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SOCB > SEC Filings for SOCB > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for SOUTHCOAST FINANCIAL CORP


3-May-2013

Quarterly Report


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

The following discussion and analysis should be read in conjunction with the financial statements and related notes appearing herein and in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. Results of operations for the period ending March 31, 2013 are not necessarily indicative of the results to be attained for any other period.

This Report on Form 10-Q may contain forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and similar matters. All statements that are not historical facts are "forward-looking statements." The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. Forward-looking statements include statements with respect to management's beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond the Company's control, and which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. These forward-looking statements can be identified through use of words such as "may," "will," "anticipate," "assume," "should," "indicate," "would," "believe," "contemplate," "expect," "seek," "estimate," "continue," "plan," "point to," "project," "projection," "predict," "could," "intend," "target," "potential," and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

o future economic and business conditions;

o lack of sustained growth and disruptions in the economy of the Greater Charleston area, including, but not limitedto, continued falling real estate values and increasing levels of unemployment;

o government monetary and fiscal policies;

o the effects of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the valuesof loan collateral, securities, and interest sensitive assets and liabilities;

o the effects of competition from a wide variety of local, regional, national and other providers of financial,investment, and insurance services;

o the effects of credit rating downgrades on the value of investment securities issued or guaranteed by variousgovernments and government agencies, including the United States of America;

o credit risks;

o higher than anticipated levels of defaults on loans;

o perceptions by depositors about the safety of their deposits;

o the failure of assumptions underlying the establishment of the allowance for loan losses and other estimates, including the value of collateral securing loans;

o changes in assumptions underlying allowances on deferred tax assets;

o changes in assumptions underlying, or accuracy of, analysis relating to other-than-temporary impairment of assets;

o the risks of opening new offices, including, without limitation, the related costs and time of building customer relationships and integrating operations as part of these endeavors and the failure to achieve expected gains, revenue growth and/or expense savings from such endeavors;

o changes in laws and regulations, including tax, banking and securities laws and regulations and deposit insurance assessments;

o the effect of agreements with regulatory authorities, which restrict various activities and impose additional administrative requirements without commensurate benefits;

o changes in the requirements of regulatory agencies;

o changes in accounting policies, rules and practices;

o changes in technology or products may be more difficult or costly, or less effective than anticipated;

o the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect generaleconomic conditions and economic confidence;

o ability to continue to weather the current economic downturn;

o loss of consumer or investor confidence; and

o other factors and information described in any of the reports that we file with the Securities and ExchangeCommission under the Securities Exchange Act of 1934.

All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The Company has no obligation, and does not undertake, to update, revise or correct any of the forward-looking statements after the date of this report. The Company has expressed its expectations, beliefs, and projections in good faith and believes they have a reasonable basis. However, there is no assurance that these expectations, beliefs or projections will result or be achieved or accomplished.


SOUTHCOAST FINANCIAL CORPORATION

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

Results of Operations

The Company's net income for the three months ended March 31, 2013 was approximately $1,006,000 or $0.14 per basic share, compared to net income of approximately $1,243,000, or $.18 per basic share, for the three months ended March 31, 2012. The average number of basic shares outstanding for the three months ended March 31, 2013 was 7,070,375 compared to 7,031,247 for the three months ended March 31, 2012, after adjustment for 15% stock dividends declared in 2013 and 2012.

Net Interest Income

Net interest income is the difference between the interest earned on interest earning assets and the interest paid for funds acquired to support those assets, and is the principal source of the Company's earnings. Net interest income was approximately $3.4 million for the three months ended March 31, 2013, compared to approximately $3.2 million for the three months ended March 31, 2012.

Changes that affect net interest income include changes in the average rate earned on interest earning assets, changes in the average rate paid on interest bearing liabilities, and changes in the volumes of interest earning assets and interest bearing liabilities. The increase in the Company's net interest income for the three months ended March 31, 2013 compared to the same period of 2012 was primarily due to a decrease in interest expense between the two periods, as interest income was nearly flat comparatively. Interest income remained relatively flat due to increases in volume which almost completely offset a decrease in rates. The decrease in interest expense was completely driven by a decrease in average rates, as volumes remained nearly constant between the two periods.

Average earning assets for the three months ended March 31, 2013 increased 3.2 percent to $379.1 million from the $367.5 million reported for the three months ended March 31, 2012. The increase was attributable to an increase of $16.9 million in average loans, partially offset by a $5.3 million decrease in average total investments, cash, and federal funds sold. The increase in average loans between the two periods was primarily due to moderate growth in the Company's loan portfolio during the final nine months of 2012. The decrease in the Company's average investments and federal funds sold was due to several factors, including sales of municipal securities during the final nine months of 2012, accelerated paydowns on its mortgage backed securities, and the maintenance of lower levels of interest bearing deposits and federal funds sold.

Average interest bearing liabilities for the three months ended March 31, 2013 decreased 1.8 percent to $350.3 million from the $356.8 million reported for the three months ended March 31, 2012. The decrease was attributable to a decrease of $12.8 million in average time deposits, partially offset by increases of $2.5 million and $3.8 million in average savings and transaction accounts and other borrowings, respectively. The decrease in average time deposits was attributable to a decrease of $35.6 million in average brokered and wholesale time deposits, partially offset by a $22.8 million increase in average retail time deposits. The increase in average other borrowings was primarily attributable to a $3.3 million increase in average Federal Home Loan Bank Borrowings.


                        SOUTHCOAST FINANCIAL CORPORATION

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

Net Interest Income - (continued)

The following table compares the average balances, yields and rates for the
interest sensitive segments of the Company's balance sheets for the three months
ended March 31, 2013 and 2012.

                                     For the three months ended                   For the three months ended
                                           March 31, 2013                               March 31, 2012
                                Average         Income/       Yield/         Average         Income/       Yield/
                                Balance         Expense       Rate(1)        Balance         Expense       Rate(1)
Assets
Cash and Federal funds sold   $    10,789      $       6          0.22 %   $    12,882      $       6          0.19 %
Investments - taxable              44,114            203          1.84          45,725            237          2.07
Investments - nontaxable
(2)                                 5,061             49          3.89           6,643             67          4.04

Total investments and
federal funds sold                 59,964            258          1.72          65,250            310          1.90

Loans (3)(4)                      319,177          4,201          5.27         302,222          4,155          5.51

Total earning assets/
interest income                   379,141          4,459          4.72 %       367,472          4,465          4.87 %
Other assets                       52,349                                       60,291

Total assets                  $   431,490                                  $   427,763

Liabilities
Savings and transaction
accounts                      $   114,274            138          0.48 %   $   111,783            189          0.68 %
Time deposits                     160,818            375          0.94         173,640            504          1.17
Other borrowings                   64,922            466          2.88          61,048            542          3.56
Subordinated debt                  10,310             47          1.81          10,310             53          2.05

Total interest bearing
liabilities/interest
expense                           350,324          1,026          1.17 %       356,781          1,288          1.45 %

Non-interest bearing
liabilities                        46,401                                       39,672

Total liabilities                 396,725                                      396,453

Equity                             34,765                                       31,310

Total liabilities and
equity                        $   431,490                                  $   427,763

Net interest income/margin
(5)                                            $   3,433          3.63 %                    $   3,177          3.46 %

Net interest spread (6)                                           3.55 %                                       3.43 %

(1) Annualized

(2) Yield is not calculated on a tax equivalent basis due to the full valuation allowance on the deferred tax assets.

(3) Does not include nonaccruing loans.

(4) Income includes loan fees of $164,181 in 2013 and $205,541 in 2012.

(5) Net interest income divided by total earning assets.

(6) Total interest earning assets yield less interest bearing liabilities rate.


SOUTHCOAST FINANCIAL CORPORATION

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

Net Interest Income - (continued)

As shown above, for the three months ended March 31, 2013 the average yield on earning assets was 4.72 percent, while the average cost of interest bearing liabilities was 1.17 percent. For the three months ended March 31, 2012 the average yield on earning assets was 4.87 percent and the average cost of interest-bearing liabilities was 1.45 percent. The decrease in the asset yields and average rates paid is due to market rate decreases over the last year. The net interest margin was 3.63 percent and 3.46 percent for the three months ended March 31, 2013 and 2012, respectively. The increase in the net interest margin is primarily attributable to a reduction in interest expense, which outpaced the reduction in interest income, as net interest income rose by $256,000. Interest income declined by $6,000 while interest expense declined by $262,000. The decrease in interest expense was driven by maturities of higher cost time deposits, restructuring of other borrowings into new borrowings with expanded maturities and lower rates, and the partial replacement of these funding sources with core deposits consisting of lower cost savings and transaction accounts.

The following tables present changes in the Company's net interest income which are primarily a result of changes in the volume and rates of its interest-earning assets and interest-bearing liabilities.

                                                         Analysis of Changes in Net Interest Income
                                                          For the three months ended March 31, 2013
                                                        Versus three months ended March 31, 2012 (1)
                                                    Volume                  Rate                Net Change
Interest income:

Cash and Federal funds sold                      $          (1 )       $            1         $            -
Investments - taxable                                       (8 )                  (26 )                  (34 )
Investments - non taxable (2)                              (16 )                   (2 )                  (18 )

Total investments and federal funds sold                   (25 )                  (27 )                  (52 )

Net loans (3)(4)                                           230                   (184 )                   46

Total interest income                                      205                   (211 )                   (6 )

Interest expense:

Savings and transaction accounts                             4                    (55 )                  (51 )
Time deposits                                              (37 )                  (92 )                 (129 )
Other borrowings                                            34                   (110 )                  (76 )
Subordinated debt                                            -                     (6 )                   (6 )

Total interest expense                                       1                   (263 )                 (262 )

Net interest income                              $         204         $           52         $          256

(1) Changes in rate/volume have been allocated to each category on a consistent basis between rate and volume.

(2) Yield is not calculated on a tax equivalent basis due to the full valuation allowance on the deferred tax assets.

(3) Income includes loan fees of $164,181 in 2013 and $205,541 in 2012.

(4) Does not include nonaccruing loans.


SOUTHCOAST FINANCIAL CORPORATION

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

Noninterest Income and Expenses

Noninterest income for the three months ended March 31, 2013 was approximately $589,000, compared to approximately $906,000 for the three months ended March 31, 2012, a decrease of approximately $317,000. This was primarily due to decreases of approximately $215,000 and $124,000 in gains on sales of available for sale securities and gains on the sale of premises and equipment, respectively. The Company's fees on loans held for sale increased by $56,000 for the three months ended March 31, 2013 when compared to the three months ended March 31, 2012.

Noninterest expenses for the three months ended March 31, 2013 were approximately $2,960,000, compared to approximately $2,652,000 for the three months ended March 31, 2012, an increase of approximately $308,000. This increase was primarily due to an approximate $448,000 decrease in gains on the sale of other real estate owned. These gains totaled approximately $288,000 and $736,000 for the three months ended March 31, 2013 and March 31, 2012, respectively. Of the $736,000 of gains for the three months ended March 31, 2012, approximately $550,000 was related to the sale of one property. The Company did not finance the purchase of this property for the buyer. Partially offsetting this decrease in gains on the sale of other real estate owned was a $221,000 reduction in expenses and impairments, offset by rental income related to other real estate owned. This amount totaled a net expense of $4,000 for the three months ended March 31, 2013, compared to a net expense of $225,000 for the three months ended March 31, 2012. Salaries and employee benefits totaled $1,679,000 for the three months ended March 31, 2013, compared to $1,596,000 for the three months ended March 31, 2012, an increase of $83,000.

Income Taxes

For the period ended June 30, 2011, as referenced in Note 7 to the Condensed Consolidated Financial Statements, due to its recent loss history and the potential negative impact of the economy on its future earnings, the Company provided for a full valuation allowance of its deferred tax assets. The gross amount of the Company's deferred tax assets totaled approximately $7.5 million at March 31, 2013. During the three months ended March 31, 2013 and March 31, 2012, the Company recorded tax expenses of $56,000 and $88,000, respectively, related to state income taxes for South Carolina.

Liquidity

Liquidity is the ability to meet current and future obligations through liquidation or maturity of existing assets or the acquisition of additional liabilities. Adequate liquidity is necessary to meet the requirements of customers for loans and deposit withdrawals in the most timely and economical manner. Some liquidity is ensured by maintaining assets which may be immediately converted into cash at minimal cost (amounts due from banks and federal funds sold). However, the most manageable sources of liquidity are composed of liabilities, with the primary focus of liquidity management being on the ability to obtain deposits within the Bank's service area. Core deposits (total deposits less certificates of deposit $100,000 or more, wholesale and brokered deposits) provide a relatively stable funding base, and were equal to 79.8% of total deposits as of March 31, 2013. Asset liquidity is provided from several sources, including amounts due from banks and federal funds sold and funds from maturing loans. The Bank is a member of the Federal Home Loan Bank of Atlanta ("FHLBA") and, as such has the ability to borrow against pledges of its 1-4 family residential mortgage loans and its commercial real estate loans. Available borrowings under this line totaled $38.5 million at March 31, 2013. The Company also has federal funds accommodations of $10 million with Alostar Bank of Commerce, and $10 million with Center State Bank. These accommodations may be withdrawn at any time at the sole discretion of these institutions. Additionally, the Company has a borrowing line with the Federal Reserve Bank of Richmond's discount window. The Company has pledged its portfolios of construction and land development loans and commercial and industrial loans against this borrowing line. Total available borrowings under this line were $33.1 million at March 31, 2013.


SOUTHCOAST FINANCIAL CORPORATION

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

Loans

Gross loans totaled approximately $324,172,000 and $327,469,000 at March 31, 2013 and December 31, 2012, respectively. At March 31, 2013, the Company had $8.7 million of nonaccrual loans and $91,000 of loans 90 days delinquent and still accruing interest. Of these, $7.9 million are secured by real estate. The primary risk of loss on these loans is a potential deterioration of real estate collateral values. At December 31, 2012, the Company had $9.7 million of nonaccrual loans and no loans 90 days past due and still accruing interest. At March 31, 2012, the Company had $19.9 million of nonaccrual loans and no loans 90 days past due and still accruing interest. The allowance for loan losses was 2.41 percent of loans as of March 31, 2013, compared to 2.49 percent as of December 31, 2012 and 2.96 percent as of March 31, 2012.

For the three months ended March 31, 2013 the Company recorded no loan loss provision compared to a loan loss provision of $100,000 during the first three months of 2012. Loan chargeoffs net of recoveries for the three months ended March 31, 2013 totaled approximately $352,000. For the three months ended March 31, 2013 the Company's other general reserves and unallocated portions of the allowance for loan losses decreased by $447,000 and $160,000, respectively. The general reserve calculation accounts for repayment risk that is allocable to all loans within each loan type and is a broader measurement of overall portfolio risk than the portions of the reserve allocated by loan type. The general reserve calculation includes risk factors related to certain higher risk loans such as variable rate loans and loans with excessive loan to value ratios, capital concentrations by collateral type, and new loan production levels. Improvements in the credit quality of the Company's loan portfolio during the three months ended March 31, 2013, were consistent with decreases in the Company's other general and unallocated reserves. Total loans with credit grades of 6 through 9 totaled approximately $39.9 million and $48.3 million at March 31, 2013 and December 31, 2012, respectively.

For the three months ended March 31, 2013, net chargeoffs to average loans outstanding totaled 0.43% on an annualized basis while the allowance for loan losses to gross loans totaled 2.41% at March 31, 2013.

Management identifies and maintains a list of potential problem loans. These are loans that are internally risk graded substandard or below but which are not included in nonaccrual status and are not past due 90 days or more. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of the borrower which raises serious doubts as to the ability of such borrower to comply with the current loan repayment terms. At March 31, 2013 potential problem loans totaled $14.6 million. The Company's potential problem loans are comprised of $2.4 million of construction and land development real estate loans, $5.3 million of nonfarm, nonresidential real estate loans, $4.7 million of 1-4 family mortgage loans, $374,000 of multifamily real estate loans, and $1.8 million of various loan types not secured by real estate, primarily commercial and industrial loans. As the majority of potential problem loans are real estate secured, management closely tracks the current values of real estate collateral when assessing the collectibility of these loans.

Other Real Estate Owned

Other real estate owned totaled approximately $6.8 million as of March 31, 2013, $9.6 million at December 31, 2012, and $7.1 million as of March 31, 2012, net of a valuation reserve. Sales of other real estate owned totaled approximately $3.5 million and $3.4 million for the three months ended March 31, 2013, and 2012, respectively. The Company generated loans to facilitate the sales of other real estate owned totaling $730,000 and $672,000 during the three months ended March 31, 2013 and March 31, 2012, respectively. Impairment charges on other real estate owned totaled $0 and $228,000 for the three months ended March 31, 2013, and 2012, respectively.


SOUTHCOAST FINANCIAL CORPORATION

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

Deposits

Deposits increased $1.0 million during the first three months of 2013 to $320.6 million at March 31, 2013. Included in this amount were increases of $7.0 million in noninterest bearing transaction accounts, partially offset by a decrease of $6.0 million in interest bearing accounts. The decrease in interest bearing deposits included a decrease of $18.8 million in time deposits. Of this decrease, $11.6 million was related to retail time deposits and $7.2 million was related to brokered and wholesale time deposits. Brokered and wholesale time deposits totaled $6.4 million and $13.6 million at March 31, 2013 and December 31, 2012, respectively. Partially offsetting the decrease in time deposits was an increase of $11.3 million in savings and money market accounts. This increase was primarily attributable to a $10.0 million deposit made into an existing municipal money market account at the end of the quarter. These funds remained in this account only temporarily and were withdrawn several days after quarter end.

Federal Home Loan Bank Borrowings

Other borrowings are primarily comprised of FHLBA advances. FHLBA advances are
collateralized by pledged FHLBA stock and certain residential mortgage and
commercial real estate loans. On March 18, 2013, the Bank refinanced eight
advances totaling $42 million and reduced the weighted average cost of these
advances from 3.80% to 3.24%. FHLBA advances outstanding at March 31, 2013 and
December 31, 2012 are summarized as follows:

             March 31, 2013
Maturity         Rate        Balance
April 2013        0.24 %   $  1,500,000
April 2013        0.23 %      7,000,000
February 2014     0.36 %     10,000,000
March 2016        2.04 %     10,000,000
March 2017        2.31 %      2,000,000
March 2018        2.33 %      5,000,000
April 2018        3.03 %      5,000,000
March 2019        3.56 %      5,000,000
March 2019        3.51 %      5,000,000
March 2021        3.71 %      5,000,000
March 2021        3.74 %      5,000,000
March 2021        3.80 %      5,000,000
March 2021        3.87 %      5,000,000
Balance                    $ 70,500,000

December 31, 2012
Maturity         Rate        Balance
January 2013      0.18 %   $  7,000,000
February 2013     0.36 %      5,000,000
July 2015         2.32 %     10,000,000
July 2015         2.91 %      2,000,000
October 2016      4.25 %      5,000,000
November 2016     4.08 %      5,000,000
. . .
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