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BCAR > SEC Filings for BCAR > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for BANK OF THE CAROLINAS CORP

Form 10-Q for BANK OF THE CAROLINAS CORP


14-Aug-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

Introduction

Bank of the Carolinas Corporation ("the Company") is the parent holding company of Bank of the Carolinas ("the Bank"). Because the Company has no separate operations and conducts no business on its own other than owning the Bank, the discussion contained in this Management's Discussion and Analysis concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as "the Company" unless otherwise noted.

The Bank began operations in December 1998 as a state chartered bank and currently has eight offices in the Piedmont region of North Carolina. The Bank competes for loans and deposits throughout the markets it serves. The Bank, like most community banks, derives most of its revenue from net interest income which is the difference between the income it earns from loans and securities and the interest expense it incurs on deposits and borrowings.

Written Agreement with Federal Reserve

The Company entered into a written agreement (the "Agreement") with the Federal Reserve Bank of Richmond on August 26, 2011. The description of the Agreement set forth below is qualified in its entirety by reference to the full text of the Agreement, a copy of which is included as Exhibit 10.01 to the Company's Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on November 14, 2011, and incorporated herein by reference.

Source of Strength. The Agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC, and the Bank.

Dividends, Distributions, and other Payments. The Agreement prohibits the Company's payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors. It also prohibits the Company from directly or indirectly taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank of Richmond.

Under the terms of the Agreement, the Company and Bank of the Carolinas Trust I may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation.

Debt and Stock Redemption. The Agreement requires that the Company and any non-bank subsidiary of the Company not, directly or indirectly, incur, increase or guarantee any debt without the prior written approval of the Federal Reserve Bank. The Agreement also requires that the Company not, directly or indirectly, purchase or redeem any shares of its capital stock without the prior written approval of the Federal Reserve Bank of Richmond.

Capital Plan, Cash Flow Projections and Progress Reports. The Agreement requires that the Company file an acceptable capital plan and certain cash flow projections with the Federal Reserve Bank of Richmond. It also requires that the Company file a written progress report within 30 days after the end of each calendar quarter while the Agreement remains in effect.

The Agreement will remain in effect until modified or terminated by the Federal Reserve Bank of Richmond.

Consent Order with Regulators

The Bank entered into a Stipulation to the Issuance of a Consent Order (the "Stipulation") with the Federal Deposit Insurance Corporation (the "FDIC") and the North Carolina Office of the Commissioner of Banks (the "Commissioner") and the FDIC and the Commissioner issued the related Consent Order (the "Order"), effective April 27, 2011. The description of the Stipulation and the Order set forth below is qualified in its entirety by reference to the Stipulation and the Order, copies of which are included as exhibits 10.1 and 10.2, respectively, to the Company's Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 3, 2011, and incorporated herein by reference.


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Management. The Order required that the Bank have and retain qualified management, including a chief executive officer, senior lending officer, and chief operating officer with qualifications and experience commensurate with their assigned duties and responsibilities within 60 days from the effective date of the Order. Within 30 days of the effective date of the Order, the board of directors was required to retain a bank consultant to develop a written analysis and assessment of the Bank's management needs. Within 60 days from receipt of the consultant's management report, the Bank was required to formulate a written management plan that incorporated the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a time frame for completing each action.

Capital Requirements. While the Order is in effect, the Bank must maintain a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. If the Bank's capital ratios are below these levels as of the date of any call report or regulatory examination, the Bank must, within 30 days from receipt of a written notice of capital deficiency from its regulators, present a plan to increase capital to meet the requirements of the Order. At June 30, 2013, the Bank was not in compliance with the capital requirements contained in the Order.

Allowance for Loan and Lease Losses and Call Report. Upon issuance of the Order, the Bank was required to make a provision to replenish the allowance for loan and lease losses ("ALLL"). Within 30 days of the effective date of the Order, the Bank was required to review its call reports filed with its regulators on or after December 31, 2010, and was required to amend those reports if necessary to accurately reflect the financial condition of the Bank. Within 60 days of the effective date of the Order, the Bank was required to submit a comprehensive policy for determining the adequacy of the ALLL.

Concentrations of Credit. Within 60 days of the issuance of the Order, the Bank was required to perform a risk segmentation analysis with respect to its concentrations of credit and develop a written plan for systematically reducing and monitoring the Bank's commercial real estate and acquisition, construction, and development loans to an amount commensurate with the Bank's business strategy, management expertise, size, and location.

Charge-Offs, Credits. The Order required that the Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified "loss" and 50% of those assets classified "doubtful." If an asset is classified "doubtful," the Bank may alternatively charge off the amount that is considered uncollectible in accordance with the Bank's written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, "loss" or "doubtful" and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified "substandard." These limitations do not apply if the Bank's failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify its regulators at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank's asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from its regulators.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of its regulators. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution's market area. An "adequately capitalized" institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC. As of June 30, 2013, the Bank was classified as " significantly undercapitalized."


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Written Plans and Other Material Terms. Under the terms of the Order, the Bank was required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management

Plan to reduce assets of $500,000 or greater classified "doubtful" and "substandard"

Revised lending and collection policy to provide effective guidance and control over the Bank's lending and credit administration functions

Effective internal loan review and grading system

Policy for managing the Bank's other real estate

Business/strategic plan covering the overall operation of the Bank

Plan and comprehensive budget for all categories of income and expense for the year 2011

Policy and procedures for managing interest rate risk

Assessment of the Bank's information technology function

Under the Order, the Bank's board of directors agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank's activities. The Bank was also required to establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and the Commissioner.


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CHANGES IN FINANCIAL CONDITION

Total Assets

At June 30, 2013, total assets were $429.0 million, a decrease of 1.9% compared to $437.4 million at December 31, 2012. The asset decrease was primarily the result of reductions in investment securities due to maturities and calls. The Company had earning assets of $399.8 million at June 30, 2013 consisting of $269.5 million in loans, $93.2 million in investment securities, and $37.1 million in temporary investments. Stockholders' equity was $6.2 million at June 30, 2013 compared to $9.1 million at December 31, 2012.

Investment Securities

Investment securities totaled $93.2 million at June 30, 2013, compared to $106.9 million at December 31, 2012. The decrease was primarily a result of the maturity of a corporate security and agency calls. A summary of the Company's investment securities holdings by major category at June 30, 2013 and December 31, 2012 is included in Note 3 of "Notes to Consolidated Financial Statements".

Loans and Allowance for Loan Losses

At June 30, 2013, the loan portfolio totaled $269.5 million and represented 62.8% of total assets compared to $270.4 million or 61.8% of total assets at December 31, 2012. Total loans at June 30, 2013 decreased $877,000 or 0.3% from December 31, 2012. The decrease in loans outstanding in the six-month period is the result of net recoveries of $666,000 and principal repayments in excess of new loans originated due to slower loan demand under the current economic conditions. Real estate loans, including commercial real estate, constituted approximately 90% of the loan portfolio, and commercial business and other loans comprised approximately 10% of the total loan portfolio at both June 30, 2013 and December 31, 2012.

The allowance for loan losses is created by direct charges to income. Losses on loans are charged against the allowance in the period in which such loans, in management's opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence management's judgment in determining the amount charged to operating expense include past loan experience, composition of the loan portfolio, current economic conditions and probable losses.

The appropriateness of the allowance for loan losses is measured on a quarterly basis using an allocation model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses. It must be emphasized, however, that the determination of the reserve using the Company's procedures and methods rests upon various judgments and assumptions about current economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, bank regulatory agencies, as an integral part of their routine examination process, periodically review the Company's allowance. Those agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance is appropriate based on management's current analysis.

The allowance for loan losses at June 30, 2013, amounted to $6.4 million, a decrease of $492,000, or 7.1% from December 31, 2012. The allowance consists of specific reserves of $676,000 and a general allowance $5.7 million. The Bank's provisions for loan losses amounted to a reversal of $1.2 million during the six months ended June 30, 2013 compared to $1.5 million provision during the six months ended June 30, 2012. The loan loss provision for 2013 reflects a specific recovery of a $1.25 million loan that was previously charged off in 2011. While the Company has not participated in "subprime" lending activities, we have been affected by the economic downturn in our markets. We continue to work with our customers with troubled credit relationships to the extent that it is reasonably possible.

Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Company also attempts to reduce default risks by adhering to internal credit underwriting policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies. A loan is placed in nonaccrual status when, in management's judgment, the collection of interest appears doubtful.


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The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past due loans as of June 30, 2013 and December 31, 2012 (dollars in thousands):

                                                          June 30,          December 31,
                                                            2013                2012
Loans accounted for on a nonaccrual basis:
Real estate loans:
1-4 family residential                                    $   2,473        $        2,491
Commercial real estate                                        1,383                 4,153
Construction and development                                  1,020                   880

Total real estate loans                                       4,876                 7,524
Commercial business and other loans                             577                   202
Consumer loans                                                    2                     7

Total nonaccrual loans                                        5,455                 7,733
Accruing loans which are contractually past due 90
days or more                                                     -                     -

Total nonperforming loans                                     5,455                 7,733
Other real estate owned                                       1,589                 4,976

Total nonperforming assets                                $   7,044        $       12,709

Total nonperforming loans as a percentage of loans             2.02 %                2.86 %
Allowance for loan losses as a percentage of total
nonperforming loans                                          117.29 %               89.10 %
Allowance for loan losses as a percentage of total
loans                                                          2.37 %                2.55 %
Total nonperforming assets as a percentage of loans
and other real estate owned                                    2.60 %                4.62 %
Total nonperforming assets as a percentage of total
assets                                                         1.64 %                2.91 %

Deposits

The Company's deposit services include business and individual checking accounts, interest bearing checking accounts, savings accounts, money market accounts, IRA deposits and certificates of deposit. At June 30, 2013, total deposits were $366.3 million compared to $373.0 million at December 31, 2012. The June 30, 2013 amount represents a decrease of 1.8% from December 31, 2012, which is mainly recognized in customer time deposits and brokered CDs. At June 30, 2013, the deposit mix was comparable to December 31, 2012.


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The following table presents a breakdown of our deposit base at June 30, 2013 and December 31, 2012 (dollars in thousands):

                                                          June 30,         December 31,
                                                            2013               2012
Noninterest bearing demand deposits                       $  33,353       $       36,622
Interest checking deposits                                   41,131               37,768
Savings deposits                                             14,462               13,531
Money market deposits                                        97,321               97,928
Customer time deposits                                      176,586              172,039
Brokered certificates of deposit                              3,455               15,084

Total deposits                                            $ 366,308       $      372,972

Time deposits $100,000 or more:
Brokered certificates of deposit                          $   3,455       $       15,084
Customer time deposits issued in denominations of
$100,000 or more                                            109,320              101,042

Total time deposits issued in denominations of
$100,000 or more                                          $ 112,775       $      116,126

As a percent of total deposits:
Noninterest bearing demand deposits                            9.11 %               9.82 %
Interest checking deposits                                    11.23                10.13
Savings deposits                                               3.95                 3.63
Money market deposits                                         26.57                26.26
Customer time deposits                                        48.21                46.13
Brokered certificates of deposit                               0.94                 4.04
Total time deposits issued in denominations of
$100,000 or more                                              30.79                31.14

Liquidity

Liquidity management is the process of managing assets and liabilities, as well as their maturities, to ensure adequate funding for loan and deposit activities. Sources of liquidity come from both balance sheet and off-balance sheet sources. We define balance sheet liquidity as the relationship that net liquid assets have to unsecured liabilities. Net liquid assets are the sum of cash and cash items, less required reserves on demand and interest checking deposits, plus demand deposits due from banks, plus temporary investments, including federal funds sold, plus the fair value of investment securities, less collateral requirements related to public funds on deposit and repurchase agreements. Unsecured liabilities are equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest checking deposits less the outstanding balances of all secured liabilities, whether secured by liquid assets or not. We consider off-balance sheet liquidity to include unsecured federal funds lines from other banks and loan collateral which may be used for additional advances from the Federal Home Loan Bank. As of June 30, 2013 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 19.70% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 21.41%.

In addition, we have the ability to borrow $10.0 million from the discount window of the Federal Reserve subject to our pledge of marketable securities, which could be used for temporary funding needs. We also have the ability to borrow from the Federal Home Loan Bank on similar terms. While we consider these arrangements sources of back-up funding, we do not consider them as liquidity sources because they require our pledge of liquid assets as collateral. We regularly borrow from the Federal Home Loan Bank as a normal part of our business. These advances, of which there were none at June 30, 2013, are secured by various types of real estate-secured loans. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at June 30, 2013 is adequate to meet its operating needs.


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Interest Rate Sensitivity

Fluctuating interest rates, increased competition, and changes in the regulatory environment continue to significantly affect the importance of interest rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company's net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. Our goal is to maintain an interest rate sensitivity position as close to neutral as practicable whereby little or no change in interest income would occur as interest rates change. On June 30, 2013, we were cumulatively liability sensitive for the next twelve months, which means that our interest bearing liabilities would reprice more quickly than our interest bearing assets. Theoretically, our net interest margin will decrease if market interest rates rise or increase if market interest rates fall. However, the repricing characteristic of assets is different from the repricing characteristics of funding sources. Therefore, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

Capital Adequacy

Regulatory guidelines require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for measuring the capital adequacy of banks and bank holding companies. All applicable capital standards must be satisfied for the Company and the Bank to be considered in compliance with regulatory requirements.

As described above, the Bank is subject to a consent order issued by the FDIC and the North Carolina Office of the Commissioner of Banks and the Company is party to a written agreement with the Federal Reserve Bank of Richmond. These regulatory agreements require that the Bank maintain capital levels in excess of normal regulatory minimums, including a Leverage Capital Ratio of at least 8.0% and a Total Risk-Based Capital Ratio of at least 10.0%, and that the Company and the Bank seek the approval of their respective regulators prior to the payment of any cash dividend. At June 30, 2013, the Bank was not in compliance with the minimum capital requirements set forth in the consent order. As a result, the Bank was required to present its federal and state regulators with a plan to increase its capital ratios to the required percentages. The Bank hired a consultant to help formulate this plan and assist in the exploration of other strategic alternatives.

At June 30, 2013, the Company's leverage and Tier 1 risk-weighted Capital Ratios were 1.88% and 2.60%, respectively, which are below the minimum level required by regulatory guidelines. At June 30, 2013, the Company's Total risk-weighted Capital Ratio was 5.69%, which is below the minimum level required by regulatory guidelines. At June 30, 2013, the Bank's leverage and Tier 1 risk-weighted Capital Ratios were 3.26% and 4.52%, respectively, which are below the minimum levels required by regulatory guidelines. At June 30, 2013, the Bank's Total risk-weighted Capital Ratio was 5.78%, which is below the minimum level required by regulatory guidelines. At June 30, 2013, the Bank's leverage and Total risk-weighted Capital Ratios were both non-compliant with the levels specified in the above referenced consent order with bank regulators. Banks are placed into one of five capital categories based on the above three separate capital ratios. The five categories are "well-capitalized," "adequately capitalized," "under-capitalized," "significantly under-capitalized," and "critically under-capitalized." The Bank was considered "significantly under-capitalized" as of June 30, 2013.

Revised Capital Requirements. On July 2, 2013, the Federal Reserve and the Office of the Comptroller of the Currency adopted a final rule that will revise . . .

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