ITEM 1 - BUSINESS
General
New Century Bancorp, Inc. (the “Registrant”) was incorporated under the laws of the State of North Carolina on May 14, 2003, at the direction of the Board of Directors of New Century Bank, for the purpose of serving as the bank holding company for New Century Bank and became the holding company for New Century Bank on September 19, 2003. To become New Century Bank’s holding company, the Registrant received the approval of the Federal Reserve Board as well as New Century Bank’s shareholders. Upon receiving such approval, each share of $5.00 par value common stock of New Century Bank was exchanged on a one-for-one basis for one share of $1.00 par value common stock of the Registrant.
The Registrant operates for the primary purpose of serving as the holding company for its subsidiary depository institution, New Century Bank (the “Bank”). The Registrant’s headquarters is located at 700 West Cumberland Street, Dunn, North Carolina 28334.
New Century Bank was incorporated on May 19, 2000 as a North Carolina-chartered commercial bank, opened for business on May 24, 2000, and is located at 700 West Cumberland Street, Dunn, North Carolina.
The Board of Directors of New Century Bancorp as well as the boards of directors of New Century Bank and New Century Bank South, voted to merge the two banks in early 2008. The merger was completed on March 28, 2008. The merged bank is called New Century Bank and the headquarters and operations center of the merged bank are in Dunn, North Carolina. A 15-member holding company board also serves as the board of directors of the Bank, includes current directors from both banks.
New Century Bank South was incorporated on December 23, 2003 as a North Carolina-chartered commercial bank and opened for business on January 2, 2004. New Century Bank and New Century Bank South merged on March 28, 2008. The combined bank, New Century Bank, is the remaining bank subsidiary of New Century Bancorp.
The combined Bank operates for the primary purpose of serving the banking needs of individuals and small to medium-sized businesses in its market area. The Bank offers a range of banking services including checking and savings accounts, commercial, consumer, mortgage and personal loans, and other associated financial services.
Primary Market Area
The Registrant’s market area consists of southeastern North Carolina. The Registrant’s market area has a population of over 920,000 with an average household income of over $40,600.
The June 2008 total deposits in the Registrant’s market area exceeded $7.6 billion. The leading economic components of Harnett and Johnston Counties are services, manufacturing, and retail trade. In contrast, Cumberland County’s leading sector is federal government and military, followed by services and retail trade. In Sampson County, leading sectors include manufacturing, services, and state and local government. Wayne County’s leading sectors are federal government and military services, retail trade and agriculture. The largest employers in the Registrant’s market area include Kelly-Springfield Tires, Black & Decker, Bayer, Morganite, Inc. and the United States military.
- 4 -
Competition
Commercial banking in North Carolina is extremely competitive in large part due to statewide branching. Registrant competes in its market areas with some of the largest banking organizations in the state and the country and other financial institutions, such as federally and state-chartered savings and loan institutions and credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of Registrant’s competitors have broader geographic markets and higher lending limits than Registrant and are also able to provide more services and make greater use of media advertising. As of June 30, 2008, data provided by the FDIC Deposit Market Share Report indicated that, within the Registrant’s market area, there were 226 offices of 23 other commercial and savings institutions (30 in Harnett County, 41 in Johnston County, 4 in Hoke County, 66 in Cumberland County, 33 in Robeson County, 17 in Sampson County, and 35 in Wayne County).
The enactment of legislation authorizing interstate banking has caused great increases in the size and financial resources of some of Registrant’s competitors. In addition, as a result of interstate banking, out-of-state commercial banks have acquired North Carolina banks and heightened the competition among banks in North Carolina.
Despite the competition in its market areas, Registrant believes that it has certain competitive advantages that distinguish it from its competition. Registrant believes that its primary competitive advantages are its strong local identity and affiliation with the community and its emphasis on providing specialized services to small and medium-sized business enterprises, as well as professional and upper-income individuals. Registrant offers customers modern, high-tech banking without forsaking community values such as prompt, personal service and friendliness. Registrant offers many personalized services and intends to attract customers by being responsive and sensitive to their individualized needs. Registrant also relies on goodwill and referrals from shareholders and satisfied customers, as well as traditional media to attract new customers. To enhance a positive image in the community, Registrant supports and participates in local events and its officers and directors serve on boards of local civic and charitable organizations.
Employees
As of December 31, 2008, the Registrant employed 132 full time equivalent employees. None of the Registrant’s employees are covered by a collective bargaining agreement. The Registrant believes relations with its employees to be good.
REGULATION
Regulation of the Bank
The Bank is extensively regulated under both federal and state law. Generally, these laws and regulations are intended to protect depositors and borrowers, not shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable law or regulation may have a material effect on the business of the Registrant and the Banks.
State Law. The Bank is subject to extensive supervision and regulation by the North Carolina Commissioner of Banks (the “Commissioner”). The Commissioner oversees state laws that set specific requirements for bank capital and regulate deposits in, and loans and investments by, banks, including the amounts, types, and in some cases, rates. The Commissioner supervises and performs periodic examinations of North Carolina-chartered banks to assure compliance with state banking statutes and regulations, and the Bank is required to make regular reports to the Commissioner describing in detail its resources, assets, liabilities and financial condition. Among other things, the Commissioner regulates mergers and consolidations of state-chartered banks, the payment of dividends, loans to officers and directors, record keeping, types and amounts of loans and investments, and the establishment of branches.
- 5 -
Deposit Insurance. As member institutions of the FDIC, the Bank’s deposits are insured to applicable limits through the FDIC’s Deposit Insurance Fund (the “DIF”) generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The Emergency Economic Stabilization Act temporarily increased the maximum amount per separately insured depositor from $100,000 to $250,000 in October 2008. Unless this increase is further extended by law, the maximum insured amount will return to $100,000 in December 2009. The DIF is administered by the FDIC and each member institution is required to pay semi-annual deposit insurance premium assessments to the FDIC. The FDIC determines the Bank’s deposit insurance assessment rates on the basis of four risk categories. The Bank’s assessment is determined by a formula that ranges from 0.02% to 0.04% at the lowest assessment category up to a maximum of 0.40% of the Bank’s average deposit base, with the exact assessment determined by the Bank’s assets, its capital and the FDIC’s supervisory opinion of its operations. The insurance assessment rate may change periodically and was significantly increased for all depository institutions during 2008. Increases in the assessment rate may have an adverse effect on the Bank’s operating results.
The FDIC has set a designated reserve ratio of 1.25% ($1.25 against $100 of insured deposits) for the DIF. The FDIC has the authority to set the ratio between 1.15% and 1.50%, and must adopt a restoration plan when the ratio falls below 1.15% and begin paying dividends when the reserve ratio exceeds 1.35%. There is no requirement to achieve a specific ratio within a given time frame. The DIF reserve ratio calculated by the FDIC that was in effect at December 31, 2008 was .76%. In October 2008, the FDIC adopted a restoration plan that would increase the reserve ratio to the 1.15% threshold within five years. As part of that plan, the FDIC increased risk-based assessment rates uniformly by seven cents, on an annual basis, for the first quarter of 2009 due to deteriorating financial conditions in the banking industry.
In addition to risk-based deposit insurance assessments, additional assessments may be imposed by the Financing Corporation, a separate U.S. government agency affiliated with the FDIC, on insured deposits to pay for the interest cost of Financing Corporation bonds. Financing Corporation assessment rates for 2008 ranged from $0.0110 to $0.0114 per $100 of deposits.
The FDIC can terminate a depository institution’s deposit insurance if it finds that the institution is being operated in an unsafe and unsound manner or has violated any rule, regulation, order or condition administered by the institution’s regulatory authorities. Any such termination of deposit insurance would likely have a material adverse effect on the Company, the severity of which would depend on the amount of deposits affected by such a termination. The FDIC evaluates the risk of each financial institution based on its supervisory rating, its financial ratios, and its long-term debt issuer rating. Deposit insurance premium rates in 2008 for nearly all of the financial institution industry varied between five and seven cents for every $100 of domestic deposits. The deposit insurance assessment rates are determined quarterly.
On December 16, 2008, the FDIC adopted a final rule increasing its risk-based deposit insurance assessment scale uniformly by seven (7) basis points for the first quarter of 2009. The assessment scale for first quarter of 2009 will range from twelve (12) basis points of assessable deposits for the strongest institutions to fifty (50) basis points for the weakest. The FDIC attributes the assessment increase to recent failures of FDIC-insured institutions. The FDIC’s action applies only to the first quarter of 2009. The FDIC is considering further changes to the risk-based assessment scale effective April 1, 2009, designed to make the assessment system more risk sensitive and ensure that riskier institutions bear a greater share of the assessments. Proposed adjustments to the scale include: (i) adding a surcharge for certain institutions (institutions in the three riskiest categories for FDIC assessment purposes) that use brokered deposits to fund growth, (ii) providing a possible discount of up to two (2) basis points based on an institution’s ratio of long-term unsecured debt, including senior unsecured and subordinated debt, to domestic deposits (for “small institutions” (generally, those with less than $10 billion in assets), the ratio could include a certain amount of Tier 1 capital) and (iii) adding a surcharge based upon an institution’s ratio of secured liabilities (including Federal Home Loan Bank advances, securities sold under repurchase agreements, secured Federal Funds purchased and certain other secured borrowings) to domestic deposits, if greater than 15%.
- 6 -
On February 27, 2009, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) voted to amend the restoration plan for the Deposit Insurance Fund. The Board took action by imposing a special assessment on insured institutions of 20 basis points, implementing changes to the risk-based assessment system, and increased regular premium rates for 2009, which banks must pay on top of the special assessment. The 20 basis point special assessment on the industry will be as of June 30, 2009 payable on September 30, 2009.
On March 5, 2009, the FDIC Chairman announced that the FDIC intends to lower the special assessment from 20 basis points to 10 basis points. The approval of the cutback is contingent on whether Congress clears legislation that would expand the FDIC’s line of credit with the Treasury to $100 billion. Legislation to increase the FDIC’s borrowing authority on a permanent basis is also expected to advance to Congress, which should aid in reducing the burden on the industry.
Capital Requirements. The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off-balance sheet items are multiplied by one of several risk adjustment percentages which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.
A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. “Tier 1,” or core capital, includes common equity, qualifying noncumulative perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions. “Tier 2,” or supplementary capital, includes among other things, limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations and less required deductions. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total capital to risk-weighted assets of at least 8%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. As of December 31, 2008, the Registrant was classified as well capitalized with Tier 1 and Total Risk-Based Capital of 13.18% and 14.43%, respectively. Also, as of December 31, 2008, the Bank was classified as well capitalized with Tier 1 and Total Risk-Based Capital of 12.88% and 14.14%, respectively.
The federal banking agencies have adopted regulations specifying that they will include, in their evaluations of a bank’s capital adequacy, an assessment of the bank’s interest rate risk exposure. The standards for measuring the adequacy and effectiveness of a banking organization’s interest rate risk management include a measurement of board of director and senior management oversight, and a determination of whether a banking organization’s procedures for comprehensive risk management are appropriate for the circumstances of the specific banking organization.
Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions, including limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital and, in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as the measures described under the “Federal Deposit Insurance Corporation Improvement Act of 1991” below, as applicable to undercapitalized institutions. In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Banks to grow and could restrict the amount of profits, if any, available for the payment of dividends to the shareholders.
- 7 -
Federal Deposit Insurance Corporation Improvement Act of 1991. In December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDIC Improvement Act”), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. The FDIC Improvement Act provides for, among other things:
•
publicly available annual financial condition and management reports for certain financial institutions, including audits by independent accountants,
•
the establishment of uniform accounting standards by federal banking agencies,
•
the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with greater scrutiny and restrictions placed on depository institutions with lower levels of capital,
•
additional grounds for the appointment of a conservator or receiver, and
•
restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements.
The FDIC Improvement Act also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums.
A central feature of the FDIC Improvement Act is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to the FDIC Improvement Act, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity.
The FDIC Improvement Act provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions which fail to comply with capital or other standards. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. The FDIC Improvement Act also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver.
Miscellaneous. The cash dividends that may be paid by the Bank are subject to legal limitations. In accordance with North Carolina banking law, cash dividends may not be paid by the Bank unless its capital surplus is at least 50% of its paid-in capital. Cash dividends may only be paid out of retained earnings.
The earnings of the Bank will be affected significantly by the policies of the Federal Reserve Board, which is responsible for regulating the United States money supply in order to mitigate recessionary and inflationary pressures. Among the techniques used to implement these objectives are open market transactions in United States government securities, changes in the rate paid by banks on bank borrowings, and changes in reserve requirements against bank deposits. These techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid for deposits.
- 8 -
The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Banks.
The Registrant cannot predict what legislation might be enacted or what regulations might be adopted, or if enacted or adopted, the effect thereof on the Bank’s operations.
Regulation of the Registrant
Federal Regulation. The Registrant is subject to examination, regulation and periodic reporting under the Bank Holding Company Act of 1956, as administered by the Federal Reserve Board. The Federal Reserve Board has adopted capital adequacy guidelines for bank holding companies on a consolidated basis.
The status of the Registrant as a registered bank holding company under the Bank Holding Company Act does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
The Registrant is required to obtain the prior approval of the Federal Reserve Board to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior Federal Reserve Board approval is required for the Registrant to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than five percent of any class of voting shares of such bank or bank holding company.
The merger or consolidation of the Registrant with another bank, or the acquisition by the Registrant of assets of another bank, or the assumption of liability by the Registrant to pay any deposits in another bank, will require the prior written approval of the primary federal bank regulatory agency of the acquiring or surviving bank under the federal Bank Merger Act. The decision is based upon a consideration of statutory factors similar to those outlined above with respect to the Bank Holding Company Act. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the Bank Holding Company Act and/or the North Carolina Banking Commission may be required.
The Registrant is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Registrant’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. Such notice and approval is not required for a bank holding company that would be treated as “well capitalized” and well-managed under applicable regulations of the Federal Reserve Board, that has received a composite “1” or “2” rating at its most recent bank holding company inspection by the Federal Reserve Board, and that is not the subject of any unresolved supervisory issues.
In addition, a bank holding company is prohibited generally from engaging in, or acquiring five percent or more of any class of voting securities of any company engaged in, non-banking activities. One of the principal exceptions to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the Federal Reserve Board has determined by regulation to be so closely related to banking as to be a proper incident thereto are:
•
making or servicing loans;
- 9 -
•
performing certain data processing services;
•
providing discount brokerage services;
•
acting as fiduciary, investment or financial advisor;
•
leasing personal or real property;
•
making investments in corporations or projects designed primarily to promote community welfare; and
•
acquiring a savings and loan association.
In evaluating a written notice of such an acquisition, the Federal Reserve Board will consider various factors, including among others the financial and managerial resources of the notifying bank holding company and the relative public benefits and adverse effects which may be expected to result from the performance of the activity by an affiliate of such company. The Federal Reserve Board may apply different standards to activities proposed to be commenced de novo and activities commenced by acquisition, in whole or in part, of a going concern. The required notice period may be extended by the Federal Reserve Board under certain circumstances, including a notice for acquisition of a company engaged in activities not previously approved by regulation of the Federal Reserve Board. If such a proposed acquisition is not disapproved or subjected to conditions by the Federal Reserve Board within the applicable notice period, it is deemed approved by the Federal Reserve Board.
However, with the passage of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, which became effective on March 11, 2000, the types of activities in which a bank holding company may engage were significantly expanded. Subject to various limitations, the Modernization Act generally permits a bank holding company to elect to become a “financial holding company.” A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are “financial in nature.” Among the activities that are deemed “financial in nature” are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, certain merchant banking activities and activities that the Federal Reserve Board considers to be closely related to banking.
A bank holding company may become a financial holding company under the Modernization Act if each of its subsidiary banks is “well capitalized” under the Federal Deposit Insurance Corporation Improvement Act prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve Board that the bank holding company wishes to become a financial holding company. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities. The Registrant has not yet elected to become a financial holding company.
Under the Modernization Act, the Federal Reserve Board serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Modernization Act also imposes additional restrictions and heightened disclosure requirements regarding private information collected by financial institutions.
Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve Board’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies:
•
a leverage capital requirement expressed as a percentage of adjusted total assets;
- 10 -
•
a risk-based requirement expressed as a percentage of total risk-weighted assets; and
•
a Tier 1 leverage requirement expressed as a percentage of adjusted total assets.
The leverage capital requirement consists of a minimum ratio of total capital to total assets of 4%, with an expressed expectation that banking organizations generally should operate above such minimum level. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital (which consists principally of shareholders’ equity). The Tier 1 leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated companies, with minimum requirements of 4% to 5% for all others.
The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels.
Source of Strength for Subsidiaries. Bank holding companies are required to serve as a source of financial strength for their depository institution subsidiaries, and, if their depository institution subsidiaries become undercapitalized, bank holding companies may be required to guarantee the subsidiaries’ compliance with capital restoration plans filed with their bank regulators, subject to certain limits.
Dividends. As a bank holding company that does not, as an entity, currently engage in separate business activities of a material nature, the Registrant’s ability to pay cash dividends depends upon the cash dividends the Registrant receives from the Bank. At present, the Registrant’s only source of income is dividends paid by the Bank and interest earned on any investment securities the Registrant holds. The Registrant must pay all of its operating expenses from funds it receives from the Bank. Therefore, shareholders may receive dividends from the Registrant only to the extent that funds are available after payment of our operating expenses and the board decides to declare a dividend. In addition, the Federal Reserve Board generally prohibits bank holding companies from paying dividends except out of operating earnings where the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. We expect that, for the foreseeable future, any dividends paid by the Bank to us will likely be limited to amounts needed to pay any separate expenses of the Registrant and/or to make required payments on our debt obligations, including the debentures which underlie our trust preferred securities.
The FDIC Improvement Act requires the federal bank regulatory agencies biennially to review risk-based capital standards to ensure that they adequately address interest rate risk, concentration of credit risk and risks from non-traditional activities and, since adoption of the Riegle Community Development and Regulatory Improvement Act of 1994, to do so taking into account the size and activities of depository institutions and the avoidance of undue reporting burdens. In 1995, the agencies adopted regulations requiring as part of the assessment of an institution’s capital adequacy the consideration of (a) identified concentrations of credit risks, (b) the exposure of the institution to a decline in the value of its capital due to changes in interest rates and (c) the application of revised conversion factors and netting rules on the institution’s potential future exposure from derivative transactions.
In addition, the agencies in September 1996 adopted amendments to their respective risk-based capital standards to require banks and bank holding companies having significant exposure to market risk arising from, among other things, trading of debt instruments, (1) to measure that risk using an internal value-at-risk model conforming to the parameters established in the agencies’ standards and (2) to maintain a commensurate amount of additional capital to reflect such risk. The new rules were adopted effective January 1, 1997, with compliance mandatory from and after January 1, 1998.
- 11 -
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default.
Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions imposed by the Federal Reserve Act on any extension of credit to, or purchase of assets from, or letter of credit on behalf of, the bank holding company or its subsidiaries, and on the investment in or acceptance of stocks or securities of such holding company or its subsidiaries as collateral for loans. In addition, provisions of the Federal Reserve Act and Federal Reserve Board regulations limit the amounts of, and establish required procedures and credit standards with respect to, loans and other extensions of credit to officers, directors and principal shareholders of the Bank, the Registrant, any subsidiary of the Registrant and related interests of such persons. Moreover, subsidiaries of bank holding companies are prohibited from engaging in certain tying arrangements (with the holding company or any of its subsidiaries) in connection with any extension of credit, lease or sale of property or furnishing of services.
Any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and to 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 would be assumed by the bankruptcy trustee and entitled to a priority of payment. This priority would also apply to guarantees of capital plans under the FDIC Improvement Act.
Interstate Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle Act”), the Federal Reserve Board may approve bank holding company acquisitions of banks in other states, subject to certain aging and deposit concentration limits. As of June 1, 1997, banks in one state may merge with banks in another state, unless the other state has chosen not to implement this section of the Riegle Act. These mergers are also subject to similar aging and deposit concentration limits.
North Carolina “opted-in” to the provisions of the Riegle Act. Since July 1, 1995, an out-of-state bank that did not already maintain a branch in North Carolina was permitted to establish and maintain a de novo branch in North Carolina, or acquire a branch in North Carolina, if the laws of the home state of the out-of-state bank permit North Carolina banks to engage in the same activities in that state under substantially the same terms as permitted by North Carolina. Also, North Carolina banks may merge with out-of-state banks, and an out-of-state bank resulting from such an interstate merger transaction may maintain and operate the branches in North Carolina of a merged North Carolina bank, if the laws of the home state of the out-of-state bank involved in the interstate merger transaction permit interstate merger.
Future Legislation
Registrant cannot predict what legislation might be enacted or what regulations might be adopted, or if enacted or adopted, the effect thereof on Registrant’s operations.
ITEM 1A
ITEM 1A - RISK FACTORS
Not required for smaller reporting companies.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
Not required for smaller reporting companies.
- 12 -
ITEM 2
ITEM 2 - PROPERTIES
The following table sets forth the location of the main office, branch offices, and operation centers of the Registrant’s subsidiary depository institution, New Century Bank, as well as certain information relating to these offices.
- 13 -
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Registrant, or any of its subsidiaries, is a party, or of which any of their property is the subject.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to security holders during the fourth quarter of 2008.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the NASDAQ Global Market under the trading symbol “NCBC.” Howe Barnes Hoefer & Arnett, Ryan Beck & Company, Morgan Keegan, McKinnon & Company, Sandler O’Neill & Partners, L.P., and Scott & Stringfellow provide bid and ask quotes for our common stock. At December 31, 2008, there were 6,831,149 shares of common stock outstanding, which were held by 1,451 shareholders of record.
See Item 12 of this report for disclosure regarding securities authorized for issuance under equity compensation plans required by Item 201(d) of Regulation S-K.
- 14 -
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
- 15 -
(1) Adjusted for all years presented to reflect the effects of a 20% stock dividend in December 2006, a 50% stock dividend in July 2005 and 10% stock dividends in June 2004 and September 2003, respectively.
(2) Efficiency ratio is calculated as non-interest expenses divided by the sum of net interest income and non-interest income.
(3) Nonperforming loans consist of non-accrual loans and restructured loans.
(4) Allowance for loan losses to period-end loans ratio excludes loans held for sale
(5) Fully taxable equivalent basis
- 16 -
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following presents management’s discussion and analysis of our financial condition and results of operations and should be read in conjunction with the financial statements and related notes contained elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of various factors, many of which are beyond our control. The following discussion is intended to assist in understanding the financial condition and results of operations of New Century Bancorp, Inc. Because New Century Bancorp, Inc. has no material operations and conducts no business on its own other than owning its consolidated subsidiary, New Century Bank, and its unconsolidated subsidiary, New Century Statutory Trust I, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of the bank subsidiary. However, for ease of reading and because the financial statements are presented on a consolidated basis, New Century Bancorp, Inc and, New Century Bank are collectively referred to herein as the Company unless otherwise noted.
DESCRIPTION OF BUSINESS
The Company is a commercial bank holding company that was incorporated on September 19, 2003 and has only one banking subsidiary, New Century Bank, which became a subsidiary of the Company as part of a holding company reorganization, (referred to as the “Bank”). In September 2004, the Company formed New Century Statutory Trust I, which issued trust preferred securities to provide additional capital for general corporate purposes, including the current and future expansion of New Century Bank. New Century Statutory Trust I is not a consolidated subsidiary of the Company. The Company’s only business activity is the ownership of the Bank. Accordingly, this discussion focuses primarily on the financial condition and operating results of the Bank.
The Board of Directors of New Century Bancorp as well as the boards of directors of New Century Bank and New Century Bank South, voted to merge the two banks in early 2008. The merger was completed on March 28, 2008. The merged bank is called New Century Bank and the headquarters and operations center of the merged bank are in Dunn, North Carolina. A 15-member holding company board also serves as the board of directors of the Bank.
The Bank’s lending activities are oriented to the consumer/retail customer as well as to the small-to-medium sized businesses located in southeastern North Carolina. The Bank offers the standard complement of commercial, consumer, and mortgage lending products, as well as the ability to structure products to fit specialized needs. The deposit services offered by the Bank include small business and personal checking, savings accounts and certificates of deposit. The Bank concentrates on customer relationships in building its customer deposit base and competes aggressively in the area of transaction accounts.
- 17 -
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
YEARS ENDED DECEMBER 31, 2008 AND 2007
The quarterly financial data may not aggregate to annual amounts due to rounding.
- 18 -
FINANCIAL CONDITION
DECEMBER 31, 2008 AND 2007
Overview
Total assets at December 31, 2008 were $605.8 million, which represents an increase of $14.7 million or 2.5% from December 31, 2007. Earning assets at December 31, 2008 totaled $560.5 million and consisted of $451.8 million in net loans, $82.9 million in investment securities, $23.7 million in overnight investments and interest-bearing deposits in other banks and $2.1 million in non-marketable equity securities. Total deposits and shareholders’ equity at December 31, 2008 were $505.1 million and $62.7 million, respectively.
Investment Securities
Investment securities increased to $82.9 million from $76.5 million at December 31, 2007. The Company’s investment portfolio at December 31, 2008, which consisted of U.S. government agency securities, mortgage-backed securities and bank-qualified municipal securities, aggregated $82.9 million with a weighted average yield of 4.97%. The Company also holds an investment of $1.1 million in the form of Federal Home Loan Bank Stock with a weighted average yield of 5.06%. This dividend has been recently adjusting downward due to declining interest rates and the current trend of financial institutions to preserve capital during these uncertain economic times. The investment portfolio increased $6.4 million in 2008, the result of $30.6 million in purchases, $26.4 million of maturities and prepayments and an increase of $2.0 million in the market value of securities held available for sale and net accretion of investment discounts. There were no sales of investment securities during 2008.
The following table summarizes the securities portfolio by major classification:
Securities Portfolio Composition
(dollars in thousands)
- 19 -
Loans Receivable
Loans receivable increased by $17.8 million, or 4.0% to $460.6 million as of December 31, 2008. The growth was primarily due to our growth in existing markets. The loan portfolio at December 31, 2008 was comprised of $363.1 million in real estate loans, $76.9 million in commercial and industrial loans, and $20.9 million in loans to individuals. Also included in loans outstanding are $338,000 in net deferred loan fees.
The following table describes our loan portfolio composition by category:
- 20 -
The following table presents as of December 31, 2008 (i) the aggregate maturities of loans in the named categories of our loan portfolio and (ii) the aggregate amounts of such loans, by variable and fixed rates that mature within one year, after one year but within five years, and after five years:
Past Due Loans and Nonperforming Assets
In 2007, the Company’s management identified certain underwriting and credit administration weaknesses that existed. Management and the Board subsequently took actions to identify problem loans and improve internal controls in the lending and credit administration areas. These actions included conducting extensive loan risk rating reviews; addressing problem loans and enhancing the credit administration department; improving loan documentation, lender training, enhanced collection efforts, policies and procedures; and addressing known violations of rules, regulations and policies.
At December 31, 2008, the Company had nearly $1.5 million in loans that were 30 days or more past due. This represented 0.32% of gross loans outstanding on that date. This is a decrease from December 31, 2007 when there was $5.8 million in loans that were past due 30 days or more, or 1.31% of gross loans outstanding. Non-accrual loans increased $3.5 million from December 31, 2007 to $8.5 million at December 31, 2008.
- 21 -
The table below sets forth, for the periods indicated, information about the Company’s non-accrual loans, loans past due 90 days or more and still accruing interest, total non-performing loans (non-accrual loans plus restructured loans), and total non-performing assets.
In addition to the nonperforming assets summarized above, the Company had $0.5 million in loans that were considered to be impaired for reasons other than their past due status. In total, there were $9.1 million of loans that were considered to be impaired at December 31, 2008, a decrease of $3.0 million from the $12.1 million at December 31, 2007. Impaired loans have been evaluated by management in accordance with SFAS 114 and $3.4 million has been included in the allowance for loan losses as of December 31, 2008 for these loans.
- 22 -
Allowance for Loan Losses
The allowance for loan losses increased 4 basis points to 1.92% of gross loans at December 31, 2008 from 1.88% at December 31, 2007. The increase resulted from increases allocable to the downgrading of loans, resulting from both internal and external loan reviews, an increase in the level of non-performing loans and the impact on the actual loss experience resulting from net charge-offs of $3.7 million in 2008. In evaluating the adequacy of the allowance, management considers the growth, composition and industry diversification of the portfolio, historical loss experience, current delinquency levels, trends in past dues, adverse situations that may affect a borrower’s ability to repay, estimated value of underlying collateral, prevailing economic conditions and other relevant factors derived from the Company’s history of operations. During 2008, management continued to make enhancements to the Company’s process for determining the allowance for loan losses, including the aforementioned loan review process. Other steps taken include regular management meetings and past due conference calls to review and monitor problem assets and improved processes for identification and measurement of impaired loans in accordance with SFAS 114.
While the Company believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making determinations regarding the allowance. While the Company believes that the allowance for loan losses has been established in conformity with generally accepted accounting principles, there can be no assurance that banking regulators, in reviewing the loan portfolio, will not require adjustments to the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increased provisions to the allowance will not be necessary should the quality of any loans deteriorate. Any material increase in the allowance for loan losses may adversely affect the Company’s financial condition and results of operations and the value of the Company’s common stock.
Management believes the allowance for loan losses as of December 31, 2008 is appropriate in light of the risk inherent within the Company’s loan portfolio.
The following table presents the Company’s allowance for loan losses as a percentage of loans at December 31 for the years indicated.
- 23 -
The following table presents information regarding changes in the allowance for loan losses for the years indicated:
Other Assets
At December 31, 2008 non-earning assets totaled $45.3 million, a decrease of $2.6 million from $47.9 million at December 31, 2007. The decrease reflects a lower level of non-interest bearing cash and balances at banks of $3.3 million at December 31, 2008 compared to December 31, 2007. Non-earning assets at December 31, 2008 consisted of: cash and due from banks-$8.1 million, premises and equipment-$11.9 million, goodwill-$8.7 million, accrued interest receivable-$2.5 million, bank owned life insurance-$7.2 million and others totaling $6.9 million.
The Company has an investment in bank owned life insurance of $7.2 million, which increased $0.3 million from December 31, 2007. The change reflects an increase in cash surrender value. Since the income on this investment is included in non-interest income, the asset is not included in the Company’s calculation of earning assets.
- 24 -
Deposits
Total deposits at December 31, 2008 were $505.1 million and consisted of $62.9 million in non-interest-bearing demand deposits, $74.1 million in money market and NOW accounts, $27.2 million in savings accounts, and $340.9 million in time deposits. Total deposits grew by $7.0 million from $498.1 million as of December 31, 2007. Non-interest-bearing demand deposits decreased by $2.8 million from $65.6 million as of December 31, 2007. Savings accounts decreased by $9.1 million due to the special rate pricing on a premium MMDA account. Time deposits decreased by $1.8 million during 2008.
The following table shows historical information regarding the average balances outstanding and average interest rates for each major category of deposits:
Short Term and Long Term Debt
As of December 31 2008, the Company had $23.2 million in short-term debt, all of which were repurchase agreements, and $12.4 million in long-term debt, all of which were junior subordinated debentures issued to New Century Statutory Trust I in connection with the Company’s issuance of trust preferred securities in September 2004.
Shareholders’ Equity
Total shareholders’ equity at December 31, 2008 was $62.7 million, an increase of $1.5 million from $61.2 million as of December 31, 2007. Changes in shareholders’ equity included $193,000 in net loss, an increase of $513,000 from stock options exercised, an increase of $188,000 from stock based compensation, a $276,000 charge to retained earnings related to the adoption of EITF 06-04, a $27,000 tax benefit due to the exercise of stock options and $1.2 million increase in other comprehensive income.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Overview
During 2008, New Century Bancorp incurred a net loss of $0.2 million compared to net income of $1.7 million for 2007, a decrease of 112%. Both basic and diluted loss per share for the year ended December 31, 2008 were $.03. , compared with basic earnings per share of $.25 and diluted earnings per share of $.24 for 2007. The decrease in net income is primarily due to a decrease in net interest income of $3.1 million together with a decrease in non-interest income of $1.5 million for 2008 as compared to 2007 offset by a decrease in the provision for loan losses of $1.7 million.
- 25 -
Net Interest Income
Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by the average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by the levels on non-interest bearing liabilities and capital.
Net interest income decreased by $3.1 million to $17.9 million for the year ended December 31, 2008. The Company’s total interest income benefited from continued growth in interest earning assets that was offset by a gradual declining interest rate environment. Average total interest-earnings assets were $554.8 million in 2008 compared with $539.5 million in 2007. The yield on those assets decreased by 136 basis points from 7.76% in 2007 to 6.40% in 2008. Earning asset yields were adversely impacted by income reversed when loans were placed into non-accrual status. Meanwhile, average interest-bearing liabilities increased by $17.5 million from $450.5 million for the year ended December 31, 2007 to $468.0 million for the year ended December 31, 2008. Cost of funds decreased by 87 basis points to 3.71% from 4.58% in 2007. In 2008, the Company’s net interest margin was 3.27% and net interest spread was 2.69%. In 2007, net interest margin was 3.93% and net interest spread was 3.18%.
Provision for Loan Losses
Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan losses, current delinquency and impairment levels, adverse situations that may affect a borrower’s ability to repay, estimated value of underlying collateral, prevailing economic conditions and other relevant factors.
The Company recorded a $4.3 million provision for loan losses in 2008, a decrease of $1.7 million from the $6.0 million provision that was recorded in 2007. The 2008 provision for loan losses was significantly impacted by the downgrading of loans, resulting from both internal and external loan reviews, an increase in the level of non-performing loans resulting in changes in the specific reserves provided on these loans, and net charge-offs of $3.7 million.
Non-Interest Income
Non-interest income for the year ended December 31, 2008 was $2.4 million, a decrease of $1.5 million over the year ended December 31, 2007. When compared to last year, the Company had an increase in deposit service fees and charges of $47,000, or 3%. Fees from pre-sold mortgages decreased to $514,000 in 2008, a decline of $253,000 or 33% as compared to 2007. Also, the Company realized no gains from the sale of loans held for sale in 2008, as compared to $460,000 in such gains in 2007. In addition for 2008, the Company experienced a $357,000 loss on the repurchase of a loan participation, $239,000 in losses on the write down of OREO, and a $125,000 refund of SBA premiums, of which none of these were incurred in 2007 except for a $108,000 write down in OREO.
Non-Interest Expenses
Non-interest expenses increased by $0.2 million or 1% to $16.4 million for the year ended December 31, 2008, from $16.2 million for the same period in 2007. Salaries and employee benefits decreased to $8.7 million in 2008 from $9.0 million in 2007. Occupancy and equipment expenses increased by $100,000 to $1.5 million for the year ended December 31, 2008. The following highlight other changes in non-interest expenses from 2007 to 2008:
- 26 -
•
Data processing and other outsourced service expenses increased from $1.4 million in 2007 to $1.5 million in 2008 due to growth in the Company.
•
Professional service expenses decreased from $1.3 million in 2007 to $1.2 million in 2008, due to a leveling of the expenses related to audit, legal, other outsourced services pertaining to compliance with section 404 of the Sarbanes Oxley Act, and external loan reviews coupled with the efficiencies realized from the merger of the two banks in the first quarter of 2008.
•
Other operating expense increased from $2.3 million in 2007 to $2.6 million in 2008 due to general growth of the Company and an increase of $275,000 in FDIC assessments.
Provision for Income Taxes
The Company’s effective tax rate in 2008 was a 55.3% benefit resulting from the net operating loss in addition to non taxable income as compared to a 36.5% expense on net operating income in 2007.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006
Overview
During 2007, New Century Bancorp generated net income of $1.7 million compared to net income of $4.0 million for 2006, a decrease of 58%. Basic earnings per share and diluted earnings per share for the year ended December 31, 2007 were $.25 and $.24, respectively, compared with basic earnings per share of $.69 and diluted earnings per share of $.65 for 2006. The decrease in net income is primarily due to increases in the provision for loan losses that were necessitated by the identification of problem loans in the portfolio of New Century Bank. The increase in the loan loss provision was partially offset by the effect of a full year’s operating results in 2007 following the acquisition of Progressive State Bank in July of 2006.
Net Interest Income
Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by the average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by the levels on non-interest bearing liabilities and capital.
Net interest income increased by $1.3 million to $20.9 million for the year ended December 31, 2007. The Company’s total interest income benefited from continued growth in interest earning assets that was partially offset by a gradually declining interest rate environment. Average total interest-earnings assets were $539.5 million in 2007 compared with $459.0 million in 2006. The yield on those assets decreased by 9 basis points from 7.85% in 2006 to 7.76% in 2007. Earning asset yields were impacted by income reversed when loans went into non-accrual status. Meanwhile, average interest-bearing liabilities increased by $69.0 million from $381.5 million for the year ended December 31, 2006 to $450.5 million for the year ended December 31, 2007. Cost of funds increased by 34 basis points to 4.58% from 4.24% in 2006. In 2007, the Company’s net interest margin was 3.93% and net interest spread was 3.18%. In 2006, net interest margin was 4.33% and net interest spread was 3.62%.
Provision for Loan Losses
Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that
- 27 -
include growth, composition and industry diversification of the portfolio, historical loan losses, current delinquency and impairment levels, adverse situations that may affect a borrower’s ability to repay, estimated value of underlying collateral, prevailing economic conditions and other relevant factors.
The Company recorded a $6.0 million provision for loan losses in 2007, an increase of $3.2 million from the $2.8 million provision that was recorded in 2006. The 2007 provision for loan losses was significantly impacted by the downgrading of loans, resulting from both internal and external loan reviews, an increase in the level of non-performing loans and net charge-offs of $5.2 million.
Non-Interest Income
Non-interest income for the year ended December 31, 2007 was $3.9 million, an increase of $600,000 over the year ended December 31, 2006. Generally, there were increases in many categories of non-interest income due to having a full year of service charges and other fees from the loans and deposits acquired in the merger with Progressive in 2006 and from continued organic growth. Compared to 2006, the Company had an increase in deposit service fees and charges of $419,000, or 30% in 2007. In addition, fees from pre-sold mortgages grew by $63,000 from $704,000 in 2006 to $767,000 in 2007.
Non-Interest Expenses
Non-interest expenses increased by $2.4 million to $16.2 million for the year ended December 31, 2007, from $13.8 million for the same period in 2006. Like non-interest income, there was an increase in all categories of non-interest expenses due to having a full year of expenses related to the additional offices acquired in the Progressive merger in 2006 and from organic growth. In October 2007, the Company consolidated the two offices in Lumberton and closed the office in Dublin in order to eliminate redundant expenses and improve efficiencies. This lowered the number of full-time equivalent employees on a year-to-year basis but salaries and benefits had already increased during the first nine months of the year due to the merger in 2006 and the opening of the second office in Fayetteville. Salaries and employee benefits increased to $9.0 million in 2007 from $8.2 million in 2006. Occupancy and equipment expenses increased by $200,000 to $1.4 million for the year ended December 31, 2007. The increase in occupancy and equipment is due to the merger and the opening of the second office in Fayetteville and the new building in Lillington. The following highlight other changes in non-interest expenses from 2006 to 2007:
•
Data processing and other outsourced service expenses increased from $1.2 million in 2006 to $1.4 million in 2007 due to growth in the Company.
•
Professional service expenses increased from $520,000 in 2006 to $1.3 million in 2007, due to increases for audit, legal, and other outsourced services related to compliance with section 404 of the Sarbanes Oxley Act, and to the aforementioned external loan reviews.
•
Other operating expense increased from $1.9 million in 2006 to $2.3 million in 2007 due to general growth of the Company and an increase of $83,000 in amortization of the core deposit intangible resulting from the acquisition of Progressive’s deposits.
Provision for Income Taxes
The Company’s effective tax rate was 36.5% in 2007 and 37.3% in 2006. The decrease is attributable to a favorable change in the mix of taxable and non-taxable revenue and expense items
NET INTEREST INCOME
The following table sets forth, for the periods indicated, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or costs, net interest income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. Nonaccrual loans have been included in determining average loans.
- 28 -
- 29 -
RATE/VOLUME ANALYSIS
The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.
LIQUIDITY
Market and public confidence in the Company’s financial strength and in the strength of financial institutions in general will largely determine the Company’s access to appropriate levels of liquidity. This confidence is significantly dependent on the Company’s ability to maintain sound asset quality and appropriate levels of capital resources. The term “liquidity” refers to the Company’s ability to generate adequate amounts of cash to meet our needs for funding loan originations, deposit withdrawals, maturities of borrowings and operating expenses. Management measures the Company’s liquidity position by giving consideration to both on and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.
Liquid assets (consisting of cash and due from banks, interest-earning deposits with other banks, federal funds sold and investment securities classified as available for sale) comprised 18.9% and 19.4% of total assets at December 31, 2008 and 2007 respectively.
The Company has been a net seller of federal funds, maintaining liquidity sufficient to fund new loan demand. When the need arises, the Company has the ability to sell securities classified as available for sale, sell loan participations to other banks, or to borrow funds as necessary. The Company has established credit lines with other financial institutions to purchase up to $8.8 million in federal funds. Also, as a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Company may obtain advances of up to 10% of
- 30 -
assets, subject to our available collateral. A floating lien of $23.7 million on qualifying loans is pledged to FHLB to secure such borrowings. In addition, the Company may borrow at the Federal Reserve discount window, subject to our available collateral. As another source of short-term borrowings, the Company also utilizes securities sold under agreements to repurchase. At December 31, 2008, borrowings consisted of securities sold under agreements to repurchase of $23.2 million.
At December 31, 2008, the Company’s outstanding commitments to extend credit consisted of loan commitments of $40.7 million, undisbursed lines of credit of $31.8 million, and letters of credit of $2.0 million. The Company believes that its combined aggregate liquidity position from all sources is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.
Total deposits were $505.1 million and $498.1 million at December 31, 2008 and 2007, respectively. Time deposits, which are the only deposit accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 67.5% and 68.8% of total deposits at December 31, 2008 and 2007, respectively. Time deposits of $100,000 or more represented 30.4% and 30.5%, respectively, of the total deposits at December 31, 2008 and 2007. Management believes most other time deposits are relationship-oriented. While competitive rates will need to be paid to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, management anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity.
Management believes that current sources of funds provide adequate liquidity for the Company’s current cash flow needs.
CAPITAL
A significant measure of the strength of a financial institution is its capital base. Federal regulations have classified and defined capital into the following components: (1) Tier 1 capital, which includes common shareholders’ equity and qualifying preferred equity (including trust preferred securities), and (2) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify as Tier 1 capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines that require a financial institution to maintain capital as a percent of its assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets). A financial institution is required to maintain, at a minimum, Tier 1 capital as a percentage of risk-adjusted assets of 4.0% and combined Tier 1 and Tier 2 capital as a percentage of risk-adjusted assets of 8.0%. In addition to the risk-based guidelines, federal regulations require that we maintain a minimum leverage ratio (Tier 1 capital as a percentage of tangible assets) of 4.0%. The Company’s equity to assets ratio was 10.34% at December 31, 2008. As the following table indicates, at December 31, 2008, the Company and its bank subsidiary exceeded regulatory capital requirements.
- 31 -
During 2004, the Company issued $12.4 million of junior subordinated debentures to a newly formed subsidiary, New Century Statutory Trust I, which in turn issued $12.0 million of trust preferred securities. The proceeds provided additional capital for the current and future expansion of the Bank. . Under the current applicable regulatory guidelines, all of the debentures qualify as Tier 1 capital. Management expects that the Company and the Bank will remain “well-capitalized” for regulatory purposes, although there can be no assurance that additional capital will not be required in the near future due to greater-than-expected growth, or otherwise.
ASSET/LIABILITY MANAGEMENT
The Company’s results of operations depend substantially on its net interest income. Like most financial institutions, the Company’s interest income and cost of funds are affected by general economic conditions and by competition in the marketplace.
The purpose of asset/liability management is to provide stable net interest income growth by protecting the Company’s earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. The Company maintains, and has complied with, a Board approved asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Company’s policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a narrow range around an “earnings neutral position,” which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.
When suitable lending opportunities are not sufficient to utilize available funds, the Company has generally invested such funds in securities, primarily securities issued by governmental agencies, mortgage-backed securities and municipal obligations. The securities portfolio contributes to the Company’s profits and plays an important part in overall interest rate management. However, management of the securities portfolio alone cannot balance overall interest rate risk. The securities portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in the overall management of the securities portfolio are safety, liquidity, yield, asset/liability management (interest rate risk), and investing in securities that can be pledged for public deposits.
In reviewing the needs of the Company with regard to proper management of its asset/liability program, the Company’s management estimates its future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing), and forecasted interest rate changes.
The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is a standard tool for the measurement of exposure to interest rate risk. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2008, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts and negotiable order of withdrawal or other transaction accounts are assumed to be subject to immediate repricing and depositor availability and have been placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received throughout the lives of the loans. The interest rate sensitivity of the Company’s assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.
- 32 -
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. The following is a summary of the Company’s most complex and judgmental accounting policies: the allowance for loan losses and accounting for goodwill impairment.
Asset Quality and the Allowance for Loan Losses
The financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on the loan portfolio, unless a loan is placed on a non-accrual basis. Loans are placed on a non-accrual basis when there are serious doubts about the collectability of principal or interest. Amounts received on non-accrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur.
- 33 -
See the previous section titled “Past Due Loans and Nonperforming Assets” for a discussion on past due loans, non-performing assets and other impaired loans.
The allowance for loan losses is maintained at a level considered appropriate in light of the risk inherent within the Company’s loan portfolio, based on management’s assessment of various factors affecting the loan portfolio, including a review of problem loans, business conditions and loss experience and an overall evaluation of the quality of the underlying collateral. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. Additional information regarding the Company’s allowance for loan losses and loan loss experience are presented above in the discussion of the allowance for loan losses and in Note D to the accompanying financial statements.
Goodwill and Other Intangibles
Management has developed procedures to test goodwill for impairment on an annual basis, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This testing procedure evaluates possible impairment based on the following:
Goodwill represents the excess of the cost of an acquisition over the fair vale of the net assets acquired. Other intangible assets represent purchased intangible assets that can be separately distinguished from goodwill. Goodwill impairment testing is performed annually or more frequently if events or circumstances indicate possible impairment. The evaluation of goodwill for impairment uses both the income and market approaches to value the Company. The income approach consists of discounting projected long-term future cash flows, which are derived from internal forecasts and economic expectations for the Company. The significant inputs to the income approach include the long-term target tangible equity to tangible assets ratio and the discount rate, which is determined utilizing the Company’s cost of capital adjusted for a company-specific risk factor. The company-specific risk factor is used to address the uncertainty of growth estimates and earnings projections of management. Under the market approach, a value is calculated from an analysis of comparable acquisition transactions based on earnings, book value, assets and deposit premium multiples from the sale of similar financial institutions. Our goodwill testing for 2008, which was updated as of December 31, 2008, indicated that the goodwill booked at the time of the acquisition of Progressive State Bank continues to properly value the acquired company and has not been impaired. No impairment has been recorded as a result of goodwill testing performed during 2008 or 2007. Given the substantial decline in our common stock price and the economic outlook for out industry, the excess of the fair value over carrying value has narrowed compared with previous assessments. If our stock price continues to decline, if the Company does not produce anticipated cash flows, or if comparable banks begin selling at significantly lower prices than in the past, our goodwill may be impaired in the future.
Intangible assets with finite lives include core deposits and other intangibles. Intangible assets other than goodwill are subject to impairment testing at least annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Core deposit intangibles are amortized on the straight-line method over a period not to exceed 10 years. Note B contains additional information regarding goodwill and other intangible assets.
OFF-BALANCE SHEET ARRANGEMENTS
Information about the Company’s off-balance sheet risk exposure is presented in Note M to the accompanying financial statements. During 2004 the Company formed an unconsolidated subsidiary trust to which the Company has issued $12.4 million of junior subordinated debentures (see Note I to the consolidated financial statements). Otherwise, as part of its ongoing business, the Company has not participated in, nor does it anticipate participating in, transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (SPEs), which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
- 34 -
RECENT ACCOUNTING PRONOUNCEMENTS
See Note B to the financial statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.
IMPACT OF INFLATION AND CHANGING PRICES
A commercial bank has an asset and liability make-up that is distinctly different from that of a company with substantial investments in plant and inventory because the major portions of a commercial bank’s assets are monetary in nature. As a result, a bank’s performance may be significantly influenced by changes in interest rates. Although the banking industry is more affected by changes in interest rates than by inflation in the prices of goods and services, inflation is a factor that may influence interest rates. However, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect operating expenses in that personnel expenses and the cost of supplies and outside services tend to increase more during periods of high inflation.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require future cash outflows. The following table reflects contractual obligations of the Company outstanding as of December 31, 2008.
The following table reflects other commitments outstanding as of December 31, 2008.
- 35 -
FORWARD-LOOKING INFORMATION
Statements contained in this annual report, which are not historical facts, are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Amounts herein could vary as a result of market and other factors. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with the U.S. Securities and Exchange Commission from time to time. Such forward-looking statements may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “might,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, expected or anticipated revenue, results of operations and business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services.
REGULATORY MATTERS
Effective December 27, 2007, the Board of Directors of New Century Bank entered into a Memorandum of Understanding with the FDIC and the North Carolina Commissioner of Banks. The Memorandum of Understanding represents an agreement between the Board of Directors of New Century Bank, the Regional Director of the FDIC’s Atlanta Regional Office and the North Carolina Commissioner of Banks and requires that New Century Bank’s management take certain actions to improve the bank’s lending function. Specifically, the Memorandum of Understanding requires the Bank to address problem loans by charging off certain classified assets within 30 days and also requires that the Bank accomplish the following within a 90 day time frame: formulate a proposal for the reduction or improvement of any classified lines of credit, conduct a reevaluation of the performance and abilities of the Bank’s loan officers and credit administration staff; improve loan documentation, policies and procedures; and correct known violations of rules, regulations and policies. The Memorandum of Understanding also requires management to file various reports with the FDIC and the North Carolina Commissioner of Banks within 90 days, including a budget, earnings forecast and capital plan, with quarterly progress reports thereafter.
Compliance with the terms of the Memorandum of Understanding and remediation of the related material weakness that was originally identified in connection with the assessment of disclosure controls and procedures as of December 31, 2006 are high priorities for the Company. As a result, management devoted significant resources to these matters during the fiscal year ended December 31, 2008 and intends to continue to do so during 2009. Specific actions taken included the hiring of a new Chief Credit Officer with substantial experience, evaluation and reorganization of lending and credit administration personnel, assessment and revision of lending and credit administration policies and implementing procedures containing more effective processes for identification and valuation of problem credits.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not required for smaller reporting companies.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- 36 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors
New Century Bancorp, Inc.
Dunn, North Carolina
We have audited the accompanying consolidated balance sheets of New Century Bancorp, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008. 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 New Century Bancorp, Inc. and subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note B to the consolidated financial statements, effective January 1, 2008 the Company adopted Emerging Issues Task Force Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.
Raleigh, North Carolina
March 31, 2009
- 37 -
NEW CENTURY BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and
See accompanying notes.
- 38 -
NEW CENTURY BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes.
- 39 -
NEW CENTURY BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes.
- 40 -
NEW CENTURY BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes.
- 41 -
NEW CENTURY BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes.
- 42 -
NEW CENTURY BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 2008, 2007 and 2006
See accompanying notes.
- 43 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE A - ORGANIZATION AND OPERATIONS
New Century Bancorp, Inc. (“Company”) is a bank holding company whose principal business activity consists of ownership of New Century Bank (referred to as the “Bank”). All significant intercompany transactions and balances have been eliminated in consolidation. In 2004, the Company formed New Century Statutory Trust I, which issued trust preferred securities to provide additional capital for general corporate purposes, including the current and future expansion of the Company. New Century Statutory Trust I is not a consolidated subsidiary of the Company. The Company is subject to the rules and regulations of the Federal Reserve Bank and the North Carolina Commissioner of Banks.
New Century Bank was incorporated on May 15, 2000 and began banking operations on May 24, 2000. New Century Bank South began operations on January 2, 2004. The two banks merged on March 28, 2008 and New Century Bank continues as the only banking subsidiary of New Century Bancorp with the headquarters and operations center located in Dunn, NC. The Bank is engaged in general commercial and retail banking in southeastern North Carolina and operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of 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 the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the evaluation of goodwill for impairment.
Cash and Cash Equivalents
For the purpose of presentation in the statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions “Cash and due from banks,” “Interest-earning deposits in other banks,” and “Federal funds sold.”
Investment Securities Available for Sale
Investment securities available for sale are reported at fair value and consist of debt instruments that are not classified as either trading securities or as held to maturity securities. Unrealized holding gains and losses, net of deferred income tax, on available for sale securities are reported as a net amount in accumulated other comprehensive income. Gains and losses on the sale of investment securities available for sale are determined using the specific-identification method. Declines in the fair value of held to maturity securities and available for sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.
- 44 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. Loans held for sale are held at the lower of cost or fair market value until sold.
Allowance for Loan Losses
The provision for loan losses is based upon management’s estimate of the amount needed to maintain the allowance for loan losses at an adequate level. In making the evaluation of the adequacy of the allowance for loan losses, management gives consideration to current economic conditions, statutory examinations of the loan portfolio by regulatory agencies, delinquency information and management’s internal review of the loan portfolio. Loans are considered impaired when it is probable that all amounts due will not be collected in accordance with the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, or upon the fair value of the collateral if readily determinable. If the recorded investment in the loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Company to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination.
Foreclosed Real Estate
Real estate acquired through, or in lieu of, loan foreclosure is recorded at the lower of cost or net realizable value, less the estimated cost to sell, at the date of foreclosure. After foreclosure, management periodically performs valuations of the property and valuation allowances are established when the carrying value exceeds the estimated net realizable value. Revenue and expenses from operations and changes in the valuation allowance are included in other non-interest expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets. Estimated useful lives are 40 years for buildings, 5 to 10 years for furniture, fixtures and equipment and 3 years for computers and related equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.
- 45 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock in Federal Home Loan Bank of Atlanta
As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (“FHLB”). This investment is carried at cost. Due to the redemption provisions of the FHLB, the Company estimated that fair value equals cost and that this investment was not impaired at December 31, 2008.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are also recognized for operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized.
Bank Owned Life Insurance
Bank Owned Life Insurance (“BOLI”) is carried at its cash surrender value on the balance sheet and is classified as a non-interest-earning asset. Death benefit proceeds received in excess of the policy’s cash surrender value are recognized to income. Returns on the BOLI assets are added to the carrying value and included as non-interest income in the consolidated statement of operations. Any receipt of benefit proceeds is recorded as a reduction to the carrying value of the BOLI asset. At December 31, 2008 and 2007, the Company held no policy loans against its BOLI cash surrender values or restrictions on the use of the proceeds.
Goodwill and Intangible Assets
Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased intangible assets that can be separately distinguished from goodwill. Goodwill impairment testing is performed annually on June 30, or more frequently if events and circumstances indicate possible impairment. Management completed the annual goodwill impairment test as of June 30, 2008 and also on December 31, 2008. Both tests indicated that no impairment had occurred. Intangible assets with finite lives include core deposits and other intangibles. Intangible assets are subject to impairment testing whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company’s core deposit intangible is amortized using the straight-line method over nine years.
Stock-Based Compensation
The Company has certain stock-based employee compensation plans, described more fully in Note O. Effective January 1, 2006, the Company adopted SFAS 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”) using the modified prospective application method and accordingly did not restate prior period amounts. SFAS 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). SFAS 123R also requires the compensation cost for all awards granted after the date of adoption and any unvested awards that remained outstanding as of the date of adoption to be measured based on the fair value of the award on the grant date.
- 46 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income.
The Company reports as comprehensive income all changes in shareholders’ equity during the year from sources other than shareholders. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net income. The Company’s only component of other comprehensive income is unrealized gains and losses on investment securities available for sale.
Segment Information
The Company follows the provisions of SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information, which specifies guidelines for determining an entity’s operating segments and the type and level of financial information to be disclosed. Based on these guidelines, management has determined that the Bank operates as one business segment, the providing of general commercial and retail financial services to customers located in the Company’s market areas. The various products, as well as the methods used to distribute them, are those generally offered by community banks.
Stock Dividends
When the Company issues stock dividends and the balance in retained earnings at the date of the dividend declaration is less than the quoted market value of the shares at the date of declaration (as adjusted to take into account the increased number of shares that would be outstanding), the Company accounts for these issuances similar to stock splits. Therefore, the Company capitalizes only the par value of the common stock issuances from its paid in capital account. This accounting treatment is based on guidance from Topic C: Accounting for Stock Dividend When There Is a Retained Earnings Deficit, from the March 2001 meeting between the SEC Staff and the AICPA SEC Regulations Committee (Topic C). The Staff’s views on Topic C state “we believe all stock dividends payable to common stockholders when retained earnings are in a deficit position should be accounted for by capitalizing only the stock’s par value from paid in capital.”
The Company applied this guidance to its situations where the capitalization of the market value of the shares to be issued from retained earnings would otherwise have resulted in a deficit balance in retained earnings.
Net Income per Common Share and Common Shares Outstanding
Basic earnings per share, represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options.
All references in these financial statements to net income per common share, weighted average common and common equivalent shares outstanding, outstanding stock options and option exercise prices have been adjusted to reflect a 20% stock dividend in December 2006.
- 47 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Basic and diluted net income per share have been computed based upon net income as presented in the accompanying statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:
The Company had no anti-dilutive stock options as of December 31, 2008, 114,301 anti-dilutive stock options as of December 31, 2007 and no anti-dilutive stock options as of December 31, 2006.
Recent Accounting Pronouncements
The following summarizes recent accounting pronouncements and their expected impact on the Company:
Statement of Financial Accounting Standard (SFAS) No. 157 “Fair Value Measurement”
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements, which provides a common definition of fair value and a framework for measuring assets and liabilities at fair values when a particular standard prescribes it. In addition, the statement prescribes a more enhanced disclosure of fair value measures, and requires a more expanded disclosure when non-market date is used to assess fair values. The Company adopted the statement beginning January 1, 2008. The effect of adoption during 2008 did not have a material impact on the Company’s results of operations.
Statement of Financial Accounting Standard (SFAS) No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities”
The provisions of SFAS 159 became effective January 1, 2008 since the Company did not early adopt in February 2007. SFAS 159 generally permits the measurement of selected eligible financial instruments at fair value at specified election dates. Changes in fair value from one period to the next are recognized through the income statement. This election can generally be applied on an instrument by instrument basis. The Company chose not to account for any financial assets or liabilities under the fair value option.
Emerging Issues Task Force (EITF) No. 06-4 “Accounting for Deferred Compensation and Postretirement benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”
In September 2006, the FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF 06-4. EITF 06-4 states that an employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion-1967”. The Company adopted EITF 06-4 on
- 48 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
January 1, 2008, and in connection therewith recorded a liability of $276,000 as a reduction of retained earnings. Subsequent increases in this liability will be reflected as an expense in determining operating results.
Statement of Financial Accounting Standard (SFAS) No. 161 “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
In March 2008, the FASB issued SFAS No. 161. SFAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS 133). The Company does not currently utilize derivative instruments for hedging activities and therefore does not expect the adoption of the provisions of SFAS 161, which is effective for fiscal years beginning after November 15, 2008 to have a material effect on the Company’s financial condition and results of operations.
From time to time, the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.
Reclassifications
Certain amounts in the 2006 and 2007 consolidated financial statements have been reclassified to conform to the presentation adopted for 2008. These reclassifications had no effect on net income or shareholders’ equity as previously reported.
NOTE C - INVESTMENT SECURITIES
The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, follow:
- 49 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE C - INVESTMENT SECURITIES (Continued)
Securities with a carrying value of $38.7 million and $32.5 million at December 31, 2008 and 2007, respectively, were pledged to secure public monies on deposit as required by law and customer repurchase agreements.
The following tables show gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position as of December 31, 2008 and 2007. For the seven investment securities with unrealized losses at December 31, 2008, one municipal bond had continuous unrealized losses for more than twelve months. The unrealized losses relate to debt securities that have incurred fair value reductions due to higher market interest rates since the securities were purchased. The unrealized losses are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations and the Company has the intent and ability to hold these securities to maturity, no other than temporary impairments were identified for these investments having unrealized losses for the periods ended December 31, 2008 and December 31, 2007.
- 50 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE C - INVESTMENT SECURITIES (Continued)
The following table sets forth certain information regarding the amortized costs, carrying values, and contractual maturities of the Company’s investment portfolio at December 31, 2008.
- 51 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE C - INVESTMENT SECURITIES (Continued)
For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.
NOTE D - LOANS
Following is a summary of loans at December 31, 2008 and 2007:
Loans are primarily made in southeastern North Carolina. Real estate loans can be affected by the condition of the local real estate market and can be affected by the local economic conditions.
- 52 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE D - LOANS (Continued)
Impaired loans at December 31, 2008 and 2007 consisted of loans of approximately $9.1 million and $12.1 million respectively. Impaired loans at December 31, 2008 were comprised of $8.6 million in non-accrual loans, and $0.5 million in other loans that management has classified as impaired for other reasons. There were no restructured loans or loans that were 90 days or more past due and still accruing as of December 31, 2008. Impaired loans at December 31, 2007 consisted of $5.0 million in non-accrual and restructured loans, $1.0 million in loans that were 90 days or more past due and still accruing and $7.1 million in other loans that management has classified as impaired for other reasons.
Nonperforming assets at December 31, 2008 and 2007 consist of the following:
The average recorded investment in impaired loans was approximately $10.6 million and $10.9 million for the years ended December 31, 2008 and 2007, respectively. Approximately, $4.2 million of the $ 9.1 million in impaired loans at December 31, 2008 had special allowances provided. Approximately, $8.9 million of the $12.1 million in impaired loans at December 31, 2007 had special allowances provided. The allowance allocated for impaired loans for 2008 and 2007 was approximately $3.4 million and $2.3 million, respectively.
At December 31, 2008 and 2007, the Company had no troubled debt restructures.
The average balance of non-accrual loans was $8.9 million and $4.4 million for the years ended December 31, 2008 and 2007, respectively. In 2008 and 2007, interest forgone on non-accrual loans was approximately $560,000 and $365,000. Non-accrual loans did not materially affect interest income for the year ended December 31, 2006.
At December 31, 2008 and 2007, the Company had $0 and $3.9 million in loans held for sale that were guaranteed by the Small Business Administration. During 2008, these loans were transferred back into the Company’s loan portfolio.
- 53 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE D - LOANS (Continued)
Following is a summary of activity in the allowance for loan losses for the years indicated:
At December 31, 2008, the Company had pre-approved but unused lines of credit totaling $74.5 million. In management’s opinion, these commitments, and undisbursed proceeds on construction loans in process reflected above, represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity.
The Bank has had loan transactions with its directors and executive officers. Such loans were made in the ordinary course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and did not involve more than the normal risk of collectibility or present other unfavorable features. The following table represents loan transactions for directors and executive officers who held that position as of December 31, 2008. A summary of related party loan transactions, in thousands, is as follows:
At December 31, 2008, there was $4.8 million of unused lines of credit outstanding to directors and executive officers of the Company and its subsidiaries.
- 54 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE E - PREMISES AND EQUIPMENT
Following is a summary of premises and equipment at December 31, 2008 and 2007:
Depreciation amounting to $702,000, $732,000 and $622,000 for the years ended December 31, 2008, 2007 and 2006, respectively, is included in occupancy and equipment expense, data processing and other outsourced services expense and other expenses.
The Company has operating leases for its corporate offices and branches that expire at various times through 2027. Future minimum lease payments under the leases for years subsequent to December 31, 2008 are as follows:
During 2008, 2007, and 2006, payments under operating leases were approximately $270,000, $250,000 and $249,000, respectively. These payments were accounted for on a straight basis.
NOTE F - DEPOSITS
At December 31, 2008, the scheduled maturities of time deposits are as follows:
- 55 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE G - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase generally mature within one to four days from the transaction date and are classified as short term debt. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. These repurchase agreements are collateralized by U. S. Government agency obligations. The following table presents certain information for securities sold under agreements to repurchase:
NOTE H - ADVANCES FROM FEDERAL HOME LOAN BANK
At December 31, 2008, the Company had available lines of credit totaling approximately $8.8 million with various financial institutions for borrowing on a short-term basis. These lines are subject to annual renewals with varying interest rates. Also, as a member of the Federal Home Loan Bank of Atlanta, the Company may obtain advances of up to 10% of assets, subject to available collateral.
At December 31, 2008 and 2007 the Company had no advances from the Federal Home Loan Bank of Atlanta.
NOTE I - JUNIOR SUBORDINATED DEBENTURES
On September 20, 2004, $12.4 million of junior subordinated debentures were issued to New Century Statutory Trust I (“the Trust”) in exchange for the proceeds of trust preferred securities issued by the Trust. All of the Trust’s common equity is owned by the Company. The junior subordinated debentures are included in long term debt and the Company’s equity interest in the Trust is included in other assets.
The Company pays interest on the junior subordinated debentures at an annual rate, reset quarterly, equal to 3 month LIBOR plus 2.15%. The debentures are redeemable on September 20, 2009 or afterwards in whole or in part, on any March 20, June 20, September 20 or December 20. Redemption is mandatory at September 20, 2034. The Company has fully and unconditionally guaranteed repayment of the trust-preferred securities. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.
The trust preferred securities qualify as Tier 1 capital for regulatory capital purposes subject to certain limitations, none of which were applicable at December 31, 2008.
- 56 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE J - INCOME TAXES
The significant components of the provision for income taxes for the years ended December 31, 2008, 2007 and 2006 are as follows:
The difference between the provision for income taxes and the amounts computed by applying the statutory federal income tax rate of 34% to income before income taxes is summarized below:
- 57 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE J - INCOME TAXES (Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred taxes at December 31, 2008 and 2007 are as follows:
Effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Income Tax Uncertainties, an interpretation of FASB Statement No. 109 (the “Interpretation”). This Interpretation provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. As a result of the initial adoption of this Interpretation, retained earnings were increased by $135,000 and accrued expenses were reduced by the same amount. As of January 1, 2008, there were no uncertain tax positions. The amount of uncertain tax positions may increase or decrease in the future for various reasons including adding amounts for current tax positions, expiration of open tax returns due to statutes of limitations, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions. The Company’s policy is to report interest and penalties, if any, related to uncertain tax positions in income tax expense in the Consolidated Statements of Operations. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2005.
- 58 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE K - OTHER NON-INTEREST EXPENSE
The major components of other non-interest expense for the years ended December 31, 2008, 2007 and 2006 are as follows:
NOTE L - REGULATORY MATTERS
The Company is subject to various regulatory capital requirements administered by federal and state 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 effect on the Company’s consolidated financial statements. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios, as set forth in the table below. Management believes, as of December 31, 2008, that the Company meets all capital adequacy requirements to which it is subject. The Company’s significant assets are its investments in New Century Bank and New Century Statutory Trust I.
The Bank may not declare or pay a cash dividend, or repurchase any of its capital stock, unless its capital surplus is equal to at least 50% of its paid-in capital. In addition, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the bank. The North Carolina Commissioner of Banks and the FDIC are also authorized to prohibit the payment of dividends under certain other circumstances.
The Company’s actual capital amounts and ratios are presented in the table below as of December 31, 2008 and 2007:
- 59 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE L - REGULATORY MATTERS (Continued)
New Century Bank’s actual capital amounts and ratios are presented in the table below as of December 31, 2008 and 2007:
New Century Bank South merged into New Century Bank on March 28, 2008. Therefore, regulatory capital ratios do not apply for 2008.
The reserve balance required to be maintained under the requirements of the Federal Reserve was approximately $25,000 at December 31, 2008.
Effective December 27, 2007, the board of directors of registrant’s subsidiary, New Century Bank, entered into a Memorandum of Understanding with the FDIC and the North Carolina Commissioner of Banks as a result of the joint examination by the FDIC and the North Carolina Commissioner’s Office. The Memorandum of Understanding sets forth certain actions required to be taken by management of New Century Bank to rectify unsatisfactory conditions identified by the federal and state banking regulators. The primary issues to be addressed by management relate to New Century Bank’s lending function, including conducting extensive loan risk rating reviews; addressing problem loans and enhancing the credit administration department; developing specific plans and proposals for classified credit relationships; improving loan documentation, policies and procedures; correcting all known violations of laws, rules and regulations; and developing capital and strategic plans for New Century Bank.
Compliance with the terms of the Memorandum of Understanding and remediation of the related material weakness that was originally identified in connection with the assessment of disclosure controls and procedures as of December 31, 2006 are high priorities for the Company. As a result, management devoted significant resources to these matters during the fiscal year ended December 31, 2008 and intends to continue to do so during 2009. Specific actions taken included the hiring of a new Chief Credit Officer with substantial experience, evaluation and reorganization of lending and credit administration personnel,
- 60 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE L - REGULATORY MATTERS (Continued)
assessment and revision of lending and credit administration policies and implementing procedures containing more effective processes for identification and valuation of problem credits.
As of December 31, 2008 and 2007, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum amounts and ratios, as set forth in the tables above. There are no conditions or events since that notification that management believes have changed the Bank’s category.
NOTE M - OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.
A summary of the contract amount of the Company’s exposure to off-balance sheet credit risk as of December 31, 2008 is as follows:
NOTE N - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
Financial instruments include cash and due from banks, interest-earning deposits with banks, investments, loans, deposit accounts and borrowings. Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and
- 61 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE N - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Fair Value Hierarchy
Under SFAS 157, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
•
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.
•
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
•
Level 3 - Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flows models and similar techniques.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 114). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2008,
- 62 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE N - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of December 31, 2008 (dollars in thousands):
As of December 31, 2008, the Bank identified $9.1 million in impaired loans, of which $4.2 million required a specific allowance of $3.4 million.
Cash and Due from Banks, Interest-Earning Deposits in Other Banks and Federal Funds Sold
The carrying amounts for cash and due from banks, interest-earning deposits in other banks and federal funds sold approximate fair value because of the short maturities of those instruments.
Investment Securities Available for Sale
Fair value for investment securities available for sale equals quoted market price if such information is available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans and Loans Held for Sale
For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Stock in Federal Home Loan Bank of Atlanta and Silverton Bank
The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank. The fair value of stock in Silverton Bank is assumed to approximate carrying value.
- 63 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE N - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Bank Owned Life Insurance
The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.
Deposits
The fair value of demand deposits is the amount payable on demand at the reporting date. The fair values of time deposits are estimated using the rates currently offered for instruments of similar remaining maturities.
Short Term Debt
The fair values of short term debt (sweep accounts that reprice weekly) are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.
Long Term Debt
The fair values of long term debt are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.
Accrued Interest Receivable and Accrued Interest Payable
The carrying amounts of accrued interest receivable and payable approximate fair value, because of the short maturities of these instruments.
Financial Instruments with Off-Balance Sheet Risk
With regard to financial instruments with off-balance sheet risk discussed in Note N, it is not practicable to estimate the fair value of future financing commitments.
- 64 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE N - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
The following table presents the carrying values and estimated fair values of the Company’s financial instruments at December 31, 2008 and 2007.
NOTE O - EMPLOYEE AND DIRECTOR BENEFIT PLANS
401(k) Plan
The Company has a 401(k) Plan and substantially all employees participate in the Plan. In December 2005, the Board of Directors approved the matching of 100% of the first 6% of an employee’s compensation contributed to the plan. This increase was implemented in January of 2006. Expenses attributable to the Plan amounted to $295,000, $296,000 and $267,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Effective January 1, 2007, the Company approved an amendment to the plan to allow for immediate vesting of matching contributions.
Employment Agreements
The Company has entered into employment agreements with its five executive officers and two of its senior officers to ensure a stable and competent management base. The agreements provide for benefits as spelled out in the contracts and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officers’ right to receive certain vested rights, including compensation. In the event of a change in control of the Company, as outlined in the agreements, the acquirer will be bound to the terms of those contracts.
- 65 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE O - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)
Supplemental Executive Retirement Plans
The Company implemented a supplemental executive retirement plan for the former Chief Executive Officer during 2003. Benefits will accrue and vest during the period of employment, and will be paid in monthly benefit payments over the officer’s life after retirement. Provisions of $47,000, $116,000 and $92,000 were expensed for future benefits to be provided under this plan during 2008, 2007 and 2006, respectively. In conjunction with the implementation of this plan, the Company has purchased life insurance on certain key officers to provide future funding of benefit payments. The life insurance policies provide the payment of a death benefit in the event an insured officer dies prior to attainment of retirement age. The total liability under this plan at December 31, 2008 and 2007 was $464,000 and $434,000, respectively.
As part of the acquisition of Progressive State Bank, the Company assumed a liability for the supplemental early retirement plan for Progressive’s Chief Executive Officer. At the time of the merger, a liability of $267,000 was recorded and a provision of $6,000 was expensed in 2006, resulting in a total liability of $273,000 as of December 31, 2006. Provisions of $21,000 and $16,000 and were expensed in 2008 and 2007, resulting in a total liability of $310,000 as of December 31, 2008. Corresponding to this liability, Progressive had purchased a life insurance policy on certain key officers to provide future funding of benefit payments. This policy was acquired by the Company upon its acquisition of Progressive.
Directors Deferred Compensation
The Company has instituted a Directors’ Deferral Plan whereby individual directors may elect annually to defer receipt of all or a designated portion of their fees for the coming year. Amounts so deferred are used to purchase shares of the Company’s common stock on the open market by the administrator of the Deferral Plan or to issue shares from the Company’s authorized but unissued shares, with such deferred compensation disbursed in the future as specified by the director at the time of his or her deferral election. Compensation and other expenses attributable to this plan for the years ended December 31, 2008, 2007 and 2006 were $190,000, $186,000, and $151,000, respectively.
Stock Option Plans
The Company has shareholder approved stock option plans under which options are granted to directors and employees of the Company and its subsidiary banks. Options granted to directors under the 2000 Nonqualified Plan typically vest immediately at the time of grant. During the year ended December 31, 2008, the Company granted 13,000 options to employees under the 2000 Incentive Plan. These options will vest over a three-year period with none vested at the time of grant. Also in 2008, the Company granted 35,800 options to employees under the 2004 Incentive Stock Option Plan, which vest over a five-year period with none vested at the time of grant.
- 66 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE O - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)
The estimated fair market value of each option awarded, using the Black-Scholes option pricing model, together with the assumptions used in estimating those fair values, are displayed below:
A summary of the Company’s option plans as of and for the year ended December 31, 2008 is as follows:
The aggregate intrinsic value of options outstanding and options exercisable as of December 31, 2008 was $42,000 each.
- 67 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE O - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)
Stock Option Plans (Continued)
The weighted average remaining life of options outstanding and options exercisable as of December 31, 2008 and 2007 is 5.45 years and 5.61 years, respectively. Information regarding the stock options outstanding at December 31, 2008 is summarized below:
A summary of the status of the Company’s nonvested shares as of December 31, 2008 and changes during the year ended December 31, 2008, is presented below:
For the years ended December 31, 2008, 2007 and 2006, the intrinsic value of options exercised was $293,000, $1.2 million, and $333,000, respectively, and the grant-date fair value of options vested was $188,000, $238,000, and $166,000, respectively. Cash received from stock option exercises for the year ended December 31, 2008 was approximately $513,000. The actual tax benefit in shareholders’ equity realized for the tax deductions from option exercises was approximately $27,000.
As of December 31, 2008, there was approximately $462,000 of total unrecognized compensation expense related to the Company’s stock option plans. This cost is expected to be recognized over a weighted average period of 1.78 years.
- 68 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE P - PARENT COMPANY FINANCIAL DATA
Following are the condensed balance sheets of New Century Bancorp as of and for the years ended December 31, 2008 and 2007 and the related condensed statements of operations and cash flows for each of the years in the three-year period ended December 31, 2008 (amounts in thousands):
Condensed Balance Sheets
December 31, 2008 and 2007
Condensed Statements of Operations
Years Ended December 31, 2008, 2007 and 2006
- 69 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE P - PARENT COMPANY FINANCIAL DATA (Continued)
Condensed Statements of Cash Flows
Years Ended December 31, 2008, 2007 and 2006
NOTE Q - RELATED PARTY TRANSACTIONS
During 2008, the Company purchased various insurance policies from a company owned by one of the directors of New Century Bancorp. Premiums paid totaled approximately $50,200 for these policies, which include a three-year policy for directors and officers liability coverage, a three-year policy for fidelity bond coverage as well as commercial property and other insurance policies. All such policies were purchased on terms at least as favorable to the Company as could be obtained from an unaffiliated third party.
Beginning in July 2008, the Company began leasing a building owned by one of the directors of New Century Bancorp for a portion of its operations center. The two year lease will total approximately $57,000 paid to the director, through 2009 and part of 2010.
- 70 -
NEW CENTURY BANCORP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
NOTE Q - RELATED PARTY TRANSACTIONS (Continued)
In October 2007, New Century Bank South purchased a portion of the building that houses its Raeford Road branch from one of its directors for $1.4 million. This additional office space will be used by lending and administrative staff. New Century Bank South obtained an appraisal of the property’s value from an independent third party appraiser and the transaction was subject to prior approval by a committee of disinterested directors.
All related party transactions are “arms length” transactions.
- 71 -
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
At the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14.
Based upon that evaluation and the identification of the no material weakness in the Company’s internal control over financial reporting as described in Management’s Annual Report on Internal Control over Financial Reporting below, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for preparing the Company’s annual consolidated financial statements and for establishing and maintaining adequate internal control over financial reporting for the Company. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has made a comprehensive review, evaluation and assessment of the Company’s internal control over financial reporting as of December 31, 2008. In making its assessment of internal controlover financial reporting, Management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework.
Based on this assessment, Management has concluded that that the Company’s internal control over financial reporting as of December 31, 2008 was effective and no material weaknesses were detected. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected in a timely basis.
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
- 72 -
Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
/s/ William L. Hedgepeth II
/s/ Lisa F. Campbell
William L. Hedgepeth II
President and
Chief Executive Officer
Lisa F. Campbell
Executive Vice President,
Chief Operating Officer and Chief Financial Officer
Changes in Internal Control over Financial Reporting
Management of the Company has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the fourth quarter of 2008. With the exception of the remedial measures undertaken to address the material weakness described above, Management has concluded that there have been no changes to the Company’s internal controls over financial reporting that occurred since the beginning of the Company’s fourth quarter of 2008 that have materially affected, or are likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B
ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Incorporated by reference to the Registrant’s Proxy Statement for the 2009 Annual Meeting of Shareholders.
The Registrant has adopted a code of ethics that applies, among others to its principal executive officer and principal financial officer. The Registrant’s code of ethics will be provided to any person upon written request made to Ms. Brenda Bonner, New Century Bancorp, Inc., 700 W. Cumberland Street, Dunn, NC 28334.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
Incorporated by reference to the Registrant’s Proxy Statement for the 2009 Annual Meeting of Shareholders.
- 73 -
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference to the Registrant’s Proxy Statement for the 2009 Annual Meeting of Shareholders.
In 2000, the shareholders of New Century Bank approved the New Century Bank 2000 Nonqualified Stock Option Plan for Directors (the “2000 Nonqualified Plan”) and the New Century Bank 2000 Incentive Stock Option Plan (the “2000 Incentive Plan”). Both plans were adopted by the Registrant upon its organization as the holding company for New Century Bank on September 19, 2003. At the 2004 Annual Meeting of Shareholders, the shareholders approved amendments to 2000 Nonqualified Plan and the 2000 Incentive Plan and also approved the New Century Bancorp, Inc. 2004 Incentive Stock Option Plan. The maximum number of shares reserved for issuance upon the exercise of outstanding options granted under the 2000 Nonqualified Plan is 478,627 (adjusted for stock dividends). The maximum number of shares reserved for issuance upon the exercise of outstanding options granted under the 2000 Incentive Plan is 278,102 (adjusted for stock dividends). The maximum number of shares reserved for issuance upon exercise of outstanding options granted under the 2004 Incentive Plan is 75,600. Option prices for each of the plans are established at market value at the time of grant.
The following chart contains details of the grants:
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Incorporated by reference to the Registrant’s Proxy Statement for the 2009 Annual Meeting of Shareholders.
ITEM 14
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference to the Registrant’s Proxy Statement for the 2009 Annual Meeting of Shareholders.
- 74 -
PART IV
ITEM 15
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
1. Financial statements required to be filed by Item 8 of this Form:
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, 2007 and 2006
Consolidated Statements of Comprehensive Income for the years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006
Notes to Consolidated Financial Statements.
2. Financial statement schedules required to be filed by Item 8 of this Form:
None
3. Exhibits
- 75 -
RIDER A
Exhibits
To be filed with the Securities and Exchange Commission pursuant to Rule 14a-6.
- 76 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
NEW CENTURY BANCORP, INC.
Registrant
By:
/s/ William L. Hedgepeth, II
William L. Hedgepeth, II
Date: March 31, 2009
President and Chief Executive Officer
- 77 -
Pursuant to the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
- 78 -
- 79 -
RIDER B
EXHIBIT INDEX
* Incorporated by reference
- 80 -