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BKSC > SEC Filings for BKSC > Form 10-K on 11-Mar-2014All Recent SEC Filings

Show all filings for BANK OF SOUTH CAROLINA CORP

Form 10-K for BANK OF SOUTH CAROLINA CORP


11-Mar-2014

Annual Report


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

Management's discussion and analysis is included to assist the Shareholder in understanding our financial condition, results of operations, and cash flow. This discussion should be reviewed in conjunction with the audited consolidated financial statements and accompanying notes presented in Item 8 of this report and the supplemental financial data appearing throughout this report. Since the primary asset of the Company is its wholly-owned subsidiary, most of the discussion and analysis relates to the Bank.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report, including information included or incorporated by reference in this document, contains statements which constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1934. We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1996 and are including this statement for the express purpose of availing the Company of protections of such safe harbor with respect to all "forward-looking statements" contained in this Form 10-K. Forward looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of the Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Actual results may differ materially from those anticipated in any forward-looking statements. The words "may," "would," "could," "should," "will," "expect," "anticipate," "predict," "project,", "potential," "continue," "assume," "believe," "intend," "plan," "forecast," "goal," and "estimate," as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitations, those described under the heading "Risk Factors" in this Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the Securities and Exchange Commission (the SEC") and the following:

Risk from changes in economic, monetary policy, and industry conditions
Changes in interest rates, shape of the yield curve, deposit rates, the net interest margin and funding sources
Market risk (including net income at risk analysis and economic value of equity risk analysis) and inflation
Risk inherent in making loans including repayment risks and changes in the value of collateral
Loan growth, the adequacy of the allowance for loan losses, provisions for loan losses, and the assessment of problem loans
Level, composition, and re-pricing characteristics of the securities portfolio
Deposit growth, change in the mix or type of deposit products and services
Continued availability of senior management
Technological changes
Ability to control expenses
Changes in compensation
Risks associated with income taxes including potential for adverse adjustments
Changes in accounting policies and practices
Changes in regulatory actions, including the potential for adverse adjustments
Recently enacted or proposed legislation
Current uncertainty in the financial service industry

These risks are exacerbated by the developments over the last five years in national and international financial markets, and we are unable to predict what effect continued uncertainty in market conditions will have on us. There can be no assurance that the unprecedented developments experienced over the last five years will not materially and adversely affect our business, financial condition and results of operations.

All forward-looking statements in this report are based on information available to us as of the date of this report. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that these expectations will be achieved. We will undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings by the Company with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company, which are not statements of historical fact, constitute forward-looking statements.

OVERVIEW

Bank of South Carolina Corporation (the "Company") is a financial institution holding company headquartered in Charleston, South Carolina, with $340.9 million in assets as of December 31, 2013 and net income of $969,868 and $4,076,924, respectively, for the three and twelve months ended December 31, 2013. The Company offers a broad range of financial services through its wholly-owned subsidiary, The Bank of South Carolina (the "Bank"). The Bank is a state-chartered commercial bank which operates principally in the Charleston, Dorchester, and Berkeley counties of South Carolina. The Bank's original and current concept is to be a full service financial institution specializing in personal service, responsiveness, attention to detail to foster long standing relationships.

We derive most of our income from interest on loans and investments (interest bearing assets). The primary source of funding for making these loans and investments is our interest and non-interest bearing deposits. Consequently, one of the key measures of the our success is the amount of net interest income, or the difference between the income on its interest earning assets, such as loans and investments, and the expense on its interest bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest bearing assets and the rate we pay on our interest bearing liabilities.

A consequence of lending activities is that we may incur credit losses. The amount of such losses will vary depending upon the risk characteristics of the loan and lease portfolio as affected by economic conditions such as rising interest rates and the financial performance of borrowers. The reserve for credit losses consists of the allowance for loan and lease losses (the "Allowance") and a reserve for unfunded commitments (the "Unfunded Reserve"). The Allowance provides for probable and estimable losses inherent in our loan and lease portfolio. The Allowance is increased or decreased through the provisioning process. For a detailed discussion on the allowance for loan losses see "Allowance for Loan Losses".

In addition to earning interest on loans and investments, we earn income through fees and other expenses we charge to the customer. The following discussion includes various components of this non-interest income and non-interest expenses. The discussion and analysis also identifies significant factors that have affected the Company's financial position and operating results as of December 31, 2013 as compared to December 31, 2012 and December 31, 2012 as compared to December 31, 2011, and should be read in conjunction with the financial statements and the related notes included in this report. In addition, a number of tables have been included to assist in the discussion.

CRITICAL ACCOUNTING POLICIES

We adopted various accounting policies that govern the application of principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are set forth in the notes to the consolidated financial statements in this report.

Certain accounting policies involve significant judgments and assumptions by the Company that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the number of judgments and assumptions that we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and results of operations.

We consider our policy regarding the allowance for loan losses to be its most subjective accounting policy due to the significant degree of management judgment. We have developed what we believe to be appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations and the discovery of information with respect to borrowers which were not known by management at the time of the issuance of the consolidated financial statements. For additional discussion concerning our allowance for loan losses and related matters, see "Allowance for loan losses".

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2013 TO DECEMBER 31, 2012

Net income increased $410,096 or 11.18% to $4,076,924 or basic and diluted earnings per share of $.92 and $.91, respectively for the year ended December 31, 2013 from $3,666,828 or basic and diluted earnings per share of $.82 and $.82, respectively for the year ended December 31, 2012. Our return on average assets and average equity for the year ended December 31, 2013 were 1.23% and 11.72%, respectively, compared with 1.16% and 10.97%, respectively, for the year ended December 31, 2012.

Our higher income was primarily due to the following:

Interest and fees on loans increased $155,821 or 1.41% to $11,188,748. Outstanding loans increased $1,191,680 or 0.55% as a result of an improving market leading to an increase in loan demand. Average loans increased $5,486,600 with a yield of 4.94% for the year ended December 31, 2013, from $220,780,471 for the year ended December 31, 2012 and a yield of 5.00%.

Interest and dividends on investment securities increased $135,074 or 10.02% to $1,482,594 for the year ended December 31, 2013, from $1,347,520 in 2012. We were earning .25% on our funds deposited at the Federal Reserve. This low rate coupled with a rising yield curve gave us reason to invest our excess cash in investment securities. Average investments increased $9,501,384 to $67,484,036 with a yield of 2.20%

The provision for loan losses decreased $142,500 to $207,500 for the year ended December 31, 2013. This decrease was primarily due to improving credit quality and as well as the improvement in the underlying risk profile of our loan portfolio.

Mortgage banking income increased $143,782 for the twelve months ended December 31, 2013. Mortgage banking income was $1,521,670 in 2013, compared to $1,377,888 in 2012. This increase was due to obtaining better margins(discounts earned and service release premiums) selling loans on the secondary market. Our software's pricing engine allowed a side by side comparison allowing us to execute the most profit on each loan. Mortgage discount points, a form of interest, increased $301,378 to $1,547,649 for the twelve months ended December 31, 2013.

Other operating expenses decreased $209,412 or 8.99% for the twelve months ended December 31, 2013. With the introduction of new banking products such as remote deposit capture, we were able to reduce the cost of our courier service by $58,605 for the twelve months ended December 31, 2013 compared to the same period in 2012. Data processing fees decreased $115,731 as a result of the renegotiation of our contract. Professional audit and legal fees were reduced by $45,500 and $55,823, respectively. We lowered our audit fees by hiring a Risk Management Officer who conducts our Sarbanes Oxley Act testing in-house. Legal fees were reduced as the result of fewer cases brought by the Company or those against the Company which required legal review. Offsetting these decreases was an increase of $73,980 in sundry losses from $6,102 in 2012 to $80,081 in 2013. This loss resulted from fraud by persons outside the Company. We believe that our internal controls have been designed to minimize losses. However, there are no assurances that a loss will not occur.

Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities. Net interest margin is a measuring of the difference between interest income on earning assets less interest paid on interest bearing liabilities relative to the amount of interest bearing assets. Net interest income increased $328,424 to $12,335,664 for the year ended December 31, 2013, from $12,007,240 for the year ended December 31, 2012. Our average earning assets increased $14,125,768 in 2013 as compared to 2012. Average loans increased $5,486,600 with a yield of 4.94%, a decrease of 6 basis points. We made a decision to invest some of our excess cash in securities rather than leaving it at the Federal Reserve where it was earning .25%. Average investments increased $9,501,384 with a yield of 2.20%. Total yield on our average earnings assets decreased 9 basis points from 4.01% in 2012 to 3.92% in 2013. Our net interest margin decreased 7 basis points to 3.79% in 2013 from 3.86% in 2012.

Average interest bearing deposits increased $4,536,053 to $210,108,383 in 2013, with a total yield of .20%, a decrease of 2 basis points from .22% at December 31, 2012. Our interest paid on deposits decreased $39,491 or 8.67% to $416,128 in 2013 compared to $455,619 in 2012. Rates paid on our interest bearing liabilities decreased 2 basis points to .20% in 2013. Rates paid on transaction accounts and savings accounts remained unchanged from 2012 to 2013. The rate paid on certificates of deposit decreased 11 basis points from .54% in 2012 to .43% for the year ended December 31, 2013.

The provision for loan losses reflects our judgment of the expense or benefit necessary to achieve the appropriate amount of the allowance for loan losses (the "allowance"). We maintain the allowance at levels adequate to cover our estimate of probable credit losses as of the balance sheet date presented. The allowance is determined through detailed analyses of our loan portfolio. The allowance is based on our loss experience and changes in the economic environment, as well as an ongoing assessment of our credit quality. We recorded a provision of $207,500 in 2013 and $350,000 in 2012. The lower provision recorded in 2013 was reflective of continued improvements in our credit quality metrics. For further discussion on the allowance, see "Allowance for Loan Losses."

The allowance consists of an allocated and unallocated allowance. The allocated portion is determined by types and ratings of loans within the portfolio. The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses. We had $205,904 in unallocated reserves at December 31, 2013 as compared to $376,067 at December 31, 2012. Management believes this amount is appropriate and properly supported through the environmental factors of its allowance for loan losses.

There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. In addition the allowance is subject to examination and testing for adequacy by regulatory agencies. Such regulatory agencies could require management to adjust the allowance based on information available to them at the time of their examination.

During 2013, the Company recorded net charge-offs of $348,067 as compared to net charge-offs of $24,040 in 2012. The variance between 2013 and 2012 can be attributed to an unexpected large recovery in 2012. Although uncertainty in the economic outlook still exists, management believes the loss exposure in the portfolio is identified, reserved against and closely monitored to ensure that changes are promptly addressed in the analysis of reserve adequacy.

Impaired loans at December 31, 2013 totaled $7,136,907, a decrease of 37.93% over total impaired loans of $11,498,279 at December 31, 2012. Our impaired loans included non-accrual loans of $1,575,441 and four restructured loans (TDR) totaling $1,196,341 at December 31, 2013. Impaired loans include non-accrual loans of $3,993,816 and five restructured loans (TDR) totaling $1,618,278 at December 31, 2012. At December 31, 2012 there was one credit totaling $2,623,556 which was entirely secured by a first mortgage. This loan paid off in the second quarter of 2013. There were no loans over 90 days past due still accruing interest at December 31, 2013 or December 31, 2012.

Non-interest income increased $150,954 or 6.44% to $2,496,417 in 2013. As previously stated, our mortgage banking income increased $143,782 or 10.44% due to obtaining better margins (discounts earned and SRP) selling loans on the secondary market. Our software's pricing engine allowed a side by side comparison allowing us to execute the most profit on each loan. Although the economy in our market area is improving, we began to see a decrease in loan originations in the third and fourth quarter of 2013. This decrease comes as a result of increasing interest rates and the increase in home prices. We saw a clear shift from refinancing to home purchases in 2013. This trend is likely to continue into 2014.

Our non-interest expense decreased $13,775 from $8,731,625 in 2012 to $8,717,850 in 2013. Salaries and employee benefits increased $145,802 in 2013 as a result of annual merit increases and the addition of a mortgage loan originator and a Risk Management Officer. In addition, health insurance increased $50,693 and workers compensation insurance expense increased $19,111. The increase in health insurance expense can be attributed to the addition of two employees and a rate increase. Workers compensation increased as a result of an audit performed by the insurance company on the Company's 2012 insurance coverage. As previously noted above, we saw a decrease in other operating expenses of $209,412. This decrease was primarily due to the decrease in courier service fees, data processing fees, and professional audit and legal fees. We offer a courier service to pick up our business customers' deposits. We also offer remote deposit capture to our business customers. Many of our business customers opted to use remote deposit capture which allowed us to cut our courier expense by 36% from $159,943 for the year ended December 31, 2012 to $101,338 in 2013. Data processing fees decreased $115,731 as the result of the renegotiation of our contract. Professional audit and legal fees were reduced by $45,500 and $55,823, respectively. We lowered our audit fees by hiring a Risk Management Officer who conducts our Sarbanes Oxley Act testing in-house. Legal fees were reduced as the result of fewer cases brought against the Company requiring legal review. In 2012 we had two cases brought against the Company, one of which was heard by the South Carolina Supreme Court, resulting in higher legal fees in 2012 as compared to 2013. Offsetting the decreases in expenses described above was an increase of $73,979 in sundry losses from $6,102 in 2012 to $80,081 in 2013. This loss resulted from fraud by persons outside the Company. We believe that our internal controls have been designed to minimize losses; however, there are no assurances that a loss will not occur.

Income tax expense increased 14.06% to $1,829,807 at December 31, 2013 from $1,604,250 at December 31, 2012. The Company's effective tax rate was approximately 30.98% for the year ended December 31, 2013 compared to 30.44% for the year ended December 31, 2012.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2012 TO DECEMBER 31, 2011

Net income increased $477,510 or 14.97% to $3,666,828 or basic and diluted earnings per share of $.82 and $.82, respectively, for the year ended December 31, 2012 from $3,189,318 or basic and diluted earnings per share of $.72 and $.72, respectively for the year ended December 31, 2011. This increase was primarily due to an increase in mortgage banking income and a decrease in the cost of funds. Historically low interest rates helped to increase the volume of mortgage loan originations. In addition, our market area of Berkeley, Charleston and Dorchester counties saw an increase in home sales during the year ended December 31, 2012. Mortgage loan originations increased $48,649,766 or 81.02% to $108,699,648 for the year ended December 31, 2012, from $60,049,882 for the year ended December 31, 2011.

The cost of funds decreased as a result of lower rates paid on interest bearing deposits coupled with a decrease in interest bearing deposits and an increase in non-interest bearing deposits. Interest bearing deposits decreased $23,283,733 or 10.08% to $207,626,168 for the year ended December 31, 2012. The cost associated with these deposits decreased $322,409 or 41.44% to $455,619 for the year ended December 31, 2012. On February 7, 2012, we were notified by a large depositor that it would begin to withdraw its deposits by the end of that month. This depositor was a company that was started in Charleston, SC and was purchased by an out-of-state company in 2007. The deposits remained with the Bank with the understanding that these deposits would eventually be moved. The balance of the deposits, all of which were interest bearing, at December 31, 2011 was $32,462,427 with $546,000 remaining at December 31, 2012. Non-interest bearing accounts increased $13,230,061 or 18.84% to $83,447,675 for the year ended December 31, 2012. We had a strong increase in the number of small business accounts, due to our business development efforts. The Dodd-Frank Act included a provision which required the Federal Deposit Insurance Corporation (FDIC) to provide unlimited federal deposit insurance for non-interest bearing demand accounts. This provision expired on December 31, 2012. We have not experienced any impact from the expiration of this provision.

Net interest income increased $507,664 or 4.42% to $12,007,240 for the year ended December 31, 2012 from $11,499,576 for the year ended December 31, 2011. Net interest income is a primary source of revenue. Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on interest earning assets and the rates paid on interest bearing liabilities, the relative amounts of interest earning assets and interest bearing liabilities, and the degree of mismatch and maturity and repricing characteristics of its interest earning assets and interest bearing liabilities. The increase in net interest income was primarily due to an increase in interest and fees on loans and, as discussed above, a decrease in the cost of funds.

We experienced a modest increase of $145,218 or 1.33% from interest and fees on loans, and $37,777 or 2.88% increase from interest and dividends on investment securities. Average loans increased $7,819,484 to $220,780,471 for the year ended December 31, 2012. A large portion of this increase was primarily due to an increase of $4,725,259 in average mortgage loans to be sold, from $3,164,168 for the year ended December 31, 2011 to $7,889,427 for the year ended December 31, 2012. We had 480 mortgage originations totaling $108,699,648 for the year ended December 31, 2012 as compared to 281 mortgage originations totaling $60,049,882 for the year ended December 31, 2011. As stated previously, the increase in mortgage originations resulted from the historically low interest rates and an increase in home sales in our market area.

Average investments increased $5,693,516 to $57,982,652 for the year ended December 31, 2012. The yield on these investments decreased from 2.50% for the year ended December 31, 2011 to 2.32% for the year ended December 31, 2012. During 2011, we had one US Treasury Note, two Federal Agency Securities and two Municipal Securities mature that were yielding between 5.069% and 3.396%. The funds from these maturities were re-invested at significantly lower interest rates.

We maintain an allowance for loan losses (the "allowance") which is management's best estimate of probable losses inherent in the outstanding loan portfolio. The allowance is decreased by actual loan charge-offs, net of recoveries, and is increased as necessary by charges to current period operating results through the provision for loan losses. The allowance is based on management's continuing review and credit risk evaluation of the losses inherent in the loan portfolio. Management takes into consideration many factors such as the balance of impaired loans, the quality, mix and size of our overall loan portfolio, economic conditions that may affect the borrower's ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. Based on management's evaluation, we recorded a provision for loan losses of $350,000 for the year ended December 31, 2012, a decrease of 27.08% or $130,000 from $480,000 for the year ended December 31, 2011.

The allowance consists of an allocated and unallocated allowance. The allocated portion is determined by types and ratings of loans within the portfolio. The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses. We had $376,067 in unallocated reserves at December 31, 2012 as compared to $558,267 at December 31, 2011. Management believes this amount is appropriate and properly supported through the environmental factors of its allowance for loan losses.

There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. In addition the allowance is subject to examination and testing for adequacy by regulatory agencies. Such regulatory agencies could require management to adjust the allowance based on information available to them at the time of their examination.

During 2012, we recorded net charge-offs of $24,040 as compared to net charge-offs of $311,703 in 2011. Although uncertainty in the economic outlook still exists, management believes the loss exposure in the portfolio is identified, reserved against and closely monitored to ensure that changes are promptly addressed in the analysis of reserve adequacy.

Impaired loans at December 31, 2012 totaled $11,498,279, an increase of 55.01% over total impaired loans of $7,417,892 at December 31, 2011. Impaired loans include non-accrual loans of $3,993,816 and five restructured loans (TDR) totaling $1,618,278 at December 31, 2012. In addition, there was one credit totaling $2,623,556 which was entirely secured by a first mortgage, improving our existing second real estate mortgage secured position and including the existing unsecured debt. Impaired loans at December 31, 2011 included non-accrual loans of $923,671 and two restructured loans totaling $491,153. There were no loans over 90 days past due still accruing interest at December 31, 2012 and one loan over 90 days past due that was still accruing interest at December 31, 2011. Comparing the year ended December 31, 2012 and the year ended December 31, 2011, the increase in non-accrual loans was primarily due to the addition of two very well secured first real estate mortgage loans to one borrower which totaled $1,822,592, one secured real estate mortgage totaling $508,651, and three past due loans (greater than 90 days) totaling $743,154.

Non-interest income increased $567,506 or 31.92% to $2,345,463 for the year ended December 31, 2012 from $1,777,957 for the year ended December 31, 2011. This increase was primarily due to an increase in mortgage banking income offset by a decrease in gains on securities. Mortgage banking income increased $703,183 . . .

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