Providence Bank Annual Report

Transcription

1 Providence Bank Annual Report 2011

2 Providence Bank Report to Shareholders Dear Shareholders, You can be excited about the results of your bank during Before taxes, we earned $2,182,426, 48% over the previous year a remarkable achievement in such a difficult economic environment. Even with tax and dividend payments to the US Treasury, earnings available to common stockholders for the year 2011 netted $1,011,609. That translated into $0.80 per basic share, and compares favorably to $0.67 from the previous year. Before reaching that bottom line figure, we showed steady growth in all key measurement areas for banks. Our deposits and our loans, as presented in the following pages, show that we are doing a very good job of managing the bank. Our capital levels are high, our efficiency ratios are good, and the numbers show that we are performing well. While all banks have some underperforming loans in this climate, we are able to report that we have a small percentage in comparison to overall loans and we are confident that our loan loss reserves of $2.4 million will cover any potential losses. Another positive in 2011 was our ability to fully repay our Capital Purchase Program funds. At the same time, we qualified for the Treasury s Small Business Lending Fund. Only a handful of banks in our state were able to participate in the Lending Fund, and we believe this is a good program for our small business and farming customers. We also continue to take part in a Build America program for our homebuilders. We reduced interest rates for builders who can show at least 50 percent American-made materials. This, indirectly, helps keep jobs active and our communities moving forward. Other news: we were voted Best Bank by readers of the Rocky Mount Telegram, an award we have won for the past four years. We are improving our awareness in our markets, and being more organized in reaching out to our customers and prospects. Maybe the best way to describe our progress is that we are growing up. After six years, we have proven our ability to serve the people and businesses of our area. I believe that one of the most important events of this year was the approval by the Board of Directors to provide a cash return to our stockholders. We can confidently say that this is a bank with staying power. We see a lot changes on the banking landscape, and the more those names and people change, the more we are perceived as sturdy and solid, safe and secure. We stand firm as a Main Street bank, far removed from the problems of Wall Street financial institutions. I encourage you to look at the banking experience here, as well as the products and services we provide. As a shareholder, you can be proud of our work. As a customer, you can come see why. Sincerely, John A. Barker President and Chief Executive Officer

3 Providence Bank TABLE OF CONTENTS Page No. Independent Auditors Report... 1 Financial Statements Balance Sheets... 2 Statements of Operations... 3 Statements of Changes in Stockholders Equity... 4 Statements of Cash Flows... 5 Notes to Financial Statements... 7 Board of Directors Management and Bank Personnel General Corporate Information... 38

4 INDEPENDENT AUDITORS REPORT To the Stockholders and the Board of Directors Providence Bank Rocky Mount, North Carolina We have audited the balance sheets of Providence Bank (the Bank ) as of and the related statements of operations, changes in stockholders equity and cash flows for the years then ended. These financial statements are the responsibility of the Bank s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Bank s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Providence Bank at and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Greenville, North Carolina February 22,

5 BALANCE SHEETS ASSETS Cash and due from banks $ 4,187,020 $ 3,142,093 Interest-earning deposits with banks 48,266,304 16,575,550 Investment securities available for sale, at fair value 2,000,277 2,516,387 Loans 149,528, ,785,599 Allowance for loan losses (2,429,000) (2,450,000) NET LOANS 147,099, ,335,599 Accrued interest receivable 600, ,322 Foreclosed real estate, net 861, ,714 Bank premises and equipment, net 356, ,714 Stock in Federal Home Loan Bank of Atlanta, at cost 735, ,500 Other assets 5,531,051 1,479,826 LIABILITIES AND STOCKHOLDERS EQUITY TOTAL ASSETS $ 209,637,308 $ 166,520,705 Liabilities: Deposits $ 181,002,149 $ 133,904,834 Accrued interest payable 82,382 88,206 Accrued expenses and other liabilities 339, ,293 Short-term borrowings 482,788 3,803,272 Long-term borrowings 8,000,000 10,000,000 Commitments (Notes D and L) TOTAL LIABILITIES 189,907, ,002,605 Stockholders equity: Preferred stock, no par value, 2,000,000 shares authorized; none issued and outstanding - - Non-cumulative perpetual preferred stock (Series A), no par value, 4,000 shares authorized, 0 shares and 4,000 shares outstanding as of December 31, 2011 and 2010, respectively - 3,819,260 Non-cumulative perpetual preferred stock (Series B), no par value, 175 shares authorized, 0 shares and 4,000 shares outstanding as of December 21, 2011 and 2010, respectively - 199,715 Non-cumulative perpetual preferred stock (Series C), no par value, 4,250 shares authorized, issued and outstanding 4,250,000 - Common stock, $5.00 par value, 10,000,000 shares authorized; 1,260,000 shares issued and outstanding 6,300,000 6,300,000 Additional paid-in capital 7,603,240 7,574,084 Retained earnings 1,576, ,547 Accumulated other comprehensive income 154 9,494 TOTAL STOCKHOLDERS EQUITY 19,730,150 18,518,100 TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $ 209,637,308 $ 166,520,705 See accompanying notes 2

6 STATEMENTS OF OPERATIONS Years Ended INTEREST INCOME Loans $ 8,061,946 $ 7,411,584 Federal funds sold and deposits in other banks 71,838 31,914 Investment securities 26,684 46,328 Federal Home Loan Bank dividends 8,854 3,547 TOTAL INTEREST INCOME 8,169,322 7,493,373 INTEREST EXPENSE Money market, NOW and savings deposits 230, ,086 Time deposits 1,846,073 1,684,302 Short term borrowings 2,200 4,960 Long term borrowings 260, ,397 TOTAL INTEREST EXPENSE 2,339,529 2,211,745 NET INTEREST INCOME 5,829,793 5,281,628 PROVISION FOR LOAN LOSSES 315, ,430 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,514,283 4,531,198 NON-INTEREST INCOME 222, ,959 NON-INTEREST EXPENSE Salaries and employee benefits 1,845,780 1,719,570 Occupancy and equipment 421, ,329 Advertising and promotion 41,612 73,303 Data processing and outside service fees 283, ,424 Office supplies, printing, and postage 56,886 55,703 Professional services 193, ,589 FDIC insurance 180, ,501 Foreclosed real estate, net 155,468 - Other 375, ,990 TOTAL NON-INTEREST EXPENSE 3,554,714 3,212,409 INCOME BEFORE INCOME TAXES 2,182,426 1,472,748 INCOME TAXES 835, ,752 NET INCOME 1,347,426 1,091,996 Preferred stock dividends 179, ,750 Accretion of discount, net 156,025 36,402 NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 1,011,609 $ 839,844 NET INCOME PER COMMON SHARE-BASIC $ 0.80 $ 0.67 NET INCOME PER COMMON SHARE-DILUTED $ 0.77 $ 0.65 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING Basic 1,260,000 1,260,000 Diluted 1,307,470 1,300,270 See accompanying notes 3

7 STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY Years Ended Retained Accumulated Preferred stock Additional earnings other Total Series A Series B Series C Common stock paid-in (accumulated comprehensive stockholders Amount Amount Amount Shares Amount capital deficit) income equity Balance at December 31, 2009 $ 3,776,989 $ 205,584 $ - $ 1,260,000 $ 6,300,000 $ 7,480,677 $ (224,297) $ 5,367 $ 17,544,320 Comprehensive income: Net income ,091,996-1,091,996 Unrealized gain on available-for-sale securities, net of tax ,127 4,127 Total comprehensive income 1,096,123 Stock based compensation , ,407 Preferred stock net accretion, amortization, and costs 42,271 (5,869) (36,402) - - Cash dividends paid on preferred stock (215,750) - (215,750) Balance at December 31, ,819, ,715-1,260,000 6,300,000 7,574, ,547 9,494 18,518,100 Comprehensive income: Net income ,347,426-1,347,426 Unrealized loss on available-for-sale securities, net of tax (9,340) (9,340) Total comprehensive income 1,338,086 Stock based compensation , ,156 Issuance of preferred stock in connection with Small Business Lending Fund - - 4,250, ,250,000 Preferred stock net accretion, amortization, and costs 180,740 (24,715) (156,025) - - Cash dividends paid on preferred stock (179,792) - (179,792) Repurchase of preferred Stock, series A and B (4,000,000) (175,000) (4,175,000) Cash dividends declared on common stock (50,400) - (50,400) Balance at December 31, 2011 $ - $ - $ 4,250,000 1,260,000 $ 6,300,000 $ 7,603,240 $ 1,576,756 $ 154 $ 19,730,150 See accompanying notes. 4

8 STATEMENTS OF CASH FLOWS Years Ended CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,347,426 $ 1,091,996 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 115, ,564 Net accretion and amortization 1, Deferred income taxes (29,752) (429,302) Provision for loan losses 315, ,430 Impairment of foreclosed real estate 146,425 - Loss on sale of foreclosed real estate 7,918 - Stock based compensation 29,156 93,407 Income from bank owned life insurance (35,938) - Change in assets and liabilities: Increase in accrued interest receivable (16,701) (103,018) Decrease in other assets 20, ,952 Decrease in accrued interest payable (5,824) (18,071) Increase (decrease) in accrued expenses and other liabilities 83,146 (297,394) NET CASH PROVIDED BY OPERATING ACTIVITIES 1,978,069 1,333,454 CASH FLOWS FROM INVESTING ACTIVITIES Net increase in loans (7,602,258) (20,097,741) Purchases of bank premises and equipment (21,494) (70,991) Purchase of available-for-sale securities (1,500,175) (2,501,770) Proceeds from calls of available-for-sale securities 2,000,000 3,000,000 Purchase of bank owned life insurance (4,000,000) - Repayment of Federal Home Loan Bank stock 209, ,900 NET CASH USED BY INVESTING ACTIVITIES (10,914,427) (19,557,602) CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 47,097,315 21,479,408 Proceeds from borrowings - 374,765 Repayments of borrowings (5,320,484) (2,000,000) Dividends paid on preferred stock (179,792) (215,750) Repurchase of preferred stock (Series A and B) (4,175,000) - Proceeds from issuance of preferred stock (Series C) 4,250,000 - NET CASH PROVIDED BY FINANCING ACTIVITIES 41,672,039 19,638,423 NET INCREASE IN CASH AND CASH EQUIVALENTS 32,735,681 1,414,275 CASH AND CASH EQUIVALENTS, BEGINNING 19,717,643 18,303,368 CASH AND CASH EQUIVALENTS, ENDING $ 52,453,324 $ 19,717,643 See accompanying notes. 5

9 STATEMENTS OF CASH FLOWS (Continued) Years Ended SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest paid $ 2,345,353 $ 2,229,816 Taxes paid $ 939,000 $ 1,205,666 Unrealized (loss) gain on investment securities available for sale, net of tax $ (9,340) $ 4,127 Transfer from loans to foreclosed real estate $ 562,821 $ 492,714 Loans originated related to the sale of foreclosed real estate $ 40,000 $ - See accompanying notes. 6

10 NOTE A - ORGANIZATION AND OPERATIONS Providence Bank (the Bank ) was incorporated and began banking operations on March 14, The Bank is engaged in general commercial and retail banking principally in Nash and Edgecombe Counties of North Carolina, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities. NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans. Cash Equivalents For the purpose of presentation in the statement of cash flows, cash and cash equivalents include cash and due from banks and interest-earning deposits. Investment Securities Available for Sale Investment securities available for sale are reported at fair value and consist of debt instruments that are not classified as either trading securities or as held to maturity securities. Unrealized holding gains and losses on available for sale securities are reported as a net amount in other comprehensive income, net of tax. Gains and losses on the sale of investment securities available for sale are determined using the specific-identification method. Declines in the fair value of individual held to maturity and investment securities available for sale below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on impaired loans is discontinued when, in management s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. 7

11 NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Purchased Impaired Loans Purchased impaired loans are accounted for under the Receivables topic of the FASB Accounting Standards Codification when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Bank will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due and nonaccrual status. Purchased impaired loans generally meet the Bank s definition for nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference which is included in the carrying amount of the loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reversal of the nonaccretable difference with a positive impact on future interest income. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Allowance for Loan Losses The provision for loan losses is based upon management s estimate of the amount needed to maintain the allowance for loan losses at an adequate level. In making the evaluation of the adequacy of the allowance for loan losses, management gives consideration to current economic conditions, statutory examinations of the loan portfolio by regulatory agencies, delinquency information and management s internal review of the loan portfolio. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, or upon the fair value of the collateral if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Bank to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Foreclosed real estate Real estate acquired through, or in lieu of, loan foreclosure is initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations of the property are periodically performed by management and the real estate is carried at the lower of cost or fair value minus estimated cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in foreclosed real estate expense. 8

12 NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets, which ranges from 3 to 20 years for furniture and equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations. Stock in Federal Home Loan Bank of Atlanta As a requirement for membership, the Bank invests in stock of the Federal Home Loan Bank of Atlanta ( FHLB ). This investment is carried at cost. Due to the redemption provisions of the FHLB, the Bank estimated that fair value equals cost and that this investment was not impaired at December 31, 2011 and Bank Owned Life Insurance The Bank has purchased life insurance policies on certain key executives. Bank owned life insurance, included in other assets, is recorded at its cash surrender value or the amount that can be realized. Borrowings Borrowings consist of securities sold under agreements to repurchase and long-term Federal Home Loan Bank advances. Derivatives The Bank carries derivative financial instruments on its balance sheet as either an asset or liability at their respective fair values. For derivatives which qualify as hedges, the fair value adjustments are recorded through accumulated other comprehensive (loss) income. For derivatives which do not qualify as a hedge according to accounting principles generally accepted in the United States of America, the changes in fair value are recorded through earnings. The Bank may use certain derivatives for risk management purposes, which will generally not qualify as hedges, to manage the Bank s exposure to changes in interest rates and other market risks. Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are also recognized for operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. 9

13 NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Income Taxes (Continued) Uncertainty in income taxes is accounted for in accordance with the Income Taxes topic of the FASB Accounting Standards Codification, which clarifies the accounting for the recognition and measurement of the benefits of individual tax positions in the financial statements. Tax positions must meet a recognition threshold of more-likely-than-not in order for the benefit of those tax positions to be recognized in the Bank s financial statements. The Bank has determined that it does not have any material unrecognized tax benefits or obligations as of. Interest and penalties related to income tax assessments, if any, are reflected in income taxes in the accompanying statement of operations. Fiscal years ending on or after December 31, 2008 remain subject to examination by federal and state tax authorities. Comprehensive Income The Bank reports as comprehensive income all changes in stockholders' equity during the year from sources other than stockholders. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net income. The Bank's only component of other comprehensive income is unrealized gains and losses on investment securities available for sale, net of applicable income taxes. There were no realized gains or losses for the years ended. The components of other comprehensive income (loss) and related tax effects are as follows (in thousands): Unrealized (losses) gains arising during the year $ (15) $ 7 Tax effect 6 (3) Net of tax amount $ (9) $ 4 Stock Based Compensation The Bank recognizes the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). The cost of employee services received in exchange for an award is measured based on the grant-date fair value of the award. Excess tax benefits are reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows. Per Share Results Basic earnings per share represents income available to common stockholders divided by the weightedaverage number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Bank relate to outstanding stock options and warrants, and are determined using the treasury stock method. For the year ended, there were 2,500 and 2,000 stock options that were anti-dilutive, respectively.

14 NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Per Share Results (Continued) In the Bank s original subscription offering of common stock made prior to opening, subscribers received one warrant to purchase an additional share of common stock at $11 per share for every five shares subscribed. These warrants, which are not detachable, expire seven years after the Bank s incorporation due to a two year extension approved during Without regard to the expiration date of the warrants, the Bank will have the right to call the warrants at any time after March 14, As of December 31, 2011 and 2010, 252,000 such warrants were outstanding. New Accounting Standards The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Bank. In July 2010, the Receivables topic of the Accounting Standards Codification ( ASC ) was amended by Accounting Standards Update ( ASU ) to require expanded disclosures related to a company s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Bank is required to include these disclosures in its annual financial statements. See Note D. Disclosures about Troubled Debt Restructurings ( TDRs ) required by ASU were deferred by the Financial Accounting Standards Board ( FASB ) in ASU issued in January In April 2011, FASB issued ASU to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present. Disclosures related to TDRs under ASU have been presented in Note D. ASU was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments will be effective for the Bank beginning January 1, 2012 but are not expected to have a material effect on the financial statements. The Comprehensive Income topic of the ASC was amended by ASU in June The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders equity. The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The amendments will be applicable to the Bank on January 1, 2012 and will be applied retrospectively. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Bank s financial position, results of operations and cash flows. Subsequent Events In preparing these financial statements, the Bank has evaluated events and transactions for potential recognition or disclosure through February 22, 2012, the date the financial statements were available to be issued. 11

15 NOTE C - INVESTMENT SECURITIES The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, are as follows: December 31, 2011 Gross Gross Amortized unrealized unrealized Fair cost gains losses value (Dollars in thousands) Securities available for sale: U.S. government securities and obligations of U.S. government agencies $ 2,000 $ - $ - $ 2,000 December 31, 2010 Gross Gross Amortized unrealized unrealized Fair cost gains losses value (Dollars in thousands) Securities available for sale: U.S. government securities and obligations of U.S. government agencies $ 2,500 $ 17 $ (1) $ 2,516 There were no sales of investment securities during the years ended. The amortized cost and fair value of the Bank s investment securities at December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Fair Cost Value (Dollars in thousands) Securities available for sale: U.S. government agency securities Due in one year or less $ 1,000 $ 1,000 Due after one but within five years 1,000 1,000 2,000 2,000 Securities with an amortized cost of $2.0 million and a fair value of $2.0 million were pledged to secure repurchase agreements at December 31,

16 NOTE D - LOANS Following is a summary of loans at (in thousands): Real estate loans: One to four family residential $ 26,941 $ 27,227 Multi-family residential and commercial 59,188 49,004 Multi-family residential and commercial - CICCAR 21,081 21,401 Construction 15,716 19,800 Home equity lines of credit 8,744 8,266 Total real estate loans 131, ,698 Other loans: Commercial and industrial 17,382 16,558 Loans to individuals Total other loans 17,859 17,088 Total loans 149, ,786 Less: Allowance for loan losses 2,429 2,450 Total loans, net $ 147,100 $ 140,336 Loans presented above are net of unamortized loan costs of $423 thousand and $455 thousand at, respectively. Loans are primarily made in Nash and Edgecombe Counties, North Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans can be affected by the local economic conditions. The Bank has had loan transactions with its directors and executive officers. Such loans were made in the ordinary course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and did not involve more than the normal risk of collectability or present other unfavorable features. A summary of related party loan transactions is as follows (in thousands): Balance at December 31, 2010 $ 8,796 Loan disbursements 3,953 Loan repayments (6,141) Balance at December 31, 2011 $ 6,608 At, the Bank had pre-approved but unused lines of credit totaling approximately $2.5 million and $1.2 million, respectively, to executive officers, directors and their related interests. 13

17 NOTE D - LOANS (Continued) The following is a summary of impaired loans (in thousands), which are further expanded upon in the following tables and disclosures Impaired loans, total $ 4,319 $ 4,582 Impaired loans with recorded allowance 3,048 2,766 Related allowances Impaired loans with no recorded allowance 1,271 1,816 Impaired loans with previously recorded allowance (1) - - Related partial chargeoffs - - Average recorded investment in impaired loans 4,248 2,565 Nonaccrual loans 4,319 4,582 Troubled debt restructurings (2) 2,136 - (1) These impaired loans are included within the impaired loans with no recorded allowance total in the table above. As a result of the stated previous chargeoffs, it was determined that these impaired loans did not require additional allowance for loan losses at year end. (2) Troubled debt restructured loans are included within impaired loans. The Company is not committed to advance additional funds on restructured loans. All nonaccrual loans are considered to be impaired at. During the years ended, the Bank recognized no interest income on impaired loans. The interest income foregone for loans on nonaccrual status for 2011 was approximately $172 thousand and approximately $229 thousand for The following describe the risk characteristics relevant to each of the portfolio segments. Real estate Commercial and residential real estate secured loans are underwritten utilizing independent appraisal or evaluations and financial analysis of the borrowers. These loans are either cash flow loans or development loans paid from the real estate sale and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher risk and higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in real estate markets or the general economy. The properties securing the Company s commercial real estate portfolio are principally secured by owner-occupied buildings including professional practices, office and church properties and single family rental properties. Management monitors and evaluates commercial real estate loans based on collateral, market area and risk grade criteria. Residential real estate loans are typically secured by the primary residence of the borrower and the combined loan-to-value ratio is usually 90% or less. Construction loans are generally based upon estimates of costs and value associated with the project as completed. Construction loans often involve the disbursement of funds with the repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans or sales of developed property. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions, availability of long-term financing and government regulation of real property. 14

18 NOTE D - LOANS (Continued) Commercial and industrial Non-real estate secured commercial and industrial loans are underwritten after analyzing the borrowers financial condition and ability to generate profits sufficient to support the loans. Commercial and industrial loans are primarily made based on the indentified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and the guarantors, as applicable. The cash flows of borrowers, however, may not materialize as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and usually incorporate a personal guaranty. In the case of loans secured by accounts receivable, the availability of the funds for repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. 15

19 NOTE D - LOANS (Continued) The ending balances of loans and the related allowance presented by portfolio class and allowance methodology as of December 31, 2011 are as follows (in thousands): Multi Family Multi Family Residential Residential Home 1 4 Family and and Equity Residential Commercial - Commercial - Construction Lines of Commercial Real Estate Real Estate CICCAR Real Estate Credit & Industrial Consumer Total Allowance for credit losses Beginning balance $ 461 $ 941 $ 105 $ 630 $ 102 $ 205 $ 6 $ 2,450 Charge-offs (46) (80) - (211) (337) Recoveries Provision (2) (141) (2) 315 Ending balance $ 420 $ 1,102 $ 103 $ 278 $ 123 $ 399 $ 4 $ 2,429 Ending balance: individually evaluated for impairment $ 43 $ - $ - $ 179 $ - $ 35 $ - $ 257 Ending balance: collectively evaluated for impairment 377 1, ,172 Ending balance: loans acquired with deteriorated credit quality Financing receivables: Ending balance $ 26,941 $ 59,188 $ 21,081 $ 15,716 $ 8,744 $ 17,382 $ 477 $ 149,529 Ending balance: individually evaluated for impairment , ,319 Ending balance: collectively evaluated for impairment 26,742 59,188 21,081 11,695 8,744 17, ,210 During 2010, the allowance of $1.8 million was increased by provision for loan losses of $750 thousand, with adjustments for $116 thousand in charge-offs and no recoveries, which ended the period with an allowance of $2.5 million. 16

20 NOTE D - LOANS (Continued) Credit Risk Profile by Internally Assigned Grade The loan portfolio is reviewed, both internally and through the use of independent external sources, to validate the credit risk on a periodic basis. Also, loans are monitored for credit quality on a monthly basis through evaluation of past due status. The composition of the loans outstanding at December 31, 2011 by credit quality indicator is provided below. The credit quality indicators used are dependent on the portfolio segment to which the loan relates. Loan credit quality indicators for all loans within the portfolio are developed through review of individual borrowers on an ongoing basis. The indicators represent the rating for loans as of the date presented based on the most recent assessment performed. These credit quality indicators are defined below (in thousands). Multi Family Multi Family Residential Residential Home 1 4 Family and and Equity Residential Commercial - Commercial - Construction Lines of Commercial Real Estate Real Estate CICCAR Real Estate Credit & Industrial Consumer Total Grade: Superior $ - $ - $ - $ - $ 31 $ 1,014 $ 219 $ 1,264 Minimal - 2, ,890-6,064 Average 7,408 11,421-2,533 4,690 6, ,517 Acceptable with Care 19,316 45,799 20,701 7,331 3,352 6, ,621 Special Mention , ,317 Substandard , ,319 Doubtful Loss Total $ 26,923 $ 59,261 $ 20,701 $ 15,721 $ 8,687 $ 17,346 $ ,102 Overdrafts 4 Deferred Costs 423 TOTAL $ 149,529 17

21 NOTE D - LOANS (Continued) Risk Grade Definitions Superior Credits in this category are fully secured by cash equivalents or high grade, readily marketable securities. Minimal Credits in this category are to a borrower of unquestionable financial strength. Financial information exhibits superior earnings, leverage and liquidity positions, which firmly establish a repayment source, that is substantial in relation to debt. These borrowers would generally have access to national credit and equity markets. Average Credits in this category are to borrowers of satisfactory financial strength. Earnings performance is consistent with primary and secondary sources of repayment well defined and adequate to retire the debt in a timely and orderly fashion. These businesses would generally exhibit satisfactory asset quality and liquidity with moderate leverage, average performance to their peer group and experienced management in key positions. May also include a loan in which strong reliance for a secondary repayment source is placed on a guarantor who exhibits the ability and willingness to repay. Acceptable with Care Credits in this category are sound and collectible but contain considerable risk. Although asset quality remains acceptable, the borrower has a smaller and/or less diverse asset base, very little liquidity and limited debt capacity. The borrower may also have the following characteristics: Earnings performance is inconsistent and the borrower is not strong enough to sustain major setbacks. The borrower may be highly leveraged and below average size or a lower-tier competitor. Limited management experience and depth. May be a well conceived start-up venture, but repayment is still dependent upon a successful operation. These credits may have a strong reliance for a secondary repayment source placed on a guarantor who exhibits the ability and willingness to repay. These credits require significant supervision by the lender and covenants structured to ensure adequate protection. These credits may also include satisfactory borrowers in industries with a higher than normal credit risk. Special Mention Credits in this category are potentially weak credits. Assets rated Special Mention are currently protected but potentially weak. These assets constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of Substandard. Loans in this category have potential weaknesses, which may, if not corrected, weaken the asset, or inadequately protect the Bank s credit position at some future date. Substandard Assets classified Substandard have a well-defined weakness(es) in the credit that jeopardize the repayment of all principal and interest in accordance with the contractual terms of the credit. Substandard assets are inadequately protected by the current net worth and paying capacity of the obligor or the collateral that is pledged. 18

22 NOTE D - LOANS (Continued) Doubtful An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Loss Assets classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. Age Analysis of Past Due Financing Receivables The aging of the outstanding loans by class at December 31, 2011 is provided in the table below (in thousands). The calculation of days past due begins on the day after payment is due and includes all days through which all required interest or principal have not been paid. Loans less than 30 days past due are considered current due to certain grace periods that allow borrowers to make payments within a stated period after the due date and still remain in compliance with the loan agreement. Greater than Days Days 90 Days Total Total Past Due Past Due Past Due Past Due Current Loans 1 4 Family Residential Real Estate $ - $ - $ 24 $ 24 $ 26,917 $ 26,941 Multi Family Residential & Commercial - Real Estate ,188 59,188 Multi Family Residential & Commercial CICCAR ,081 21,081 Construction Real Estate - - 4,021 4,021 11,695 15,716 Home Equity Lines of Credit ,709 8,744 Commercial and industrial ,268 17,382 Consumer loans Total $ 63 $ - $ 4,131 $ 4,194 $ 145,335 $ 149,529 As of December 31, 2011, there were no loans greater than 90 days and accruing interest. There were loans of approximately $4.6 million that were 90 days or more delinquent for which the accrual of interest had ceased at December 31,

23 NOTE D - LOANS (Continued) Impaired Loans The following table provides information on impaired loans at December 31, 2011, including interest income recognized in the period during which the loans and leases were considered impaired (in thousands). Average Interest Recorded Legal Related Recorded Income Investment Balance Allowance Investment Recognized With no related allowance recorded: Construction Real Estate $ 1,271 $ 1,271 $ - $ 1,271 $ - With an allowance recorded: 1 4 Family Residential Real Estate $ 199 $ 240 $ 43 $ 256 $ - Construction Real Estate 2,750 4, ,591 - Commercial & Industrial Total: 1 4 Family Residential Real Estate $ 199 $ 240 $ 43 $ 256 $ - Multi Family Residential and Commercial - Real Estate Multi Family Residential and Commercial - CICCAR Construction Real Estate 4,021 5, ,862 - Home Equity Lines of Credit Commercial and industrial Consumer loans Total $ 4,319 $ 5,615 $ 257 $ 4,248 $ - Financing Receivables on Nonaccrual Status The recorded investment, by class, in loans on nonaccrual status at December 31, 2011 is as follows (in thousands): 1 4 Family Residential Real Estate $ 199 Multi Family Residential and Commercial - Real Estate - Multi Family Residential and Commercial - CICCAR - Construction Real Estate 4,021 Home Equity Lines of Credit - Commercial and industrial 99 Consumer loans - Total $ 4,319 20

24 NOTE D - LOANS (Continued) During 2011, there were two troubled debt restructurings. One 1-4 Family Residential Real Estate loan valued at $215 thousand prior to the modification and $175 thousand after modification was classified as a troubled debt restructuring due to forgiveness of principal. One Construction Real Estate loan valued at $1.96 million prior to and after modification is classified as a troubled debt restructuring due to extended payment terms. Since modification, both loans are paying as restructured. There were no troubled debt restructurings as of December 31, NOTE E - BANK PREMISES AND EQUIPMENT Following is a summary of bank premises and equipment at (in thousands): Furniture and equipment $ 502 $ 481 Vehicles Leasehold improvements Accumulated depreciation (494) (379) Total $ 357 $ 451 Depreciation and amortization amounting to $115 thousand and $125 thousand for the years ended, respectively is included in occupancy and equipment expense and data processing and outside service fees. The Bank has noncancellable operating leases for three branch locations. These leases have various expiration dates through 2015 and generally contain renewal options periods ranging from two to four years. Rental expense for operating leases during 2011 and 2010 was $161 thousand each year, of which $42 thousand represents rent paid to a lessor company each year, one of whose owners and principals is a director of the Bank. The Bank leased automobiles under operating leases which expired at various dates through Annual lease payments under these leases total approximately $3 thousand for the year ended December 31, A summary of the minimum future rental payments under the leases described above is as follows at December 31, 2011 (in thousands): 2012 $ $

25 NOTE F - DEPOSITS Deposits consist of the following (in thousands): Demand $ 7,212 $ 5,833 Savings 15,200 9,793 Money market and NOW 60,419 24,924 Time 98,171 93,355 Total $ 181,002 $ 133,905 The aggregate amount of time deposits in denominations of $100 thousand or more at December 31, 2011 and 2010 was $40.2 million and $35.6 million, respectively. Interest expense on such deposits aggregated approximately $587 thousand and $682 thousand, respectively, in 2011 and At December 31, 2011, the scheduled maturities of certificates of deposit are as follows (in thousands): Less than $100,000 $100,000 or more Total 2012 $ 21,670 $ 25,013 $ 46, ,188 11,488 22, , , ,683 1,142 4, ,830 1,912 4,742 Thereafter 13,927-13,927 Total $ 57,985 $ 40,186 $ 98,171 NOTE G - BORROWINGS Advances from the Federal Home Loan Bank consist of the following (in thousands): Maturing in Interest December 31, Type Year Ending Rate Variable % $ - $ 3,000 Fixed % - 2,000 Fixed % 4,000 4,000 Convertible % 2,000 2,000 Convertible % 2,000 2,000 $ 8,000 $ 13,000 22

26 NOTE G - BORROWINGS (Continued) Pursuant to collateral agreements with the Federal Home Loan Bank ( FHLB ) at December 31, 2011 and 2010, advances are secured by pledged loans with a carrying amount of $34.5 million and $38.1 million, respectively. At, the Bank s maximum borrowing availability was equal to 30% of total assets. There were no short term FHLB advances outstanding at December 31, 2011 and $3.0 million outstanding at December 31, The Bank enters into agreements with customers to transfer excess funds in demand deposit accounts into a repurchase agreement. Under the repurchase agreement, the Bank sells the customer an interest in securities that are United States government agencies. The customer s interest in the underlying security shall be repurchased by the Bank at the opening of the next banking day. The rate fluctuates monthly and is based on current deposit rates of the Bank. As of, the Bank had a balance outstanding of $483 thousand and $803 thousand, respectively, under these repurchase agreements. The Bank has available lines of credit with various credit facilities to provide additional liquidity if and as needed. These include available lines of credit with correspondent banks totaling $15 million. At, there were no federal funds purchased outstanding under these lines of credit. NOTE H - DERIVATIVES Financial derivatives are reported at fair value in other assets and other liabilities. The accounting for changes in fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings. In 2009, the Bank entered into interest rate swap agreements to facilitate customer transactions in connection with their financing needs. Upon entering into an agreement with the borrower to meet their financing needs, the Bank entered into an offsetting position with a counterparty to minimize the risk to the Bank. These back-to-back interest rate swap arrangements qualify as derivatives but are not designated as hedging instruments. Interest rate swap contracts involve the risk of dealing with borrowers and counterparties and their ability to meet contractual terms. A summary of the Bank s interest rate swap arrangements is included in the following table (in thousands): Notional Amount Estimated Fair Value Pay fixed / receive variable swap $ 1,133 $ 158 Pay variable / receive fixed swap 1,133 (158) Total $ 2,266 $ - 23