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ASBB > SEC Filings for ASBB > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for ASB BANCORP INC


15-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The objective of this section is to help readers understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the consolidated financial statements and the notes to consolidated financial statements that appear at the end of this annual report.


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Operating Strategy

Our primary objective is to operate and grow a profitable community-oriented financial institution serving customers in our primary market areas. We have sought to achieve this through the adoption of a business strategy designed to maintain a strong capital position and high asset quality. We continue to execute our plan to resolve our asset quality problems. In recent years, we have hired senior management with substantial experience in consumer and commercial banking to help us diversify our product offerings and expand our consumer and commercial deposit and lending products, while emphasizing high asset quality standards. Our operating strategies include the following:

continuing to provide products and services to individuals and businesses in the communities served by our branch offices;

continuing to originate residential and commercial mortgage loans;

expanding our commercial and industrial lending activities and emphasizing the origination of small business loans;

emphasizing lower cost core deposits to maintain low funding costs;

expanding our market share within our primary market area; and

seeking to enhance fee income through providing investment advisory services.

Continuing to provide products and services to individuals and businesses in the communities served by our branch offices.

We have continually operated as a community-oriented financial institution since we were established in 1936. We are committed to meeting the financial needs of the communities in which we operate, and we are dedicated to providing quality personal service to our customers. We provide a broad range of consumer and business financial services through our network of banking center offices and will remain steadfast in our pursuit of ways to improve convenience, safety, and service through our product offerings.

Continuing to originate residential and commercial mortgage loans.

Our primary lending focus has been, and will continue to be, on operating as a residential and commercial mortgage lender. We originate fixed and adjustable-rate residential and commercial mortgage loans that are retained in our loan portfolio. However, most of the fixed-rate residential mortgage loans that we originate are sold into the secondary market with servicing released as part of our efforts to reduce our interest rate risk. At December 31, 2012, residential mortgage loans totaled $163.6 million, or 42.1% of our total loan portfolio, and commercial mortgage loans totaled $138.8 million, or 35.8% of our total loan portfolio. Our total residential and commercial mortgage loans decreased to $302.4 million at December 31, 2012 from $315.8 million at December 31, 2011 as we managed our problem loans and experienced lower loan demand throughout this period, but we intend to continue to emphasize our residential and commercial mortgage lending activities.

Expanding our commercial and industrial lending activities and emphasizing the origination of small business loans.

We intend to expand our commercial and industrial lending activities and to originate an increased number of small business loans. Management has hired additional experienced lending officers and credit management personnel over the past several years in order to continue to safely manage this type of lending. Although commercial and industrial lending has decreased recently as we have managed our problem loans and experienced low loan demand, our goal is to increase this portion of our portfolio using conservative underwriting practices to increase the yield in our loan portfolio.


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Emphasizing lower cost core deposits to maintain low funding costs.

We seek to increase our net interest income by controlling our costs of funding. As a traditional thrift institution, a greater percentage of our deposit accounts has historically been higher balance, higher cost certificates of deposits. Over the past several years, we have worked to reduce our dependence on traditional higher cost deposits in favor of stable lower cost core deposits. We have used additional product offerings, technology, and a focus on customer service in working toward this goal. In addition, we intend to seek demand deposits by growing commercial banking relationships.

Expanding our market share within our primary market area.

We intend to expand our market share in our primary market area by evaluating additional branch expansion opportunities. Subject to favorable market conditions, our goal is to continue to open additional branch offices in our primary market area. In addition, we are interested in pursuing opportunities to acquire other financial institutions, including through Federal Deposit Insurance Corporation assisted transactions, and branches of other financial institutions in our primary market area and surrounding areas, although we currently have no definitive plans or commitments regarding potential acquisition opportunities.

Seeking to enhance fee income through providing investment advisory services.

Through a relationship with LPL Financial LLC, we currently provide a full array of investment services for individuals and small businesses, including full access to financial market instruments such as mutual funds. As of December 31, 2012 and 2011, commission income relating to our investment advisory services totaled $242,000 and $275,000, respectively. In the future, we intend to continue to enhance our fee income by providing investment advisory services to our customers through our relationship with LPL.

Overview

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and securities, and interest expense, which is the interest that we pay on our deposits and borrowings. Other significant sources of pre-tax income are deposit and other service charge income, mortgage banking income derived from the sale of loans in the secondary market, income from debit card services, and income from the sale of securities.

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a monthly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.

Expenses. The noninterest expense we incur in operating our business consists of salaries and employee benefits expenses, occupancy expenses, federal deposit insurance premiums and assessments, data processing expenses and various other miscellaneous expenses. Our noninterest expenses also include expenses related to shareholder communications and meetings, stock exchange listing fees, the employee stock ownership plan, stock compensation plans, and legal and accounting services.

Salaries and employee benefits expenses consist primarily of salaries, wages and bonuses paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We anticipate recognizing additional future employee compensation expenses stemming from our adoption of new equity-based benefit plans. We are in the process of determining the actual amount of future compensation expense that will result from these new proposed equity-based benefit plans because applicable accounting guidance requires that the compensation expense recognized on the shares of common stock granted under these plans be based on the fair market value of the common shares measured at specific points in the future.


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Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, rental expenses, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to forty years.

Data processing expenses are the fees we pay to third parties for processing customer information, deposits and loans.

Federal deposit insurance premiums and assessments are payments we make to the Federal Deposit Insurance Corporation for insurance of our deposit accounts.

Other expenses include expenses for professional services, advertising, office supplies, postage, telephone, foreclosed properties, insurance and other miscellaneous operating expenses.

Critical Accounting Policies

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

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to earnings. Management's estimates of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impaired loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance monthly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect our earnings. See notes 1 and 5 included in the notes to consolidated financial statements included in this annual report.

Fair Value of Investments. Securities are characterized as available for sale or held to maturity based on management's ability and intent regarding such investment at acquisition. On an ongoing basis, management estimates the fair value of its investment securities based on information and assumptions it deems reliable and reasonable, which may be quoted market prices or if quoted market prices are not available, fair values extrapolated from the quoted prices of similar instruments. Based on this information, an assessment must be made as to whether any decline in the fair value of an investment security should be considered as an other than temporary impairment and recorded in noninterest income as a loss on investments. The determination of such impairment is subject to a variety of factors, including management's judgment and experience. See notes 3 and 14 of the notes to the consolidated financial statements included in this annual report.


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Deferred Tax Assets. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred tax asset will not be realized. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. A reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. See notes 1 and 10 of the notes to the consolidated financial statements included in this annual report.

Pension Plan. The Company has a noncontributory defined benefit pension plan. This plan is accounted for under the provisions of ASC Topic 715:
Compensation-Retirement Benefits, which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. ASC Topic 715 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. Management must make certain estimates and assumptions when determining the projected benefit obligation. These estimates and assumptions include the expected return on plan assets, the rate of compensation increases over time, and the appropriate discount rate to be used in determining the present value of the obligation. See note 12 of the notes to the consolidated financial statements included in this annual report.

Comparison of Financial Condition at December 31, 2012 and December 31, 2011

General. Total assets decreased $41.5 million, or 5.2%, to $749.4 million at December 31, 2012 from $790.9 million at December 31, 2011. Investment securities decreased $5.7 million, or 2.3%, to $243.4 million at December 31, 2012 from $249.1 million at December 31, 2011, primarily due to securities sold in late December the proceeds from which were not reinvested until January, partially offset by the reinvestment into investment securities of proceeds from loan repayments and prepayments. Loans receivable, net of deferred fees, decreased $45.2 million, or 10.4%, to $387.7 million at December 31, 2012 from $432.9 million at December 31, 2011 as loan repayments, prepayments, and foreclosures continued to outpace new loan originations. In December of 2012, the Bank completed the foreclosure on the collateral of its largest nonperforming loan in the amount of $9.8 million, net of write-downs, which was moved into foreclosed properties.

Loans. Loan originations totaled $207.4 million for the year ended December 31, 2012 compared to $140.3 million for the year ended December 31, 2011. Residential mortgage loan originations totaled $110.7 million in 2012 compared to $81.7 million in 2011, while residential construction and land development loan originations totaled $11.0 million in 2012 compared to $10.7 million in 2011. Originations of commercial mortgage, commercial construction and land development, and commercial and industrial loans totaled $61.9 million, $1.1 million and $5.9 million, respectively, for the year ended December 31, 2012 compared to $32.7 million, $1.1 million and $7.2 million, respectively, for the year ended December 31, 2011. Revolving mortgage originations totaled $7.1 million in 2012 compared to $6.4 million in 2011, while consumer loan originations totaled $9.8 million in 2012 compared to $483,000 in 2011. The increase in consumer loan originations during 2012 was attributable to management's decision to re-enter the market for indirect automobile loan financing that was suspended in 2009. Origination activity was significantly offset by $139.9 million of normal loan repayments and prepayments and $91.0 million in loan sales for the year ended December 31, 2012, compared to $131.4 million and $68.9 million, respectively, for the year ended December 31, 2011.


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Loan Portfolio Composition

The following table sets forth the composition of our loan portfolio at the
dates indicated.



                                                                       December 31,
                                               2012                        2011                        2010
(dollars in thousands)                 Amount       Percent        Amount       Percent        Amount       Percent

Commercial:
Commercial mortgage                   $ 138,804        35.76 %    $ 139,947        32.30 %    $ 164,553        32.88 %
Commercial construction and land
development                               5,161         1.34 %       22,375         5.17 %       28,473         5.69 %
Commercial and industrial                11,093         2.86 %       17,540         4.05 %       17,656         3.53 %

Total                                   155,058        39.96 %      179,862        41.52 %      210,682        42.10 %


Non-commercial:
Residential mortgage                    163,571        42.14 %      175,866        40.59 %      180,439        36.06 %
Residential construction and land
development                               3,729         0.96 %        3,907         0.90 %        8,670         1.73 %
Revolving mortgage                       48,221        12.42 %       51,044        11.78 %       53,432        10.68 %
Consumer                                 17,552         4.52 %       22,588         5.21 %       47,212         9.43 %

Total                                   233,073        60.04 %      253,405        58.48 %      289,753        57.90 %


Total loans                             388,131       100.00 %      433,267       100.00 %      500,435       100.00 %


Less: net deferred loan origination
fees                                        410                         384                         432
Less: allowance for loan losses           8,513                      10,627                      12,676

Loans receivable, net                 $ 379,208                   $ 422,256                   $ 487,327

                                                                     December 31,
                                                          2009                          2008
(dollars in thousands)                            Amount        Percent         Amount        Percent

Commercial:
Commercial mortgage                              $ 197,239         32.98 %     $ 141,565         23.97 %
Commercial construction and land development        30,158          5.04 %        28,998          4.91 %
Commercial and industrial                           22,794          3.81 %        27,367          4.63 %

Total                                              250,191         41.83 %       197,930         33.51 %


Non-commercial:
Residential mortgage                               190,965         31.93 %       201,160         34.06 %
Residential construction and land development       15,141          2.53 %        23,491          3.98 %
Revolving mortgage                                  55,038          9.20 %        53,834          9.10 %
Consumer                                            86,768         14.51 %       114,268         19.35 %

Total                                              347,912         58.17 %       392,753         66.49 %


Total loans                                        598,103        100.00 %       590,683        100.00 %


Less: net deferred loan origination fees               502                           588
Less: allowance for loan losses                      8,994                         6,403

Loans receivable, net                            $ 588,607                     $ 583,692


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Loan Portfolio Maturities

The following tables set forth certain information at December 31, 2012 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The tables do not include any estimate of prepayments that significantly shorten the average life of our loans and may cause our actual repayment experience to differ from that shown below. Demand loans, which are loans having no stated schedule of repayments and no stated maturity, are reported as due in one year or less.

                                                                 December 31, 2012
                                                           Commercial
                                                          Construction         Commercial
                                        Commercial          and Land              and               Total
(in thousands)                          Mortgages          Development         Industrial         Commercial

Amounts due in:
One year or less                       $     32,501       $       1,552       $      2,729       $     36,782
More than one year through two
years                                        26,127               1,082              1,702             28,911
More than two years through three
years                                        11,774                 778                807             13,359
More than three years through five
years                                        42,494                 981              2,984             46,459
More than five years through ten
years                                        14,862                 590              2,871             18,323
More than ten years through
fifteen years                                11,046                 178                 -              11,224

Total                                  $    138,804       $       5,161       $     11,093       $    155,058

                                                                        December 31, 2012
                                                      Residential
                                                     Construction
                                    Residential        and Land         Revolving                     Total Non-        Total
(in thousands)                       Mortgages        Development       Mortgages      Consumer       Commercial        Loans

Amounts due in:
One year or less                   $       7,985     $         128     $       259     $   2,410     $     10,782     $  47,564
More than one year through two
years                                      1,246                -              273         4,342            5,861        34,772
More than two years through
three years                                2,606                -              286         2,960            5,852        19,211
More than three years through
five years                                 6,109                -            2,428         2,728           11,265        57,724
More than five years through ten
years                                     11,190                -           27,055         5,112           43,357        61,680
More than ten years through
fifteen years                             14,213                -           17,920            -            32,133        43,357
More than fifteen years                  120,222             3,601              -             -           123,823       123,823

Total                              $     163,571     $       3,729     $    48,221     $  17,552     $    233,073     $ 388,131


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Fixed vs. Adjustable Rate Loans

The following table sets forth the dollar amount of all loans at December 31,
2012 that have contractual maturities after December 31, 2013 and have either
fixed interest rates or floating or adjustable interest rates. The amounts shown
below exclude unearned loan origination fees.



                                                       Due After December 31, 2013
                                                               Floating or
                                                  Fixed        Adjustable
(in thousands)                                    Rates           Rates           Total

Commercial:
Commercial mortgage                             $  55,314     $      50,989     $ 106,303
Commercial construction and land development        2,031             1,578         3,609
Commercial and industrial                           6,664             1,700         8,364

Total commercial                                   64,009            54,267       118,276

Non-commercial:
Residential mortgage                               72,311            83,275       155,586
Residential construction and land development       1,360             2,241         3,601
Revolving mortgage                                     55            47,907        47,962
Consumer                                           15,142                -         15,142

Total non-commercial                               88,868           133,423       222,291

Total loans receivable                          $ 152,877     $     187,690     $ 340,567

Some of our adjustable rate loans contain rate floors that are equal to the initial interest rate on the loan. When market interest rates fall below the rate floor, as has occurred in recent months, loan rates do not adjust further downward. As market interest rates rise in the future, the interest rates on these loans may rise based on the contract rate (index plus the margin) exceeding the initial interest rate floor; however, contract interest rates will only increase when the index plus margin exceed the imposed rate floor.


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Loan Activity

The following table shows loans originated, purchased and sold during the
periods indicated, including residential mortgage loans intended for sale in the
secondary market.



                                                                 Year Ended December 31,
(in thousands)                               2012           2011           2010           2009          2008

Total loans at beginning of period         $ 428,846      $ 495,713      $ 592,497      $ 586,618     $ 518,628

Loans originated:
Commercial:
. . .
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