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CRFN > SEC Filings for CRFN > Form 10-K on 29-Mar-2013All Recent SEC Filings

Show all filings for CRESCENT FINANCIAL BANCSHARES, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for CRESCENT FINANCIAL BANCSHARES, INC.


29-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Crescent Financial Bancshares, Inc. (the "Company" or "Crescent Financial"), is a bank holding company incorporated under the laws of Delaware in 2011 and is a successor company to Crescent Financial Corporation, which was a bank holding company incorporated under the laws of North Carolina in 2001. The Company conducts its business operations primarily through its commercial bank subsidiary, VantageSouth Bank (formerly known as Crescent State Bank). The Company's headquarters are located in Raleigh, North Carolina. Crescent Financial is a subsidiary of Piedmont Community Bank Holdings, Inc. ("Piedmont").

VantageSouth Bank (or the "Bank") was incorporated in 1998 as a North Carolina-chartered commercial bank. The Bank serves central North Carolina to the coast with twenty full service branch offices located in Apex, Burlington
(2), Cary (2), China Grove, Clayton, Fayetteville, Garner, Holly Springs, Knightdale, Pinehurst, Raleigh (3), Salisbury, Sanford, Southern Pines and Wilmington (2), North Carolina.

Piedmont Acquisition of Crescent Financial

Piedmont was established in 2009 as a bank holding company headquartered in Raleigh, North Carolina for the purpose of building a community banking franchise in the North Carolina, South Carolina, and Virginia markets. On November 18, 2011, Crescent Financial completed the issuance and sale to Piedmont of 18,750,000 shares of common stock for $75.0 million in cash, or $4.00 per share. As part of its investment, Piedmont also made a tender offer to Crescent Financial's stockholders pursuant to which it purchased 6,128,423 shares of Crescent Financial's common stock for $29.1 million, or $4.75 per share (the "Tender Offer"). As a result of Piedmont's investment and the Tender Offer, Piedmont acquired approximately 88 percent of Crescent Financial's outstanding common stock.

Crescent Financial's financial condition and results of operations were significantly impacted by Piedmont's investment. Because of the level of Piedmont's ownership and control following the controlling investment, push-down accounting was applied. Accordingly, Crescent Financial's assets, liabilities and non-controlling interests were adjusted to estimated fair value at the acquisition date, and the allowance for loan losses was eliminated.

Piedmont Acquisition of VantageSouth Bank

VantageSouth Bank ("Legacy VantageSouth") was organized and incorporated under the laws of the State of North Carolina and commenced operations in 2006. Prior to its merger with Crescent State Bank on November 30, 2012, Legacy VantageSouth was headquartered in Burlington, North Carolina and operated five branch offices in central North Carolina. On February 19, 2010, Legacy VantageSouth sold 1,768,794 shares of its newly issued Series A Convertible Perpetual Preferred Stock (the "Series A Stock") to Piedmont for an aggregate price of $7.7 million, or $4.35 per share. The Series A Stock was immediately convertible on a one-for-one basis into shares of Legacy VantageSouth's common stock, which totaled approximately 62 percent of its outstanding common stock at the date of Piedmont's investment (as adjusted for the assumed conversion of the Series A Stock). The investment in Legacy VantageSouth gave Piedmont voting control over a majority of Legacy VantageSouth's outstanding common stock and the ability to control the election of Legacy VantageSouth's Board of Directors.


Piedmont Acquisition of Community Bank of Rowan and Merger of Community Bank of Rowan into Legacy VantageSouth

On April 19, 2011, Piedmont acquired Community Bank of Rowan, a North Carolina-chartered bank ("Rowan"). Piedmont purchased all 813,083 shares of Rowan's common stock for an aggregate purchase price of $9.5 million. Immediately following the acquisition, Piedmont purchased an additional 569,158 shares of newly issued common stock for an aggregate price of $7.0 million. Since Piedmont owned 100% of Rowan following its acquisition, purchase accounting fair value adjustments were pushed down to Rowan's financial statements at that date. In addition, Legacy VantageSouth and Rowan became commonly controlled by Piedmont beginning on the date of Piedmont's acquisition of Rowan.

On February 1, 2012, a transaction was completed whereby Piedmont purchased the remaining non-controlling interests in Legacy VantageSouth and simultaneously merged Rowan into Legacy VantageSouth. Piedmont purchased all remaining shares of Legacy VantageSouth common stock from non-controlling shareholders for an aggregate purchase price of $4.8 million, or $4.35 per share. Following this transaction, Piedmont wholly owned the combined Legacy VantageSouth except for directors' qualifying shares. Because Piedmont purchased the remaining non-controlling common stock of Legacy VantageSouth with this transaction, push-down accounting was applied to Legacy VantageSouth so that the basis reported in Legacy VantageSouth's financial statements from that date forward reflected Piedmont's basis in Legacy VantageSouth. The merger of Rowan into Legacy VantageSouth was a merger of commonly controlled companies and was accounted for in a manner similar to a pooling of interests transaction.

Merger of Legacy VantageSouth into Crescent Financial and Change in Reporting Entity

On November 30, 2012, Crescent Financial completed the merger of Legacy VantageSouth into Crescent State Bank in a share exchange. All outstanding Legacy VantageSouth shares of common stock were converted into Crescent Financial's shares at a 5.3278 exchange ratio for a total transaction value of $35.0 million. At the time of merger, Piedmont owned all outstanding shares of Legacy VantageSouth except for directors' qualifying shares. Piedmont owned approximately 90 percent of the Company's outstanding common stock following the merger. The Company re-branded its wholly-owned banking subsidiary as VantageSouth Bank immediately following the merger.

The merger of Legacy VantageSouth into Crescent State Bank was a merger of commonly controlled companies and was accounted for in a manner similar to a pooling of interests transaction. Thus, the Company's financial statements have been retrospectively adjusted to combine the financial statement balances of Crescent Financial and Legacy VantageSouth beginning on November 18, 2011, the date the two companies became commonly controlled by Piedmont. In addition, periods prior to the date of common control reflect only Legacy VantageSouth's historical balances since it was the first company acquired by Piedmont, which resulted in a change in reporting entity. Due to the application of push-down accounting to Legacy VantageSouth's financial statements on February 1, 2012, periods prior to this date are labeled as "Predecessor Company" and periods after this date are labeled as "Successor Company."

Proposed ECB Bancorp, Inc. Merger

On September 25, 2012, the Company entered into a merger agreement with ECB Bancorp, Inc. ("ECB"). Pursuant to the ECB merger agreement, ECB will merge with and into Crescent Financial, which will be the surviving bank holding corporation in 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 VantageSouth Bank. At the time of the merger, ECB's outstanding shares of common stock will be converted into the right to receive 3.55 shares of the common stock of the Company.

The merger has received all regulatory and stockholder approvals and is expected to be completed in April 2013. ECB is a bank holding company, headquartered in Engelhard, North Carolina. As of December 31, 2012, ECB had total consolidated assets of $899.6 million, loans of $509.4 million, and deposits of $751.7 million. The East Carolina Bank has twenty-five 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 mortgage, agricultural banking and wealth management services.

Executive Summary

The following is a summary of the Company's financial results and significant events in 2012:

Net income totaled $3.8 million in the successor period from February 1 to December 31, 2012 ("2012 successor period") and $529 thousand in the predecessor period from January 1 to January 31, 2012 ("2012 predecessor period"). Net income in the predecessor year ended December 31, 2011 totaled $968 thousand.


After preferred stock dividends, the Company recognized net income of $0.07 per basic and diluted common share in the 2012 Successor Period and net income of $0.01 per common share during the 2012 predecessor period. Net income per common share equaled $0.07 for the predecessor year ended December 31, 2011.

Merger, conversion and re-branding costs totaled $3.4 million in the 2012 successor period, which reduced net income by $2.1 million on an after-tax basis.

Annualized net loan growth in the last six months of 2012 was 19 percent, which was driven by loan originations for the second half of 2012 totaling $162.3 million, a significant increase from $82.9 million in the first half of 2012. Fourth quarter 2012 loan originations totaled $87.6 million.

Net interest margin improved to 4.40 percent in the 2012 successor period and 4.55 percent in the 2012 predecessor period from 4.19 percent in the predecessor year ended December 31, 2011.

Asset quality improved as nonperforming assets to total assets declined to 1.71 percent as of December 31, 2012 from 3.44 percent as of December 31, 2011.

Rowan was successfully merged into Legacy VantageSouth in February 2012.

Legacy VantageSouth was successfully merged into Crescent State Bank in November 2012.

The combined bank was re-branded as VantageSouth Bank, which now operates on a single technology platform and utilizes common business processes and policies.

The Company signed a merger agreement with ECB and expects to consummate the transaction in April 2013.

The following discussion and analysis includes descriptions of significant transactions, trends and other factors affecting the Company's operating results and financial condition for the 2012 successor period, the 2012 predecessor period, and the predecessor year ended December 31, 2011. Because of the separate reporting for predecessor and successor periods in 2012 as well as the two mergers between entities under common control in 2012 and change in reporting entity, the Company's results of operations between these periods are not comparable. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this report.

Analysis of Results of Operations

Net income totaled $3.8 million in the 2012 successor period and $529 thousand in the 2012 predecessor period. Net income in the predecessor year ended December 31, 2011 totaled $968 thousand. Net income in the 2012 successor period was significantly influenced by merger, conversion and re-branding costs as well as a tax benefit from the reversal of a valuation allowance on deferred taxes generated by Legacy VantageSouth. After dividends and accretion on preferred stock, the Company recognized net income available to common stockholders of $2.4 million, or $0.07 per basic and diluted common share, in the 2012 successor period and net income available to common stockholders of $407 thousand, or $0.01 per basic and diluted common share, during the 2012 predecessor period. Net income available to common stockholders equaled $786 thousand, or $0.07 per basic and diluted common share, in 2011.

Two commonly used measures of bank profitability are return on average assets (net income as a percentage of average total assets)and return on average stockholders' equity (net income as a percentage of average stockholders' equity). Annualized return on average assets was 0.39 percent for the 2012 successor period, 0.58 percent for the 2012 predecessor period, and 0.32 percent in 2011. Annualized return on average stockholders' equity was 2.41 percent for the 2012 successor period, 3.67 percent for the 2012 predecessor period, and 3.67 percent in 2011.


Net Interest Income

2012 successor period

Net interest income totaled $37.3 million in the 2012 successor period. Taxable equivalent net interest margin ("NIM") was 4.40 percent in the 2012 successor period compared to 4.55 percent in the 2012 predecessor period and 4.19 percent in 2011. The yield on earning assets was 5.12 percent in the 2012 successor period compared to 5.35 percent in the 2012 predecessor period and 5.20 percent in 2011. Funding costs declined as the cost of interest-bearing liabilities improved to 0.86 percent in the 2012 successor period from 0.95 percent in the 2012 predecessor period and 1.15 percent in 2011.

Income accretion on purchased loans totaled $14.7 million in the 2012 successor period, which consisted of $13.9 million of accretion on purchased credit-impaired ("PCI") loans and $832 thousand of accretion income on purchased non-impaired loans. PCI loan accretion represents all interest income recorded for those loans in the period while accretion income on purchased non-impaired loans represents accretion of the fair value discount on the effective yield method, which increased interest income above contractual yields. Time deposit premium amortization totaled $2.7 million, which reduced interest expense, while accretion of the discount on long-term debt totaled $136 thousand, which increased interest expense. The net decrease in interest expense related to time deposit amortization and long-term debt accretion reduced the cost of interest-bearing liabilities by 0.38 percent in the 2012 successor period.

Average earning assets totaled $934.1 million in the 2012 successor period, which included $727.3 million in average loans, $164.1 million in average investment securities, and $42.6 million in average federal funds sold and interest-earning cash in other banks. Average loan balances in the period were positively impacted by strong loan growth in the last half of 2012. Annualized net loan growth in the last six months of 2012 was 19 percent, which was driven by loan originations for the second half of 2012 totaling $162.3 million, a significant increase from $82.9 million in the first half of 2012.

Average interest-bearing liabilities totaled $785.8 million in the 2012 successor period, which included $759.5 million in average interest-bearing deposits, $3.4 million in average short-term borrowings, and $23.0 million in average long-term debt.

2012 predecessor period

Net interest income totaled $3.6 million in the 2012 predecessor period. NIM was 4.55 percent in the 2012 predecessor period, which was an increase from 4.19 percent in 2011. The yield on earning assets was 5.35 percent in the 2012 predecessor period compared to 5.20 percent in 2011. Funding costs declined as the cost of interest-bearing liabilities improved to 0.95 percent in the 2012 predecessor period from 1.15 percent in 2011.

Income accretion on purchased loans totaled $1.6 million in the 2012 predecessor period, which consisted of $1.4 million of accretion on PCI loans and $203 thousand of accretion income on purchased non-impaired loans. Time deposit premium amortization totaled $311 thousand, which reduced interest expense, while accretion of the discount on long-term debt totaled $12 thousand, which increased interest expense. The net decrease in interest expense related to time deposit amortization and long-term debt accretion reduced the cost of interest-bearing liabilities by 0.46 percent in the 2012 predecessor period.

Average earning assets totaled $934.3 million in the 2012 predecessor period, which included $762.1 million in average loans, $180.2 million in average investment securities, and $23.7 million in average federal funds sold and interest-earning cash. Average interest-bearing liabilities totaled $787.3 million in the 2012 predecessor period, which included $759.5 million in average interest-bearing deposits, $968 thousand in average short-term borrowings, and $24.2 million in average long-term debt.

Predecessor year ended December 31, 2011

Net interest income totaled $11.6 million in the predecessor year ended December 31, 2011. In 2011, NIM was 4.19 percent, the yield on earning assets was 5.20 percent, and the cost of interest-bearing liabilities was 1.15 percent. Piedmont's acquisitions of Rowan in 2011 significantly impacted the Company's balance sheet and NIM.

Income accretion on purchased loans totaled $3.7 million in 2011, which consisted of $2.4 million of accretion on PCI loans and $1.3 million of accretion income on purchased non-impaired loans. Time deposit premium amortization totaled $632 thousand, which reduced interest expense, while accretion of the discount on long-term debt totaled $17 thousand, which increased interest expense. The net decrease in interest expense related to time deposit amortization and long-term debt accretion reduced the cost of interest-bearing liabilities by 0.29 percent in 2011.


Average earning assets totaled $276.3 million in 2011, which included $201.1 million in average loans, $29.8 million in average investment securities, and $45.4 million in average federal funds sold and interest-earning cash. The mix of average earning assets in 2011 was heavily impacted by Crescent Financial's investment portfolio restructuring following its acquisition in November 2011. This portfolio restructuring elevated the average balance of low-yielding federal funds sold and interest-earning cash in the period. Average interest-bearing liabilities totaled $241.1 million in 2011, which included $211.8 million in average interest-bearing deposits, $1.4 million in average short-term borrowings, and $27.9 million in average long-term debt.

The following table summarizes the major components of net interest income and the related yields and costs for the periods presented.

                                      Successor Company                                                               Predecessor Company
                                        February 1 to
                                      December 31, 2012                               January 1 to January 31, 2012                           Year Ended December 31, 2011
                           Average                                               Average                                                 Average
                           Balance        Interest*      Yield/Cost*             Balance             Interest*      Yield/Cost*          Balance           Interest*      Yield/Cost*
Assets:
Loans                   $   727,339     $    39,717          5.97 %       $       730,387          $     3,807          6.15 %     $    201,106          $    13,362          6.64 %
Investment securities       164,113           3,990          2.66 %               180,220                  419          2.74 %           29,827                  903          3.03 %
Federal funds and other
interest-earning assets      42,603              85          0.22 %                23,719                    4          0.20 %           45,384                  102          0.22 %
Total interest-earning
assets                      934,055          43,792          5.12 %               934,326                4,230          5.35 %          276,317               14,367          5.20 %
Non-interest-earning
assets                      127,572                                               134,240                                                28,430
Total assets            $ 1,061,627                                       $     1,068,566                                          $    304,747

Liabilities and Equity:
Interest-bearing demand $   149,394             540          0.39 %       $       172,363                  109          0.75 %     $     36,756                  338          0.92 %
Money market and
savings                     236,735           1,333          0.62 %               184,716                   96          0.61 %           59,813                  565          0.94 %
Time deposits               373,337           3,213          0.94 %               404,999                  325          0.95 %          115,245                1,132          0.98 %
Total interest-bearing
deposits                    759,466           5,086          0.73 %               762,078                  530          0.82 %          211,814                2,035          0.96 %
Short-term borrowings         3,351              19          0.62 %                   968                    -             - %            1,429                   18          1.26 %
Long-term debt               22,966           1,065          5.07 %                24,217                  103          5.02 %           27,850                  725          2.60 %
Total interest-bearing
liabilities                 785,783           6,170          0.86 %               787,263                  633          0.95 %          241,093                2,778          1.15 %
Non interest-bearing
deposits                     97,250                                               107,156                                                24,549
Other liabilities             6,858                                                 4,184                                                 1,266
Total liabilities           889,891                                               898,603                                               266,908
Stockholders' equity        171,736                                               169,963                                                37,839
Total liabilities and
stockholders' equity    $ 1,061,627                                       $     1,068,566                                          $    304,747

Net interest income                     $    37,622                                                $     3,597                                           $    11,589
Interest rate spread                                         4.26 %                                                     4.40 %                                                4.05 %
Net interest margin                                          4.40 %                                                     4.55 %                                                4.19 %


* Taxable equivalent basis

The Company has not included a standard table presenting the variances between the periods caused by changes in interest rates versus changes in volumes because of the incomparability of the periods, which is due to the difference in the number of days in each period and the difference in the basis of accounting between the periods.


Provision for Loan Losses

2012 successor period

Provision for loan losses totaled $5.2 million for the 2012 successor period. Annualized net charge-offs in this period were 0.37 percent of average loans. The allowance for loan losses ("ALL") and related provision were calculated in separate models for the Company's following three portfolio categories: (1) new loans, (2) purchased non-impaired loans, and (3) PCI loans. The following table summarizes the changes in ALL for each loan category in the 2012 successor period.

(Dollars in thousands)          New Loans      Purchased Non-Impaired       PCI        Total

Balance at February 1, 2012    $     1,276    $                -          $     -    $ 1,276
Net charge-offs                          -                (2,437 )              -     (2,437 )
Provision for loan losses            1,389                 2,492            1,278      5,159
Balance at December 31, 2012   $     2,665    $               55          $ 1,278    $ 3,998

The ALL of $2.7 million on new loans as of December 31, 2012 was 0.93 percent of related outstanding new loan balances. There were no charge-offs on this portfolio in the 2012 successor period.

Although purchased non-impaired loans were adjusted to fair value at each respective acquisition, the Company records charge-offs for losses and provides reserves for deterioration in credit quality on these loans. Due to their nature, all revolving loans were classified as purchased non-impaired at acquisition and a majority of the charge-offs and provision in the 2012 successor period relate to acquired revolving home equity lines of credit. The Company recognized provisions for loan losses and charge-offs of $1.6 million on home equity loans and lines of credit. The elevated charge-offs recorded on this portfolio in the 2012 successor period were primarily related to three loans where the borrowers defaulted in the period.

The ALL on the purchased non-impaired portfolio is calculated by first estimating losses on loans evaluated individually for impairment and loans evaluated collectively for impairment. Consistent with the Company's policy, estimated losses for loans evaluated individually for impairment are determined by the use of current appraisals for collateral dependent loans or discounted expected cash flows for loans that are not collateral dependent. Estimated losses for loans evaluated collectively for impairment are determined by grouping similar loans together and applying annualized historical loss rates (using a trailing two-year historical loss period), adjusted for certain qualitative factors, to outstanding principal balances. The unpaid principal balance less estimated incurred losses is then compared to the carrying value of the loans, and any deficit is recorded to provision and ALL. As of December 31, 2012, the Company had home equity loans and lines of credit with unpaid principal balances and carrying values totaling $66.6 million and $63.5 million, respectively. The $3.1 million discount to unpaid principal combined with the $85 thousand of ALL on this portfolio represented 4.85 percent of unpaid principal balances as of December 31, 2012, or 208.58 percent of nonperforming home equity loans and lines of credit.

Because the Company has experienced more credit deterioration in the home equity portfolio compared to other sectors of the loan portfolio, additional credit risk monitoring on this sector has been implemented. In addition to closely monitoring payment history, credit scores on the borrowers are reviewed and routinely refreshed, which allows the Company to more timely identify non-performers and freeze open lines of credit, if necessary.

Loans acquired with evidence of credit deterioration since origination were grouped into pools of loans with similar risk characteristics at acquisition and are accounted for as PCI loans. Subsequent to acquisition of these loans, estimates of pool-level 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 pool-level cash flows expected to be collected, 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 pool-level cash flows expected to be collected, the Company will first reverse any previously established ALL and then increase interest income as a prospective yield adjustment over the remaining life of the loans. The Company's quarterly PCI cash flow re-estimations resulted in total provision in the 2012 successor period of $1.3 million. Of this amount, $552 thousand was related to a residential real estate loan pool, $443 thousand was related to a commercial real estate loan pool, $267 thousand was related to a construction and development loan pool, and $16 thousand was related to a consumer loan pool. . . .

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