Financial Statements Years Ended December 31, 2015 and 2014 and Independent Auditor s Report
Table of Contents Independent Auditors Report... 1 Financial Statements Balance Sheets... 2 Statements of Operations... 3 Statements of Comprehensive Income... 4 Statements of Changes in Stockholders Equity... 5 Statements of Cash Flows... 6... 7
Independent Auditors Report Stockholders and the Board of Directors Coastal Bank & Trust Jacksonville, North Carolina We have audited the accompanying financial statements of Coastal Bank & Trust (the Bank ), which comprise the balance sheets as of December 31, 2015 and 2014 and the related statements of operations, comprehensive income, stockholders equity and cash flows for the years ended, and the related notes to the financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors Responsibility 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. These standards require that we plan and perform the audit to obtain assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on auditors judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall financial statement presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Coastal Bank & Trust at December 31, 2015 and 2014 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 April 7, 2016 1
Balance Sheets December 31, 2015 and 2014 2015 2014 ASSETS Cash and due from banks $ 1,994,098 $ 3,816,829 Interest-earning deposits with banks 2,027,808 2,999,158 Certificates of deposit with other banks 1,090,000 840,000 Investment securities available for sale, at fair value 5,070,107 4,317,848 Investment securities held to maturity, at amortized cost 494,010 646,923 Loans held for sale 1,144,300 320,589 Loans 66,309,186 55,166,371 Allowance for loan losses (1,124,481) (982,264) Net loans 65,184,705 54,184,107 Stock in the Federal Home Loan Bank of Atlanta, at cost 62,000 56,100 Stock in the Federal Reserve Bank, at cost 219,650 192,750 Accrued interest receivable 198,210 185,418 Bank premises and equipment, net 420,569 431,692 Other real estate owned 710,000 600,000 Other assets 87,965 91,889 Total assets $ 78,703,422 $ 68,683,303 LIABILITIES AND STOCKHOLDERS EQUITY Deposits: Noninterest bearing demand $ 15,495,645 $ 13,643,690 Savings, money market, and NOW 32,094,183 31,169,680 Time 23,379,729 16,389,470 Total deposits 70,969,557 61,202,840 Accrued interest payable 26,893 18,122 Accrued expenses and other liabilities 103,258 152,194 Total liabilities 71,099,708 61,373,156 Stockholders equity: Preferred stock, $100 par value, 1,000,000 shares authorized; 0 and 17,000 issued and outstanding at December 31, 2015 and 2014-1,700,000 Common stock, $4 par value; 10,000,000 shares authorized; 1,344,695 and 1,018,505 shares issued and outstanding at December 31, 2015 and 2014 5,378,780 4,074,020 Additional paid-in capital 6,616,164 6,114,674 Accumulated other comprehensive loss (36,031) (29,843) Accumulated deficit (4,355,199) (4,548,704) Total stockholders equity 7,603,714 7,310,147 Total liabilities and stockholders equity $ 78,703,422 $ 68,683,303 See accompanying notes. 2
Statements of Operations For the Years Ended December 31, 2015 and 2014 2015 2014 Interest income: Loans $ 2,819,855 $ 2,334,914 Investment securities 97,370 88,648 Interest-earning deposits in other bank, and certificates of deposit 57,551 70,094 Total interest income 2,974,776 2,493,656 Interest expense: Money market, NOW and savings deposits 120,276 143,775 Time deposits 183,581 153,445 Total interest expense 303,857 297,220 Net interest income 2,670,919 2,196,436 Recovery of loan losses - (1,000,000) Net interest income after recovery of loan losses 2,670,919 3,196,436 Non-interest income: Gain on sale of loans 4,747 152,845 Mortgage income 403,381 181,339 Other 329,229 197,426 Total non-interest income 737,357 531,610 Non-interest expense: Salaries and employee benefits 1,847,081 1,573,902 Occupancy and equipment 351,222 429,996 Advertising and promotion 38,479 55,696 Data processing and outside service fees 333,193 329,348 Office supplies, printing, and postage 49,370 51,909 FDIC insurance 41,764 53,862 Professional services 202,842 306,650 Other 244,570 221,740 Total non-interest expense 3,108,521 3,023,103 Income before income taxes 299,755 704,943 Income taxes - - Net income $ 299,755 $ 704,943 Net income per common share Basic $ 0.25 $ 0.69 Diluted $ 0.25 $ 0.59 Weighted average common shares outstanding Basic 1,181,600 1,018,505 Diluted 1,181,600 1,185,338 See accompanying notes. 3
Statements of Comprehensive Income For the Years Ended December 31, 2015 and 2014 2015 2014 Net income $ 299,755 $ 704,943 Other comprehensive income (loss): Investment securities available for sale Unrealized holding gain (losses) (6,188) 93,802 Tax effect to unrealized (gain) losses - - (6,188) 93,802 Total comprehensive income $ 293,567 $ 798,745 See accompanying notes. 4
Statements of Changes in Stockholders Equity For the Years Ended December 31, 2015 and 2014 Accumulated Additional other Total Common stock Preferred stock paid-in Accumulated comprehensive stockholders Amount Amount capital deficit income (loss) equity Balance at December 31, 2013 $ 4,074,020 $ - $ 6,114,674 $ (5,253,647) $ (123,645) $ 4,811,402 Net income - - - 704,943-704,943 Issuance of preferred stock - 1,700,000 - - - 1,700,000 Other comprehensive income - - - - 93,802 93,802 Balance at December 31, 2014 4,074,020 1,700,000 6,114,674 (4,548,704) (29,843) 7,310,147 Net income - - - 299,755-299,755 Preferred stock dividend 80,760-25,490 (106,250) - - Preferred stock conversion 1,224,000 (1,700,000) 476,000 - - - Other comprehensive loss - - - - (6,188) (6,188) Balance at December 31, 2015 $ 5,378,780 $ - $ 6,616,164 $ (4,355,199) $ (36,031) $ 7,603,714 See accompanying notes. 5
Statements of Cash Flows For the Years Ended December 31, 2015 and 2014 2015 2014 Cash flows from operating activities: Net income $ 299,755 $ 704,943 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation 97,500 112,627 Recovery of loan losses - (1,000,000) Net change in loans held for sale (823,711) 320,589 Net amortization on securities 10,638 8,176 Net writedowns/loss on other real estate 30,000 - Change in assets and liabilities: (Increase) decrease in accrued interest receivable (12,792) 7,920 (Increase) decrease in other assets 3,924 (4,490) Increase (decrease) in accrued interest payable 8,771 (2,852) Increase (decrease) in accrued expenses and other liabilities (48,936) 58,263 Net cash (used) provided by operating activities (434,851) 205,176 Cash flows from investing activities: Net increase in certificates of deposit (250,000) - Purchases of investment securities available for sale (3,027,698) (2,005,483) Proceeds from calls of investment securities available for sale 2,000,000 1,000,000 Paydowns on investment securities available for sale 263,929 133,432 Paydowns on investment securities held to maturity 147,597 153,308 Net increase in loans (11,140,598) (9,091,660) Purchases of bank premises and equipment (86,377) (151,636) Proceeds from sale of bank premises and equipment - 960,070 (Purchase) sale of stock in the Federal Home Loan Bank of Atlanta (26,900) 26,600 Purchase of stock in the Federal Reserve Bank (5,900) (7,300) Net cash (used) by investing activities (12,125,947) (8,982,669) Cash flows from financing activities: Net increase in deposits 9,766,717 4,242,056 Proceeds from issuance of preferred stock - 1,700,000 Net cash provided by financing activities 9,766,717 5,942,056 Net decrease in cash and cash equivalents (2,794,081) (2,835,437) Cash and cash equivalents, beginning 6,815,987 9,651,424 Cash and cash equivalents, ending $ 4,021,906 $ 6,815,987 Supplemental disclosures of cash flow information: Interest paid $ 295,086 $ 404,811 Supplemental disclosure of noncash financing and investing activities: Unrealized loss on securities available for sale, net $ (6,188) $ 93,802 Transfer of loans to other real estate $ 140,000 $ 600,000 Issuance of common stock effected as a preferred stock dividend $ 106,250 $ - Conversion of preferred stock to common stock $ 1,700,000 $ - See accompanying notes. 6
Organization and Operations Coastal Bank & Trust (the Bank ) was incorporated and began banking operations on April 13, 2009. The Bank is engaged in general commercial and retail banking in the Jacksonville area of North Carolina, principally Onslow County, 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. 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 with banks. Certificates of Deposit with Other Banks Certificates of deposit with other banks currently have original maturities ranging from May 2016 through October 2016 and bear interest rates ranging from 0.80% to 0.98%. Investment Securities The Bank s portfolio consists of held to maturity and available for sale securities. Securities classified as held to maturity are government and federal agency securities that management has the positive intent and ability to hold to maturity and are reported at cost, adjusted for amortization of premiums and accretion of discounts that are recognized in interest income using methods approximating the interest method over the period to maturity. Securities not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method and are recorded on the trade date basis. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. In determining whether otherthan-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The full amount of the write down is recognized in earnings if the holder is unable to assert that they do not intend to sell the security prior to recovery and that it is more likely than not the holder will not be required to sell the impaired security prior to recovery. Otherwise, the credit loss portion of the write down is recognized in earnings and the remaining write down is recognized in other comprehensive income. 7
Loans Held for Sale Loans held for sale include mortgage loans as well as SBA loan originations. Mortgage loans held for sale are carried at the lower of cost of market as determined by the outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis, and are generally sold at par value, servicing released and without recourse. For SBA loans, certain guaranteed portions are available for sale, typically ranging from 75 to 80% of the principal balance. Servicing of these loans is retained by the Bank. Loans Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for any charge-offs and the allowance for loan losses. Loan origination fees are deferred and recognized as an adjustment of the related loan yield using the interest method. Discounts and premiums on any purchased loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Interest is accrued and credited to income based on the principal amount outstanding. 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. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well secured and in the process of collection. Loans that are current or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt (as determined by the contractual terms of the note). Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms. While a loan (including an impaired loan) is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding. When the future collectability of the recorded loan balance is not in doubt, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management monitors the loan portfolio and loss experience to ensure that the recorded allowance for loan losses is adequate to address the risk present within the portfolio. 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. 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. 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. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into 8
consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. 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 adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Federal Home Loan Bank Stock and Federal Reserve Bank Stock As a requirement for membership, the Bank invests in stock of the Federal Home Loan Bank of Atlanta ( FHLB ) and the Federal Reserve Bank ( FRB ). These investments are carried at cost. Due to the redemption provisions of the FHLB and FRB, the Bank estimated that fair value equals cost and that these investments were not impaired at December 31, 2015 or 2014. 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 is 3 to 7 years for furniture and equipment and approximately 40 years for buildings. 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. Other Real Estate Owned Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure, establishing a new cost basis. Any write down at the time of transfer to foreclosed assets is charged to the allowance for loan losses. Subsequent write downs are charged to other expense. After foreclosure, valuations are periodically performed by management, and the real estate is carried at the lower of carrying amount of fair value, less cost to sell. Costs relating to improvement of the property are capitalized while holding costs of the property are charged to expense in the period incurred. 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 the tax benefits will not be realized. Uncertainty in income taxes is accounted for in accordance with the Income Taxes topic of the Financial Accounting Standards Board s ( 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 December 31, 2015 and 2014. 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, 2012 remain subject to examination by federal and state tax authorities. 9
Per Share Results During 2014, the Bank issued $1,700,000 of preferred stock, $100 par value. On June 30, 2015, all outstanding preferred stock was converted to common shares at a conversion ratio of 18-for-1. Dividends payable on the preferred shares were paid out with unissued common stock. Due to conversion of preferred stock into common shares, there is no remaining preferred stock for the year ended December 31, 2015. Basic earnings per share of common stock represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. In the Bank s original subscription offering of common stock made prior to opening, original subscribers received one warrant to purchase an additional share of common stock at $11 per share for every $11 of seed capital invested in the organizational limited liability company, CB&T Organizers, LLC. These warrants, which are not detachable, expire ten years after the Bank s incorporation. As of December 31, 2015 and 2014, approximately 99,990 such warrants were outstanding and are not dilutive. 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 May 2014, the Financial Accounting Standards Board ( FASB ) issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers ("ASU 2014-09"). This guidance will supersede most of the existing revenue recognition requirements in US GAAP and will require entities to recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a customer. The new standard also requires significantly expanded disclosures regarding the qualitative and quantitative information of an entity s nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. For nonpublic entities, the pronouncement is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period and is to be applied retrospectively, with early application not permitted. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases ( ASU 2016-02 ). This guidance requires lessees to recognize assets and liabilities to recognize assets and liabilities related to certain operating leases on the balance sheet. The guidance also requires additional disclosures by lessees and contains targeted changes to accounting by lessors. This guidance is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the financial statements of the Bank and monitors the status of changes to and proposed effective dates of exposure drafts. 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. 10
Investment Securities The amortized cost and fair values of investment securities available for sale and held to maturity consist of the following (in thousands): December 31, 2015 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities available for sale: US government agency bonds $ 2,999 $ - $ 21 $ 2,978 Mortgage-backed securities 1,726 2 13 1,715 SBA securities 381-4 377 Total securities available for sale 5,106 2 38 5,070 Securities held to maturity: Mortgage-backed securities 494 12-506 $ 5,600 $ 14 $ 38 $ 5,576 December 31, 2014 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities available for sale: US government agency bonds $ 2,999 $ 2 $ 35 $ 2,966 Mortgage-backed securities 915 6-921 SBA securities 434-3 431 Total securities available for sale 4,348 8 38 4,318 Securities held to maturity: Mortgage-backed securities 647 19-666 $ 4,995 $ 27 $ 38 $ 4,984 At December 31, 2015, the Company had five available for sale securities with an unrealized loss for twelve or more consecutive months including three U.S. government agency GSE s, one mortgage-backed GSE, and one SBA. Since none of the unrealized losses relate to the liquidity of the securities or the issuer s ability to honor redemption obligations and the Company has the intent and ability to hold these securities to recovery, no other than temporary impairments were identified for these investments having unrealized losses for the periods ended December 31, 2015 and December 31, 2014. The following table provides the amortized cost and fair value by contractual maturity. Expected maturities will differ from contractual maturities on certain securities because borrowers and issuers may have the right to call or prepay obligations with or without prepayment penalties. Repayments of mortgage-backed securities are dependent on the repayments of the underlying loan balances. Amortized Fair December 31, 2015 Cost Value Securities available for sale: Due after one year through five years $ 2,999 $ 2,978 Due after ten years 2,107 2,092 Securities held to maturity: Due after ten years 494 506 $ 5,600 $ 5,576 11
Amortized Fair December 31, 2014 Cost Value Securities available for sale: Due after one year through five years $ 2,999 $ 2,966 Due after ten years 1,349 1,352 Securities held to maturity: Due after five years through ten years 647 666 $ 4,995 $ 4,984 The Bank had pledged securities of $0.0 and $3.1 million as of December 31, 2015 and 2014, respectively. Loans Following is a summary of loans at December 31, 2015 and 2014 (in thousands): 2015 2014 Real estate loans: One to four family residential $ 11,865 $ 8,609 Multi-family residential and commercial 29,203 27,851 Secured by farmland 465 1,363 Construction 12,180 6,076 Home equity lines of credit ( HELOC ) 5,868 3,169 Total real estate loans 59,581 47,068 Other loans: Commercial and industrial 5,437 6,824 Consumer 1,387 1,362 Total other loans 6,824 8,186 Total loans 66,405 55,254 Less: Allowance for loan losses (1,124) (982) Deferred loan fees, net (96) (88) Total loans, net $ 65,185 $ 54,184 Loans are primarily made in Onslow County and New Hanover County, North Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial and consumer 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. 12
A summary of related party loan transactions is as follows (in thousands): Balance at December 31, 2013 $ 2,827 Loan disbursements 618 Loan repayments (381) Balance at December 31, 2014 3,064 Loan disbursements 1,480 Loan repayments (1,429) Balance at December 31, 2015 $ 3,115 The Bank had pre-approved but unused lines of credit totaling approximately $416,000 and $420,000 to executive officers, directors and their related interests at year end 2015 and 2014, respectively. 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. Multifamily residential and commercial real estate loans, and farmland 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. Loans within these segments may be more adversely affected by conditions in real estate markets or the general economy. The properties securing the loans within these classes are principally secured by owner-occupied buildings, commercial rental properties, farm land, and residential rental properties. Management monitors and evaluates loans within these segments based on collateral, market area and risk grade criteria. Residential HELOC and 1-4 family 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. Other loans Other loans include commercial and industrial loans, as well as consumer loans. 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 identified 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. Consumer loans include loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment. 13
The ending balances of loans and the related allowance presented by portfolio segment and allowance methodology as of December 31, 2015 and 2014 are as follows (in thousands): Real Estate Other Loans Loans Total December 31, 2014 $ 816 $ 166 $ 982 Charge offs (22) (25) (47) Recoveries - 189 189 December 31, 2015 $ 794 $ 330 $ 1,124 Real Estate Other Loans Loans Total December 31, 2013 $ 873 $ 351 $ 1,224 Charge offs (285) (268) (553) Recoveries 28 1,283 1,311 Recovery of loan losses 200 (1,200) (1,000) December 31, 2014 $ 816 $ 166 $ 982 Real Estate Other As of December 31, 2015 Loans Loans Total Individually evaluated for impairment $ 108 $ - $ 108 Collectively evaluated for impairment 882 134 1,016 Total loan loss allowance $ 990 $ 134 $ 1,124 Real Estate Other As of December 31, 2014 Loans Loans Total Individually evaluated for impairment $ 121 $ 1 $ 122 Collectively evaluated for impairment 695 165 860 Total loan loss allowance $ 816 $ 166 $ 982 14
The following segregates total loans by portfolio segment and impairment methodology as of December 31, 2015 and 2014 (in thousands): Real Estate Other As of December 31, 2015 Loans Loans Total Individually evaluated for impairment $ 108 $ - $ 108 Collectively evaluated for impairment 57,508 8,789 66,297 Total $ 57,616 $ 8,789 $ 66,405 Real Estate Other As of December 31, 2014 Loans Loans Total Individually evaluated for impairment $ 279 $ 345 $ 624 Collectively evaluated for impairment 46,789 7,841 54,630 Total $ 47,068 $ 8,186 $ 55,254 At December 31, 2015, there were no loans greater than 30 days past due. At December 31, 2014, there was one commercial and industrial loan and one construction loan greater than 90 days past due totaling $231,334, collectively, and no loans 60 to 89 days past due. The following table shows an analysis of impaired loans by loan class as of December 31, 2015 (in thousands): Unpaid Interest Recorded Principal Recorded Recorded Income Investment Balance Allowance Investment Recognized With a specific allowance: Commercial and industrial $ 108 $ 108 $ 108 $ 115 $ 4 Total: Commercial and industrial $ 108 $ 108 $ 108 $ 115 $ 4 The following table shows an analysis of impaired loans by loan class as of December 31, 2014 (in thousands): Unpaid Interest Recorded Principal Recorded Recorded Income Investment Balance Allowance Investment Recognized With no specific allowance: Multi-family residential and commercial $ 279 $ 279 $ - $ 284 $ 16 With a specific allowance: Construction 279 279 121 291 7 Commercial and industrial 66 66 1 106 3 345 345 122 397 10 Total: Construction 279 279 121 291 7 Commercial and industrial 66 66 1 106 3 Multi-family residential and commercial 279 279-284 16 $ 624 $ 624 $ 122 $ 681 $ 26 15
Troubled Debt Restructurings There were no loans that were modified as troubled debt restructurings ( TDRs ) during 2015 or 2014. There were no TDRs with a payment default in either year. 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, 2015 and 2014 by credit quality indicator is provided below. The credit quality indicators used are dependent on the loan class to which the loan relates. Loan risk grades for all loans within the portfolio are developed through review of individual borrowers on an ongoing basis. The grades represent the rating for loans as of the date presented based on the most recent assessment performed. These risk grades are defined below (in thousands). December 31, 2015: Risk 10 30 35 40 42 50 55 60 Total One to four family residential $ 37 $ 2,577 $ 6,630 $ 2,621 $ - $ - $ - $ - $ 11,865 Multi-family residential and commercial - 4,815 11,983 11,337 1,068 - - - 29,203 Secured by farmland - - 465 - - - - - 465 Construction - 3,667 5,349 3,164 - - - - 12,180 Home equity lines of credit - 3,206 1,785 834 43 - - - 5,868 Commercial and industrial 1,445 1,089 834 1,447 514 108 - - 5,437 Consumer 827 226 159 175 - - - - 1,387 $ 2,309 $ 15,580 $ 27,205 $ 19,578 $ 1,625 $ 108 $ - $ - $ 66,405 December 31, 2014: Risk 10 30 35 40 42 50 55 60 Total One to four family residential $ 231 $ 1,388 $ 4,941 $ 2,049 $ - $ - $ - $ - $ 8,609 Multi-family residential and commercial - 2,951 9,850 12,489 2,216 279 66-27,851 Secured by farmland - 776 587 - - - - - 1,363 Construction - 1,536 1,642 2,898 - - - - 6,076 Home equity lines of credit - 1,235 1,025 862 47 - - - 3,169 Commercial and industrial 1,812 1,280 1,216 2,237-114 - 165 6,824 Consumer 883 155 139 185 - - - - 1,362 $ 2,926 $ 9,321 $ 19,400 $ 20,720 $ 2,263 $ 393 $ 66 $ 165 $ 55,254 Risk Grade Definitions Risk grades 10 through 40 are considered Pass grades, whereas loans with risk grade of 42 are considered Special Mention, and loans with risk grades 50 through 60 are considered Classified. Risk Grade 10 Credits in this category are well-collateralized by cash or cash equivalent instruments held by the Bank. The repayment program is well-defined and achievable, and repayment sources are numerous. 16
Risk Grade 20 This grade is reserved for loans secured by readily marketable collateral, or loans within guidelines to borrowers substantial liquid assets, particularly relative to debts. These loans have excellent sources of repayment, with no significant identifiable risk of collection. Risk Grade 30 These loans have excellent sources of repayment, with no significant identifiable risk of collection. Generally, loans assigned this risk grade will demonstrate the following characteristics: Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources. Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor. Risk Grade 35 This grade is given to acceptable loans that have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this risk grade will demonstrate the following characteristics: General conformity to the Bank's underwriting requirements, with limited exceptions to the Bank's policy, product or underwriting guidelines. All exceptions noted have documented mitigating factors that offset any additional risk associated with the exceptions noted. Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources. Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor. Risk Grade 40 This grade is given to acceptable loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss. Loans assigned this grade may demonstrate some or all of the following characteristics: Exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank. Although the combination and/or severity of identified exceptions is greater for this risk grade, the exceptions may be properly mitigated by other documented factors that offset any additional risks. Unproven, insufficient or marginal primary sources of repayment that appear sufficient to service the debt. Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance. Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor. Risk Grade 42 This grade is given to loans that show the same signs of weakness outlined above, where it is evident that competition, volatility or other industry factors present a higher than average degree of risk to the Bank. Loans assigned this grade may demonstrate some or all of the following characteristics: Limited, insufficient or marginal primary sources of repayment that are volatile or subject to significant fluctuations, or is based upon outdated (> 1 year old) financial information. Borrowing entities with management that is inexperienced, untested, demonstrate an inadequate succession plan, or otherwise show issues or internal controls that are in need of improvement. 17
Weak, undependable or unproven secondary sources to liquidate the debt, including guarantors with an overextended personal financial condition. Risk Grade 50 Substandard loans are inadequately protected by the current sound net worth and paying capacity of the obligors or of the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Risk Grade 55 Doubtful loans have all the weaknesses inherent in loans classified Substandard, plus 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. However, these loans are not yet rated as Loss because certain events, including injection of capital, alternative financing, or liquidation of assets or the pledging of additional collateral, may occur which would salvage the debt. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off. Risk Grade 60 Loss loans are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future. Bank Premises and Equipment Following is a summary of bank premises and equipment at December 31, 2015 and 2014 (in thousands): 2015 2014 Buildings $ 217 $ 211 Furniture, equipment 545 502 Land 101 101 Leasehold improvements 84 47 947 861 Accumulated depreciation (526) (429) Total $ 421 $ 432 Depreciation and amortization amounting to $97,500 and $112,000 for the years ended December 31, 2015 and 2014, respectively, is included in occupancy and equipment expense. The Bank leases a corporate office and branch facility in Jacksonville under an operating lease with a company, an owner of which is a director of the Bank. The lease is for a five year term expiring in 2018. The Bank has the option to purchase the building at the end of each of the three remaining renewal periods, at a price equal to ninety percent of the appraised value at the time the option is exercised. Monthly rental payments totaling $9,785 are to be made during the first five year renewal term and will be increased at each renewal date by 3%. 18
A summary of the minimum future rental payments under the leases described above is as follows at December 31, 2015 (in thousands): 2016 $ 137 2017 135 2018 131 2019 133 2020 133 2021 and after 1,599 Total $ 2,268 Total rent expense under operating leases was $133,000 and $126,000 for the years ended December 31, 2015 and 2014, respectively, and is included in occupancy expense. The Bank earned $6,000 and $85,000 in rental income on a property owned for the years ended December 31, 2015 and 2014, respectively. Deposits The aggregate amount of time deposits in denominations of $250,000 or more at December 31, 2015 and 2014 was $3.4 million and $2.9 million, respectively. Interest expense on such time deposits aggregated to $46,000 and $32,000 in 2015 and 2014, respectively. At December 31, 2015, the scheduled maturities of certificates of deposit are as follows (in thousands): Less than $250,000 $250,000 or more Total 2016 $ 15,887 $ 1,283 $ 17,170 2017 2,978 1,021 3,999 2018 924 278 1,202 2019 136 861 997 2020 and after 12-12 Total $ 19,937 $ 3,443 $ 23,380 Short-Term Borrowings The Bank may purchase federal funds through three unsecured federal funds lines of credit aggregating $5.70 million. These lines are intended for short-term borrowing and are subject to restrictions limiting the frequency and term. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate. There were no outstanding advances under these lines of credit at December 31, 2015 and 2014, respectively. 19
Income Taxes The significant components of the provision for income taxes for the year and period ended December 31, 2015 and 2014 are as follows (in thousands): 2015 2014 Deferred tax expense (benefit): Federal $ 87 $ 232 State 62 44 Total deferred tax expense (benefit) 149 276 Provision for income tax benefit before adjustment to deferred tax asset valuation allowance 149 276 Decrease in valuation allowance (149) (276) Net provision for income taxes $ - $ - The difference between the provision for income taxes and the amounts computed by applying the statutory federal income tax rate of 34% to loss before income taxes for the year and period ended December 31, 2015 and 2014 is summarized below (in thousands): 2015 2014 Tax benefit computed at the statutory federal rate $ 102 $ 240 Increase (decrease) resulting from: State income taxes, net of federal tax effect 41 29 Adjustment to deferred tax asset valuation allowance (149) (276) Other permanent differences 6 7 Provision for income taxes $ - $ - Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred taxes at December 31, 2015 and 2014 are as follows (in thousands): 2015 2014 Deferred tax assets relating to: Pre-opening costs and expenses $ 220 $ 251 Net operating loss carryforwards 1,773 1,870 Other 22 41 Total deferred tax assets 2,015 2,162 Less valuation allowance (1,886) (2,035) Net deferred tax assets 129 127 Deferred tax liabilities relating to: Allowance for loan losses 123 125 Premises and equipment 6 2 Total deferred tax liabilities 129 127 Net recorded deferred tax liability $ - $ - The Bank has federal net operating loss carryforwards of approximately $4,841,000 and state net economic loss carryforwards of approximately $4,815,000 expiring in 2035 and 2030, respectively, which are available to offset future taxable income. 20
Regulatory Matters The Bank, as a North Carolina banking corporation, may pay cash dividends only out of undivided profits as determined pursuant to North Carolina General Statutes. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such limitation is in the public interest and is necessary to ensure financial soundness of the Bank. The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank s assets, liabilities, and certain off-balancesheet items as calculated under regulatory accounting practices. The Bank s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, as prescribed by regulations, of total and Tier I capital to risk-weighted assets, common equity to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 2015 and 2014 that the Bank meets all capital adequacy requirements to which it is subject, as set forth below: Minimum to be well Minimum for capital capitalized under prompt Actual adequacy purposes corrective action provision Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) December 31, 2015 Total Capital (to Risk-Weighted Assets) $ 8,518 12.17% $ 5,601 8.0% $ 7,001 10.0% Tier I Capital (to Risk-Weighted Assets) 7,640 10.91% 4,201 4.0% 5,601 8.0% Common Equity (to Risk-Weighted Assets) 7,640 10.91% 3,151 4.5% 4,551 6.5% Tier I Capital (to Average Assets) 7,640 9.67% 3,160 4.0% 3,951 5.0% December 31, 2014 Total Capital (to Risk-Weighted Assets) $ 8,101 13.36% $ 4,852 8.0% $ 6,065 10.0% Tier I Capital (to Risk-Weighted Assets) 7,340 12.10% 2,426 4.0% 3,639 6.0% Tier I Capital (to Average Assets) 7,340 11.39% 2,578 4.0% 3,223 5.0% Off-Balance Sheet Risk The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by 21