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ASBB > SEC Filings for ASBB > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for ASB BANCORP INC

Form 10-K for ASB BANCORP INC


14-Mar-2014

Annual Report


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

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


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Operating Strategy

Our primary objective is to operate and grow a profitable community-oriented financial institution serving customers in our primary market areas. We seek to achieve this through the adoption of a business strategy to provide superior financial services to help our customers and communities prosper by focusing on our core values while achieving sustainable profitability and reasonable returns for our stockholders. We plan to continue our focus on loan growth in 2014. In recent years, we hired senior management with substantial experience in consumer and commercial banking to help us diversify our product offerings and expand our consumer and commercial deposit and lending products, while maintaining high asset quality standards. Our operating strategies include the following:

continue to provide competitive products, services and pricing to individuals and businesses in the communities served by our branch offices;

profitable growth of our residential mortgage banking;

profitable growth of our commercial and industrial lending activities and small business relationships; and

increase efficiencies and productivity bank wide.

Continue to provide competitive products, services and pricing to individuals and businesses in the communities served by our branch offices.

We have continually operated as a community-oriented financial institution since we were established in 1936. We are committed to meeting the financial needs of the communities in which we operate, and we are dedicated to providing quality personal service to our customers. We provide a broad range of consumer and business financial services through our network of banking center offices. As we continue to refine our information technology, infrastructure and operations to support business growth, we will remain steadfast in our pursuit of ways to become a highly efficient bank with an emphasis on managing costs while providing more innovative, productive ways of doing business.

Profitable growth of our residential mortgage banking.

Residential mortgage lending remains an important part of our lending activities. We originate fixed and adjustable-rate residential mortgage loans that are retained in our loan portfolio. However, most of the fixed-rate residential mortgage loans that we originate are sold into the secondary market with servicing released as part of our efforts to reduce our interest rate risk. At December 31, 2013, residential mortgage loans totaled $161.4 million, or 35.9% of our total loan portfolio.

Profitable growth of our commercial and industrial lending activities and small business relationships.

We intend to expand our commercial and industrial lending activities and to originate an increased number of small business loans. Management has hired additional experienced lending officers and credit management personnel over the past several years in order to continue to safely manage this type of lending. Commercial and industrial lending has increased recently as we have managed our problem loans and experienced higher loan demand. Our goal is to increase this portion of our portfolio using conservative underwriting practices to increase the yield in our loan portfolio. Also, our focus on creating a full relationship with clients has enhanced our value proposition and contributed to growth in business services and deposit activities.


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Increase efficiencies and productivity bank wide.

We seek to increase our profitability by improving efficiencies and productivity throughout the Bank. This necessitates right-sizing the Bank's cost structure for revenue growth by allocating resources in alignment with our strategic priorities. This will require a laser-like focus that must be embedded in the culture of the Bank, having infrastructure, processes, procedures, technology and the like that makes it easier, simpler, faster and less expensive to conduct business. We plan to evaluate the Bank's processes, policies, and technology to make it easy for the customer to do business with the Bank - simpler, faster and easier. This includes facilitating our teams' abilities to recognize opportunities, delivering on commitments to customers and aligning our overall cost structure with our operating revenues.

Overview

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

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

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

Salaries and employee benefits expenses consist primarily of salaries, wages and bonuses paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We recognized additional employee compensation expenses during 2013 stemming from our adoption of equity-based benefit plans. See note 11 in the notes to consolidated financial statements included in this annual report for the amount of future compensation expense to be recognized on the shares of common stock granted under these plans.

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

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

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

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


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Critical Accounting Policies

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

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to earnings. Management's estimates of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impaired loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance monthly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect our earnings. See notes 1 and 4 included in the notes to consolidated financial statements included in this annual report.

Fair Value of Investments. Securities are characterized as available for sale or held to maturity based on management's ability and intent regarding such investment at acquisition. On an ongoing basis, management estimates the fair value of its investment securities based on information and assumptions it deems reliable and reasonable, which may be quoted market prices or if quoted market prices are not available, fair values extrapolated from the quoted prices of similar instruments. Based on this information, an assessment must be made as to whether any decline in the fair value of an investment security should be considered as an other than temporary impairment and recorded in noninterest income as a loss on investments. The determination of such impairment is subject to a variety of factors, including management's judgment and experience. See notes 2 and 13 of the notes to the consolidated financial statements included in this annual report.

Foreclosed Real Estate. The Company's valuations of its foreclosed real estate involve significant judgments and assumptions by management, which have a material impact on the reported values of foreclosed real estate assets and noninterest expense recorded in the financial statements. The judgments and assumptions used by management are described in "Foreclosed Real Estate" under note 1 of the notes to the consolidated financial statements included in this annual report.


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Pension Plan. The Company has a noncontributory defined benefit pension plan. This plan is accounted for under the provisions of ASC Topic 715:
Compensation-Retirement Benefits, which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. ASC Topic 715 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. Management must make certain estimates and assumptions when determining the projected benefit obligation. These estimates and assumptions include the expected return on plan assets, the rate of compensation increases over time, and the appropriate discount rate to be used in determining the present value of the obligation. See note 11 of the notes to the consolidated financial statements included in this annual report.

Comparison of Financial Condition at December 31, 2013 and December 31, 2012

General. Total assets decreased $16.3 million, or 2.2%, to $733.0 million at December 31, 2013 from $749.4 million at December 31, 2012. Investment securities decreased $53.8 million, or 22.1%, to $189.6 million at December 31, 2013 from $243.4 million at December 31, 2012, primarily due to the sale of investment securities to fund loan growth. Loans receivable, net of deferred fees, increased $61.5 million, or 15.9%, to $449.2 million at December 31, 2013 from $387.7 million at December 31, 2012 as new loan originations exceeded loan repayments, prepayments, and foreclosures. Of the $61.5 million increase in loans receivable at December 31, 2013, $43.6 million were in commercial mortgages that were at fixed rates, the majority of which carry five-year to seven-year calls allowing for re-pricing opportunities.

Loans. Loan originations totaled $313.1 million for the year ended December 31, 2013 compared to $207.4 million for the year ended December 31, 2012. Residential mortgage loan originations, largely from residential purchase transactions, totaled $120.6 million in 2013 compared to $110.7 million in 2012, while residential construction and land development loan originations totaled $21.9 million in 2013 compared to $11.0 million in 2012. Originations of commercial mortgage, commercial construction and land development, and commercial and industrial loans totaled $102.3 million, $14.8 million and $9.7million, respectively, for the year ended December 31, 2013 compared to $61.9 million, $1.1 million and $5.9 million, respectively, for the year ended December 31, 2012. Revolving mortgage originations totaled $18.7 million in 2013 compared to $7.1 million in 2012, while consumer loan originations totaled $25.2 million in 2013 compared to $9.8 million in 2012. The increase in consumer loan originations mostly attributable to indirect automobile financing through local automobile dealers. Origination activity was significantly offset by $150.0 million of normal loan repayments and prepayments and $105.8 million in loan sales for the year ended December 31, 2013, compared to $139.9 million and $91.0 million, respectively, for the year ended December 31, 2012.


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Loan Portfolio Composition

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

                                                         December 31,
                                 2013                        2012                        2011
(dollars in
thousands)               Amount        Percent       Amount        Percent       Amount        Percent

Commercial:
Commercial mortgage     $ 171,993         38.23 %   $ 138,804         35.76 %   $ 139,947         32.30 %
Commercial
construction and land
development                15,593          3.47 %       5,161          1.34 %      22,375          5.17 %
Commercial and
industrial                 14,770          3.28 %      11,093          2.86 %      17,540          4.05 %
Total                     202,356         44.98 %     155,058         39.96 %     179,862         41.52 %

Non-commercial:
Residential mortgage      161,437         35.89 %     163,571         42.14 %     175,866         40.59 %
Residential
construction and land
development                 8,759          1.95 %       3,729          0.96 %       3,907          0.90 %
Revolving mortgage         49,561         11.02 %      48,221         12.42 %      51,044         11.78 %
Consumer                   27,719          6.16 %      17,552          4.52 %      22,588          5.21 %
Total                     247,476         55.02 %     233,073         60.04 %     253,405         58.48 %

Total loans               449,832        100.00 %     388,131        100.00 %     433,267        100.00 %

Less:  Net deferred
loan origination fees         598                         410                         384
Less:  Allowance for
loan losses                 7,307                       8,513                      10,627
Loans receivable, net   $ 441,927                   $ 379,208                   $ 422,256



                                                                   December 31,
                                                         2010                        2009
(dollars in thousands)                           Amount        Percent       Amount        Percent

Commercial:
Commercial mortgage                             $ 164,553         32.88 %   $ 197,239         32.98 %
Commercial construction and land development       28,473          5.69 %      30,158          5.04 %
Commercial and industrial                          17,656          3.53 %      22,794          3.81 %
Total                                             210,682         42.10 %     250,191         41.83 %

Non-commercial:
Residential mortgage                              180,439         36.06 %     190,965         31.93 %
Residential construction and land development       8,670          1.73 %      15,141          2.53 %
Revolving mortgage                                 53,432         10.68 %      55,038          9.20 %
Consumer                                           47,212          9.43 %      86,768         14.51 %
Total                                             289,753         57.90 %     347,912         58.17 %

Total loans                                       500,435        100.00 %     598,103        100.00 %

Less:  Net deferred loan origination fees             432                         502
Less:  Allowance for loan losses                   12,676                       8,994
Loans receivable, net                           $ 487,327                   $ 588,607


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Loan Portfolio Maturities

The following tables set forth certain information at December 31, 2013
regarding the dollar amount of loan principal repayments becoming due during the
periods indicated. The tables do not include any estimate of prepayments that
significantly shorten the average life of our loans and may cause our actual
repayment experience to differ from that shown below. Demand loans, which are
loans having no stated schedule of repayments and no stated maturity, are
reported as due in one year or less.

                                                           December 31, 2013
                                                      Commercial
                                                     Construction       Commercial
                                     Commercial        and Land            and             Total
(in thousands)                       Mortgages        Development       Industrial       Commercial

Amounts due in:
One year or less                    $     20,687     $       1,184     $      3,112     $     24,983
More than one year through two
years                                     12,461             6,667              464           19,592
More than two years through three
years                                     13,360               952            1,302           15,614
More than three years through
five years                                76,034             1,036            6,201           83,271
More than five years through ten
years                                     38,951             5,717            3,568           48,236
More than ten years through
fifteen years                             10,500                37                -           10,537
More than fifteen years                        -                 -              123              123
Total                               $    171,993     $      15,593     $     14,770     $    202,356



                                                                December 31, 2013
                                             Residential
                                            Construction
                           Residential        and Land         Revolving                      Total Non-        Total
(in thousands)              Mortgages        Development       Mortgages       Consumer       Commercial        Loans

Amounts due in:
One year or less          $         656     $         213     $       266     $    1,219     $      2,354     $  27,337
More than one year
through two years                 2,326                 -             197          1,375            3,898        23,490
More than two years
through three years               1,762                 -             651            856            3,269        18,883
More than three years
through five years               12,204                 -           2,986          8,953           24,143       107,414
More than five years
through ten years                 6,820                 -          30,425         14,688           51,933       100,169
More than ten years
through fifteen years            14,265                 -          15,036              -           29,301        39,838
More than fifteen years         123,404             8,546               -            628          132,578       132,701
Total                     $     161,437     $       8,759     $    49,561     $   27,719     $    247,476     $ 449,832


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Fixed vs. Adjustable Rate Loans

The following table sets forth the dollar amount of all loans at December 31,
2013 that have contractual maturities after December 31, 2014 and have either
fixed interest rates or floating or adjustable interest rates. The amounts shown
below exclude unearned loan origination fees.

                                                       Due After December 31, 2014
                                                               Floating or
                                                  Fixed        Adjustable
(in thousands)                                    Rates           Rates           Total

Commercial:
Commercial mortgage                             $ 105,616     $      45,690     $ 151,306
Commercial construction and land development        3,023            11,386        14,409
Commercial and industrial                           7,447             4,211        11,658
Total commercial                                  116,086            61,287       177,373
Non-commercial:
Residential mortgage                               73,042            87,739       160,781
Residential construction and land development       2,303             6,243         8,546
Revolving mortgage                                     44            49,251        49,295
Consumer                                           26,500                 -        26,500
Total non-commercial                              101,889           143,233       245,122
Total loans receivable                          $ 217,975     $     204,520     $ 422,495

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


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Loan Activity

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

                                                       Year Ended December 31,
(in thousands)                      2013          2012          2011          2010          2009

Total loans at beginning of
period                            $ 388,967     $ 428,846     $ 495,713     $ 592,497     $ 586,618
Loans originated:
Commercial:
Commercial mortgage                 102,280        61,910        32,688        43,547        74,382
Construction and land
development                          14,772         1,050         1,068             -             -
Commercial and industrial             9,698         5,853         7,199         7,737        10,742
Non-commercial:
Residential mortgage                120,555       110,682        81,705       121,439       131,017
Construction and land
development                          21,913        10,986        10,734        15,845        12,142
Revolving mortgage                   18,683         7,107         6,385         7,966        20,524
Consumer                             25,237         9,830           483           523        26,248
Total loans originated              313,138       207,418       140,262       197,057       275,055

Loans purchased:
Commercial:
Commercial mortgage                      55         2,909           125         2,191         6,209
Construction and land
development                               -             -           560            41             -
Total loans purchased                    55         2,909           685         2,232         6,209

Total loans originated and
purchased                           313,193       210,327       140,947       199,289       281,264

Deduct:
Loan principal repayments           150,027       139,879       131,393       163,910       151,368
Loan sales                          105,849        90,955        68,850        97,103       116,352
Foreclosed loans transferred to
foreclosed properties                   708        17,464         3,533        12,585         2,968
Charge-offs                             525         3,995         6,134        18,863         2,193
Deductions (additions) for
other items (1)                      (1,018 )      (2,087 )      (2,096 )       3,612         2,504
Net loan activity during the
period                               57,102       (39,879 )     (66,867 )     (96,784 )       5,879
Total loans at end of period      $ 446,069     $ 388,967     $ 428,846     $ 495,713     $ 592,497



(1) Other items consist of deferred loan fees, the allowance for loan losses and loans in process.

Loan originations come from a number of sources. The primary sources of loan originations are existing customers, walk-in traffic, advertising and referrals from customers. We generally sell in the secondary market long-term fixed-rate residential mortgage loans that we originate. Our decision to sell loans is based on prevailing market interest rate conditions, interest rate management and liquidity needs.


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Investment Security Portfolio

At December 31, 2013, our securities portfolio consisted of mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae, securities of U.S. government agencies and corporations, securities of various government sponsored entities and securities of state and local governments. Our securities portfolio is used to invest excess funds for increased yield, manage interest rate risk and as collateralization for public unit deposits.

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