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SOCB > SEC Filings for SOCB > Form 10-Q on 13-May-2014All Recent SEC Filings

Show all filings for SOUTHCOAST FINANCIAL CORP

Form 10-Q for SOUTHCOAST FINANCIAL CORP


13-May-2014

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/A for the year ended December 31, 2013. Results of operations for the period ending March 31, 2014 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 limited to, 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 values of 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, as well as competitors that offer banking products and services by mail, telephone, computer and/or the Internet;

o the effects of credit rating downgrades on the value of investment securities issued or guaranteed by various governments 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 accuracy of fair value measurements and the methods and assumptions used to estimate fair value;

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 cybersecurity risk related to our dependence on internal security systems and the technology of outside service providers, as well as the potential impacts of third party security breaches;

o the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic 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 Exchange Commission under the Securities Exchange Act of 1934.


SOUTHCOAST FINANCIAL CORPORATION

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

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.

Results of Operations

The Company's net income for the three months ended March 31, 2014 was $643,000 or $0.09 per basic share, compared to net income of $1,006,000, or $.14 per basic share, for the three months ended March 31, 2013. The average number of basic shares outstanding for the three months ended March 31, 2014 was 7,085,818 compared to 7,070,375 for the three months ended March 31, 2013.

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 $3.6 million for the three months ended March 31, 2014, compared to approximately $3.4 million for the three months ended March 31, 2013.

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, 2014 compared to the same period of 2013 was due to increased interest income and decreased interest expense between the two periods. The increase in interest income related to interest income on loans and taxable investments. The decrease in interest expense was primarily driven by lower interest expense on time deposits. Interest expense on time deposits decreased between the two periods due to changes in both volume and rate, as the Company was able to lower its cost of funds on time deposits while changing its funding mix towards deposits with lower funding costs.

Average earning assets for the three months ended March 31, 2014 increased 1.2 percent to $383.7 million from the $379.1 million reported for the three months ended March 31, 2013. The increase was attributable to an increase of $6.5 million in average loans, partially offset by a $1.9 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. The decrease in the Company's average investments and federal funds sold was primarily due to sales of municipal securities during the final nine months of 2013 and paydowns on mortgage backed securities.

Average interest bearing liabilities for the three months ended March 31, 2014 decreased 5.7 percent to $330.3 million from the $350.3 million reported for the three months ended March 31, 2013. The decrease was attributable to a decrease of $25.9 million in average time deposits, partially offset by increases of $4.7 million and $1.2 million in average savings and transaction accounts and other borrowings, respectively. The decrease in average time deposits was attributable to decreases of $15.6 million and $10.3 million in retail and wholesale time deposits, respectively.


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, 2014 and 2013.



                                    For the three months ended                     For the three months ended
                                          March 31, 2014                                 March 31, 2013
                              Average         Income/         Yield/         Average         Income/         Yield/
                              Balance         Expense        Rate(1)         Balance         Expense        Rate(1)
Assets
Cash and Federal funds
sold                        $    11,636      $        6           0.21 %   $    10,789      $        6           0.22 %
Investments - taxable            42,469             263           2.48          44,114             203           1.84
Investments - nontaxable          3,919              59           6.04           5,061              76           6.07

Total investments and
federal funds sold               58,024             328           2.27          59,964             285           1.91

Loans (2)(3)                    325,643           4,235           5.21         319,177           4,201           5.27

Total earning
assets/interest income          383,667           4,563           4.77 %       379,141           4,486           4.75 %
Other assets                     57,429                                         52,349

Total assets                $   441,096                                    $   431,490

Liabilities
Savings and transaction
accounts                    $   118,937             177           0.60 %   $   114,274             138           0.48 %
Time deposits                   134,917             246           0.73         160,818             375           0.94
Other borrowings                 66,152             444           2.69          64,922             466           2.88
Subordinated debt                10,310              45           1.77          10,310              46           1.81

Total interest bearing
liabilities/interest
expense                         330,316             912           1.11 %       350,324           1,025           1.17 %

Non-interest bearing
liabilities                      67,717                                         46,401

Total liabilities               398,033                                        396,725

Equity                           43,063                                         34,765

Total liabilities and
equity                      $   441,096                                    $   431,490

Net interest
income/margin (4)                            $    3,651           3.81 %                    $    3,461           3.65 %

Net interest spread (5)                                           3.66 %                                         3.58 %

(1) Annualized

(2) Does not include nonaccruing loans.

(3) Income includes loan fees of $171,000 in 2014 and $164,000 in 2013.

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

(5) 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, 2014 the average yield on earning assets was 4.77 percent, while the average cost of interest bearing liabilities was 1.11 percent. For the three months ended March 31, 2013 the average yield on earning assets was 4.75 percent and the average cost of interest-bearing liabilities was 1.17 percent. The moderate increase in the overall asset yield is primarily due to an increase in yields on taxable investments, which had yields of 2.48% and 1.84% for the three months ended March 31, 2014 and March 31, 2013, respectively. The increased yields on these investments was primarily due to significantly lower levels of prepayments on mortgage backed securities during the three months ended March 31, 2014. Prepayments on the Company's mortgage backed securities totaled $644,000 and $2,517,000 during the three months ended March 31, 2014 and March 31, 2013, respectively. All mortgage backed securities in the Company's investment portfolio were purchased at a premium, so slower prepayment speeds have the effect of increasing the interest income and yield on these investments. The decrease in the cost of average interest bearing liabilities was due to decreases in average rates paid on time deposits and other borrowings, slightly offset by increased rates paid on interest bearing savings and transaction accounts. The net interest margin was 3.81 percent and 3.65 percent for the three months ended March 31, 2014 and 2013, respectively. The increase in the net interest margin was attributable to an increase of $190,000 in net interest income, which was comprised of an increase in interest income of $77,000 and a decrease in interest expense of $113,000. The increase in interest income was primarily due to a $60,000 increase in interest income on taxable investments, while the interest expense reduction was primarily attributable to a $129,000 decrease in interest expense on time deposits.

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, 2014
                                                      Versus three months ended March 31, 2013 (1)
                                                  Volume                 Rate                Net Change
Interest income:

Cash and Federal funds sold                    $           -         $           -         $             -
Investments - taxable                                     (8 )                  68                      60
Investments - non taxable                                (17 )                   -                     (17 )

Total investments and federal funds sold                 (25 )                  68                      43

Net loans (2)(3)                                          84                   (50 )                    34

Total interest income                                     59                    18                      77

Interest expense:

Savings and transaction accounts                           5                    34                      39
Time deposits                                            (59 )                 (70 )                  (129 )
Other borrowings                                           9                   (31 )                   (22 )
Subordinated debt                                          -                    (1 )                    (1 )

Total interest expense                                   (45 )                 (68 )                  (113 )

Net interest income                            $         104         $          86         $           190

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

(2) Income includes loan fees of $171,000 in 2014 and $164,000 in 2013.

(3) 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, 2014 was approximately $488,000, compared to approximately $589,000 for the three months ended March 31, 2013, a decrease of approximately $101,000. This was primarily due to decreases of approximately $83,000 and $22,000 in gains on sale of mortgage loans held for sale and service fees on deposit accounts, respectively. The decrease in the gain on sale of mortgage loans held for sale was reflective of the Company's decision to keep nearly all of its mortgage loans originated during the three months ended March 31, 2014.

Noninterest expenses for the three months ended March 31, 2014 were $3,130,000, compared to $2,960,000 for the three months ended March 31, 2013, an increase of $170,000. The largest contributing factor to this increase was a $183,000 decrease in gains on sales of other real estate owned, which are accounted for as an offset to noninterest expense. Additionally, salaries and benefits increased by $80,000 due primarily to routine salary increases. Partially offsetting these increases were decreases of $51,000 and $54,000 related to software and insurance expenses, respectively. The decrease in software expense was primarily related to the Company's conversion from an internal core processing function to an outsourced core processing vendor arrangement, while the decrease in insurance related to lower FDIC premiums.

Income Taxes

At June 30, 2013, as referenced in Note 7 to the Condensed Consolidated Financial Statements, the Company reversed the majority of its valuation allowance on its deferred tax assets. The net amount of the Company's deferred tax assets totaled $7,020,000 at March 31, 2014. The Company's income tax expense for the three months ended March 31, 2014 totaled $345,000, comprised of $318,000 for Federal income taxes and $27,000 for South Carolina income taxes. The Company's income tax expense for the three months ended March 31, 2013 totaled $56,000, which was comprised entirely of South Carolina income taxes. During the first three months of 2013, the Company maintained a full valuation allowance on its deferred tax assets, as a result of which Federal income tax liabilities incurred during the quarter reduced the size of the deferred tax asset related to the net operating loss carryforward and its corresponding valuation allowance. Due to the valuation allowance reversal at June 30, 2013, Federal income tax liabilities generated during the three months ended March 31, 2014 were recognized as income tax expense, and represented a direct reduction to the Company's deferred tax asset related to the Company's net operating loss carryforward, as referenced in Note 7.

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 78.2% of total deposits as of March 31, 2014. 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 $43.3 million at March 31, 2014. 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, 2014.

Loans

Gross loans totaled approximately $339,291,000 and $331,906,000 at March 31, 2014 and December 31, 2013, respectively. At March 31, 2014, the Company had $8.5 million of nonaccrual loans and $102,000 of loans 90 days delinquent and still accruing interest. Of these, $7.7 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, 2013, the Company had $9.9 million of nonaccrual loans and no loans 90 days past due and still accruing interest. At March 31, 2013, the Company had $8.7 million of nonaccrual loans and $91,000 of loans 90 days past due and still accruing interest. The allowance for loan losses was 1.81 percent of loans as of March 31, 2014, compared to 1.82 percent as of December 31, 2013 and 2.41 percent as of March 31, 2013.


SOUTHCOAST FINANCIAL CORPORATION

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

Loans - (continued)

For each of the three months ended March 31, 2014 and 2013, the Company recorded no loan loss provision. Net (chargeoffs) recoveries for the three months ended March 31, 2014 totaled approximately $105,000 and ($352,000), respectively. The need for future loan loss provisions will be influenced by loan delinquency levels, loan chargeoffs beyond what has already been provided for on individual loans, the level of loans with credit grades of 6 through 9, and the need for additional specific reserves on loans individually evaluated for impairment, among other factors. In reviewing the adequacy of the allowance for loan losses at each quarter end, management takes into consideration the historical loan losses we experienced, current levels of past due loans by loan type, the historical severity of loan losses by loan type, loan to value exceptions in our loan portfolio, potential repayment risk for floating and adjustable rate loans due to the potential for rising interest rates, risks posed by unseasoned loans durings periods of growth in the loan portfolio, and collateral values of impaired loans deemed to be collateral dependent. As referenced in Note 6, the Company's other general reserves portion of its allowance for loan losses increased by $212,000 during the three months ended March 31, 2014, from $1,339,000 at December 31, 2013 to $1,551,000 at March 31, 2014. Other general reserves at March 31, 2014 and December 31, 2013 were comprised of the following risk factors:

(Dollars in Thousands)                   March 31, 2014       December 31, 2013

Loan To Value Exposure                  $            885     $               672
Floating and Adjustable Rate Exposure                662                     665
Portfolio Growth Exposure                              4                       2
Total                                   $          1,351     $             1,339

As shown above, the increase in other general reserves during the three months ended March 31, 2014 was primarily attributable to reserves related to loan to value exposure, which increased by $213,000. This increase was the result of a methodology modification for loans with loan to value exposure that also carry interest only terms and have credit risk grades of 7 or below. The exposure from loans with these additional risk characteristics is now calculated at 2.5 times the base amount due to the additional risks posed by these characteristics. After charging off all known losses, management considers the allowance for loan losses adequate to cover its estimate of inherent losses in the loan portfolio as of March 31, 2014.

For the three months ended March 31, 2014, net recoveries to average loans outstanding totaled 0.13% on an annualized basis while the allowance for loan losses to gross loans totaled 1.81% at March 31, 2014. 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, 2014 potential problem loans totaled $14.0 million. The Company's potential problem loans were comprised of $2.1 million of construction and land development real estate loans, $7.2 million of nonfarm, nonresidential real estate loans, $3.6 million of 1-4 family mortgage loans, $348,000 of multifamily real estate loans, and $791,000 of various loan types not secured by real estate, primarily commercial and industrial loans. At March 31, 2013 potential problem loans totaled $14.6 million. The Company's potential problem loans were 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.


SOUTHCOAST FINANCIAL CORPORATION

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

Other Real Estate Owned

Other real estate owned totaled approximately $4.3 million as of March 31, 2014, $5.2 million at December 31, 2013, and $6.8 million as of March 31, 2013, net of . . .

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