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CRFN > SEC Filings for CRFN > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for CRESCENT FINANCIAL BANCSHARES, INC.

Form 10-Q for CRESCENT FINANCIAL BANCSHARES, INC.


13-Nov-2012

Quarterly Report


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

Management's discussion and analysis is intended to assist readers in understanding and evaluating the financial condition and consolidated results of operations of Crescent Financial Bancshares, Inc. (the "Company"). This discussion and analysis includes descriptions of significant transactions, trends and other factors affecting the Company's operating results for the successor three and nine months ended September 30, 2012 and the predecessor three and nine months ended September 30, 2011 as well as the financial condition of the Company as of September 30, 2012. This discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes included in this report.

Crescent State Bank ("CSB" or the "Bank"), which is the wholly-owned banking subsidiary of the Company, is a North Carolina-chartered commercial bank which operates fifteen full-service branch offices in the communities of Cary (2), Apex, Clayton, Holly Springs, Pinehurst, Raleigh (3), Southern Pines, Sanford, Garner, Wilmington (2) and Knightdale, North Carolina. CSB is a community bank with the objective of serving businesses, business owners and professionals within its markets. The following discussion and analysis includes financial results of the Bank, which are consolidated with financial results of the Company. The Company and its consolidated banking subsidiary are collectively referred to herein as the Company unless otherwise noted. The Company also has an interest in Crescent Financial Capital Trust I (the "Trust"). The Trust was formed for the sole purpose of issuing trust preferred securities and is not consolidated with the financial results of the Company.

VantageSouth Bank Merger Agreement

On July 27, 2012, the Company filed an application with the Bank's regulators to merge VantageSouth Bank, which is 100% owned by Piedmont Community Bank Holdings, Inc. ("Piedmont"), into CSB. Additional information relating to Piedmont's ownership interest in the Company is found in the "Piedmont Investment" section below. On August 10, 2012, an Agreement and Plan of Merger ("Merger Agreement") was entered into by the Company, CSB, and VantageSouth Bank to merge VantageSouth Bank into CSB in a share exchange based on the Company's volume weighted average stock price. Pursuant to terms of the Merger Agreement, outstanding VantageSouth Bank shares will be converted into the Company's shares equal to the exchange ratio. The exchange ratio will be 4.8204 if the Company's volume weighted average stock price is at or above $5.25. If the Company's volume weighted average stock price is at or below $4.75, the exchange ratio will be 5.3278, and if the Company's volume weighted average stock price is below $5.25 but above $4.75, the exchange ratio will be equal to $25.307 divided by a number equal to the Company's volume weighted average stock price. VantageSouth Bank's common stock is not registered under the Exchange Act and, as a result, VantageSouth Bank does not file securities reports with the SEC. However, additional financial and regulatory information is available in Reports of Condition and Income filed quarterly by VantageSouth Bank with the Federal Deposit Insurance Corporation, which are publicly accessible at http://www.fdic.gov. Such reports are not incorporated by reference in this Form 10-Q.

VantageSouth Bank is headquartered in Burlington, North Carolina, and operates five branch offices located in Burlington (2), Fayetteville, and Salisbury (2), North Carolina. As of September 30, 2012, VantageSouth Bank had approximately $260.7 million in total assets and 1,382,961 outstanding common shares. The Company's board of directors established an independent special committee which evaluated, negotiated, and made a favorable recommendation to the board regarding the proposed merger. The North Carolina Banking Commission granted its formal approval of the Merger on September 26, 2012, and the FDIC granted its final approval of the Merger on October 30, 2012. The completion of the merger is subject to stockholder approval.

East Carolina Bancorp Merger Agreement

On September 25, 2012, Crescent Financial and ECB entered into an Agreement and Plan of Merger (the "ECB Merger Agreement"). Pursuant to the ECB Merger Agreement, ECB will, on the terms and subject to the conditions set forth in the ECB Merger Agreement, merge with and into the Company so that the Company is the surviving bank holding corporation in the merger (the "Merger"). Immediately following the Merger, The East Carolina Bank, a North Carolina banking corporation and a wholly-owned subsidiary of ECB, will be merged with and into Crescent State Bank, a North Carolina banking corporation and a wholly-owned subsidiary of the Company. At the effective time of the Merger (the "Effective Time"), each share of common stock, par value $3.50 per share, of ECB issued and outstanding immediately before the Effective Time (the "ECB Common Stock"), except for shares of ECB Common Stock owned by ECB or the Company (other than certain trust account shares), will be converted into the right to receive 3.55 shares of the common stock, par value $0.001 per share of the Company. The completion of the merger is subject to all required regulatory and stockholder approvals.

ECB is a bank holding company, headquartered in Engelhard, North Carolina, whose wholly-owned subsidiary, The East Carolina Bank, is a state-chartered, independent community bank insured by the FDIC with 25 branch offices in eastern North Carolina stretching from the Virginia to South Carolina state lines east of Interstate 95. ECB offers a full range of financial services including

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Mortgages, Agricultural Banking and Wealth Management services. The Company's common stock is listed on NYSE Amex under the symbol "ECBE".

Piedmont Investment

On November 18, 2011, the Company completed the issuance and sale to Piedmont of 18,750,000 shares of common stock for $75.0 million in cash (the "Piedmont Investment"). As part of its investment, Piedmont also made a tender offer to the Company's stockholders commencing on November 8, 2011 to purchase up to 67% (6,442,105 shares) of the Company's outstanding common stock at a price of $4.75 per share ("Tender Offer"). Pursuant to the Tender Offer, Piedmont purchased 6,128,423 shares of the Company's common stock for $29.1 million. As a result of the Piedmont Investment and the Tender Offer, Piedmont owns approximately 88% of the Company's outstanding common stock.

The Company's results of operations in the third quarter and first nine months of 2012 were significantly impacted by the controlling investment in the Company by Piedmont. Because of the level of Piedmont's ownership and control following the controlling investment and the Tender Offer, the Company applied push-down accounting. Accordingly, the Company's assets and liabilities were adjusted to estimated fair value at the acquisition date, and the allowance for loan losses was eliminated. The Company is currently within the one-year measurement period with respect to the acquisition date, and thus, material adjustments to these purchase accounting fair value adjustments are possible. In the nine months of 2012, goodwill increased by $3.1 million as a result of adjustments to refine the Company's acquisition date estimate of market rent on two branch leases, adjustments to refine the valuation of certain other real estate owned, and adjustments to refine acquisition date cash flow estimates and the related valuation of certain loans. Balances and activity in the Company's consolidated financial statements prior to the Piedmont Investment have been labeled with "Predecessor Company" while balances and activity subsequent to the Piedmont Investment have been labeled with "Successor Company."

Certain Regulatory Restrictions Lifted on Payment of Interest and Dividends

On April 12, 2012, the Company received approval from the Federal Reserve Bank of Richmond (the "Federal Reserve Bank") to resume payment of preferred dividends on securities issued to the U.S. Treasury in connection with the TARP Capital Purchase Program ("TARP Preferred Stock") and interest payments due on its subordinated debentures issued in connection with trust preferred securities. The Company deferred dividend payments on its TARP Preferred Stock beginning with the payment due February 15, 2011. The Company paid all deferred cumulative preferred dividends of $1.6 million plus current dividends on the quarterly payment date of May 15, 2012. The Company deferred interest payments on its trust preferred securities beginning with the payment due April 7, 2011 but continued to accrue interest expense in its consolidated financial statements. The Company paid all accrued deferred interest on its trust preferred securities of $371,000 plus current interest on the quarterly payment date of July 7, 2012.

Executive Overview

The following is a summary of the Company's results of operations and changes in financial condition in the third quarter and first nine months of 2012:

Net income totaled $337 thousand during the nine months ended September 30, 2012 compared to a net loss of $13.5 million in the predecessor nine months ended September 30, 2011. Net income in the third quarter of 2012 equaled $46 thousand compared to a net loss of $3.0 million in the predecessor third quarter of 2011.

After the preferred stock dividend, the Company recognized net loss attributable to common shareholders of $0.03 per common share during the first nine months of 2012 compared to a net loss of $1.54 per common share in the predecessor first nine months of 2011. The Company recognized a net loss of $0.01 per common share during the third quarter of 2012 compared to a net loss of $0.36 per common share in the predecessor third quarter of 2011.

Asset quality continued to improve as non-performing assets decreased to 1.62 percent of total assets at September 30, 2012 from 2.38 percent of total assets at June 30, 2012 and 3.87 percent of total assets at December 31, 2011.

The Company originated $56.3 million of commercial and consumer loans in the third quarter of 2012 after $48.0 million of loan originations in the second quarter of 2012 and $15.0 million of loan originations on the first quarter of 2012.

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The taxable equivalent net interest margin improved to 4.38 percent in the first nine months of 2012 from 2.98 percent in the predecessor first nine months of 2011. Net interest margin improved to 4.44 percent in the third quarter of 2012 from 3.17 percent in the predecessor third quarter of 2011.

Mortgage banking income improved to $2.4 million in the first nine months of 2012 compared to $900 thousand in the predecessor first nine months of 2011. Mortgage banking income improved to $1.1 million in the third quarter of 2012 from $475 thousand in the predecessor third quarter of 2011.

Comparison of Financial Condition as of September 30, 2012 to December 31, 2011

Total assets equaled $793.8 million at September 30, 2012, a decrease of $42.5 million, or 5.1 percent, from total assets of $836.3 million at December 31, 2011. Earning assets totaled $687.8 million, or 86.7 percent of total assets, at September 30, 2012 compared to $723.9 million, or 86.6 percent of total assets, at December 31, 2011. Earning assets at September 30, 2012 consisted of $540.9 million in gross loans held for investment, $134.2 million in investment securities and Federal Home Loan Bank ("FHLB") stock, $5.6 million in federal funds sold and interest-earning deposits with correspondent banks and $7.0 million in mortgage loans held for sale. Earning assets at December 31, 2011 consisted of $551.4 million in gross loans held for investment, $152.2 million in investment securities and FHLB stock, $16.5 million in federal funds sold and interest-earning deposits and $3.8 million in mortgage loans held for sale. Total deposits and stockholders' equity at September 30, 2012 were $633.9 million and $142.8 million, respectively, compared to $693.2 million and $143.1 million, respectively, at December 31, 2011.

Loans

Gross loans held for investment, net of deferred loan fees, totaled $540.9 million at September 30, 2012 reflecting a $10.4 million, or 1.9 percent, decrease compared to $551.4 million at December 31, 2011. This decline resulted from a combination of principal payments in the normal course of business, problem asset resolutions, which include loan sales, and a change in the Company's business model which has shifted the loan portfolio mix to favor business and consumer lending over construction and speculative land loans. Most of the loan categories experienced a balance reduction in the first nine months of 2012, except for commercial loans and, to a lesser extent, residential real estate loans which reflects the Company's lending strategy and new focus. The changes in the portfolio, by category, were as follows: construction and land development loans, $25.3 million decline, or 30.2 percent; commercial real estate loans, $3.6 million decline, or 1.2 percent; residential 1-4 family mortgage loans, $7.8 million increase, or 11.6 percent; commercial and industrial loans, $17.5 million increase, or 44.5 percent; home equity loans and lines of credit, $8.1 million decline, or 16.5 percent; and consumer loans, $216 thousand increase, or 6.5 percent.

The composition of the Company's loan portfolio at September 30, 2012 was as follows: 56.7 percent commercial real estate mortgage loans, 10.8 percent construction and land development loans, 13.8 percent residential one-to-four family mortgage loans, 7.6 percent home equity lines and loans, 10.5 percent commercial and industrial loans and consumer loans at 0.6 percent. The composition of the loan portfolio at December 31, 2011 was as follows: 56.1 percent commercial real estate loans, 15.2 percent construction and land development loans, 12.1 percent residential 1-4 family mortgage loans, 8.9 percent home equity loans and lines of credit, 7.1 percent commercial and industrial loans, and consumer loans at 0.6 percent.

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The following table summarizes the gross unpaid borrower principal balances ("UPB") and carrying amounts in the loan portfolio by type at September 30, 2012 and December 31, 2011:

                                        September 30, 2012                       December 31, 2011
                                                           Carrying                                 Carrying
                                             Carrying     Amount as                   Carrying     Amount as
                                  UPB         Amount       % of UPB        UPB         Amount       % of UPB
Commercial real estate        $ 312,722     $ 306,722         98.1 %   $ 323,426     $ 310,315         95.9 %
Residential real estate          76,559        74,760         97.7 %      69,312        67,004         96.7 %
Construction and
development                      63,671        58,585         92.0 %     109,965        83,930         76.3 %
Commercial                       58,640        56,976         97.2 %      41,466        39,434         95.1 %
Home equity loans and lines
of credit                        42,526        40,875         96.1 %      51,700        48,940         94.7 %
Consumer                          3,139         3,084         98.3 %       3,439         3,300         96.0 %

Total loans                   $ 557,257     $ 541,002         97.1 %   $ 599,308     $ 552,923         92.3 %

Non-performing loans as a percentage of total loans held for investment totaled 1.67 percent at September 30, 2012, which was a decline from 2.90 percent at June 30, 2012 and 4.14 percent at December 31, 2011. Total non-performing assets (which include non-accrual loans, loans past due 90 days or more and still accruing, other real estate owned and repossessed loan collateral) as a percentage of total assets at September 30, 2012 totaled 1.62 percent, which was a decline from 2.38 percent at June 30, 2012 and 3.87 percent at December 31, 2011.

As part of an ongoing, focused effort to reduce its problem asset levels, the Company has completed loan sales to various investors in the first nine months of 2012. Proceeds from these loan sales totaled $14.8 million. Of those sold, loans with a carrying value of $8.1 million were classified as non-performing at year-end 2011. Included in these loan sales was a sale of notes with a total carrying value of $5.0 million to VantageSouth Holdings, LLC, a Delaware limited liability company that is a wholly-owned subsidiary of Piedmont. These loans were sold at estimated fair value, and no gain or loss was recorded on the transaction. For more information regarding non-performing assets, see section below entitled "Non-Performing Assets."

Allowance for Loan Losses

The allowance for loan losses at September 30, 2012 increased to $2.3 million from $227 thousand at December 31, 2011. The net increase is due to a $3.7 million for loan losses, which was partially offset by $1.7 million in net charge-offs. The allowance for loan losses at September 30, 2012 consisted of $1.3 million related to estimated losses inherent in loans originated subsequent to the Piedmont Investment ("New Loans"), $86 thousand of estimated losses on purchased non-impaired loans, and $907 thousand of impairment on purchased credit-impaired loans. The increase in allowance for loan losses on New Loans was primarily attributable to the origination of approximately $119.3 million in new loans during 2012 rather than credit deterioration of existing loans originated subsequent to the Piedmont Investment.

The following table summarizes the change in allowance for loan losses for new loans, purchased non-impaired loans and purchased credit-impaired loans during the nine months ended September 30, 2012:

                              New        Purchased          Purchased
                             Loans      Non-Impaired     Credit-Impaired       Total
                                              (dollars in thousands)
Balance January 1           $   227    $        -       $               -    $   227
Net charge-offs                   -        (1,693 )                     -     (1,693 )
Provision for loan losses     1,044         1,779                     907      3,730

Balance September 30        $ 1,271    $       86       $             907    $ 2,264

There were no impaired or past due new loans at September 30, 2012 or December 31, 2011. Although purchased non-impaired loans were adjusted to fair value at acquisition, the Company records charge-offs for losses and provides reserves for deterioration

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in credit quality on these loans. All revolving loans were classified as purchased non-impaired at acquisition and a majority of the charge-offs and provision relate to acquired revolving home equity lines of credit.

Loans acquired with evidence of credit deterioration since origination are accounted for as purchased credit-impaired loans. At acquisition date the Company elected to pool loans with similar attributes and risk characteristics. Subsequent to acquisition of these loans, estimates of cash flows expected to be collected are updated each reporting period based on assumptions regarding default rates, loss severities, and other factors that reflect current market conditions. If the Company has probable decreases in cash flows expected to be collected at the pool level (other than due to decreases in interest rates), the provision for loan losses is charged, resulting in an increase to the allowance for loan losses. If there are probable and significant increases in cash flows expected to be collected at the pool level, the Company will first reverse any previously established allowance for loan losses and then increase interest income as a prospective yield adjustment over the remaining life of the loans.

Results of the Company's third quarter of 2012 cash flow re-estimation are summarized as follows:

                                                         Cash Flow       New     Previous
                                         Impairment     Improvement     Yield      Yield
                                                      (dollars in thousands)
Loan pools with cash flow improvement   $     (143 )   $       1,026    6.44 %      6.09 %
Loan pools with impairment                     278                 -    8.18 %      8.18 %

Total                                   $      135     $       1,026    6.67 %      6.49 %

The third quarter of 2012 cash flow re-estimation indicated net improved cash flows on purchased credit-impaired loan pools of $891 thousand. The $1.0 million of cash flow improvement on related loan pools will be recorded as additional interest income as a prospective yield adjustment over the remaining life of the loans. The $135 thousand impairment was recorded to the provision for loan losses in the third quarter of 2012. The pool-level impairment and cash flow improvement were calculated as the difference between the pool-level recorded investment and the net present value of estimated cash flows at the time of the cash flow re-estimation.

For more information regarding the allowance for loan losses, see section below entitled "Analysis of Allowance for Loan Losses."

Investment Securities

The amortized cost and fair value of the securities portfolio were $129.7 million and $133.0 million, respectively, at September 30, 2012 compared to $143.5 million for both at December 31, 2011. All marketable investment securities are accounted for as available for sale and are recorded at fair value with unrealized gains and losses charged to accumulated other comprehensive income. The investment securities portfolio at September 30, 2012 consisted of residential mortgage-backed securities ("RMBS"), commercial mortgage-backed securities ("CMBS"), collateralized mortgage obligations ("CMO"), non-taxable and taxable municipal bonds, investment grade corporate bonds and the common stock of two publicly traded companies. All RMBSs and CMOs were issued by either a Government Sponsored Enterprise ("GSE"), such as Federal Home Loan Mortgage Corporation ("Freddie Mac") or the Federal National Mortgage Association ("Fannie Mae") or the government-owned Government National Mortgage Association ("Ginnie Mae"). All CMOs were issued by a GSE. The Company's two CMBSs were issued by non-GSE financial institutions and are Aaa rated by Moody's.

At September 30, 2012 and December 31, 2011, the securities portfolio had $3.3 million and $525 thousand, respectively, of unrealized gains and $97 thousand and $507 thousand, respectively, of unrealized losses. None of these securities had been in an unrealized loss position for more than twelve months at either date.

The following table summarizes the amortized costs and fair value of available for sale securities at September 30, 2012 and December 31, 2011:

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                                         September 30, 2012                December 31, 2011
                                     Amortized                         Amortized          Fair
                                        Cost          Fair Value          Cost            Value
                                                        (dollars in thousands)
Residential mortgage-backed
securities - GSE                   $     22,692     $     23,312     $     19,452     $    19,364
Commercial mortgage-backed
securities - private                      6,759            6,872                -               -
Collateralized mortgage
obligations - GSE                        47,855           47,918           82,192          82,095
Municipals - non-taxable                 15,510           16,218           13,281          13,514
Municipals - taxable                      1,635            1,646                -               -
Corporate bonds                          35,217           36,917           28,042          27,966
Marketable equity securities                 37               70              519             565

Total securities available for
sale                               $    129,705     $    132,953     $    143,486     $   143,504

The Company also owned $1.3 million and $8.7 million of FHLB stock at September 30, 2012 and December 31, 2011, respectively. This stock is recorded at cost and is classified separately from investment securities on the consolidated balance sheets.

Non-Interest Earning Assets

Total non-interest earning assets decreased from $112.4 million at December 31, 2011 to $106.0 million at September 30, 2012. Cash and due from banks, premises and equipment, bank owned life insurance, and other assets increased by $405 thousand, $398 thousand, $539 thousand, and $249 thousand, respectively. Foreclosed assets declined by $5.2 million as the Company has continued to focus on reducing problem assets through a variety of resolution strategies.

Net deferred tax assets increased by $604 thousand during the first nine months of 2012 to a balance of $30.9 million at September 30, 2012. Deferred tax assets represent, among other items, the tax impact of purchase accounting fair value adjustments as well as predecessor company net operating losses that are available to be carried forward and used to offset future taxable income.

The Company has evaluated its deferred tax assets to determine whether a valuation allowance is necessary. In conducting this evaluation, all available evidence, both positive and negative, was considered based on the more-likely-than-not criteria that such assets will be realized. This evaluation included, but was not limited to: (1) available carry back potential to offset federal tax; (2) potential future reversals of existing deferred tax liabilities, which historically have a reversal pattern generally consistent with deferred tax assets; (3) potential tax planning strategies; and (4) future projected taxable income. Our assessment of future projected taxable income considered significant changes in our operations which occurred because of the recapitalization associated with the Piedmont Investment. These changes include improved capital levels, improved asset quality, significant management and organizational improvements, improved liquidity and improved risk management processes. These factors have significantly improved the Company's earnings potential since the Piedmont Investment. Based on this evaluation, and considering the weight of the positive evidence compared to the negative evidence, the Company concluded that at September 30, 2012, a valuation allowance was not necessary.

Goodwill and other intangibles totaled $23.1 million and $2.0 million, respectively, and $23.1 million and $2.2 million, respectively, at September 30, 2012 and December 31, 2011. Goodwill represents the excess of purchase price in the Piedmont Investment over the fair value of acquired net assets, including non-controlling interests. As part of the valuation of net assets, the Company also identified and recorded the value of customer deposit relationships, or core deposit intangible, as an other intangible asset. The core deposit intangible is being amortized over its estimated useful life using an accelerated method. The Company is currently within the one-year measurement . . .

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