Item 1. Description of Business
This report contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Potential risks and uncertainties include, but are not limited to, those described below under “Risk Factors” as well as the following:
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our short operating history;
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significant increases in competitive pressure in the banking and financial services industries;
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changes in the interest rate environment which could reduce anticipated or actual margins;
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our ability to control costs, expenses and loan delinquency rates;
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changes in political conditions or the legislative or regulatory environment;
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general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;
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changes occurring in business conditions and inflation;
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changes in technology;
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changes in deposit flows;
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the lack of seasoning of our loan portfolio;
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changes in monetary and tax policies;
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the level of allowance for loan loss;
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the rate of delinquencies and amounts of charge-offs;
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the rates of loan growth;
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adverse changes in asset quality and resulting credit risk-related losses and expenses;
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loss of consumer confidence and economic disruptions resulting from terrorist activities;
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changes in the securities markets; and
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other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.
The above risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will have on our company. During 2008, the capital and credit markets experienced extended volatility and disruption, and the volatility and disruption have reached unprecedented levels. There can be no assurance that these unprecedented recent developments will not materially and adversely affect our business, financial condition and results of operations.
We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
General
BankGreenville Financial Corporation was incorporated in South Carolina on March 18, 2005 for purposes of operating as a bank holding company pursuant to the South Carolina Bank Holding Company Act, and to own and control all of the capital stock of BankGreenville, a state-chartered bank. BankGreenville commenced business on January 30, 2006, and is primarily engaged in the business of accepting savings, demand, and time deposits and providing mortgage, consumer and commercial loans to the general public. From our inception in March 2005 and before opening the bank, we engaged in organizational and pre-opening activities necessary to obtain regulatory approvals and to prepare our subsidiary bank to commence business.
Marketing Focus and Service Area
Our service area is Greenville County, with a primary focus on Greater Greenville, including the City of Greenville and the surrounding bedroom communities of Mauldin, Simpsonville, Greer and Taylors. Our office is centrally located near the intersection of Woodruff Road and Laurens Road within the Greenville city limits and is
situated on the edge of the 1,100-acre Verdae master planned development. Woodruff Road is a well traveled thoroughfare with reasonable traffic counts and excellent accessibility and this ongoing development effort is expected to enhance the quality of this already excellent location. We moved into our permanent headquarters building in April 2007. We do not currently have plans to establish branch offices in 2009. We plan to take advantage of existing contacts and relationships with individuals and companies in this area to more effectively market the services of the bank.
We focus on providing high quality, consultative service to small-to-medium-sized businesses and the professional segment of the growing Greenville area market and offer a full complement of business and consumer services while placing particular emphasis on that portion of the market that values small business expertise and relationship-oriented service.
The Greenville banking market has seen a significant amount of consolidation as larger out-of-market institutions have acquired local community banks. While larger banks may target the small-and-medium-sized business market, we believe that through more personalized client service and local decision making, we can effectively source loan and deposit business from these clients, even without a large operational infrastructure. We target businesses with less than $15 million in annual revenues as well as their related owners and employees. Through our relationships and contacts in and around Greenville, we believe that we can attract business and consumer banking clients who desire consistent and personal banking relationships.
Location
Our permanent headquarters is located at the corner of Woodruff Road and Rocky Slope Road near Laurens Road and the 1,100-acre Verdae master planned development. Our headquarters building, approximating 10,700 square feet, was completed and we moved into this building in April 2007. We opened on January 30, 2006 in a temporary full-service banking facility, while our permanent headquarters building was under construction.
Lending Activities
General. We emphasize a range of lending services, including real estate, commercial, home equity lines and consumer loans to individuals, small-to-medium-sized businesses, and professional concerns that are located in or conduct a substantial portion of their business in the bank’s market area.
Lending Limits. The bank’s lending activities are subject to a variety of lending limits imposed by state law. In general, the bank is subject to a legal limit on loans to a single borrower equal to 15% of the bank’s capital and unimpaired surplus. Different limits may apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the bank. These limits will increase or decrease as the bank’s capital increases or decreases. For larger dollar loans, we can sell participations to other financial institutions, which allow us to manage the risk associated with these loans and meet the lending needs of credit-worthy clients.
Loan Approval and Review. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds that individual officer’s lending authority, the loan request is considered and approved by an officer with a higher lending limit or the board of directors’ loan committee. Any loan, the lesser of $500,000 or five percent of capital, to any director of the bank is approved by the board of directors of the bank and all loans to directors are made on terms not more favorable to the person than would be available to a person not affiliated with the bank. The bank currently does not originate long-term conventional first mortgage residential real estate loans, but acts as a broker as described below.
Credit Risk. The principal credit risk associated with each category of loans is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the manufacturing, services, and retail market segments. General economic factors affecting a borrower’s ability to repay include interest, inflation, employment rates, and the strength of local and national economy, as well as other factors affecting a borrower’s clients, suppliers, and employees.
Allowance for Loan Losses. We maintain an allowance for loan losses, which we have established through a provision for loan losses charged against income. We charge loans against this allowance when we believe that
collection of the principal is unlikely. The allowance is an estimated amount that we believe will be adequate to absorb losses inherent in the loan portfolio based on evaluations of its collectibility. Our allowance for loan losses at December 31, 2008 was approximately 1.22% of the outstanding balance of our loans, based on our consideration of several factors, including historical portfolio performance, regulatory guidelines, mix of our loan portfolio, and evaluations of local economic conditions as well as peer data. We periodically determine the amount of the allowance based on our consideration of several factors, including:
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an ongoing review of the quality, mix, and size of our overall loan portfolio;
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our historical loan loss experience;
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evaluation of economic conditions;
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specific problem loans and commitments that may affect the borrower’s ability to pay;
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regular reviews of loan delinquencies and loan portfolio quality by our internal auditors and our bank regulators;
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the amount and quality of collateral, including guarantees, securing the loans.
Real Estate Loans. Loans secured by first or second mortgages on real estate make up approximately 82% of the bank’s loan portfolio. These loans generally include commercial real estate loans, construction and development loans, and residential real estate loans secured by first or second mortgages on real estate. Each of these categories is discussed in more detail below, including their specific risks. Interest rates for all categories may be fixed or adjustable, and are more likely to be fixed for shorter-term loans. The bank generally charges an origination fee on these loans.
Real estate loans are subject to the same general risks as other loans. Real estate loans are also sensitive to fluctuations in the value of the real estate securing the loan. On first and second mortgage loans we do not advance more than regulatory limits. We require a valid mortgage lien on all real property loans along with a title policy or attorneys’ opinion which insures the validity and priority of the lien. We also require borrowers to obtain hazard insurance policies and flood insurance if applicable. Additionally, certain types of real estate loans have specific risk characteristics that vary according to the collateral type securing the loan and the terms and repayment sources for the loan.
We have the ability to originate real estate loans for sale to the secondary market, although at this time we do not originate loans for sale. We can limit our interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan.
• Commercial Real Estate Loans. Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. Inherent in commercial real estate loan credit risk is the risk that the primary source of repayment, the operating company’s cash flow or the cash flow from the real estate, will be insufficient to service the debt. If a real estate loan is in default, we also run the risk that the value of a commercial real estate loan’s secured real estate will decrease, and thereby be insufficient to satisfy the loan. To mitigate these risks, we evaluate each borrower on an individual basis and attempt to determine its business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio is established by independent appraisals. We typically review the personal financial statements of the principal owners and require their personal guarantees. These reviews often reveal secondary sources of payment and liquidity to support a loan request. Risks associated with commercial real estate loans include fluctuations in the value of the real estate, new job creation trends, tenant vacancy rates, and the quality of the borrower’s management. We seek to limit risk by analyzing borrowers’ cash flow and collateral value on an ongoing basis.
• Construction and Development Real Estate Loans. We offer adjustable and fixed rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own home. The term of construction and development loans is generally limited to 18 months, although payments may be structured on a longer amortization basis. Most loans mature and require payment in full upon the sale or completion of the property. Loan proceeds are typically disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or independent appraiser. Construction and development loans generally carry a higher degree of risk than
long term financing of existing properties. Repayment usually depends on the ultimate completion of the project within cost estimates and on the sale of the property. Risks associated with construction loans include fluctuations in the value of real estate, mismanaged construction, rising interest rates which may prevent sale of the property, and failure to sell completed projects in a timely manner.
We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We may also reduce risk by selling participations in larger loans to other institutions when possible.
• Residential Real Estate Loans. These loans generally have longer terms, up to 30 years. We offer fixed and adjustable rate mortgages, and we act as brokers and receive a brokerage fee, for most or all of the long-term first mortgage residential real estate loans that we generate in the secondary market. We do not intend to retain servicing rights for these loans. Inherent in residential real estate loans’ credit risk is the risk that the primary source of repayment, the residential borrower’s cash flow, will be insufficient to service the debt. If a real estate loan is in default, we also run the risk that the value of a residential real estate loan’s secured real estate will decrease, and thereby be insufficient to satisfy the loan. To mitigate these risks, we evaluate each borrower on an individual basis and attempt to determine its credit profile. By acting as a broker, we can significantly reduce our exposure to credit risk because the loans will be underwritten through a third party agent without any recourse against the bank.
Commercial Loans. The bank makes loans for commercial purposes in various lines of businesses. We generally focus our efforts on commercial loans of $1,000,000 or less. The terms of these loans vary by purpose and by type of underlying collateral.
• Equipment Loans. We typically make equipment loans for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. We expect that with appropriate loan-to-value ratios there will be sufficient collateral to compensate for fluctuations in the market value of the collateral and will minimize losses that result from poor maintenance or the introduction of updated equipment models into the market.
• Working Capital Loans. Loans to support working capital typically have terms not exceeding one year and are usually secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. The quality of the commercial borrower’s management and its ability to both properly evaluate changes in the supply and demand characteristics affecting its markets for products and services and to effectively respond to such charges are significant factors in a commercial borrower’s creditworthiness. General risks affecting a commercial borrower’s ability to repay include demand for the borrower’s products and services and changes in the local economy or industry in which the borrower operates.
We also offer small business loans utilizing government enhancements such as the Small Business Administration’s 7(a) and SBA’s 504 programs. These loans are typically partially guaranteed by the government which may help to reduce the bank’s risk. Government guarantees of SBA loans will not exceed 80% of the loan value, and will generally be less.
Consumer Loans. The bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit such as credit cards. Installment loans typically carry balances of less than $50,000 and are amortized over periods up to 60 or more months. Consumer loans may be offered on a single maturity basis where a specific source of repayment is available. Revolving loan products typically require monthly payments of interest and a portion of the principal.
We also offer home equity lines of credit. Our underwriting criteria for and the risks associated with home equity lines of credit are generally the same as those for first mortgage loans. Home equity lines of credit typically have terms of 15 years or less, carry balances less than $125,000, and may extend up to 90% of the available equity of each property.
Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because the value of the secured property may depreciate rapidly, they are often dependent on the borrower’s employment status as the sole source of repayment, and some of them are unsecured. To mitigate these risks, we analyze selective underwriting criteria for each prospective borrower, which may include the borrower’s employment history, income history, credit bureau reports, or debt to income ratios. If the consumer loan is secured by property, such as an automobile loan, we attempt to offset the risk of rapid depreciation of the collateral with a shorter loan amortization period. Despite these efforts to mitigate our risks, consumer loans have a higher rate of default than real estate loans. For this reason, we attempt to reduce our loss exposure to these types of loans by limiting their sizes relative to other types of loans.
Relative Risks of Loans. Each category of loan has a different level of credit risk. Real estate loans are generally safer than loans secured by other assets because the value of the underlying security, real estate, is generally ascertainable and does not fluctuate as much as some other assets. Certain real estate loans are less risky than others. Residential real estate loans are generally the least risky type of real estate loan, followed by commercial real estate loans and construction and development loans. Commercial loans, which can be secured by real estate or other assets, or which can be unsecured, are generally more risky than real estate loans, but less risky than consumer loans. Finally, consumer loans, which can also be secured by real estate or other assets, or which can also be unsecured, are generally considered to be the most risky of these categories of loans. Any type of loan which is unsecured is generally more risky than secured loans. These levels of risk are general in nature, and many factors including the creditworthiness of the borrower or the particular nature of the secured asset may cause any type of loan to be more or less risky than another. Additionally, these levels of risk are limited to an analysis of credit risk, and they do not take into account other risk factors associated with making loans such as the interest rate risk inherent in long-term, fixed-rate loans.
Deposit Services
We offer a full range of deposit services that are typically available in most banks and savings and loan associations. These services include checking accounts, commercial accounts, savings accounts, and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to our principal market area at rates competitive to those offered in the Greenville area. In addition, we offer IRAs. We solicit these accounts from individuals, businesses, and other organizations. We obtain these deposits through personal solicitation by our officers and directors, direct mail solicitations, and advertisements published in the local media. We solicit brokered certificates of deposit when we are able to procure these deposits at interest rates less than or comparable to interest rates on similar deposits in our local market.
Other Banking Services
We offer cashier’s checks, banking by mail, direct deposit of payroll and social security checks, United States Savings Bonds, and travelers checks. The bank is associated with the STAR and Cirrus ATM networks, which allow the bank’s clients to use other bank and third-party ATMs throughout the country as well as internationally. We also waive our clients’ foreign ATM charges for a certain number of monthly ATM transactions at third-party ATMs. We offer debit card and credit card services through a correspondent bank as an agent for the bank. Additionally, we offer lines of credit, 24-hour telephone banking, personal and corporate on-line banking and corporate cash management services.
Competition and Market Share
The Greenville market is highly competitive, with all of the largest banks in the state, as well as super regional banks, represented. The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans as well as legal lending limits to any one borrower, credit and service charges, the quality of services rendered, and the convenience of banking facilities. In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies. Size gives larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services on a statewide basis. We generally do not attempt to compete for the
banking relationships of large corporations, but concentrate our efforts on small-to-medium-sized businesses and individuals. We believe we compete effectively in this market by offering relationship banking and high quality service.
According to FDIC data at June 2008, the deposit base in Greenville County amounted to approximately $10.1 billion and the bank’s deposits represented approximately .55% of this deposit base.
Employees
As of March 10, 2009, we had 13 full-time employees and no part-time employees.
SUPERVISION AND REGULATION
Both BankGreenville Financial Corporation and BankGreenville are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.
The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations. It is intended only to briefly summarize some material provisions.
Recent Regulatory Developments
The following is a summary of recently enacted laws and regulations that could materially impact our business, financial condition or results of operations. This discussion should be read in conjunction with the remainder of the “Supervision and Regulation” section of this Form 10-K.
In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently been announced including:
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On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”). Under the CPP, Treasury will purchase debt or equity securities from participating institutions. The TARP also will include direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications;
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On October 7, 2008, the FDIC approved a plan to increase the rates banks pay for deposit insurance;
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On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (“TLGP”), which seeks to strengthen confidence and encourage liquidity in the banking system. The TLGP has two primary components that are available on a voluntary basis to financial institutions:
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Guarantee of newly-issued senior unsecured debt; the guarantee would apply to new debt issued on or before June 30, 2009 and would provide protection until June 30, 2012; issuers electing to participate would pay a 75 basis point fee for the guarantee;
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Unlimited deposit insurance for non-interest bearing deposit transaction accounts; financial institutions electing to participate will pay a 10 basis point premium in addition to the insurance premiums paid for standard deposit insurance.
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On February 17, 2009, the American Recovery and Reinvestment Act (the “Recovery Act”) was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy. The Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs. The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws. In addition, the Recovery Act imposes certain limitations on compensation paid by participants in the Treasury’s Troubled Asset Relief Program (“TARP”), which includes programs under TARP such as the Capital Purchase Program in which we participate.
On February 13, 2009, as part of the CPP, we entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the Treasury Department, pursuant to which we sold (i) 1,000 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and (ii) a ten-year warrant to purchase 50 shares of the our Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”), having a liquidation preference of $1,000 per share, at an initial exercise price of $0.01 (the “Warrant”), for an aggregate purchase price of $1,000,000 in cash. The Warrant was immediately exercised.
The Series A Preferred Stock will qualify as Tier 1 capital and will be entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series B Preferred Stock will also qualify as Tier 1 capital and will be entitled to cumulative dividends at a rate of 9% per annum. We must consult with the FDIC before we may redeem the Series A and Series B Preferred Stock but, contrary to the original restrictions in the EESA, will not necessarily be required to raise additional equity capital in order to redeem this stock. Please refer to the “Capital Resources” section of “Management’s Discussion and Analysis or Plan of Operation” as well as the “Notes to Consolidated Financial Statements” for additional details of the Series A Preferred Stock and the Warrant.
Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, management is not aware of any further recommendations by regulatory authorities that, if implemented, would have or would be reasonably likely to have a material effect on liquidity, capital ratios or results of operations.
BankGreenville Financial Corporation.
We own 100% of the outstanding capital stock of the bank, and therefore we are considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the “Federal Reserve”) under the Bank Holding Company Act and its regulations promulgated thereunder. As a bank holding company located in South Carolina, the South Carolina Board of Financial Institutions also regulates and monitors all significant aspects of our operations.
Permitted Activities. Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:
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banking or managing or controlling banks; and
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furnishing services to or performing services for our subsidiaries; and
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any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.
Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:
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factoring accounts receivable;
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making, acquiring, brokering or servicing loans and usual related activities;
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leasing personal or real property;
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operating a non-bank depository institution, such as a savings association;
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trust company functions;
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financial and investment advisory activities;
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conducting discount securities brokerage activities;
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underwriting and dealing in government obligations and money market instruments;
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providing specified management consulting and counseling activities;
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performing selected data processing services and support services;
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acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
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performing selected insurance underwriting activities.
As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities. We have not sought financial holding company status, but may elect such status in the future as our business matures. If we were to elect in writing for financial holding company status, each insured depository institution we control would have to be well capitalized, well managed and have at least a satisfactory rating under the CRA (discussed below).
The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.
Change in Control. In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated there under, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Moreover, the South Carolina Board of Financial Institutions also must approve an acquisition of a South Carolina bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either:
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the company has registered securities under Section 12 of the Securities Exchange Act of 1934; or
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no other person owns a greater percentage of that class of voting securities immediately after the transaction.
Our common stock is not registered under Section 12 of the Securities Exchange Act of 1934. If we have more than 500 shareholders of record on December 31 of any year, we will be required to register our common stock under Section 12 of the Securities Exchange Act during the first 120 days of the following year. Any shareholder of 10% or more but less than 25% of any class of our voting securities would be required to either file as a controlling shareholder of the company or rebut the presumption of control in accordance with Federal Reserve regulations. The regulations provide a procedure for rebutting control when ownership of any class of voting securities is below 25%.
Source of Strength. In accordance with Federal Reserve Board policy, we are expected to act as a source of financial strength to the bank and to commit resources to support the bank in circumstances in which we might not otherwise do so. If the bank were to become “under-capitalized (see below “BankGreenville-Prompt Corrective Action”), we would be required to provide a guarantee of the bank’s plan to return to capital adequacy. Additionally, under the Bank Holding Company Act, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition. Further, any loans by bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.
Capital Requirements. The Federal Reserve Board imposes certain capital requirements on the bank holding company under the bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the bank and are described below under “BankGreenville - Prompt Corrective Action.” Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the bank, and these loans may be repaid from dividends paid from the bank to the company. Our ability to pay dividends depends on the bank’s ability to pay dividends to us, which is subject to regulatory restrictions as described below in “BankGreenville - Payment of Dividends.” We are also able to raise capital for contribution to the bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.
South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions. We are not required to obtain the approval of the S.C. Board prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must receive the Board’s approval prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.
BankGreenville
The bank operates as a state bank incorporated under the laws of the State of South Carolina and is subject to examination by the South Carolina Board of Financial Institutions and the FDIC.
The South Carolina Board of Financial Institutions and the FDIC regulate or monitor virtually all areas of the bank’s operations, including:
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security devices and procedures;
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adequacy of capitalization and loss reserves;
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loans;
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investments;
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borrowings;
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deposits;
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mergers;
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issuances of securities;
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payment of dividends;
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interest rates payable on deposits;
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interest rates or fees chargeable on loans;
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establishment of branches;
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corporate reorganizations;
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maintenance of books and records; and
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adequacy of staff training to carry on safe lending and deposit gathering practices.
The South Carolina Board of Financial Institutions requires the bank to maintain specified capital ratios and imposes limitations on the bank’s aggregate investment in real estate, bank premises, and furniture and fixtures. The South Carolina Board of Financial Institutions also requires the bank to prepare quarterly reports on the bank’s financial condition in compliance with its minimum standards and procedures.
All insured institutions must undergo regular on site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The FDIC Improvement Act also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:
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internal controls;
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information systems and audit systems;
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loan documentation;
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credit underwriting;
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interest rate risk exposure; and
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asset quality.
Prompt Corrective Action. As an insured depository institution, the bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations thereunder, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:
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Well Capitalized - The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution is one (i) having a total capital ratio of 10% or greater, (ii) having a tier 1 capital ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.
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Adequately Capitalized - The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution is one (i) having a total capital ratio of 8% or greater, (ii) having a tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.
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Undercapitalized - The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.
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Significantly Undercapitalized - The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a tier 1 capital ratio of less than 3% or (iii) having a leverage capital ratio of less than 3%.
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Critically Undercapitalized - The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%.
If the FDIC determines, after notice and an opportunity for hearing, that the bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.
If the bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on interests paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area. Moreover, if the bank becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC. The bank also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate Federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.
An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a
distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such would cause the bank to become undercapitalized, it could not pay a management fee or dividend to us.
As of December 31, 2008, the bank was deemed to be “well capitalized.”
Standards for Safety and Soundness. The FDIA also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Under the regulations, if the FDIC determines that the bank fails to meet any standards prescribed by the guidelines, the agency may require the bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.
Deposit Insurance and Assessments. Deposits at the bank are insured by the Deposit Insurance Fund (the “DIF”) as administered by the FDIC, up to the applicable limits established by law-generally $250,000 per accountholder and $250,000 for certain retirement accountholders. In November 2006, the FDIC adopted final regulations that set the deposit insurance assessment rates that took effect in 2007. The FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information-supervisory risk ratings for all institutions, financial ratios for most institutions, including the company, and long-term debt issuer ratings for large institutions that have such ratings. The new premium rate structure imposes a minimum assessment of from five to seven cents for every $100 of domestic deposits on institutions that are assigned to the lowest risk category. This category is expected to encompass substantially all insured institutions, including the bank. A one time assessment credit is available to offset up to 100% of the 2007 assessment. Any remaining credit can be used to offset up to 90% of subsequent annual assessments through 2010. For institutions assigned to higher risk categories, the premium that took effect in 2007 ranges from ten cents to forty-three cents per $100 of deposits. In addition, on February 27, 2009, the FDIC approved an interim rule to raise 2009 second quarter deposit insurance premiums for Risk Category I banks from 10 to 14 basis points to 12 to 16 basis points. The FDIC will also impose a 20-basis point special emergency assessment payable September 30, 2009, and the FDIC board authorized the FDIC to implement an additional 10 basis-point premium in any quarter. We anticipate our future insurance costs to be higher than in previous periods. However, we are not currently able to accurately determine the amount of additional cost.
On October 3, 2008, President George W. Bush signed the Emergency Economic Stabilization Act of 2008, which temporarily raises the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The temporary increase in deposit insurance coverage became effective immediately upon the President’s signature. The legislation provides that the basic deposit insurance limit will return to $100,000 on December 31, 2009.
FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. For the quarterly period ended December 31, 2008, the Financing Corporation assessment equaled 1.61 basis points for each $100 in domestic deposits. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.
The FDIC may terminate the deposit insurance of any insured depository institution, including the bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management of the
bank is not aware of any practice, condition or violation that might lead to termination of the bank’s deposit insurance.
Transactions with Affiliates and Insiders. The company is a legal entity separate and distinct from the bank and its other subsidiaries. Various legal limitations restrict the bank from lending or otherwise supplying funds to the company or its non-bank subsidiaries. The company and the bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the bank’s capital and surplus and, as to all affiliates combined, to 20% of the bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The bank is forbidden to purchase low quality assets from an affiliate.
Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.
The bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates, and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.
Branching. Under current South Carolina law, we may open branch offices throughout South Carolina with the prior approval of the South Carolina Board of Financial Institutions. In addition, with prior regulatory approval, the bank will be able to acquire existing banking operations in South Carolina. Furthermore, federal legislation has been passed that permits interstate branching by banks if allowed by state law, and interstate merging by banks. However, South Carolina law, with limited exceptions, currently permits branching across state lines only through interstate mergers.
Anti-Tying Restrictions. Under amendments to the BHCA and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, a financial institution’s primary regulator, which is the FDIC for the bank, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our bank. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements. The FDIC conducted a CRA examination in January 2008.
Finance Subsidiaries. Under the Gramm-Leach-Bliley Act (the “GLBA”), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible. The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the bank’s assets and tangible equity for purposes of calculating the bank’s capital adequacy. In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.
Consumer Protection Regulations. Activities of the bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the bank are subject to state usury laws and federal laws concerning interest rates. The bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:
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The federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
• The Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
• The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
• The Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;
• The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
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The Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
The deposit operations of the bank also are subject to:
• the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
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the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
Enforcement Powers. The bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,000,000 a day for such violations. Criminal penalties for some financial institution crimes have been increased to twenty years. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including
restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.
Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The company and the bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, enacted in 2001 and renewed in 2006. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions found to be violating these obligations.
USA PATRIOT Act. The USA PATRIOT Act became effective on October 26, 2001, amended, in part, the Bank Secrecy Act, and provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.
Under the USA PATRIOT Act, the FBI can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The bank can be requested, to search its records for any relationships or transactions with persons on those lists. If the bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.
The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.
Privacy and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the bank’s policy not to disclose any personal information unless required by law.
Like other lending institutions, the bank utilizes credit bureau data in its underwriting activities. Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.
Payment of Dividends. A South Carolina state bank may not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. The bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions, provided that the bank received a composite rating of one or two at the last federal or state regulatory examination. The bank must obtain approval from the South Carolina Board of Financial Institutions prior to the payment of any other cash dividends. In addition, under the FDICIA, the bank may not pay a dividend if, after paying the dividend, the bank would be undercapitalized.
Check 21. The Check Clearing for the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check. Some of the major provisions include:
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allowing check truncation without making it mandatory;
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demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;
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legalizing substitutions for and replacements of paper checks without agreement from consumers;
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retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;
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requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and
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requiring the re-crediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.
Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.
Proposed Legislation and Regulatory Action. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Item 1A.
Item 1A. Risk Factors
Our business, financial condition, and results of operations could be harmed by any of the following risks, or other risks that have not been identified or which we believe are immaterial or unlikely. Shareholders should carefully consider the risks described below in conjunction with the other information in this Form 10-K and the information incorporated by reference in this Form 10-K, including our consolidated financial statements and related notes.
We are a de novo bank, and there is a risk we may never become profitable.
Our bank is a de novo bank that began operations in January 2006. As is typical with most new banks, we incurred substantial start-up expenses and are still operating with an accumulated deficit. In order for us to become profitable, we will need to attract a large number of clients to deposit and borrow money. Our future profitability is also dependent on numerous other factors including local economic conditions and favorable government regulation. While the economy in this area has been strong in recent years, it has suffered during this most recent economic crisis and continued economic downturn in the area would hurt our business. We are also a highly regulated institution. Our ability to grow and achieve profitability may be adversely affected by state and federal regulations that limit a bank’s right to make loans and purchase securities. Although we have experienced two consecutive quarters of profitability, there is a risk that continued deterioration of the local economy or adverse government regulation could affect our plans. If this happens, we may never become consistently profitable and you will lose part or all of your investment.
Our decisions regarding credit risk and reserves for loan losses may materially and adversely affect our business.
Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:
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the duration of the credit;
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credit risks of a particular client;
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changes in economic and industry conditions; and
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in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.
We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including:
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an ongoing review of the quality, mix, and size of our overall loan portfolio;
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our historical loan loss experience;
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evaluation of economic conditions;
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regular reviews of loan delinquencies and loan portfolio quality; and
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the amount and quality of collateral, including guarantees, securing the loans.
There is no precise method of predicting credit losses; therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would result in a decrease of our net income, and possibly our capital.
We may have higher loan losses than we have allowed for in our allowance for loan losses.
Our loan losses could exceed our allowance for loan losses. Our average loan size continues to increase and reliance on our historic allowance for loan losses may not be adequate. Approximately 75% of our loan portfolio is composed of construction, commercial mortgage and commercial loans. Repayment of such loans is generally considered riskier than residential mortgage loans. Industry experience shows that a portion of loans will become delinquent and a portion of loans will require partial or entire charge-off. Regardless of the underwriting criteria used, losses may be experienced as a result of various factors beyond our control, including
among other things, changes in market conditions affecting the value of loan collateral and problems affecting the credit of our borrowers.
We are dependent on key individuals and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.
Our growth and development will largely be the result of the contributions of our chief executive officer, Russ Williams, and our chief financial officer, Paula King. The performance of community banks, like BankGreenville, is often dependent upon the ability of executive officers to promote the bank in the local market area. Mr. Williams and Ms. King have extensive and long-standing ties within our primary service areas and provide us with an important medium through which to market our products and services. If we lose the services of Mr. Williams or Ms. King, they would be difficult to replace and our business and development could be materially and adversely affected. We have employment agreements with Mr. Williams and Ms. King and carry $500,000 of life insurance on each of these officers, payable to the bank.
Additionally, our directors’ community involvement, diverse backgrounds, and extensive local business relationships are important to our success. If any of our directors discontinues his or her relationship with us, or if the composition of our board of directors changes materially, our growth could be adversely affected.
Lack of seasoning of our loan portfolio may increase the risk of credit defaults in the future.
Due to our short operating history, the loans in our loan portfolio and our lending relationships are of relatively recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.
Recent negative developments in the financial industry and the domestic and international credit markets may adversely affect our operations and results.
Negative developments in the latter half of 2007 and during 2008 in the global credit and securitization markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2009. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. As a result, significant new federal laws and regulations relating to financial institutions, including, without limitation, the Emergency Economic Stabilization Act (the “EESA”) and the U.S. Treasury Department’s Capital Purchase Program, have been adopted. Furthermore, the potential exists for additional federal or state laws and regulations regarding, among other matters, lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance. We can provide no assurance regarding the manner in which any new laws and regulations will affect us.
There can be no assurance that recently enacted legislation will help stabilize the U.S. financial system.
The EESA was signed into law on October 3, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. Pursuant to EESA, the Treasury has the authority to, among other things, purchase up to $700 billion of mortgages,
mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The Treasury announced the Capital Purchase Program under EESA pursuant to which it has purchased and may continue to purchase senior preferred stock in participating financial institutions. On February 13, 2009, we entered into the CPP Purchase Agreement with the Treasury providing for our issuance of the Series A Preferred Stock and a Warrant for Series B Preferred Stock to the Treasury. On that same day, the Treasury exercised its Warrant and the Series B Preferred Stock was also issued to the Treasury.
In addition, the FDIC created the Temporary Liquidity Guarantee Program (“TGLP”) as part of a larger government effort to strengthen confidence and encourage liquidity in the nation’s banking system. The TLGP has two components. First, the TLGP includes the Transaction Account Guarantee Program (“TAGP”), which provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts. Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place. Second, the TLGP includes the Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012. The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008. Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012. The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008. We have elected to continue coverage under the TLGP.
On February 17, 2009, the American Recovery and Reinvestment Act (the “Recovery Act”) was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy. The Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs. The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws. The Recovery Act also imposes certain limitations on compensation paid by participants in the Treasury’s Capital Purchase Program in which we participate.
There can be no assurance that these government actions will achieve their purpose. The failure of the financial markets to stabilize, or a continuation or worsening of the current financial market conditions, could have a material adverse affect on our business, our financial condition, the financial condition of our customers, our common stock trading price, as well as our ability to access credit. It could also result in declines in our investment portfolio which could be “other-than-temporary impairments.”
Because of our participation in the Treasury Department’s Capital Purchase Program, we are subject to several restrictions including restrictions on compensation paid to our executives.
Pursuant to the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the CPP Purchase Agreement. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers, if any. The standards include, among other things, (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.
Legislation or regulatory changes could cause us to seek to repurchase the Series A and B preferred stock that we sold to the U.S. Treasury pursuant to the Capital Purchase Program.
Legislation that has been adopted after we closed on our sale of Series A and B Preferred Stock to the Treasury on February 13, 2009, and any legislation or regulations that may be implemented in the future, may have a material impact on the terms of our Capital Purchase Program transaction with the Treasury. If we determine that any such legislation or any regulations, in whole or in part, alter the terms of our Capital Purchase Program transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then it is possible that we may seek to unwind, in whole or in part, the Capital Purchase Program transaction by repurchasing some or all of the Series A and B Preferred Stock that we sold to the Treasury pursuant to the Capital Purchase Program. If we were to repurchase all or a portion of such preferred stock, then our capital levels could be materially reduced.
The securities purchase agreement between us and Treasury limits our ability to pay dividends on and repurchase our common stock.
The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) February 13, 2012 and (ii) the date on which all of the shares of the Series A and Series B Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) increase the cash dividend on our common stock or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock (other than the Series A Preferred Stock) or trust preferred securities. In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the Series A and Series B Preferred Stock. These restrictions, together with the potentially dilutive impact of the warrant described in the next risk factor, could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our Board of Directors.
The Series A and Series B Preferred Stock impacts net income available to our common shareholders and earnings per common share.
The dividends declared on the Series A and Series B Preferred Stock will reduce the net income available to common shareholders and our earnings per common share. The Series A and Series B Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company.
If we are unable to redeem the Series A Preferred Stock after five years, we will be required to make higher dividend payments on this stock, thereby substantially increasing our cost of capital.
If we are unable to redeem the Series A Preferred Stock prior to February 13, 2014, the dividend rate will increase substantially on that date, from 5.0% per annum to 9.0% per annum. Depending on our financial condition at the time, this increase in the annual dividend rate on the Series A Preferred Stock could have a material negative effect on our liquidity, our net income available to common shareholders, and our earnings per share.
We face strong competition for clients, which could prevent us from obtaining clients and may cause us to pay higher interest rates to attract clients.
The banking business is highly competitive, and we experience competition in our market from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our client base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not currently provide. There is a risk that we will not be able to compete successfully with other financial institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.
We are subject to extensive regulation that could limit or restrict our activities. This regulation is for protection of the bank’s depositors and not for the investors.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.
Although we are subject to extensive and comprehensive regulation by various banking regulatory agencies such as the FDIC and the South Carolina Board of Financial Institutions, the purpose of these banking regulatory agencies is to protect and insure the interests and deposits of our bank’s depositors. These agencies do not consider preserving or maximizing the investment made by the company’s investors when regulating the bank’s activities.
The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission that are now applicable to us, have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. We have experienced, and we expect to continue to experience, greater compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act.
We are exposed to changes in the regulation of financial services companies.
Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America and the General Assembly of the State of South Carolina. The agencies regulating the financial services industry also periodically adopt changes to their regulations. On September 7, 2008, the U.S. Treasury Department announced that Fannie Mae (along with Freddie Mac) has been placed into conservatorship under the control of the newly created Federal Housing Finance Agency. On October 3, 2008, EESA was signed into law, and on October 14, 2008 the U.S. Treasury Department announced its Capital Purchase Program under EESA. On February 17, 2009, the Recovery Act was signed into law further amending the Capital Purchase Program under EESA. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. See “Risk Factors - We are subject to extensive regulation that could restrict our activities. This regulation is for protection of the bank’s depositors and not for the investors.” above.
We face risks with respect to future expansion and acquisitions or mergers.
Although we do not have any current plans to do so, we may seek to acquire other financial institutions or parts of those institutions. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:
•
additional time and expense associated with identifying and evaluating potential acquisitions and merger partners;
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inaccurate estimates and judgments to evaluate credit, operations, management, and market risks with respect to the target institution or assets;
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dilution of our existing shareholders in an acquisition;
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additional time and expense associated with evaluating new markets for expansion, hiring experienced local management, and opening new offices, as there may be a substantial time lag between these activities before we generate sufficient assets and deposits to support the costs of the expansion;
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a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s attention being diverted from the operation of our existing business;
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time and expense integrating the operations and personnel of the combined businesses;
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the potential for an adverse short-term effect on our results of operations; and
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loss of key employees and clients as a result of an acquisition that is poorly received.
We have never acquired another institution before, so we lack experience in handling any of these risks. There is also a risk that any expansion effort will not be successful.
The costs of being an SEC registered company are proportionately higher for small companies such as BankGreenville Financial Corporation because of the requirements imposed by the Sarbanes-Oxley Act.
The Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the Securities and Exchange Commission have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. These regulations are applicable to our company. We expect to experience increasing compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act. These necessary costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.
Continuation of the economic downturn, especially in Greenville County, could reduce our client base, our level of deposits, and demand for financial products such as loans.
Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. The current economic downturn has negatively affected the market in which we operate and, in turn, the quality of our loan portfolio. If the community in which we operate does not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed. A continuation of the economic downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. A continued economic downturn could, therefore, result in losses that materially and adversely affect our business.
Our small-to-medium-sized business target markets may have fewer financial resources to weather a downturn in the economy.
We target the banking and financial services needs of small and medium-sized business. These businesses generally have fewer financial resources in terms of capital borrowing capacity than larger entities. If general economic conditions continue to negatively impact these businesses in the markets in which we operate, our business, financial condition and results of operations may be adversely affected.
Changes in prevailing interest rates may reduce our profitability.
Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Depending on the terms and maturities of our assets and liabilities, a significant change in interest rates could have a material adverse effect on our profitability. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer.
Our pace of growth may require us to raise additional capital in the future, and that capital may not be available when it is needed.
We are required by our regulators to maintain adequate levels of capital to support our operations. To support continued growth, we may need to raise additional capital in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are beyond our control. We cannot make assurances as to our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to expand our operations through internal growth and acquisitions could be materially affected. In addition, if we decide to raise additional capital, your interest could be diluted.
A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.
As of December 31, 2008, approximately 82% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.
There is no public market for our shares, and we do not believe that we have enough shareholders or outstanding shares to support an active trading market, even if we are eventually listed on a recognized trading exchange.
There is currently no established market for our common stock, and we have no current plans to list our stock on NASDAQ or any other exchange. For these reasons, we do not expect a liquid market for our common stock to develop for several years, if at all.
The capital and credit markets have experienced unprecedented levels of volatility.
During 2008, the capital and credit markets experienced extended volatility and disruption. In the last two quarters of 2008, the volatility and disruption reached unprecedented levels. In some cases, the markets produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. If these levels of market disruption and volatility continue, worsen or abate and then arise at a later date, there can be no assurance that we will not experience a material adverse effect on our ability to access capital, our business, our financial condition, and our results of operations.
In response to financial conditions affecting the banking system and financial markets and the potential threats to the solvency of investment banks and other financial institutions, the United States government has taken unprecedented actions. These actions include the government-assisted acquisition of Bear Stearns by JPMorgan Chase, the federal conservatorship of Fannie Mae and Freddie Mac, and a historic bill authorizing the U.S. Treasury to invest in financial institutions and purchase mortgage loans and mortgage-backed and other securities from financial institutions for the purpose of stabilizing the financial markets or particular financial institutions. There can be no assurance as to when or if the government will take further steps to intervene in the financial sector and what impact government actions will have on the financial markets. Governmental intervention (or the lack thereof) could materially and adversely affect our business, financial condition and results of operations.
Item 2.
Item 2. Description of Property
Our permanent headquarters building is located at the corner of Woodruff Road and Rocky Slope Road near Laurens Road, at 499 Woodruff Road, Greenville, South Carolina 29607. The building is a full service banking facility with three drive-thru lanes and a drive-thru ATM. The site is approximately 1.23 acres and the building is approximately 10,700 square feet. We believe that the property is adequately covered by insurance.
Item 3.
Item 3. Legal Proceedings.
We are not a party to, nor are any of our properties subject to, any material legal proceedings, other than routine litigation incidental to our business.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
We are currently quoted on the OTC Bulletin Board under the symbol “BGVF” and have a sponsoring broker-dealer to match buy and sell orders for our common stock. Although we are quoted on the OTC Bulletin Board, the trading markets on the OTC Bulletin Board lack the depth, liquidity, and orderliness necessary to maintain a liquid market. We have no current plans to seek listing on any stock exchange, and we do not expect to qualify for listing on NASDAQ or any other exchange for at least several years. The OTC Bulletin Board prices are quotations, which reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not represent actual transactions.
As of March 10, 2009, there were 1,180,000 shares of common stock outstanding held by 132 shareholders of record. All of our currently issued and outstanding common stock was issued in our initial public offering which was completed in December 2005. The price per share in our initial public offering was $10.00. The following table shows the quarterly reported high and low bid information as quoted on the OTC Bulletin Board for 2008 and 2007.
We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay dividends depends on the ability of our bank to pay dividends to us. As a South Carolina state bank, the bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, the bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital.
We entered the Purchase Agreement with the Treasury on February 13, 2009 to participate in the Treasury’s Capital Purchase Program. Refer to “Management’s Discussion and Analysis or Plan of Operation” below for details. Under the terms of the Letter Agreement associated with payment of dividends, prior to February 13, 2012, the consent of Treasury will be required for us to declare or pay any dividend or make any distributions from our common stock, unless we have already redeemed both the Series A and Series B Preferred Stock issued to Treasury pursuant to the terms of the Purchase Agreement.
Item 6.
Item 6. Selected Financial Data.
Not applicable.
Item 7.
Item 7. Management’s Discussion and Analysis or Plan of Operation.
The following discussion and analysis reviews our results of operations and assesses our financial condition, and also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. You should read this discussion and analysis in conjunction with the accompanying consolidated financial statements and the discussion of forward-looking statements and other statistical information included in this report.
General
Like most community banks, we derive the majority of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, also known as the net interest margin, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is referred to as net interest spread.
There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following sections we have included a detailed discussion of this process.
In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our clients. We describe the various components of this non-interest income, as well as our non-interest expense, in the following sections.
In response to financial conditions affecting the banking system and financial markets and the potential threats to the solvency of investment banks and other financial institutions, the United States government has taken unprecedented actions. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”). Pursuant to the EESA, the U.S. Treasury (“Treasury”) will have the authority to, among other things, purchase mortgages, mortgage-backed securities, and other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, Treasury announced the Capital Purchase Program under the EESA, pursuant to which Treasury intends to make senior preferred stock investments in participating financial institutions.
On December 26, 2008, we received preliminary approval to participate in the Capital Purchase Program described above, in the amount of $1,891,000, which represented the maximum 3% of our risk-weighted assets at September 30, 2008. After careful evaluation by our executive management and board of directors, including the impact of our participation on our capital ratios and operations as well as on our common shareholders, we elected to participate at $1 million and were able to participate under the private company terms, which limited dilution to our common shareholders. The transaction closed on February 13, 2009 and on that date we issued shares of our Series A and Series B Preferred Stock to Treasury. Refer to the “Capital Resources” section of “Management’s Discussion and Analysis or Plan of Operation” as well as the “Notes to Consolidated Financial Statements” for additional details.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in footnote 1 to our audited consolidated financial statements as of December 31, 2008, included herein. Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies.
The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan Losses
We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the creditworthiness of borrowers, the estimated value of the underlying collateral, cash flow assumptions, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.
Income Taxes
We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are re-evaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined that it is “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.
Results of Operations
General
Our net loss for the year ended December 31, 2008 was $60,863, or $0.05 per share, compared to a net loss of $494,350, or $0.42 per share, for the same period in 2007, for an improvement of $433,487, or 88%. The improvement in net loss is attributable to increases in our net interest income, which reflects the continued growth of our bank and the volume increases in our loans and investment securities as discussed below. Also, we recorded $78,162 in gains on investment securities called and sold during 2008. Refer to “Non-interest Income” for a discussion of these gains.
Our net income for the fourth quarter of 2008 was $19,863, compared to a net loss of $39,683 for the same period in 2007, an improvement of $59,546. The transition from net loss to net income is attributable to an increase in our net interest income, which reflects the continued growth of our bank and the volume increases in our interest-earning assets for the three months ended December 31, 2008, compared to the same period in 2007. In addition, we recorded $39,238 in gains on investment securities sales in the fourth quarter of 2008. Net proceeds from these sales were reinvested in investment securities with no less favorable terms to the company.
Net Interest Income
Our primary source of revenue is net interest income. Net interest income is the difference between income earned on interest-bearing assets and interest paid on deposits and borrowings used to support such assets. The level of net interest income is determined by the balances of interest-earning assets and interest-bearing liabilities and corresponding interest rates earned and paid on those assets and liabilities, respectively. In addition to the volume of and corresponding interest rates associated with these interest-earning assets and interest-bearing liabilities, net interest income is affected by the timing of the repricing of these interest-earning assets and interest-bearing liabilities.
Net interest income was $1,842,989 for the year ended December 31, 2008, an increase of $454,880, or 33%, over net interest income of $1,388,109 for the year ended December 31, 2007. Interest income of $4,027,677 for the year ended December 31, 2008 included $2,868,545 on loans, $1,141,935 on investment securities and Federal Home Loan Bank stock and $17,197 on federal funds sold. In spite of the 400 basis point drop in the prime interest rate in 2008, loan interest and related fees improved $973,710, or 51%, over 2007, due to growth of $18.5 million in the loan portfolio in 2008. Interest income on investment securities and Federal Home Loan Bank stock improved $434,839, or 61%, due to continued growth in the investment portfolio as well as the purchase of higher-yielding corporate (bank) bonds and taxable municipal bonds in 2008. Interest income on federal funds sold decreased $177,107, or 91%, due to reallocation of funding sources into higher-yielding loans. Total interest expense of $2,184,688 for the year ended December 31, 2008 included $1,879,443 related to deposit accounts, $288,572 associated with Federal Home Loan Bank borrowings and $16,673 on federal funds purchased. Interest expense on deposits increased $479,298, or 34%, due to continued growth in deposits, primarily money market accounts and brokered certificates of deposit. Interest expense on Federal Home Loan Bank borrowings increased $287,355, due to growth of $12,015,000 in borrowings in 2008.
The following tables set forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the comparative periods ended December 31, 2008 and 2007 and December 31, 2007 and 2006. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees is amortized into interest income over the life of the loans.
(1) Loan fees, which are immaterial, are included in interest income. There were $1.2 million in nonaccrual loans in 2008 and no nonaccrual loans in 2007. Nonaccrual loans are included in the average balances and income on nonaccrual loans is included on the cash basis for yield computation purposes.
Our consolidated net interest margin for the year ended December 31, 2008 was 2.70%, a decrease of 88 basis points from the net interest margin of 3.58% for the year ended December 31, 2007. The average prime interest rate was 7.69% during the twelve months ended December 31, 2007, while the average prime interest rate during the twelve-month period ended December 31, 2008 was 5.09%. With a 400 basis point decrease in prime rate during the comparable periods, and with approximately 55% of our loan portfolio tied to the prime rate, we experienced an immediate decrease in loan yields as the prime rate decreases occurred, as evidenced by the 223 basis point decline in loan yield from 2007 to 2008 shown in the table. Conversely, we relied on a higher volume of certificates of deposit, both local and brokered, to fund the growth of our loan portfolio. These deposits are priced higher than core deposits and have stated maturity dates, so there is not an immediate decrease in the interest rates paid on these time deposits. Also, during the year ended December 31, 2008, we utilized additional Federal Home Loan Bank borrowings as an alternative funding source. The net interest margin is calculated by dividing annual net interest income by annual average earning assets. Our net interest spread was 2.21% and 2.50% for the years ended December 31, 2008 and 2007, respectively. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. In pricing deposits, we consider our liquidity needs, the direction and levels of interest rates and local market conditions.
(1) Loan fees, which are immaterial, are included in interest income. There were no nonaccrual loans for either period.
Our consolidated net interest margin for the year ended December 31, 2007 was 3.58%, a decrease of 64 basis points from the net interest margin of 4.22% for the year ended December 31, 2006. This decrease can be attributed to the costs of our funding sources. We relied on a higher volume of certificates of deposits, both local and brokered, to fund the growth of our loan portfolio in 2007. These deposits are priced higher than core deposits and our average cost on time deposits increased from 5.06% to 5.29%. Additionally, for the first time in 2007, we utilized alternative funding sources of federal funds purchased and FHLB borrowings. Earning assets averaged $38.8 million for the year ended December 31, 2007, increasing from $18.7 million for the year ended December 31, 2006. The net interest margin is calculated by dividing annual net interest income by annual average earning assets.
Our net interest spread was 2.50% for the year ended December 31, 2007. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. In pricing deposits, we consider our liquidity needs, the direction and levels of interest rates and local market conditions. As such, higher rates have been paid initially to attract deposits.
Rate/Volume Analysis
Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates had on changes in net interest income for the comparative periods presented. The effect of a change attributed to volume has been determined by multiplying the change in the average balance by the average yield or rate in the prior year. The effect of a change attributed to yield or rate has been determined by multiplying the change in yield or rate by the average balance for the prior year. Changes attributed to both rate and volume, have been allocated on a pro rata basis.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as a non-cash expense to our statement of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.
Our provision for loan losses for the year ended December 31, 2008 was $219,258, compared to $238,821 for 2007. Management evaluates the adequacy of the reserve for probable loan losses given the size, mix, and quality of the current loan portfolio. Management also relies on our history of past-dues and charge-offs, as well as peer data to determine our loan loss allowance.
Refer to the discussion below under “Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period in order to maintain an appropriate allowance for loan losses. Despite the two classified and impaired borrowing relationships identified as of December 31, 2008 and discussed under “Loans” below, we believe that our provision for loan losses is adequate. The allowance as a percentage of gross loans was 1.22% at December 31, 2008 and we had no charge-offs in 2008.
Non-interest Income
Non-interest income for the year ended December 31, 2008 was $145,422 compared to $60,032, for the year ended December 31, 2007, for an improvement of $85,390, or 142%. During the twelve months ended December 31, 2008, we recognized $78,162 in gains on investment securities called or sold during the period, compared to gains of $3,313 for the year ended December 31, 2007. Four agency bonds were called during 2008. In addition three other agency bonds were sold during 2008 prior to April call dates. Management correctly estimated that interest rates would drop prior to the call dates, and sold these agency bonds before these call dates in order to reinvest the proceeds in investment securities prior to the additional interest rate decreases. One mortgage-backed security was sold as its prepayment speed had increased and the proceeds were reinvested in a higher yielding investment grade corporate (bank) bond. In addition, three mortgage-backed securities were sold and reinvested in bonds with no less favorable terms to the company.
Mortgage brokerage fees decreased $27,716, or 74%, from $37,556 for the year ended December, 31 2007 to $9,840 for the same period in 2008 due to decreased mortgage volume. Service charges on deposit accounts increased $38,257, or 200%, from $19,163 for the year ended December 31, 2007 to $57,420 for the comparable period in 2008, due to deposit growth.
Non-interest Expenses
The following table sets forth information related to our non-interest expenses for the year ended December 31, 2008 and 2007.
Non-interest expenses were $1,830,016 for the year ended December 31, 2008 compared to $1,703,670 for the year ended December 31, 2007, for an increase of 7%. The most significant component of non-interest expense is compensation and benefits, which totaled $1,048,565, for the year ended December 31, 2008, compared to $953,430 for the year ended December 31, 2007, for a 10% increase. The increase primarily related to employee performance raises and increases in bank-paid employee health care and other insurance costs. Data processing costs increased from $179,646 for the year ended December 31, 2007 to $210,954 for the same period ended December 31, 2008. This 17% increase was due to core processor increases directly related to continued growth in the bank’s deposit accounts as well as non-capitalized upgrades to the bank’s computer systems. Legal and audit expenses increased from $52,885 for the year ended December 31, 2007 to $71,178 for the same period ended December 31, 2008. This 35% increase was due to increases in both outside auditor and legal reviews of SEC filings as well as additional tax planning costs and legal fees associated with general corporate work. Regulatory fees and FDIC insurance increased from $38,974 for the year ended December 31, 2007 to $54,481, or 40%, for the year ended December 31, 2008. Our FDIC insurance assessments continue to increase as deposits grow.
Income Tax Benefit
The company had no currently taxable income for the years ended December 31, 2008 and 2007. The company has recorded a valuation allowance equal to the net deferred tax asset as the realization of this asset is dependent on the Company’s ability to generate future taxable income during the periods in which temporary differences become deductible.
Balance Sheet Review
General
At December 31, 2008, total assets were $82.6 million compared to $58.6 million at December 31, 2007, for an increase of $24.0 million, or 41%. The increase in assets resulted from volume increases in our loan and investment portfolios, funded by increases in deposits and Federal Home Loan Bank borrowings. Interest-earning assets comprised approximately 95% and 94% of total assets at December 31, 2008 and December 31, 2007, respectively. Gross loans totaled $54.7 million, an increase of $18.5 million, or 51%, from $36.2 million at December 31, 2007. Investment securities and Federal Home Loan Bank stock amounted to $21.9 million at December 31, 2008, compared to $18.7 million at December 31, 2007. At December 31, 2008, we were in a federal funds sold position of $2.2 million, compared to federal funds purchased of $1.6 million at December 31, 2007.
Deposits totaled $57.7 million at December 31, 2008, an increase of $13.6 million, or 31%, from $44.1 million at December 31, 2007. Federal Home Loan Bank borrowings were $14.5 million, at December 31, 2008 compared to $2.4 million, at December 31, 2007 for an increase of $12.0 million, or 492%. We increased our Federal Home Loan Bank borrowings in 2008 to partially fund our loan growth and purchase investment securities. Shareholders’ equity was $9.6 million and $9.7 million at December 31, 2008 and December 31, 2007, respectively.
Investments
At December 31, 2008 and 2007, our investment securities portfolio amounted to $21.1 million and $18.5 million and represented 26% and 32%, respectively, of total assets. Unrealized losses, net of tax benefit, on available for sale investment securities amounted to $27,761 at December 31, 2008 compared to unrealized gains of $57,834 at December 31, 2007, due to changes in market interest rates as discussed below. Our portfolio consisted of U.S. government sponsored agencies of $7.6 million, mortgage-backed agencies of $8.5 million, taxable municipal securities of $0.9 million and corporate bonds of $4.1 million. All of our investment securities are classified available for sale.
Contractual maturities and yields on our investment securities available for sale at December 31, 2008 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. The average life and modified duration of our investment securities portfolio were 6.35 and 4.70 years, respectively, at December 31, 2008. The average yields are based on amortized costs.
The amortized costs and the fair values of our investment securities at December 31, 2008 and 2007 are shown in the following table.
During 2008, four agency bonds were called and three bonds were sold prior to call dates in anticipation of additional interest rate decreases. The proceeds from these calls and sales were reinvested in agency mortgage-backed securities, investment grade corporate bonds and used to fund loans. One mortgage-backed security was sold as its prepayment speed had increased and the proceeds were reinvested in a higher yielding investment grade corporate (bank) bond. In addition, three mortgage-backed securities were sold and reinvested in bonds with no less favorable terms to the company. All of our corporate bonds are bank bonds and continue to be designated as investment grade by Moody’s and Standard & Poors. We believe, based on industry analyst reports and credit ratings, that deterioration in fair values of individual investment securities available for sale is attributed to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. We have the ability and intent to hold these securities until such time as the value recovers or the securities mature.
Investment securities with market values of approximately $10.1 million and $5.9 million at December 31, 2008 and 2007, respectively, were pledged to secure public deposits and Federal Home Loan Bank borrowings. Gross realized gains on the sale of available for sale securities were $78,162 and $3,313 for the years ended December 31, 2008 and December 31, 2007.
At December 31, 2008 and 2007, we held non-marketable equity securities, which consisted of Federal Home Loan Bank stock of $755,900 and $183,000, respectively. Federal Home Loan Bank stock purchases are required as the level of Federal Home Loan Bank borrowings increases. This stock increased $572,900 during 2008 as a result of the net increase of $12.0 million in Federal Home Loan Bank borrowings during the same period. No ready market exists for this stock and it has no quoted market value. Redemptions of this stock have historically been at par value. Accordingly, this investment is carried at cost, which approximates fair market value. This stock has historically paid a quarterly dividend, but is currently not paying a dividend due to the current economic environment and we are no longer accruing a dividend on this stock.
We have not held any Fannie Mae or Freddie Mac stock since we opened in 2006.
Loans
Since loans typically provide higher interest yields than other interest-earning assets, it is our goal to ensure that the highest percentage of our earning assets is invested in our loan portfolio. Gross loans outstanding at December 31, 2008 were $54.7 million, or 69% of interest-earning assets and 66% of total assets, compared to $36.2 million, or 66% of interest-earning and 62% of total assets at December 31, 2007.
Although the loan portfolio grew $18.5 million in 2008, the percentage of loans in each category remained relatively stable from 2007 to 2008 as shown in the table below. Loans secured by real estate mortgages comprised approximately 82% of loans outstanding at December 31, 2008 and 78% at December 31, 2007. Most of our real estate loans are secured by residential and commercial properties. We do not generally originate traditional long term residential mortgages, but we do originate traditional second mortgage residential real estate loans and home equity lines of credit. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 80%.
Due to the short time our portfolio has existed, the loan mix shown below may not be indicative of the ongoing portfolio mix. We attempt to maintain a relatively diversified loan portfolio to help reduce the risks inherent in concentration of certain types of collateral. The following table summarizes the composition of our loan portfolio as of December 31, 2008 and 2007.
Construction and development and land loans represented approximately 31% and 34% of total loans at December 31, 2008 and 2007, respectively. Commercial real estate loans comprised 27% and 22% of total loans at December 31, 2008 and 2007, respectively. Loans secured by land represented approximately 45% of the construction and development and land category at December 31, 2008. We have concentrations of credit, generally defined as more than 25% of Tier 1 capital and the allowance for loan losses, in the residential construction and land loan categories. We believe that we have appropriate controls in place to monitor risks associated with these concentrations.
Commercial real estate loans and construction and development loans generally entail additional risks as these loans typically involve larger balances to single borrowers or groups of related borrowers. The repayment of these loans is typically dependent upon the successful operation of the real estate project. These risks can be significantly affected by supply and demand in the market, and, as such, are subject to a greater extent to adverse conditions in the local economy. In light of the current economic conditions and supply and demand associated with
real estate in our market, these categories of our loan portfolio pose additional credit risk to the company, and we have identified large performing loans within these categories, not considered impaired, but with risk characteristics impacted by the current economic environment. We have identified a specific reserve associated with these loans and included this reserve as a component of our overall allowance for loan losses. In dealing with these risk factors, we generally limit our loans to our local real estate market or to borrowers with which we have experience. Refer to additional information regarding risks associated with commercial real estate and construction and development lending under the heading “Risk Factors” in this report.
Loans originated as exceptions to our loan policy guidelines may pose additional credit risk to the bank, if not monitored properly. We regularly monitor and report to the board of directors all loans approved with loan policy exceptions. We have determined that our loan portfolio did not include any loans considered subprime at December 31, 2008.
Our bank does not originate long-term conventional residential first mortgage loans. In these instances, we serve as a broker and accept mortgage applications. These applications are approved by a third-party provider and the bank receives a mortgage brokerage fee for services performed.
We discontinue accrual of interest on a loan when we conclude that it is doubtful that we will be able to collect interest from the borrower. Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering the borrower’s financial condition, economic and the borrower’s industry conditions, if applicable, and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual will be recognized as income when received. When a loan is placed on nonaccrual status, all previously accrued but unpaid interest is reversed and is deducted from reported interest income and earnings. Once a loan is placed on nonaccrual status, no additional interest is accrued on the loan balance. In 2008, non-accrual interest, not included in interest income, totaled $43,896. Of this amount, forgone interest reversed and deducted from interest income totaled $35,692, and pertained to the two borrowing relationships described below.
There were $1,224,000 in nonaccrual or nonperforming loans at December 31, 2008 compared to $-0- at December 31, 2007. For both periods, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments. At December 31, 2008, we were aware of two problem borrowing relationships with an aggregate principal balance of $1,262,000, which were classified substandard at December 31, 2008. Both borrowing relationships had been current until their regular monthly payments, which were due in late July and August 2008, respectively. Loans totaling $1,224,000, associated with these borrowing relationships were placed on nonaccrual status in October 2008, due to additional information obtained by management in October as well as continued past-due status. A loan for approximately $38,000, secured by a vehicle is continuing to perform. While classified as substandard due to the overall borrowing relationship, this loan continues to accrue interest due to payment status. In the fourth quarter of 2008, we began foreclosure proceedings against both of the borrowers on the real estate secured loans. Based on our evaluation of the deteriorating financial condition of the borrowers and their inability to repay the loans, we considered loans to these borrowers to be impaired under the criteria defined in FAS 114, “Accounting by Creditors for Impairment of a Loan”, at December 31, 2008. These loans are primarily collateralized by real estate, and we believe, based on our knowledge of the properties and the market and recent appraisals as well as our loan to value percentages, that the fair values less estimated costs to sell the properties are sufficient to cover the principal balances on these loans. However, because of the current economic conditions and supply and demand in our real estate market, we have identified an impairment charge or specific reserve of $150,000 associated with these loans. Refer to our discussion below in the “Allowance for Loan Losses” section.
Maturities and Sensitivity of Loans to Changes in Interest Rates
The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.
The following table summarizes the loan maturity distribution by composition and interest rate types at December 31, 2008.
Allowance for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statements of operations. The allowance for loan losses was $665,442 and $446,184 as of December 31, 2008 and December 31, 2007, respectively, and represented 1.22% of outstanding loans at December 31, 2008 and 1.23% as of December 31, 2007. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our allowance for loan losses covers estimated credit losses on individually evaluated loans that are determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan portfolio. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. We believe we have an effective loan review system and loan grading system that is designed to identify, monitor and address asset quality problems in an accurate and timely manner. Our determination of the allowance for loan losses is based on evaluations of the collectibility of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.
Due to our short operating history, the loans in our loan portfolio and our lending relationships are of very recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process known as seasoning. As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. In recent months, many banks have begun to see an overall decline in credit quality and have increased their allowance for loan losses accordingly. Though we have not experienced significant changes in credit quality during this volatile time, we continue to carefully monitor our loan portfolio for deterioration. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition. Periodically, we will adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.
In calculating the allowance for loan losses, we utilize a credit grading system, which we apply to each loan.
We calculate our general reserve based on historical and peer loss percentage allocations of each of the categories of unclassified loan types, including commercial, commercial real estate, construction and development, residential mortgages, home equity lines of credit and consumer loans. The loss factors are adjusted for qualitative factors, including those described above. We also analyze individual significant credits not considered impaired but with risk characteristics, and maintain a general unallocated reserve in accordance with December 2006 regulatory guidance in our assessment of the allowance for loan losses. Significant individual credits criticized as special mention or classified as substandard or doubtful require individual analysis. Loans in the substandard category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action such as declining or negative earnings trends and declining or inadequate liquidity or collateral. Loans in the doubtful category exhibit the same weaknesses found in the substandard category, but the weaknesses are more pronounced. These loans are not yet rated as loss because certain events may occur which could repay the debt. Loans classified as substandard totaled $1,262,000, at December 31, 2008. We considered these loans impaired under the criteria of FAS 114 at December 31, 2008 due to the deteriorating financial condition and inability of the borrowers to repay the loans secured by real estate. In situations where a loan is considered impaired, the loans are excluded from the general reserve calculations and are assigned a specific reserve. The specific reserve is based on our analysis of the most probable source of repayment which is usually the liquidation of the underlying collateral, but may also include discounted future cash flows.
These loans are primarily collateralized by real estate, and we believe, based on our knowledge of the properties and the market and recent appraisals, as well as our loan to value percentages, that the fair values less estimated costs to sell the properties are sufficient to cover the principal balances on these loans. However, because of the current economic conditions and supply and demand in our real estate market, we have identified an impairment charge or specific reserve of $150,000 associated with these loans.
There were no loans classified as doubtful at December 31, 2008 and we had no classified loans at December 31, 2007.
We have retained an independent consultant to review our loan files on a test basis to assess the grading of samples of loans. In addition, various regulatory agencies review our allowance for loan losses through their periodic examinations, and they may require us to record additions to the allowance for loan losses based on their judgment about information made available to them at the time of their examination. Our losses will undoubtedly vary from our estimates, and there is the possibility that charge-offs in future periods will exceed the allowance for loan losses as estimated at any point in time.
There were no charge-offs during the year ended December 31, 2008 compared to $3,279 in 2007. Recoveries were $263 in the year ended December 31, 2007. The only addition to the allowance for loan losses for 2008 was the accrual of the loan loss provision.
Deposits
Our primary source for our loans and investments is our deposits. Deposits increased $13.6 million, from $44.1 million at December 31, 2007 to $57.7 million at December 31, 2008. The following table shows the composition of deposits at comparable year-ends and the average rates paid on deposits during 2008 and 2007.
Core deposits, which exclude time deposits of $100,000 or more and brokered certificates of deposit, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits grew $8.3 million from $20.4 million at December 31, 2007 to $28.7 million at December 31, 2008. Our loan-to-deposit ratio was 95% and 82% at December 31, 2008 and 2007, respectively. Due to the competitive interest rate environment in our market, we utilized brokered certificates of deposit as a funding source in 2008 when we were able to procure these certificates at interest rates less than those in the local market. Brokered certificates of deposit purchased outside our primary market totaled $18.8 million and $12.2 million at December 31, 2008 and 2007, respectively. All of our time deposits are certificates of deposits.
The maturity distribution of our time deposits of $100,000 or more and brokered time deposits at December 31, 2008 was as follows:
Another aspect of the EESA (in addition to the Capital Purchase Plan described above) which became effective on October 3, 2008 was a temporary increase of the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The basic deposit insurance limit will return to $100,000 after December 31, 2009.
The bank was also included in the initial period of the FDIC’s Temporary Liquidity Guarantee Program which was announced October 14, 2008 as part of the EESA. This guarantee applies to the following transactions:
• All newly issued senior unsecured debt (up to $1.5 trillion) issued on or before June 30, 2009, including promissory notes, commercial paper, inter-bank funding, and any unsecured portion of secured debt. For eligible debt issued on or before June 30, 2009, coverage would only be provided for three years beyond that date, even if the liability has not matured; and
• Unlimited federal deposit insurance coverage on funds in non-interest-bearing transaction deposit accounts (up to $500 billion) held by FDIC-insured banks until December 31, 2009.
All FDIC institutions were covered for the first 30 days at no cost. After the initial 30 day period expired, our bank opted to participate in the extended period covered by the program. There will be a 75-basis point fee to protect new debt issues (which currently does not apply to our bank) and an additional 10-basis point fee to fully cover non-interest bearing deposit transaction accounts.
Borrowings and lines of credit
At December 31, 2008, the bank had short-term lines of credit with correspondent banks to purchase a maximum of $5.8 million in unsecured federal funds on a one to fourteen day basis for general corporate purposes. The interest rate on borrowings under these lines is the prevailing market rate for federal funds purchased. These accommodation lines of credit are renewable annually and may be terminated at any time at the correspondent banks’ sole discretion. The bank utilized these lines of credit during the year ended December 31, 2008. The average amount outstanding during the year ended December 31, 2008 was $554,000. The highest month-end amount outstanding during the twelve months was $2.2 million and the average interest rate paid on these borrowings was 2.94%. The average amount outstanding during the year ended December 31, 2007 was $1.6 million and the highest month-end amount outstanding during 2007 was $2.7 million. The average interest rate paid on these borrowings during the year was 4.50%. There were no outstanding amounts on these lines of credit as of December 31, 2008 and $1,648,000 was outstanding at December 31, 2007.
We are also a member of the Federal Home Loan Bank. At December 31, 2008 and December 31, 2007, we had $14.5 million and $2.4 million outstanding, respectively, in Federal Home Loan Bank borrowings. At December 31, 2008, we had borrowing capacity with the Federal Home Loan Bank of $2.1 million based on our total assets. These borrowings were used to fund loans and purchase investment securities, and were utilized as the interest rates charged on these borrowings were less than those we paid for brokered certificates of deposit during the timeframe. The average amount outstanding during the twelve months ended December 31, 2008 was $8.9 million and the maximum balance outstanding during the period was $14.5 million at an average interest rate of 3.23%. The maximum balance outstanding during the year ended December 31, 2007 was $2.4 million at an interest rate of 3.64%. Refer to “Liquidity” below for further discussion.
Capital Resources
Total shareholders’ equity was $9.6 million at December 31, 2008 a decrease of $91,435 from $9.7 million at December 31, 2007. Common stock increased due to stock compensation expense of $55,023 in 2008. Shareholders’ equity was reduced by our net loss of $60,863 for the year ended December 31, 2008. Unrealized losses on investment securities available for sale decreased shareholders’ equity by $85,595 during 2008.
The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. The Federal Reserve guidelines contain an exemption from the capital requirements for “small bank holding companies”, which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC. Although we file periodic reports with the SEC, we believe that because our stock is not registered under Section 12 of the Securities Exchange Act and is not listed on any exchange or otherwise actively traded, the Federal Reserve Board will interpret its new guidelines to mean that we qualify as a small bank holding company. Nevertheless, our Bank remains subject to these capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Regardless, our Bank is “well capitalized” under these minimum capital requirements as set per bank regulatory agencies.
Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.
At the bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. To be considered “adequately capitalized” under these capital guidelines, we must maintain a minimum total risk-based capital of 8%, with at least 4% being Tier 1 capital. In addition, we must maintain a minimum Tier 1 leverage ratio of at least 4%. To be considered “well-capitalized,” we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%.
The following table sets forth the holding company and the bank capital ratios at December 31, 2008 and 2007. For all periods, the bank was considered “well capitalized”.
We believe that our capital is sufficient to fund the activities of the bank for 2009 and that the rate of asset growth will not negatively impact the capital base. We have no plans for significant capital expenditures in 2009.
As stated previously, we elected to participate in the U.S. Treasury’s Capital Purchase Program under EESA. Because we were required to raise substantially more capital in our initial offering than we could immediately utilize and are still a relatively new enterprise, our capital ratios are significantly above the well-capitalized designation as shown in the table above. While we do not need capital, we believe that given the current economic conditions and the impact on credit risk as well as any future capital needs, it is prudent for us to participate. The maximum amount of capital, for which we were preliminarily approved, was $1,891,000 and we elected to participate in the program by selling Treasury preferred stock for the sum of $1 million.
On February 13, 2009, we entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with Treasury dated February 13, 2009, pursuant to which we issued and sold to Treasury (i) 1,000 shares of the company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and (ii) a ten-year warrant (the “Warrant”) to purchase 50 shares of the company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share (the “Series B Preferred Stock”), at an initial exercise price of $0.01, for an aggregate purchase price of $1,000,000 in cash. The Warrant was immediately exercised.
Cumulative dividends on the Series A Preferred Stock will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter, but will be paid only if, as, and when declared by the company’s board of directors. The Series A Preferred Stock has no maturity date and ranks senior to the company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the company. The Series A Preferred Stock generally is non-voting.
The company may redeem the Series A Preferred Stock at par after February 13, 2012. Prior to this date, the company may redeem the Series A Preferred Stock at par if (i) the company has raised aggregate gross proceeds in one or more Qualified Equity Offerings (as defined in the Purchase Agreement) in excess of approximately $250,000, and (ii) the aggregate redemption price does not exceed the aggregate net proceeds from such Qualified Equity Offerings. Any redemption is subject to the consent of the Board of Governors of the Federal Reserve System. However, pursuant to the terms of the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) the Company may, upon consultation with its primary federal regulator, repay the amount received for the Series A Preferred Stock at any time, without regard to whether the Company has replaced such funds from any source or to any waiting period. Upon repayment of the amount received for the Series A Preferred Stock, the Company may also redeem the Series B Preferred Stock issued pursuant to the Warrant in accordance with Recovery Act and any rules and regulations thereunder.
Immediately following the issuance of the Series A Preferred Stock and the Warrant, the Treasury exercised its rights under the warrant and received 50 shares of Series B Preferred Stock, with a liquidation preference of $50,000. Cumulative dividends on the Series B Preferred Stock will accrue on the liquidation preference at a rate of 9% per annum, but will be paid only if, as, and when declared by the company’s board of directors. The Series B Preferred Stock ranks senior to the company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the company. The Series B Preferred Stock generally is non-voting. Pursuant to the terms of the Recovery Act, the Company may, upon consultation with its primary federal regulator, repay the amount received for the Series B Preferred Stock at any time after redemption of Series A Preferred Stock, without regard to whether the Company has replaced such funds from any source or to any waiting period.
Prior to February 13, 2012, unless we have redeemed the Series A Preferred Stock and the Series B Preferred Stock or the Treasury has transferred the Series A Preferred Stock and the Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to declare or pay any dividend or make any distribution on our common stock. Prior to February 9, 2019, unless we have redeemed the Series A Preferred Stock and the Series B Preferred Stock or the Treasury has transferred all of the Series A Preferred Stock and the Series B Preferred Stock to a third party, the consent of the Treasury will be required for us to redeem, purchase or acquire any shares of our common stock or other equity or capital securities of the company or our subsidiary, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.
The Series A Preferred Stock, the Warrant, and the Series B Preferred Stock were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. Upon the request of Treasury at any time, the company has agreed to promptly enter into a deposit arrangement pursuant to which the Series A Preferred Stock or the Series B Preferred Stock may be deposited and depositary shares, representing fractional shares of Series A Preferred Stock or Series B Preferred Stock, as applicable, may be issued. Neither the Series A Preferred Stock nor the Series B Preferred Stock are subject to any contractual restrictions on transfer.
If we had chosen to participate in the Capital Purchase Program pursuant to the public company terms (as compared to the private company terms which we chose instead), in place of the 50 shares of Series B Preferred Stock the Treasury would have received a warrant to purchase additional common shares at 15% of the senior preferred amount, at the 20-day trailing fair market price of our stock, which at this time is trading below book value.
The Series A and Series B Preferred Stock is treated as Tier 1 capital. Holding company and bank capital ratios at December 31, 2008, adjusted for the issuance of $1 million in Series A Preferred Stock are shown below:
Return on Equity and Assets
The following table shows the return on average assets (net income (loss) divided by average total assets), return on average equity (net income (loss) divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the year ended December 31, 2008 and 2007. Since our inception, we have not paid cash dividends.
Effect of Inflation and Changing Prices
The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with accounting principles generally accepted in the United States of America.
Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. We attempt to manage the relationships between interest-sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.
Off-Balance Sheet Risk
Through the bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our clients at predetermined interest rates for a specified period of time. We evaluate each client’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.
At December 31, 2008, the bank had unfunded commitments to extend credit of approximately $6.0 million through various types of lending arrangements. Included in these commitments were standby letters of credit of $392,736. Fixed rate commitments were $0.1 million and variable rate commitments were $5.9 million. At December 31, 2007, commitments to extend credit amounted to $5.6 million.
Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. A significant portion of the unfunded commitments relate to consumer equity lines of credit and commercial lines of credit. Based on historical experience, we anticipate that a portion of these lines of credit will not be funded.
Except as disclosed in this document, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings.
Liquidity
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
At December 31, 2008, our liquid assets, consisting of cash and due from banks and federal funds sold, amounted to $3,324,498 or approximately 4.0% of total assets. Our investment securities available for sale at December 31, 2008 amounted to $21.1 million or approximately 25.6% of total assets. Unpledged investment securities of $11.0 million at December 31, 2008, traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. At December 31, 2008, $10.1 million of our investment securities were pledged to secure public entity deposits and as collateral for Federal Home Loan Bank borrowings.
Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits. In addition, we will receive cash upon the maturities and sales of loans and maturities, calls and prepayments on investment securities. We maintain federal funds purchased lines of credit with correspondent banks totaling $5.8 million. Availability on these lines of credit was $5.8 million at December 31, 2008. We are a member of the Federal Home Loan Bank, from which applications for borrowings can be made. The Federal Home Loan Bank requires that investment securities or qualifying mortgage loans be pledged to secure borrowings from them. We are also required to purchase stock in a percentage of each advance. There was approximately $2.1 million in borrowing capacity available from the Federal Home Loan Bank based on total assets at December 31, 2008. Federal Home Loan Bank borrowing capacity increases as our quarterly total assets increase and as long as we have sufficient collateral to pledge toward these borrowings. We believe that our existing stable base of core deposits along with continued growth in our deposit base will enable us to successfully meet our long term liquidity needs.
Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.
We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time.
Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.
At December 31, 2008 and December 31, 2007, we were liability-sensitive over a one-year timeframe.
Interest Rate Sensitivity
Asset-liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset-liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our asset-liability management committee monitors and considers methods of managing exposure to interest rate risk. The asset-liability management committee is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits. The following tables set forth information regarding our rate sensitivity, as of December 31, 2008 and 2007 at each of the time intervals. The information in the tables may not be indicative of our rate sensitivity position at other points in time. In addition, the repricing distribution indicated in the tables differs from the contractual maturities of certain interest-earning assets and interest-bearing liabilities presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.
Recently issued accounting standards
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting and/or disclosure of financial information by the company.
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisitions by the company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financials statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date.
SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 was effective for the company on January 1, 2009. SFAS 160 had no impact on the company’s financial position, results of operations or cash flows.
In February 2008, the FASB issued FASB Staff Position No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions,” (“FSP 140-3”). This FSP provides guidance on accounting for a transfer of a financial asset and the transferor’s repurchase financing of the asset. This FSP presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (linked transaction) under SFAS 140. However, if certain criteria are met, the initial transfer and repurchase financing are not evaluated as a linked transaction and are evaluated separately under SFAS 140. FSP 140-3 was effective for the company on January 1, 2009. The adoption of FSP 140-3 had no impact on the company’s financial position, results of operations or cash flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities, thereby improving the transparency of financial reporting. It is intended to enhance the current disclosure framework in SFAS 133 by requiring that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This disclosure is intended to convey the purpose of derivative use in terms of the risks that the entity is intending to manage. SFAS 161 was effective for the company on January 1, 2009 and will result in additional disclosures if the company enters into any material derivative or hedging activities.
In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets,” (“FSP 142-3”). This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”). The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used
to measure the fair value of the asset under SFAS 141(R) and other U.S. generally accepted accounting principles. This FSP was effective for the company on January 1, 2009 and had no material impact on the company’s financial position, results of operations or cash flows.
In May, 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS 162 is effective November 15, 2008. The FASB has stated that it does not expect SFAS 162 will result in a change in current practice. The application of SFAS 162 had no effect on the company’s financial position, results of operations or cash flows.
The SEC’s Office of the Chief Accountant and the staff of the FASB issued press release 2008-234 on September 30, 2008 (“Press Release”) to provide clarifications on fair value accounting. The Press Release includes guidance on the use of management’s internal assumptions and the use of “market” quotes. It also reiterates the factors in SEC Staff Accounting Bulletin (“SAB”) Topic 5M which should be considered when determining other-than-temporary impairment: the length of time and extent to which the market value has been less than cost; financial condition and near-term prospects of the issuer; and the intent and ability of the holder to retain its investment for a period of time sufficient to allow for any anticipated recovery in market value.
On October 10, 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”). This FSP clarifies the application of SFAS No. 157, “Fair Value Measurements” (see Note 1) in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that asset is not active. The FSP is effective upon issuance, including prior periods for which financial statements have not been issued. For the Company, this FSP was effective for the quarter ended September 30, 2008.
The Company considered the guidance in the Press Release and in FSP SFAS 157-3 when conducting its review for other-than-temporary impairment as of December 31, 2008 as discussed in Note 1.
FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EIFT Issue No. 99-20,” (“FSP EITF 99-20-1”) was issued in January 2009. Prior to the Staff Position, other-than-temporary impairment was determined by using either EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets,” (“EITF 99-20”) or SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS 115”) depending on the type of security. EITF 99-20 required the use of market participant assumptions regarding future cash flows regarding the probability of collecting all cash flows previously projected. SFAS 115 determined impairment to be other than temporary if it was probable that the holder would be unable to collect all amounts due according to the contractual terms. To achieve a more consistent determination of other-than-temporary impairment, the Staff Position amends EITF 99-20 to determine any other-than-temporary impairment based on the guidance in SFAS 115, allowing management to use more judgment in determining any other-than-temporary impairment. The Staff Position is effective for interim and annual reporting periods ending after December 15, 2008 and shall be applied prospectively. Retroactive application is not permitted. Management has reviewed the Company’s security portfolio and evaluated the portfolio for any other-than-temporary impairments as discussed in Note 2.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the company’s financial position, results of operations, or cash flows.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data.
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2008 AND DECEMBER 31, 2007
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Loss
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Elliott Davis, LLC
Accountants and Business
Advisors
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
BankGreenville Financial Corporation and Subsidiary
Greenville, South Carolina
We have audited the accompanying consolidated balance sheets of BankGreenville Financial Corporation and Subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive loss, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BankGreenville Financial Corporation and Subsidiary as of December 31, 2008 and 2007 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
We were not engaged to examine management’s assertion about the effectiveness of BankGreenville Financial Corporation and Subsidiary’s internal control over financial reporting as of December 31, 2008 included in the accompanying Management’s Report on Internal Controls Over Financial Reporting and, accordingly, we do not express an opinion thereon.
/s/ Elliott Davis LLC
Greenville, South Carolina
March 11, 2009
BANKGREENVILLE FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
BANKGREENVILLE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
BANKGREENVILLE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
AND COMPREHENSIVE LOSS
For the years ended December 31, 2008 and December 31, 2007
The accompanying notes are an integral part of these financial statements.
BANKGREENVILLE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of this financial statement.
BANKGREENVILLE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES
BankGreenville Financial Corporation (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Bank Holding Company Act, and to own and control all of the capital stock of BankGreenville (the “Bank”). The Bank is a state chartered institution organized under the laws of South Carolina to conduct general banking business in Greenville, South Carolina. From our inception on March 18, 2005 and before opening the Bank for business on January 30, 2006, we engaged in organizational and pre-opening activities necessary to obtain regulatory approvals and to prepare our subsidiary, the Bank, to commence business as a financial institution. The Company sold 1,180,000 shares of its common stock at $10.00 per share and raised $11.8 million in its initial public offering. Proceeds, net of brokerage commissions and other offering costs totaled approximately $11.04 million and the Bank was capitalized with $11 million of the net proceeds. The Bank is primarily engaged in the business of accepting deposits, insured by the FDIC, and providing commercial, consumer and mortgage loans to the general public in Greenville County, South Carolina.
The following is a description of the more significant accounting and reporting policies that the Company follows in preparing and presenting consolidated financial statements.
Basis of presentation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, the Bank. In consolidation, all significant intercompany transactions have been eliminated. The accounting and reporting policies conform to accounting principles generally accepted in the United States of America and to general practices in the banking industry. The Company uses the accrual basis of accounting.
Management’s estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change include the determination of the allowance for losses on loans, including valuation allowances for impaired loans, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and valuation of foreclosed real estate, management obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, changes in local economic conditions as well as a variety of other factors may require additions to the allowance.
In addition, as an integral part of their examination process, regulatory agencies periodically review the Company’s allowances for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for losses on loans and foreclosed real estate may change materially in the near term.
Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
Risks and uncertainties
In the normal course of its business the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default within the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.
The Company is subject to the regulations of various governmental agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to changes with respect to valuation of assets, amount of required loan loss allowance and operating restrictions resulting from the regulators’ judgments based on information available to them at the time of their examinations. The Bank makes loans to individuals and businesses in and around Greenville County, South Carolina for various consumer and commercial purposes. The Bank has a diversified loan portfolio, although approximately 82% of the loan portfolio is comprised of real estate secured loans. Borrowers’ ability to repay their loans is not dependent upon any specific economic sector.
Investment securities
Investment securities are accounted for in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. Management classifies securities at the time of purchase into securities held to maturity, trading securities and securities available for sale. Securities held to maturity are securities which the Company has the positive intent and ability to hold to maturity, and are reported at amortized cost. Trading securities are purchased and held principally for the purpose of selling them in the near future and are reported at fair value with unrealized gains and losses included in earnings. Securities available for sale are securities that may be sold under certain conditions, and are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity as accumulated other comprehensive income (loss). At December 31, 2008 and 2007, the Company’s investment securities were classified available for sale. The amortization of premiums and accretion of discounts on investment securities are recorded as adjustments to interest income. Gains or losses on sales of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Unrealized losses on securities, reflecting a decline in value or impairment judged by the Company to be other than temporary, are charged to earnings in the consolidated statements of operations.
Federal Home Loan Bank stock
The Bank is a member of the Federal Home Loan Bank, and is required to own stock in the Federal Home Loan Bank. The amount of stock owned is determined based on the Bank’s balance of outstanding borrowings. Federal Home Loan Bank stock was $755,900 and $183,000 at December 31, 2008 and 2007, respectively. No ready market or quoted market value exists for this stock. Because redemption of this stock has historically been at par value, the carrying amount is deemed to be a reasonable estimate of fair value.
Loans receivable
Loans are stated at their unpaid principal balance. Interest income is computed using the simple interest method and is recorded in the period earned. Fees earned on loans, if material, are amortized over the life of the loan.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
When serious doubt exists as to the ultimate collection of a loan or when a loan becomes contractually 90 days past due as to principal or interest, interest income is generally discontinued and the loan is placed on non-accrual status unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest. When interest accruals are discontinued, income earned but not collected is reversed and no interest is taken into income until such time as the borrower demonstrates the ability to pay both principal and interest. The Company identifies impaired loans through its normal internal loan review process.
Loans on the Company’s problem loan watch list are considered potentially impaired loans. These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected in accordance with the contractual terms. Loans are not considered impaired if a minimal payment delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected. At December 31, 2008, management has determined that the Company had $1,262,000 in impaired loans.
Allowance for loan losses
An allowance for loan losses is maintained at a level deemed appropriate by management to provide adequately for known and inherent losses in the loan portfolio. The determination of the allowance for loan losses is based on evaluations of the collectibility of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of the overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, historical loan loss experience, and a review of specific problem loans. Management also considers subjective issues such as changes in lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.
The allowance consists of an evaluation of certain individual loans, including impairment determination and a general evaluation of groups of loans with similar risk characteristics. For loans that are considered impaired, an allowance is established when the discounted cash flows or collateral value or observable market price of the impaired loan is lower that the carrying value of the loan. Larger dollar loans with risk characteristics, but not considered impaired are also identified. The general component covers groups of loans with similar risk characteristics and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating individual and general losses in the portfolio.
A loan is considered impaired when, based on current information, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays or payment shortfalls generally are not considered impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis and takes into consideration all of the circumstances surrounding the loan and the borrower.
Due to the Company’s short operating history, the loans in the loan portfolio and the lending relationships are of very recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process known as seasoning. As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because the loan portfolio is new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. Management evaluates current and future anticipated economic conditions which may affect borrowers’ ability to pay and the underlying collateral value of the loans in determining the estimate of the allowance for loan losses. Loans which are deemed to be uncollectible are charged-off and deducted from the allowance. The provision for loan losses and recoveries of loans previously charged-off are added to the allowance.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
Property and equipment
Property and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed by the straight-line method, based on the estimated useful lives for buildings of 40 years and for furniture and equipment of 5 to 10 years. Leasehold improvements are amortized over the life of the lease. The cost of assets sold or otherwise disposed of and the related allowance for depreciation are eliminated from the accounts and the resulting gains or losses are reflected in the statement of operations when incurred. Maintenance and repairs are charged to current expense. The costs of major renewals and improvements are capitalized.
Residential loan origination fees
The Company offers residential loan origination services to its clients. The loans are offered on terms and prices offered by the Company’s correspondents and are closed in the name of the correspondents. The Company receives fees in conjunction with the origination services it provides. The fees are recognized at the time the loans are closed by the Company’s correspondent. The Company does not retain servicing rights.
Income taxes
Income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes”. Under the asset and liability method of SFAS No. 109, 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 the enacted rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce deferred tax assets if it is determined to be more likely than not that all or some portion of the potential deferred tax asset will not be realized.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes,” to clarify the accounting and disclosure for uncertainty in tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. The Company implemented the provisions of FIN 48 as of January 1, 2007, and has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.
Advertising and marketing
Marketing, promotional and other advertising costs generally are expensed when incurred.
Net loss per share
Basic loss per share represents net loss available to shareholders divided by the weighted-average number of common shares outstanding during the period. Potential common shares that may be issued by the Company relate to outstanding stock options and warrants, and are determined using the treasury stock method. For the years ended December 31, 2008 and 2007, the stock options and warrants were not “in-the-money”. The exercise price of the stock options and warrants exceeded the weighted average fair market value of the common stock. The outstanding stock options and warrants were anti-dilutive, and basic and dilutive shares and loss per common share, respectively, were the same.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
Stock compensation plans
Upon completion of the offering, the Company issued stock warrants to the organizing directors for the purchase of three shares of common stock at $10.00 per share for every four shares purchased in the stock offering, up to a maximum of 10,000 warrants per director. The Company issued a total of 107,500 warrants, all of which immediately vested upon completion of the offering. 10,000 of these warrants expired in February 2008, due to the death of one of our organizing directors in 2007. At December 31, 2008, warrants outstanding amounted to 97,500. The average fair value per share of warrants issued amounted to approximately $1.83. The fair value of each warrant granted was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions used for grants: expected volatility of 6%, risk-free interest rate of 4.0%, dividend rate of 0%, and expected lives of five years.
In addition, during 2006, the Company adopted a stock option plan. 212,400 shares are authorized under the plan. The stock options authorized under this plan, vest over a five year period from the date of grant and have a contractual term of ten years. Refer to Note 11 for stock option activity in 2008 and 2007.
On January 1, 2006, the Company adopted the fair value recognition provisions of FASB SFAS No. 123(R), “Accounting for Stock-Based Compensation”, to account for compensation costs under its stock option plan. Previously, stock option plans were accounted for using the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees (as amended)" (“APB 25”). Under the intrinsic value method prescribed by APB 25, the Company would not have recognized compensation cost for stock options because the option exercise price in its plan equals the market price on the date of grant. In adopting SFAS No. 123(R), the Company elected to use the modified prospective method to account for the transition from the intrinsic value method to the fair value recognition method. Under the modified prospective method, compensation cost is recognized from the grant date for all new stock options granted and for any outstanding unvested awards, applying the fair value method to those awards as of the date of grant, and is expensed over the employee’s requisite service period.
Total unrecognized compensation cost related to non-vested options granted as of December 31, 2008 was $107,551, and is expected to be expensed ratably over the remaining vesting periods of the stock options. Net loss, as reported, included stock-based employee compensation expense of $55,023 and $58,107 for the years ended December 31, 2008 and 2007, respectively. The exercise or conversion ratio of all stock options granted was 1:1 and the aggregate intrinsic value of the stock options was zero at December 31, 2008.
There were no stock options granted in 2008. The weighted average fair value per share of options granted in 2007 amounted to $3.10. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants: expected volatility of 4%, risk-free interest rate of 5.01%, dividend rate of 0%, and expected lives of seven and a half years.
The weighted average fair value per share of options granted in 2006 amounted to $2.82. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants: expected volatility of 6%, risk-free interest rate of 4.45%, dividend rate of 0%, and expected lives of seven and a half years.
Statement of cash flows
For purposes of reporting cash flows, cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Reclassifications
Certain amounts previously reported, have been reclassified to state all periods on a comparable basis. These reclassified amounts had no impact on the Company’s retained deficit or net loss.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
Fair Value
Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. SFAS 157 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).
SFAS 157 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. SFAS 157 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
Quoted prices in active markets for identical assets or liabilities. Level 1 assets and
liabilities include debt and equity securities and derivative contracts that are traded in
an active exchange market, as well as U.S. Treasury, other U.S. Government and agency
mortgage-backed debt securities that are highly liquid and are actively traded in
over-the-counter markets.
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 and
derivative contracts 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 derivative contracts and impaired
loans.
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. For
example, this category generally includes certain private equity investments, retained
residual interests in securitizations, residential mortgage servicing rights, and
highly-structured or long-term derivative contracts.
Available for sale investment securities ($21,149,100 at December 31, 2008) are the only assets whose fair values are measured on a recurring basis using Level 1 inputs (active market quotes).
The Company is predominantly a collateral-based lender with real estate serving as collateral on a substantial majority of loans. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair values of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be level 2 inputs. The aggregate carrying amount of impaired loans at December 31, 2008 was $1,262,000.
FASB Staff Position No. 157-2 delays the implementation of SFAS 157 until the first quarter of 2009 with respect to goodwill, other intangible assets, real estate and other assets acquired through foreclosure and other non-financial assets measured at fair value on a nonrecurring basis.
The Company has no assets or liabilities whose fair values are measured using level 3 inputs.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
The Company has no liabilities carried at fair value or measured at fair value on a nonrecurring basis.
Recently issued accounting standards
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting and/or disclosure of financial information by the company.
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisitions by the company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financials statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 was effective for the company on January 1, 2009. SFAS 160 had no impact on the company’s financial position, results of operations or cash flows.
In February 2008, the FASB issued FASB Staff Position No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions,” (“FSP 140-3”). This FSP provides guidance on accounting for a transfer of a financial asset and the transferor’s repurchase financing of the asset. This FSP presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (linked transaction) under SFAS 140. However, if certain criteria are met, the initial transfer and repurchase financing are not evaluated as a linked transaction and are evaluated separately under SFAS 140. FSP 140-3 was effective for the company on January 1, 2009. The adoption of FSP 140-3 had no impact on the company’s financial position, results of operations or cash flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities, thereby improving the transparency of financial reporting. It is intended to enhance the current disclosure framework in SFAS 133 by requiring that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This disclosure is intended to convey the purpose of derivative use in terms of the risks that the entity is intending to manage. SFAS 161 was effective for the company on January 1, 2009 and will result in additional disclosures if the company enters into any material derivative or hedging activities.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets,” (“FSP 142-3”). This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”). The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other U.S. generally accepted accounting principles. This FSP was effective for the company on January 1, 2009 and had no material impact on the company’s financial position, results of operations or cash flows.
In May, 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS 162 is effective November 15, 2008. The FASB has stated that it does not expect SFAS 162 will result in a change in current practice. The application of SFAS 162 had no effect on the company’s financial position, results of operations or cash flows.
The SEC’s Office of the Chief Accountant and the staff of the FASB issued press release 2008-234 on September 30, 2008 (“Press Release”) to provide clarifications on fair value accounting. The Press Release includes guidance on the use of management’s internal assumptions and the use of “market” quotes. It also reiterates the factors in SEC Staff Accounting Bulletin (“SAB”) Topic 5M which should be considered when determining other-than-temporary impairment: the length of time and extent to which the market value has been less than cost; financial condition and near-term prospects of the issuer; and the intent and ability of the holder to retain its investment for a period of time sufficient to allow for any anticipated recovery in market value.
On October 10, 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS 157-3”). This FSP clarifies the application of SFAS No. 157, “Fair Value Measurements” (see Note 1) in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that asset is not active. The FSP is effective upon issuance, including prior periods for which financial statements have not been issued. For the Company, this FSP was effective for the quarter ended September 30, 2008.
The Company considered the guidance in the Press Release and in FSP SFAS 157-3 when conducting its review for other-than-temporary impairment as of December 31, 2008 as discussed in Note 1.
FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EIFT Issue No. 99-20,” (“FSP EITF 99-20-1”) was issued in January 2009. Prior to the Staff Position, other-than-temporary impairment was determined by using either EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets,” (“EITF 99-20”) or SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS 115”) depending on the type of security. EITF 99-20 required the use of market participant assumptions regarding future cash flows regarding the probability of collecting all cash flows previously projected. SFAS 115 determined impairment to be other than temporary if it was probable that the holder would be unable to collect all amounts due according to the contractual terms. To achieve a more consistent determination of other-than-temporary impairment, the Staff Position amends EITF 99-20 to determine any other-than-temporary impairment based on the guidance in SFAS 115, allowing management to use more judgment in determining any other-than-temporary impairment. The Staff Position is effective for interim and annual reporting periods ending after December 15, 2008 and shall be applied prospectively. Retroactive application is not permitted. Management has reviewed the Company’s security portfolio and evaluated the portfolio for any other-than-temporary impairments as discussed in Note 2.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, continued
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the company’s financial position, results of operations, or cash flows.
Note 2 - INVESTMENT SECURITIES
The amortized costs and fair values of investment securities available for sale were as follows at December 31, 2008 and 2007.
The following table shows the gross unrealized losses and fair values, by investment category, and length of time that individual investment securities have been in a continuous unrealized loss position at December 31, 2008.
At December 31, 2008, two corporate bonds, both bank bonds, had been in a continuous loss position for 12 months or more. The unrealized loss on these investment securities was $138,525 at December 31, 2008. Both of these bonds continue to be rated as investment grade by Moody’s and S & P, and the Company believes, based on industry analyst reports and credit ratings that the deterioration in fair value of individual investment securities available for sale is attributed to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature.
The amortized costs and fair values of investment securities available for sale at December 31, 2008, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers have the right to prepay the obligations.
Note 2 - INVESTMENT SECURITIES, continued
Investment securities with market values of approximately $10.1 million and $5.9 million at December 31, 2008 and 2007, respectively, were pledged to secure public deposits and Federal Home Loan Bank borrowings. Gross realized gains on sales and calls of available for sale securities were $78,162 and $3,313 for the years ended December 31, 2008 and 2007, respectively.
NOTE 3 - LOANS
Major loan categories and corresponding amounts outstanding at December 31, 2008 and 2007 were as follows.
At December 31, 2008, the Company had non-accrual loans or loans past-due 90 days or more of $1,224,000 compared to $-0- as of December 31, 2007. At December 31, 2008, forgone interest income, reversed and deducted from interest income, on non-accrual loans was $35,692 compared to $-0- as of December 31, 2007. At December 31, 2008, the Company identified impaired loans of $1,262,000 associated with two borrowing relationships. There were no impaired loans at December 31, 2007. Valuation allowances for credit losses on impaired loans totaled $150,000 and $-0- at December 31, 2008 and 2007, respectively. Interest income on impaired loans and measured on the cash basis, was $36,739 and $11,729 for the years ended December 31, 2008 and 2007, respectively. Average principal balances outstanding on impaired loans totaled $1,195,161 and $152,168 for the years ended December 31, 2008 and 2007, respectively. At December 31, 2008, all non-accrual loans were identified as impaired, and all loans contractually past due 90 days or more were on non-accrual status.
The Bank makes loans to individuals and small to medium sized businesses for various personal and commercial purposes primarily in Greenville County, South Carolina. The Company has a diversified loan portfolio and the portfolio is not dependent on any specific economic segment or industry. The Company regularly monitors credit concentration based on loan purpose, collateral type, industry type and loan amounts outstanding to any one borrower. At December 31, 2008, we had concentrations of credit, generally defined as more than 25% of Tier 1 capital and the allowance for loan losses, in the residential construction and land loan categories.
Directors, executive officers and related parties of these groups are clients of and have transactions with the Bank in the ordinary course of business. Included in these transactions are outstanding loans and commitments, all of which are made under substantially the same credit terms, including interest rates charged and collateral requirements, as those prevailing at the time for comparable transactions with unrelated parties and do not involve more than the normal risk of collectibility. Related party loan activity for the years ended December 31, 2008 and 2007 is shown below. Amounts are approximate.
At December 31, 2008 and 2007, there were commitments to extend credit of approximately $2,111,000 and $501,000, respectively, to related parties.
NOTE 3 - LOANS, continued
The amounts of fixed and variable rate loans included in the loan portfolio at December 31, 2008 and 2007 were as follows:
The allowance for loan losses is available to absorb future loan charge-offs. The allowance is increased by the provision charged to operating income and by recoveries on loans previously charged-off, and is decreased by loans deemed uncollectible and charged-off. The allowance for loan losses at December 31, 2008 and 2007 is shown below.
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation. Components of property and equipment are shown below at December 31, 2008 and 2007.
Depreciation expense for the years ended December 31, 2008 and 2007 was $103,644 and $87,659, respectively.
NOTE 5 - DEPOSITS
The following shows the components of deposit accounts at December 31, 2008 and 2007.
NOTE 5 - DEPOSITS, continued
Interest expense on time deposits greater than $100,000 was $493,796 and $506,769 for the years ended December 31, 2008 and 2007, respectively. Directors, executive officers and their related parties had deposits totaling approximately $6.1 million and $3.1 million with the Bank at December 31, 2008 and 2007, respectively. Public deposits totaled $4,159,351 at December 31, 2008, and $2,553,383 at December 31, 2007, and investment securities were pledged to secure these deposits.
At December 31, 2008, the scheduled maturities of certificates of deposit were as follows.
NOTE 6 - BORROWINGS AND UNUSED LINES OF CREDIT
At December 31, 2008, the bank had short-term lines of credit with correspondent banks to purchase a maximum of $5.8 million in unsecured federal funds on a one to fourteen day basis for general corporate purposes. The interest rate on borrowings under these lines is the prevailing market rate for federal funds purchased. These accommodation lines of credit are renewable annually and may be terminated at any time at the correspondent banks’ sole discretion. The Bank utilized these lines of credit during the year ended December 31, 2008. The average amount outstanding during the year ended December 31, 2008 was $558,000. The highest month-end amount outstanding during the twelve months was $2.2 million and the average interest rate paid on these borrowings was 2.94%. The average amount outstanding during the year ended December 31, 2007 was $1.6 million and the highest month-end amount outstanding during 2007 was $2.7 million. The average interest rate paid on these borrowings during the year was 4.50%. There were no outstanding amounts on these lines of credit as of December 31, 2008 and $1,648,000 was outstanding at December 31, 2007.
We are also a member of the Federal Home Loan Bank. At December 31, 2008 and December 31, 2007, we had $14,455,000 and $2,440,000 outstanding, respectively, in Federal Home Loan Bank borrowings. At December 31, 2008, we had borrowing capacity with the Federal Home Loan Bank of approximately $2.1 million based on a percentage of our total assets. These borrowings were used to fund loans and purchase investment securities, and were utilized as the interest rates charged on these borrowings were less than those we paid for brokered certificates of deposit during the same timeframe. Federal Home Loan Bank borrowings outstanding at December 31, 2008 are shown below.
During 2008, the highest balance outstanding as of any month end was $14.5 million, and the average balance was $8.9 million. The average rate paid on these borrowings in 2008 was 3.23%. During 2007, the highest balance outstanding at any month end was $2.4 million and the average balance was $33,000. The average interest rate paid on these borrowings in 2007 was 3.64%.
NOTE 7 - INCOME TAXES
Income tax expense for the years ended December 31, 2008 and 2007 is summarized as follows:
The gross amounts of deferred tax assets and deferred tax liabilities for the years ended December 31, 2008 and 2007 are as follows:
Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. As of December 31, 2008 and 2007, in consideration of the lack of an established earnings history, management has provided valuation allowances of 100% to reflect its estimate of net realizable value.
A reconciliation between the income tax expense and the amount computed by applying the Federal statutory rate of 34% for 2008 and 2007 to income before income taxes follows:
The Company has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions in accordance with FIN 48.
NOTE 8 - RELATED PARTY TRANSACTIONS
In 2008 and 2007, one of our directors, who is an attorney, prepared employee welfare plan documents for the Company at no cost.
In the ordinary course of business, the Bank transacts loan and deposit business with directors and executive officers as well as their immediate families and business interests. This business with related parties is conducted on substantially the same terms, including interest rates and credit requirements, as those prevailing at the time for comparable transactions with unrelated parties and do not involve more than normal risk. Refer to Notes 3 and 5 for related party loans and deposits, respectively.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
The Bank has entered into an agreement with a core data processing provider to provide item and core processing services. At December 31, 2008, the agreement had a remaining term of thirty-one months. The monthly cost of this service is based on account and activity volumes, but is expected to be no less than $14,000 per month for the remainder of the agreement.
The Board of Directors has approved employment agreements with the president and chief executive officer and the executive vice president and chief financial officer. These agreements include provisions regarding term, compensation, benefits, incentive programs, stock option plans and severance and non-compete provisions.
The Bank may become a party to litigation and claims in the normal course of business. At December 31, 2008, management believes there is no material litigation pending.
NOTE 10 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the ordinary course of business and to meet the financing needs of its clients, the Bank is a party to various financial instruments with off-balance sheet risk. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amount of those instruments reflects the extent of involvement the Bank has in particular classes of financial instruments.
The Bank has made contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to our clients at predetermined interest rates for a specified period of time. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.
At December 31, 2008, the Bank had unfunded commitments to extend credit of approximately $6.0 million through various types of lending arrangements. Included in these commitments were standby letters of credit of $392,736. Fixed rate commitments were $0.1 million and variable rate commitments were $5.9 million. At December 31, 2007, commitments to extend credit amounted to $5.6 million.
NOTE 11 - STOCK COMPENSATION PLANS
On February 14, 2006, the Company adopted a stock option plan for the benefit of officers and employees. The Board of Directors may grant up to 212,400 options at an option price per share not less than the fair market value of the stock on the date of grant. The options granted to officers and employees vest over five years and expire 10 years from the date of grant. A summary of the status of the plan and changes for the years ended December 31, 2008 and 2007 is shown below.
NOTE 11 - STOCK COMPENSATION PLANS, continued
Upon completion of the stock offering, the Company issued warrants to each of its organizing directors to purchase up to an additional total of 107,500 shares of common stock at $10.00 per share. These warrants were immediately vested and exercisable and expire in 2015. 10,000 of these warrants expired unexercised in February 2008 due to the death of one of our organizing directors. No warrants were exercised in 2008 or 2007. At December 31, 2008, 97,500 warrants were outstanding.
NOTE 12 - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material impact on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital.
The Bank is also required to maintain capital at a minimum level based on average assets, which is known as the leverage ratio. Banks are to maintain capital at the minimum requirement of 4%.
As of December 31, 2008, the most recent notification from the Bank’s primary regulator categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events that management believes have changed the Bank’s category since that notification.
The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at December 31, 2008 and 2007.
NOTE 12 - REGULATORY MATTERS, continued
The Federal Reserve Board has similar requirements for bank holding companies. The Company is currently not subject to these requirements because the Federal Reserve guidelines contain an exemption for bank holding companies of less than $500 million in consolidated assets.
NOTE 13 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS, OR ADVANCES
The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. However, certain restrictions exist regarding the ability of the subsidiary to transfer funds to the Company in the form of cash dividends, loans, or advances. As a South Carolina state bank, the Bank may not pay dividends from its capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. Refer to Note 15 for additional restrictions on the payment of dividends.
The bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions, provided that the bank received a composite rating of one or two at the last federal or state regulatory examination. The bank must obtain approval from the South Carolina Board of Financial Institutions prior to the payment of any other cash dividends.
NOTE 14- FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” requires disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. SFAS No. 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or other financial instruments.
NOTE 14- FAIR VALUE OF FINANCIAL INSTRUMENTS, continued
Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, property and equipment and other assets and liabilities.
Fair value approximates carrying value for cash and due from banks and federal funds sold due to the short-term nature of the instrument. Investment securities are valued at fair market values.
Fair value for variable rate loans that reprice frequently and for loans that mature in less than one year is based on the carrying value. Fair value for fixed rate mortgage loans, personal loans and all other loans maturing after one year is based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality.
Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity date is equal to the carrying value. Certificate of deposit accounts with a maturity within one year are valued at their carrying value. The fair value of certificate of deposit accounts with a maturity after one year is estimated by discounting cash flows from expected maturities using current interest rates on similar instruments.
Fair value approximates carrying value for federal funds purchased due to the short term nature of the instrument. Fair value of Federal Home Loan Bank borrowings with a maturity after one year is estimated by discounting cash flows from expected maturities using current interest rates.
The Company has used management’s best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts that could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair value presented.
The carrying amounts and estimated fair values, rounded to the nearest thousand, of the Company’s financial instruments at December 31, 2008 and 2007 were as follows:
NOTE 15- SUBSEQUENT EVENT
In December 2008, the U. S. Department of the Treasury, as part of the Capital Purchase Program established by Treasury under the Emergency Economic Stabilization Act of 2008 (“EESA”), preliminarily approved our application to participate in the Capital Purchase Program in the amount of $1,891,000, which represented the maximum 3% of our risk-weighted assets at September 30, 2008. After considerable evaluation, we elected to participate in the Capital Purchase Program in the amount of $1 million.
NOTE 15- SUBSEQUENT EVENT, continued
On February 13, 2009, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with Treasury dated February 13, 2009, pursuant to which the Company issued and sold to Treasury 1,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and a ten-year warrant (the “Warrant”) to purchase 50 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share at an initial exercise price of $0.01 (the “Series B Preferred Stock”), for an aggregate purchase price of $1million in cash. The Warrant was immediately exercised.
Cumulative dividends on the Series A Preferred Stock accrue at a rate of 5% annually for the first five years and at a rate of 9% annually, thereafter. The Series A Preferred Stock has no maturity date and ranks senior to the Company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Series A Preferred Stock generally is non-voting.
The Company may redeem the Series A and Series B Preferred Stock at par after February 13, 2012. Prior to this date, the Company may redeem the Series A Preferred Stock at par if (i) the Company has raised aggregate gross proceeds in one or more Qualified Equity Offerings in excess of approximately $250,000, and (ii) the aggregate redemption price does not exceed the aggregate net proceeds from such Qualified Equity Offerings. Any redemption is subject to the consent of the Board of Governors of the Federal Reserve System. However, pursuant to the terms of American Recovery and Reinvestment Act of 2009 (the “Recovery Act”), the Company may, upon consultation with its primary federal regulator, repay the amount received for the Series A and Series B Preferred Stock at any time, without regard to whether the Company has replaced such funds from any source or to any waiting period.
Cumulative dividends on the Series B Preferred Stock accrue on the liquidation preference at a rate of 9% annually. The Series B Preferred Stock ranks senior to the Company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Series B Preferred Stock generally is non-voting.
Prior to February 13, 2012, unless we have redeemed the Series A Preferred Stock and the Series B Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock and the Series B Preferred Stock to a third party, the consent of the Treasury Department will be required for us to declare or pay any dividend or make any distribution on our common stock.
The Series A Preferred Stock, the Warrant, and the Series B Preferred Stock were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.
In the Purchase Agreement, the Company agreed that, until such time as Treasury ceases to own any debt or equity securities of the Company acquired pursuant to the Purchase Agreement, the Company will take all necessary action to ensure that its benefit plans with respect to its senior executive officers comply with Section 111 of the EESA as implemented by any guidance or regulation under the EESA that has been issued and is in effect as of the date of issuance of the Series A Preferred Stock, the Warrant, and the Series B Preferred Stock, and has agreed to not adopt any benefit plans with respect to, or which covers, its senior executive officers that do not comply with the EESA.
NOTE 16- PARENT COMPANY FINANCIAL INFORMATION
Following is condensed financial information of BankGreenville Financial Corporation (parent company only):
Condensed Balance Sheets
Condensed Statements of Operations
For the years ended December 31,
Condensed Statements of Cash Flows
For the years ended December 31,
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A(T).
Item 9A(T). Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of December 31, 2008. There have been no significant changes in our internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Management’s Annual Report on Internal Controls Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f). A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2008 based on the criteria established in a report entitled “Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the interpretive guidance issued by the Commission in Release No. 34-55929. Based on this evaluation, the Company’s management has evaluated and concluded that the Company’s internal control over financial reporting was effective as of December 31, 2008.
The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This results in modifications to its processes throughout the Company. However, there has been no change in its internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
Item 9B.
Item 9B. Other Information None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The following sets forth information regarding our executive officers and directors. Our bylaws provide for a classified board of directors, so that, as nearly as possible, one-third of the directors are elected each year to serve three-year terms. The terms of office of the classes of directors expire as follows: Class I at the 2009 annual meeting of shareholders, Class II at the 2010, and Class III at the 2011 annual meeting of shareholders. Our executive officers serve at the discretion of our board of directors.
Jeffrey L. Dezen, 53, Class I director, is president of Jeff Dezen Public Relations, a marketing and communications consulting firm in Greenville, South Carolina which provides public relations counsel to a diverse group of national and regional corporations. Mr. Dezen’s experience includes sports and manufacturing sectors, professional services, the health care, not-for-profit and hospitality markets, as well as retail and business-to-business channels. He earned a B.A. from Dickinson College and a Masters degree in English at Pennsylvania State University. In addition to having held faculty positions at several universities, including Clemson University and Frostburg State University, Mr. Dezen serves on the board of directors of The Alliance for Quality Education, Senior Action and the Greenville Technical College Marketing Advisory board. He is past-president of Greenville High School’s Parent-Teacher Association. Mr. Dezen has been a Greenville resident since 1985.
Roger H. Gower, 57, Class I director, is a fifth generation native Greenvillian who returned to Greenville to join Greenville Ob-Gyn Associates in 1982 after graduating from Emory University with a B.A. in chemistry in 1973 and a medical degree from the Medical University of South Carolina in 1977. Dr. Gower was certified by the American College of Ob-Gyn in 1982 and has been annually recertified since 1999. He has been active in medical staff services with the Greenville Hospital System as chairman of planning, medical staff president and chairman of credentialing, as well as serving on the boards of the Greenville Health Corporation and the Physician Hospital Organization. Professionally, he is a fellow of the American College of Ob-Gyn, a member of the American Medical Association, South Carolina and Greenville County medical societies and the South Atlantic Society of Ob-Gyn. He serves as the physician manager of Greenville Ob-Gyn Associates, an eight-doctor group. In the
community, he has been involved with the Rotary Club, Westminster Presbyterian Church, the United Way, the American Red Cross and the Greenville County Historical Society, serving on the latter two boards.
Frank B. Halter, Jr., 53, Class I director, a third-generation Greenvillian and Realtor, has served as president of Coldwell Banker Caine Residential, a real estate brokerage company, since 1999. He manages that company’s residential, relocation and property management and new homes groups. Mr. Halter received his B.S. in finance from the University of South Carolina and has earned the Graduate Realtors Institute and the Certified Real Estate Broker designations from the National Association of Realtors. Mr. Halter is a member of the South Carolina Association of Realtors board of directors, and is president of the Greenville Downtown Business Association. He is a member of the City Board of Zoning Appeals, of the Greater Greenville Chamber of Commerce Board of Governors and a director of the Greenville Convention and Visitor’s Bureau (CVB). He also serves on the Greenville Hospital System Advisory Board. Mr. Halter is a past director of the Greater Greenville Association of Realtors, past president of the Association’s Multiple Listing Service, and past chairman of the Association’s Professional Standards Committee.
R. Bruce Harman, 54, Class II director and Audit Committee Chairman, has been employed in various positions since 1986 with R. L. Kunz, Inc., a manufacturer’s representative for industrial and commercial air handling equipment, and has served as president of the company since 2001. Mr. Harman is also a shareholder in the company and is corporate secretary. He attended Clemson University on a basketball scholarship and graduated in 1976 with a B.S. degree in administrative management. In 1979, Mr. Harman obtained an M.B.A. degree in management and marketing from Concordia University in Montreal, Quebec. Since 1986, Mr. Harman has been a licensed certified public accountant in the state of South Carolina and is a member of the American Institute of Certified Public Accountants and the South Carolina Association of Certified Public Accountants.
Arthur L. Howson, Jr., 57, Class II director and chairman of our board, is a shareholder of Gallivan, White & Boyd, P.A., where he has practiced since 1981, specializing in real estate, banking, and corporate law. He is a member of the South Carolina Bar, the Greenville County Bar, and the American Bar Association, and is listed in the book The Best Lawyers in America in the field of Real Estate Law. Mr. Howson received an A.B. degree in History from the University of North Carolina at Chapel Hill in 1973 and a J.D. degree from the University of South Carolina School of Law in 1976. While in law school, Mr. Howson was a member of the Order of Wig and Robe. He was admitted to practice law in the State of South Carolina in 1976. Mr. Howson has been active in the community through business, civic, and church activities. He has served as president of Senior Action, Inc., the Greenville Chorale, and Greenville Friends of the Zoo and has served as a member of the board of directors of Gateway House, Inc. He is a member of Westminster Presbyterian Church, where he has served as an elder and has sung in the Sanctuary Choir since 1981. He is also a member of the Real Estate Economic Development Committee of the Greenville Chamber of Commerce.
Paula S. King, CPA, 49, Class II director, is our executive vice president and chief financial officer. Ms. King, a Greenville native, began her career in the financial services industry in 1986 as vice president of Shelter Mortgage and Investment Company, a commercial mortgage loan brokerage firm. She began her banking career in 1992 as senior vice president and controller of Greenville National Bank and served in that capacity until the bank’s acquisition by Regions Bank in 1999. In 1999, Ms. King became the senior vice president and chief financial officer of New Commerce Bank, serving in this role from the bank’s start-up until 2002. From 2002 until 2003, Ms. King was a consultant for de novo banks, providing board and senior management training, and was employed in the banking group of Elliott Davis, LLC from 2004 until she began organizing efforts for our bank in February 2005. Ms. King is a 1982 graduate of Furman University with a B.A. in accounting and business administration and is a member of the South Carolina Association of Certified Public Accountants and American Institute of CPAs. She has attended the AICPA National Banking School at the University of Virginia. Ms. King serves on the South Carolina Bankers Association’s Community Bankers Council and is a past chairman of the SCBA Operations committee. She serves on the Greenville United Way Youth Evaluation Team and the Palmetto Society Women’s Leadership Council.
Jonathan T. McClure, 49, Class III director, is a Greenville native and founder and president of ISO Poly Films, Inc., a plastic films provider, founded in 1998 and located in Gray Court, South Carolina. Mr. McClure attended Liberty University from 1979 to 1981 and received his B.S. degree in business administration in 1983 from the University of South Carolina Upstate. In 2001 and 2002, Mr. McClure was named Ernst & Young’s South
Carolina Entrepreneur of the Year and in 2002 was elected to the E&Y Entrepreneur Hall of Fame. Mr. McClure’s company was recognized by Entrepreneur Magazine and Dun & Bradstreet as one of the “Hot 100” Small Businesses in the United States from 1999 to 2001. In 2002, then-Governor Jim Hodges named Mr. McClure as an economic ambassador for South Carolina. Mr. McClure received the Silver Crescent Award for Manufacturing Excellence & Manufacturer of the Year in 2003 and his company was named one of the “Top 25 Fastest Growing Companies” in South Carolina in 2002. He has made numerous presentations to the Darla Moore School of Business of the University of South Carolina, the Clemson University School of Business, and the Kenan-Flagler Business School at the University of North Carolina. Mr. McClure currently serves on boards of the Boys Home of the South, and Flexible Packaging Association.
David A. Merline, Jr., 50, Class III director, is a shareholder and the president of Merline & Meacham, P.A. where he has practiced law since 1984. He is a certified specialist in the fields of both taxation law and estate planning/probate law by the Supreme Court of South Carolina. He is listed in the book The Best Lawyers in America in the following four fields: corporate law, employee benefits law, taxation law, and trusts and estates law. Mr. Merline received his B.A. degree, magna cum laude, from Furman University, his J.D. degree from the University of South Carolina School of Law, and his Master of Laws In Taxation degree from the University of Miami School of Law. He is a Fellow of the American College of Trust and Estate Counsel. He is a past chairman of the South Carolina Estate Planning and Probate Law Specialization Advisory Board and a past member of the board of directors of the University of South Carolina Law School Association. He is a past president of the Greenville County Taxation, Estate Planning, Probate and Trust Law Section, and the Greenville Young Lawyers Association. Mr. Merline is the author of numerous articles and co-author of two books: South Carolina Limited Liability Companies & Limited Liability Partnerships, South Carolina Bar CLE Division (3d Ed. 2000), and South Carolina Corporate Practice Manual, South Carolina Bar CLE Division (2d Ed. 2005). He is a member of Buncombe Street United Methodist Church and the Rotary Club of Greenville.
William H. Pelham, 54, Class III director, is a Greenville native who has been the owner and president of Pelham Architects, L.L.C. since its founding in 1983. The architectural firm specializes in residential projects, including new houses, renovations and additions, and historic preservation. Mr. Pelham, a registered architect, graduated from Clemson University in 1977 with a B.A. degree in pre-architecture and in 1981 with a masters degree in architecture. Mr. Pelham is a partner in RPM Partnership LLP, a downtown property owner, and on the board of directors of Central Realty Corporation, Central Associates, LP, and CI, Inc. Mr. Pelham has served as chair of the Christ Church Episcopal School (CCES) Annual Fund and as president of the Board of Governors of the Poinsett Club. Currently he is on the City of Greenville’s Art in Public Places Commission, chairs its master arts plan committee, and chairs the CCES Master Facilities Plan Committee. His involvement with the Warehouse Theatre includes serving as president and as chair of the executive director search and building committees, and as a board member for over fifteen years. Mr. Pelham is a member of AIA Greenville, SC/AIA, the American Institute of Architects, the National Trust for Historic Preservation, Upstate Forever, the Greater Greenville Chamber of Commerce, the Better Business Bureau, and Buncombe Street United Methodist Church.
J. Matthew Shouse, 40, Class II director, has been employed by Lazarus-Shouse Communities, a residential development and home building company with operations in the Upstate area, since 2000 and recently became co-owner of Lazarus-Shouse Homes, focusing solely on single-family residential construction. A lifelong resident of Greenville, Mr. Shouse earned a B.A. in Business Economics from Wofford College in 1991 and was involved with convenience store operations, container sales and commercial real estate prior to joining the development/building industry. He is an active member of The Rotary Club of Greenville, past chairman of the Club’s Roper Mountain Holiday Lights and of the Rotary Family Literacy Center at the YWCA project, and past president of the Club. He is also a past member of the boards of directors of The Roper Mountain Science Center Association and the YMCA Camp Greenville. Mr. Shouse currently serves as a member of The Rotary Club of Greenville board of directors and as secretary of the Rotary Charities, Inc. board of directors. Mr. Shouse is a member of Buncombe Street United Methodist Church board of stewards and past co-chair of its recent capital campaign that raised money for debt reduction and funding assistance for the Triune Mercy Center.
Russel T. Williams, 48, Class III director, is our president and chief executive officer. From 2001 to 2005 Mr. Williams served as senior vice president, Commercial Lending with Palmetto Bank, a $900 million Upstate-based community bank. Mr. Williams began his career with The C&S National Bank of South Carolina in 1985 and has served in positions of increasing responsibility in the commercial lending and credit administration areas of
several other South Carolina financial institutions. His background includes service as a commercial lender with Carolina First, Greenville Area Executive with NBSC, and chief credit officer with New Commerce Bank. Mr. Williams also has five years of experience as a senior lender and manager in the government guaranteed small business lending industry. Mr. Williams is a 1983 graduate of Davidson College, a 1985 graduate of the University of Tennessee M.B.A. program, and a 1992 graduate “with honors” from the American Banker’s Association Stonier Graduate School of Banking. He is a graduate of Leadership Greenville Class XVIII. Mr. Williams serves on the Greenville United Way Impact Council for Financial Stability. He has served as past board president of The Juvenile Diabetes Research Foundation-Upstate South Carolina Chapter and the Speech, Hearing and Learning Center, and is a past member of the board of the Internal Medicine Associates Patient Care Center. Mr. Williams has been active in the South Carolina Bankers Association, having served as a board member of the SCBA Young Bankers Division and a member of the SCBA Credit Committee. Mr. Williams has been a Greenville resident since 1985.
Audit Committee
The company’s board of directors has appointed a number of committees, including audit, compensation, corporate governance and nominating, and asset-liability committees. Information about the audit committee is provided in this section. See the discussion under Item 13 below for information on the other committees.
The audit committee is composed of Mr. Harman, Mr. McClure, Mr. Merline and Mr. Pelham. Each of these members is considered “independent” under Rule 4350 of the National Association of Securities Dealers’ listing standards. The audit committee met four times in 2008.
The Board of Directors has determined that Mr. Harman is an “audit committee financial expert” as defined in Item 407(d)(5)(ii) of the SEC’s Regulation S-K. Mr. Harman is “independent” as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934. Additionally, the board has determined that each member is fully qualified to monitor the performance of management, the public disclosures by the company of its financial condition and performance, our internal accounting operations, and our independent auditors.
The audit committee functions are set forth in its charter, which was adopted on February 14, 2006. A copy of the audit charter is available on our website. The audit committee has the responsibility for reviewing financial statements, evaluating internal accounting controls, reviewing reports of regulatory authorities, and determining that all audits and examinations required by law are performed. The committee recommends to the board the appointment of the independent auditors for the next fiscal year, reviews and approves the auditor’s audit plans, and reviews with the independent auditors the results of the audit and management’s responses. The audit committee is responsible for overseeing the entire audit function and appraising the effectiveness of internal and external audit efforts. The audit committee reports its findings to the board of directors.
Our board of directors has implemented a process for shareholders of the company to send communications to the board. Each of our directors may receive mail at our principal office location. Any shareholder desiring to communicate with the board, or with specific individual directors, may do so by writing to the board or board member at BankGreenville Financial Corporation, P. O. Box 6246, Greenville, South Carolina 29606.
We do not have a class of securities registered under Section 12 of the Securities Exchange Act of 1934. Therefore, our directors, executive officers, promoters and control persons are not required to comply with Section 16(a) of the Exchange Act.
Code of Ethics
We have adopted a Code of Ethics that applies to our directors, principal executive officer, principal financial officer, principal accounting officer or controller, persons performing similar functions and all other employees. The Code of Ethics is available without charge to shareholders upon request. Shareholders may contact Ms. Paula S. King, BankGreenville Financial Corporation, P. O. Box 6246, Greenville, South Carolina 29606, to obtain a copy.
Item 11.
Item 11. Executive Compensation
The following table shows compensation associated with our two executive officers for the years ended December 31, 2008 and 2007.
Summary Compensation Table
(1)
On February 14, 2006, each of our named executive officers was granted stock options for 47,200
shares of common stock exercisable at $10.00 per share. The options vest at 20% per year over
a five-year vesting period and must be exercised within ten years from the grant date. This
amount is an assumed value for share-based compensation associated with these stock options
under accounting rules and does not represent current cash compensation to the executive. The
actual realization of cash from the award may depend on whether our stock price appreciates
above its price at the date of grant and whether the executive continues his or her employment
with us. The assumed value above was determined at the date of grant in 2006. Refer to Note 1,
"Stock compensation plans" in the Notes to Consolidated Financial Statements for a discussion
of the assumptions used in the valuation of the option awards.
(2) All other compensation includes car allowances, club dues (for Mr. Williams), and insurance
premiums for life, health, accident and long-term disability policies. The amount attributable
to each such perquisite or benefit for each named executive officer does not exceed the greater
of $25,000 or ten percent of the total amount of perquisites received by such named executive
officer.
Note: Although employment agreements include provisions for bonus plans for each named executive officer, to date a plan has not been formalized and no bonuses have been paid. The Company currently does not provide a 401(K) match and there are no retirement benefit plans for named executive officers.
Employment Agreements
Russel T. Williams. On November 10, 2008, we entered into an employment agreement with Mr. Williams, under which he agreed to serve as chief executive officer of BankGreenville Financial Corporation and BankGreenville for a term of one year. Mr. Williams’ employment with the company will be automatically extended for additional terms of one year each unless the company delivers a notice of termination at least six months prior to the end of the term. During this term, Mr. Williams is entitled to:
• Base salary of $140,000 per year. The board (or an appropriate committee of the board) shall review the executive’s performance and salary at least annually and may increase, but not decrease, his salary;
• An annual cash bonus of up to 45% of his annual salary based on achievement of overall bank financial performance benchmarks, which will be established by the board of directors annually. The board will consider
factors such as comparison to peer data, actual to projected performance, and other measurements as deemed appropriate from time to time;
• Participation in the Company’s long-term equity incentive program. On February 14, 2006, he was granted options to purchase 47,200 shares of common stock. The award agreement for the stock option provides that one-fifth of the shares subject to the option will vest on each of the first five anniversaries of the opening date of the bank, but only if the executive remains employed by the company or one of its subsidiaries on such date, and shall contain other customary terms and conditions. These options are a portion of the options available for issuance under the company’s stock incentive plan.
• Reasonable car allowance not to exceed $700 per month;
• Participation in our retirement, welfare, and other benefit programs;
• Payment of club dues and related assessments; and
• Reimbursement for travel and business expenses.
Pursuant to the terms of his employment agreement, Mr. Williams is prohibited from disclosing our trade secrets or confidential information. If we terminate Mr. Williams’ employment without cause, he will be entitled to severance equal to 12 months of his then base salary. In addition, following a change in control, regardless of whether Mr. Williams remains employed by the Employer or its successor, he will be entitled to severance equal to 36 months of his then base salary. Finally, during his employment and for a period of 12 months thereafter, Mr. Williams may not, subject to limited exceptions, (a) compete with us by forming, serving as an organizer, director, or officer of, or acquiring or maintaining an ownership interest in, a depository financial institution or holding company of a depository financial institution, if the depository institution or holding company has one or more offices or branches within our territory, (b) solicit our clients for a competing business, or (c) solicit our employees for a competing business.
Paula S. King. On November 10, 2008, we also entered into an employment agreement with Ms. King to serve as the chief financial officer of BankGreenville Financial Corporation and BankGreenville for a term of one year. Ms. King’s employment with the company will be automatically extended for additional terms of one year each unless the company delivers a notice of termination at least six months prior to the end of the term. During this term, Ms. King is entitled to:
• Base salary of $136,000 per year. The board (or an appropriate committee of the board) shall review the executive’s performance and salary at least annually and may increase, but not decrease, her salary;
• An annual cash bonus of up to 45% of her annual salary based on achievement of overall bank financial performance benchmarks, which will be established by the board of directors annually. The board will consider factors such as comparison to peer data, actual to projected performance, and other measurements as deemed appropriate from time to time;
• Participation in the Company’s long-term equity incentive program. On February 14, 2006, she was granted options to purchase 47,200 shares of common stock. The award agreement for the stock option provides that one-fifth of the shares subject to the option will vest on each of the first five anniversaries of the opening date of the bank, but only if the executive remains employed by the company or one of its subsidiaries on such date, and shall contain other customary terms and conditions. These options are a portion of the options available for issuance under the company’s stock incentive plan.
• Reasonable car allowance not to exceed $500 per month;
• Participation in our retirement, welfare, and other benefit programs;
• Payment of professional dues and continuing professional education costs associated with her CPA designation; and
• Reimbursement for travel and business expenses.
Pursuant to the terms of her employment agreement, Ms. King is prohibited from disclosing our trade secrets or confidential information. If we terminate Ms. King’s employment without cause, she will be entitled to severance equal to 12 months of her then base salary. In addition, following a change in control, regardless of whether Ms. King remains employed by the Employer or its successor, she will be entitled to severance equal to 36 months of his then base salary. Finally, during her employment and for a period of 12 months thereafter, Ms. King may not, subject to limited exceptions, (a) compete with us by forming, serving as an organizer, director, or officer of, or acquiring or maintaining an ownership interest in, a depository financial institution or holding company of a
depository financial institution, if the depository institution or holding company has one or more offices or branches within our territory, (b) solicit our clients for a competing business, or (c) solicit our employees for a competing business.
On February 13, 2009, Mr. Williams and Ms. King executed written agreements contain provisions for compliance with the U.S. Treasury’s Capital Purchase Program as part of the Emergency Economic Stabilization Act of 2008. Under these agreements, both executives agree to such amendments, agreements or waivers required by the U.S. Treasury to comply with the terms of the Program.
Outstanding Equity Awards at Fiscal Year-End
Option awards:
There were no stock awards granted as of December 31, 2008, so corresponding table headings have been omitted. All options were granted on February 14, 2006, vest at 20% per year over a five-year vesting period and expire ten years from the date of grant.
Our bylaws permit our directors to receive reasonable compensation as determined by a resolution of the board of directors. We did not pay any directors’ fees during the fiscal year ended December 31, 2008 and 2007, so the corresponding table has been omitted. However, we may, pursuant to our bylaws, begin to compensate our directors at some time in the future.
In December 2005, each of our organizers, all of whom also serve as directors, received for no additional consideration, a warrant to purchase three shares of common stock for $10.00 per share for every four shares they purchased in the offering, up to a maximum of 10,000 shares per organizer. These warrants vested immediately upon the closing of the offering in December 2005, as they were issued in recognition of the financial risk and efforts undertaken by the organizers in organizing the bank. Therefore, no compensation related to stock warrants is shown for 2008. The warrants are represented by separate warrant agreements and they are exercisable in whole or in part during the 10 year period following that date. If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the bank to obtain additional capital, the warrants will be forfeited if not immediately exercised.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table shows how much common stock in our company is owned by the directors, certain executive officers, and owners of more than 5% of the outstanding common stock, as of March 10, 2009. Unless otherwise indicated, the address of each beneficial owner is c/o BankGreenville Financial Corporation, P. O. Box 6246, Greenville, South Carolina 29606.
____________
*Indicates less than 1% ownership.
(1)
Includes shares for which the named person has sole voting and investment power, has shared
voting and investment power, or holds in an IRA or other retirement plan program, unless
otherwise indicated in these footnotes.
(2) Includes shares that may be acquired within the next 60 days of March 10, 2009 by exercising
vested stock options or warrants but does not include any unvested stock options or warrants.
(3) For each individual, this percentage is determined by assuming the named person exercises all
options and warrants which he or she has the right to acquire within 60 days, but that no other
persons exercise any options or warrants. For the directors and executive officers as a group,
this percentage is determined by assuming that each director and executive officer exercises
all options or warrants which he or she has the right to acquire within 60 days, but that no
other persons exercise any options. The calculations are based on 1,180,000 shares of common
stock outstanding on March 10, 2009.
(4) Mr. Halter has 10,000 shares of stock pledged as security on indebtedness to another bank.
(5) Mr. Howson has 13,500 shares of stock pledged as security on indebtedness to another bank.
(6) Ms. King has 10,300 shares of stock pledged as security on indebtedness to another bank.
(7) Mr. Williams has 12,500 shares of stock pledged as security on indebtedness to another bank.
The following table sets forth equity compensation plan information at December 31, 2008.
Equity Compensation Plan Information
Each of our organizing directors received, for no additional consideration, a warrant to purchase three shares of common stock for each four shares purchased in our initial public offering, up to a maximum of 10,000 shares, at a price of $10.00 per share. The warrants are represented by separate warrant agreements. All warrants vested immediately upon closing of the offering, and are exercisable in whole or in part during the ten-year period following this date. The warrants may not be assigned, pledged, or hypothecated in any way. The 107,500 shares issued pursuant to the warrant agreements are transferable, subject to compliance with applicable securities laws. If the South Carolina Board of Financial Institutions or the FDIC issues a capital directive or other order requiring the bank to obtain additional capital, the warrants will be forfeited if not immediately exercised. In February 2008, 10,000 warrants expired due to the death of one of our organizing directors. Warrants outstanding have been adjusted to 97,500.
On February 14, 2006, our board adopted a stock incentive plan and authorized the issuance of 212,400 shares under the stock incentive plan. We also authorized and issued stock options to several employees at $10.00 per share in 2006 and 2007. The stock incentive plan was approved by our shareholders at our 2006 annual meeting and is a qualified stock incentive plan. All of the options we have issued to date have a ten year exercise period and a five year vesting period. We will not issue stock options at less than the fair market value of the common stock on the date of grant.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
We enter into banking and other transactions in the ordinary course of business with our directors and officers and their affiliates. It is our policy that these transactions be on substantially the same terms (including price, or interest rates and collateral) as those prevailing at the time for comparable transactions with unrelated parties. We do not believe that these transactions involve more than the normal risk of collectibility nor present other unfavorable features to us. Loans to individual directors and officers must also comply with our bank’s lending policies and statutory lending limits, and directors with a personal interest in any loan application are excluded from the consideration of the loan application. All of our transactions with our affiliates are on terms no less favorable to us than could be obtained from an unaffiliated third party and to be approved by a majority of disinterested directors.
One of our directors, who is an attorney, has prepared employee welfare plan documents for us in 2008 and 2007. There have been no costs associated with these services.
Our board of directors has determined that, with the exception of Mr. Williams and Ms. King, who also serve as executive officers of the company, all of our directors are considered “independent” directors, based upon the independence criteria set forth in the corporate governance listing standards of The NASDAQ Stock Market, the exchange that we selected in order to determine whether its directors and committee members meet the independence criteria of a national securities exchange, as required by Item 407(a) of Regulation S-K.
Our board of directors has created an audit committee, a nominating committee and a compensation committee of the board. The members of each of these committees are “independent” as contemplated in the listing standards of The NASDAQ Stock Market.
Our compensation committee is composed of Mr. Dezen, Mr. Gower, Mr. McClure, and Mr. Merline. The compensation committee has the responsibility of annually reviewing the performance of our executive officers and approving the specific compensation for all executive officers. The company does not use a third party consultant to assist in determining or recommending the amount or form of executive officer compensation, but does receive input on compensation amounts from its executive officers. The committee is also responsible for reviewing all benefit plans initially as well as any significant changes to our benefit plans.
The corporate governance and nominating committee includes Mr. Gower, Mr. Halter, Mr. Howson and Mr. Merline. This committee considers whether to recommend to the Board the nomination of those directors for re-election for another term of service. The nominating committee also considers whether to recommend to the Board the nomination of persons to serve as directors whose nominations have been recommended by shareholders.
Any shareholder may recommend the nomination of any person to serve on the Board. Our bylaws require a shareholder to submit the name of the person to our secretary in writing no later than (i) with respect to an election to be held at an annual meeting of shareholders, 90 days in advance of such meeting; and (ii) with respect to an election to be held at a special meeting of shareholders for the election of directors, no more than seven days after notice of the special meeting is given to shareholders. Each notice must set forth: (i) the name and address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (ii) a representation that the shareholder is a holder of record of stock of the company entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (iii) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (iv) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to these proxy rules of the Securities and Exchange Commission, had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (v) the consent of each nominee to serve as a director of the company if so elected. The chairman of the meeting may refuse to acknowledge the nomination of any person not made in compliance with the foregoing procedure.
The nominating committee considers a number of factors in determining whether to recommend to the Board the nomination of any person for election as a director. While no single factor is determinative, the committee considers skills and business background, ability to devote the requisite time to service, reputation in the community, character and integrity, and actual and potential conflicts of interest.
In addition to the above factors, in determining whether to nominate any person for election by the shareholders, the Board assesses the appropriate size of the Board of Directors, consistent with the bylaws of the company, and whether any vacancies on the Board are expected due to retirement or otherwise. If vacancies are anticipated, or otherwise arise, the Board will consider various potential candidates for director recommended by the nominating committee. Candidates may come to the attention of the nominating committee or Board through a variety of sources including, but not limited to, current members of the Board, shareholders, or other persons. The nominating committee and Board of Directors consider properly submitted recommendations by shareholders who are not directors, officers, or employees of the company on the same basis as candidates recommended by any other person.
The company does not pay a third party to assist in identifying and evaluating candidates.
The asset-liability committee is composed of Mr. Gower, Mr. Harman, Mr. Howson, Ms. King, Mr. Shouse, and Mr. Williams. The asset-liability committee met four times in 2008. The asset-liability committee has the responsibility of reviewing the asset-liability management policy, investment policy, and the bank’s asset/liability structure.
Item 14.
Item 14. Principal Accountant Fees and Services
Elliott Davis, LLC was our auditor during the fiscal years ended December 31, 2008 and 2007. The following table shows the fees that we incurred for services performed in fiscal year ended December 31, 2008 and 2007.
Audit Fees. This category includes the aggregate fees billed or accrued for professional services rendered by the independent auditors during the company’s 2008 and 2007 fiscal years for the audits of our annual financial statements in 2008 and 2007 and reports on Form 10-Q in 2008 and 10-QSB in 2007.
Tax Fees. This category includes the aggregate fees billed for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning.
Oversight of Accountants; Approval of Accounting Fees. Under the provisions of its charter, the audit committee is responsible for the retention, compensation, and oversight of the work of the independent auditors. The charter provides that the audit committee must pre-approve the fees paid for the audit. The policy specifically prohibits certain non-audit services that are prohibited by securities laws from being provided by an independent auditor. All of the accounting services and fees reflected in the table above were reviewed and approved by the audit committee, and none of the services were performed by individuals who were not employees of the independent auditor.
Supplemental Information to be Furnished with Reports Filed Pursuant to Section 15(d) of the Exchange Act by Non-Reporting Issuers
We will furnish our proxy materials and audited financial statements to security holders subsequent to the filing of the annual report on this Form 10-K, and will furnish copies of such materials to the SEC when they are sent to security holders.
Item 15.
Item 15. Exhibits.
(a)(1) Financial Statements
The following consolidated financial statements are located in Item 8 of this report.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Operations for the years ended December 31, 2008 and 2007
Consolidated Statements of Cash Flows for the years ended December 31, 2008 and 2007
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Loss for the years ended
December 31, 2008 and 2007
Notes to the Consolidated Financial Statements
(2) Financial Statement Schedules
These schedules have been omitted because they are not required, are not applicable or have been
included in our consolidated financial statements.
(3) Exhibits
The following exhibits are required to be filed with this Report on Form 10-K by Item 601 of Regulation S-K.
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*Management contract of compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-K.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BANKGREENVILLE FINANCIAL CORPORATION
Date: March 23, 2009
By: /s/ Russel T. Williams
Russel T. Williams
President and Chief Executive Officer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Russel T. Williams, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Exhibit Index
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*Management contract of compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-K.