan * (5)
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Chief Financial Officer
32.0		Section 1350 Certifications
101.0**		The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income; (iv) the Consolidated Statement of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements. **

 

*	Management contract or compensatory plan, contract or arrangement.

**	Furnished, not filed.

(1)	Incorporated herein by reference to the exhibits to ASB Bancorp, Inc.’s Registration Statement on Form S-1 (File No. 333-174527), filed with the Securities and Exchange Commission on May 26, 2011.

(2)	Incorporated herein by reference to the exhibits to ASB Bancorp, Inc.’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 21, 2011.

(3)	Incorporated herein by reference to the exhibits to ASB Bancorp, Inc.’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 21, 2012.

(4)	Incorporated herein by reference to the exhibits to ASB Bancorp, Inc.’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 10, 2011.

(5)	Incorporated herein by reference to Appendix A to ASB Bancorp, Inc.’s definitive proxy statement on Form DEF14A filed with the Securities and Exchange Commission on April 12, 2012.

 

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SIGNATURES

Pursuant to 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.

 

						ASB BANCORP, INC.
						Registrant
May 9, 2013				By:		/s/ SUZANNE S. DEFERIE
						Suzanne S. DeFerie
						President and Chief Executive Officer
						(Principal Executive Officer)
May 9, 2013				By:		/s/ KIRBY A. TYNDALL
						Kirby A. Tyndall
						Executive Vice President and Chief Financial Officer
						(Principal Financial and Accounting Officer)

 

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