Financial Statements Years Ended December 31, 2015 and 2014
Report to Shareholders As Providence Bank (the Bank ) concludes its tenth year of operations, I believe the Bank has successfully operated under the principles for which it was established back in 2006. Our core principles have always been to constantly improve the products and services we offer our customers, reinvest in our communities through loans to businesses and individuals, support and be involved in community organizations, provide an enriching place of employment for our employees, and always listen to the concerns of our stockholders and customers. Over this ten year period, the Bank has made almost 2,700 loans and advanced $561.5 million. Through these transactions, we have assisted many customers in growing their businesses and reaching many of their dreams. The Board of Directors and management are very pleased with the results of the Bank s operations for 2015. The Bank s net income of $2.29 million for the year 2015, compared to $2.15 million for 2014, is an increase of 6.51% year-over-year. Total assets of the Bank increased by $17.78 million during the current year. The increase in assets, primarily in loans outstanding was substantially funded by a similar increase in deposits. By growing these two areas, the Bank was able to strengthen its foundation which will provide core earnings. Over the past seven years, Providence Bank has been one of two banks chartered in North Carolina consistently ranked in the top ten in overall performance by a leading financial management consulting group. For the year 2015, Providence Bank was ranked #4 in Overall Performance. One of our major priorities continues to be to enhance shareholder value. For the last eighteen quarters, the Bank has returned value to our shareholders through the payment of a cash dividend. We have also successfully added to our capital account with consistent earnings, ending 2015 with a book value of $16.51 per share. Our positive growth and our concentration on the measure of the Bank s efficiency of operations, which was 56.85% for the year, is a strong area where we were rated the best in our peer group. The second area of strength is our solid underwriting guidelines adhered to by the Bank s staff, which is evidenced by the low volume of loan write offs and low number of past due loans for 2015. Providence Bank is also pleased to announce that on February 1, 2016, the Bank redeemed the full amount of $4.25 million of preferred stock which was being held by the US Treasury through the Small Business Lending Fund ( SBLF ). During the time the Bank held the SBLF, we were able to extend a large number of loans to businesses in our area. At the end of 2015, the Bank was recognized as a well capitalized financial institution by the Federal Deposit Insurance Corporation guidelines. The Board of Directors and management of Providence Bank are very proud of the Bank s results for 2015. Even with the results we have reported, we are always looking to improve the Bank s operations. If you have any comments or suggestions, please give me a call. We thank you for your support and continued investment in Providence Bank. Sincerely, John A. Barker President & Chief Executive Officer
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... 8 Board of Directors... 35 Management and Bank Personnel... 36 General Corporate Information... 37
Independent Auditors Report Stockholders and the Board of Directors Providence Bank Rocky Mount, North Carolina We have audited the accompanying financial statements of Providence Bank, which comprise the balance sheets as of December 31, 2015 and 2014, and the related statements of operations, comprehensive income, changes in stockholders equity, and cash flows for the years then 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. Those standards require that we plan and perform the audit to obtain reasonable 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 the 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 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 Providence Bank as of December 31, 2015 and 2014, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Greenville, North Carolina February 19, 2016 1
Balance Sheets December 31, 2015 and 2014 2015 2014 ASSETS Cash and due from banks $ 4,780,156 $ 4,370,878 Interest-earning deposits with banks 35,136,688 35,508,601 Investment securities available for sale, at fair value 1,994,597 1,996,187 Loans 205,273,751 187,189,184 Allowance for loan losses (2,805,000) (2,660,000) Net loans 202,468,751 184,529,184 Accrued interest receivable 798,119 706,377 Foreclosed real estate, net 1,234,901 1,800,556 Bank premises and equipment, net 665,867 690,196 Stock in Federal Home Loan Bank of Atlanta, at cost 447,100 376,200 Other assets 7,244,277 7,017,192 Total assets $ 254,770,456 $ 236,995,371 LIABILITIES AND STOCKHOLDERS EQUITY Liabilities: Deposits $ 217,127,125 $ 203,694,769 Accrued interest payable 73,501 72,151 Accrued expenses and other liabilities 1,601,964 1,147,153 Short-term borrowings 2,497,740 635,187 Long-term borrowings 4,000,000 4,000,000 Total liabilities 225,300,330 209,549,260 Commitments (Notes 4 and 12) Stockholders equity: Preferred stock, no par value, 2,000,000 shares authorized; none issued and outstanding - - Non-cumulative perpetual preferred stock (Series C), no par value, 4,250 shares authorized, issued and outstanding 4,250,000 4,250,000 Common stock, $5.00 par value, 10,000,000 shares authorized; 1,527,461 and 1,505,711 shares issued and outstanding at December 31, 2015 and 2014, respectively 7,637,305 7,528,555 Additional paid-in capital 9,216,314 9,078,802 Retained earnings 8,369,895 6,591,120 Accumulated other comprehensive loss (3,388) (2,366) Total stockholders equity 29,470,126 27,446,111 Total liabilities and stockholders equity $ 254,770,456 $ 236,995,371 See accompanying notes. 2
Statements of Operations Years Ended December 31, 2015 and 2014 2015 2014 Interest income: Loans $ 10,363,213 $ 9,807,929 Federal funds sold and deposits in other banks 67,787 80,535 Investment securities 16,574 13,878 Federal Home Loan Bank dividends 19,488 25,871 Total interest income 10,467,062 9,928,213 Interest expense: Money market, NOW and savings deposits 433,090 351,116 Time deposits 1,539,248 1,662,544 Short term borrowings 5,057 799 Long term borrowings 112,691 146,264 Total interest expense 2,090,086 2,160,723 Net interest income 8,376,976 7,767,490 Provision for loan losses 212,733 158,177 Net interest income after provision for loan losses 8,164,243 7,609,313 Non-interest income: Deposit and other service charges income 118,589 107,623 Income from bank owned life insurance 163,371 164,718 Other 150,079 151,791 Total non-interest income 432,039 424,132 Non-interest expense: Salaries and employee benefits 3,217,452 2,841,700 Occupancy and equipment 413,251 399,978 Advertising and promotion 42,623 51,072 Data processing and outside service fees 431,466 394,910 Office supplies, printing, and postage 73,045 87,269 Professional services 133,823 131,037 FDIC insurance 117,533 127,759 Foreclosed real estate, net 19,751 58,367 Director fees 127,850 111,450 Other 414,554 419,197 Total non-interest expense 4,991,348 4,622,739 Income before income taxes 3,604,934 3,410,706 Income taxes 1,275,612 1,217,666 Net income 2,329,322 2,193,040 Preferred stock dividends 42,500 42,500 Net income available to common stockholders $ 2,286,822 $ 2,150,540 Net income per common share-basic $ 1.51 $ 1.67 Net income per common share-diluted $ 1.49 $ 1.60 Weighted average common shares outstanding Basic 1,513,493 1,284,838 Diluted 1,536,620 1,343,092 See accompanying notes. 3
Statements of Comprehensive Income Years Ended December 31, 2015 and 2014 2015 2014 Net income $ 2,329,322 $ 2,193,040 Other comprehensive loss: Unrealized losses on investment securities arising during the period (1,590) (4,118) Tax related to unrealized losses 568 1,565 Total (1,022) (2,553) Total comprehensive income $ 2,328,300 $ 2,190,487 See accompanying notes. 4
Statements of Changes in Stockholders Equity Years Ended December 31, 2015 and 2014 Accumulated Preferred stock Additional other Total Series C Common stock paid-in Retained comprehensive stockholders Amount Shares Amount capital earnings income (loss) equity Balance at December 31, 2013 $ 4,250,000 1,260,000 $ 6,300,000 $ 7,604,392 $ 4,831,992 $ 187 $ 22,986,571 Net income - - - - 2,193,040-2,193,040 Other comprehensive loss - - - - - (2,553) (2,553) Non-statutory stock options exercised - 8,911 44,555 53,466 - - 98,021 Stock issued pursuant to warrant call - 236,800 1,184,000 1,420,800 - - 2,604,800 Stock based compensation - - - 144 - - 144 Cash dividends paid on preferred stock - - - - (42,500) - (42,500) Cash dividends paid on common stock - - - - (274,719) - (274,719) Cash dividends declared on common stock - - - - (116,693) - (116,693) Balance at December 31, 2014 4,250,000 1,505,711 7,528,555 9,078,802 6,591,120 (2,366) 27,446,111 Net income - - - - 2,329,322-2,329,322 Other comprehensive loss - - - - - (1,022) (1,022) Non-statutory stock options exercised - 12,500 62,500 75,000 - - 137,500 Incentive stock options exercised - 9,250 46,250 55,500 - - 101,750 Stock based compensation - - - 7,012 - - 7,012 Cash dividends paid on preferred stock - - - - (42,500) - (42,500) Cash dividends paid on common stock - - - - (374,438) - (374,438) Cash dividends declared on common stock - - - - (133,609) - (133,609) Balance at December 31, 2015 $ 4,250,000 1,527,461 $ 7,637,305 $ 9,216,314 $ 8,369,895 $ (3,388) $ 29,470,126 See accompanying notes. 5
Statements of Cash Flows Years Ended December 31, 2015 and 2014 2015 2014 Cash flows from operating activities: Net income $ 2,329,322 $ 2,193,040 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 116,549 130,941 Deferred income taxes (122,748) (95,751) Provision for loan losses 212,733 158,177 Gain on sale of foreclosed real estate (16,401) (1,943) Stock based compensation 7,012 144 Income from bank owned life insurance (163,371) (164,718) Change in assets and liabilities: Increase in accrued interest receivable (91,742) (25,769) Decrease (increase) in other assets 59,602 (114,870) Increase (decrease) in accrued interest payable 1,350 (23,688) Increase in accrued expenses and other liabilities 437,895 346,913 Net cash provided by operating activities 2,770,201 2,402,476 Cash flows from investing activities: Net increase in loans (18,152,300) (14,451,398) Purchases of bank premises and equipment (92,220) (203,446) Purchase of bank owned life insurance - (131,005) Purchase of available-for-sale securities (2,000,000) (3,000,000) Proceeds from calls of available-for-sale securities 2,000,000 3,000,000 Proceeds from sales foreclosed real estate 609,156 188,261 Capitalized costs of foreclosed real estate (27,100) (72,644) (Purchases) repayments of Federal Home Loan Bank stock (70,900) 440,100 Net cash used by investing activities (17,733,364) (14,230,132) Cash flows from financing activities: Net increase in deposits 13,432,356 21,672,806 Advances from borrowings 5,462,553 4,075,419 Repayments of borrowings (3,600,000) (11,500,000) Stock options exercised 239,250 98,021 Stock issued pursuant to warrant call - 2,604,800 Dividends paid on preferred stock (42,500) (42,500) Cash dividends paid on common stock (491,131) (359,769) Net cash provided by financing activities 15,000,528 16,548,777 Net increase in cash and cash equivalents 37,365 4,721,121 Cash and cash equivalents, beginning 39,879,479 35,158,358 Cash and cash equivalents, ending $ 39,916,844 $ 39,879,479 See accompanying notes. 6
Statements of Cash Flows Years Ended December 31, 2015 and 2014 (Continued) 2015 2014 Supplemental disclosures of cash flow information: Interest paid $ 2,088,736 $ 2,184,411 Taxes paid $ 1,382,000 $ 1,413,000 Unrealized loss on investment securities available for sale, net of tax $ (1,022) $ (2,553) Dividends declared but not paid $ 133,609 $ 116,693 See accompanying notes. 7
1. Organization And Operations Providence Bank (the Bank ) was incorporated and began banking operations on March 14, 2006. 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 (the FDIC ) and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities. 2. 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. 8
Purchased Impaired Loans Purchased impaired loans are accounted for under the Receivables topic of the Financial Accounting Standards Board ( 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. The Bank had one loan it purchased at a discount with a nonaccretable difference totaling $615 thousand at December 31, 2014. During 2015, the Bank sold its entire interest in this loan recognizing $31 thousand in income. 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 uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. 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. 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 40 years for buildings, 3 to 20 years for furniture and equipment, and 5 years for vehicles. 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. 9
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, 2015 and 2014. 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 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. 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 morelikely-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. 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 December 31, 2015 and 2014. 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. 10
Per Share Results Basic earnings per share represents income available to common stockholders divided by the weighted-average 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. At December 31, 2015 there were 53,008 anti-dilutive stock options. There were no stock options that were anti-dilutive for the year ended December 31, 2014. 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 were not detachable, were set to expire nine years after the Bank s incorporation due to a two year extension approved during 2010 and an additional two year extension approved in 2012. During 2014, the warrants were called and subscribers were able to purchase shares of common stock, accordingly. There were no such warrants outstanding at December 31, 2015 and 2014. 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. 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 19, 2016, the date the financial statements were available to be issued. 11
3. Investment Securities The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, are as follows: December 31, 2015 Gross Gross Amortized unrealized unrealized Fair cost gains losses value (in thousands) Securities available for sale: U.S. agency securities $ 2,000 $ 1 $ (6) $ 1,995 December 31, 2014 Gross Gross Amortized unrealized unrealized Fair cost gains losses value (in thousands) Securities available for sale: U.S. agency securities $ 2,000 $ 1 $ (5) $ 1,996 There were no sales of investment securities during the years ended December 31, 2015 and 2014. All unrealized losses on investment securities were aged less than 12 months as of December 31, 2015 and 2014. The amortized cost and fair value of the Bank s investment securities at December 31, 2015, 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 Cost Fair Value (in thousands) Securities available for sale: U.S. agency securities Due after one but within five years $ 2,000 $ 1,995 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, 2015. 12
4. 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 $ 28,843 $ 27,880 Multi-family residential and commercial 121,702 109,510 Construction 19,975 17,401 Home equity lines of credit 12,242 11,902 Total real estate loans 182,762 166,693 Other loans: Commercial and industrial 21,502 19,588 Loans to individuals 1,010 908 Total other loans 22,512 20,496 Total loans 205,274 187,189 Less: Allowance for loan losses 2,805 2,660 Total loans, net $ 202,469 $ 184,529 Loans presented above are net of unamortized loan costs of $553 thousand and $627 thousand at December 31, 2015 and 2014, 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): 2015 2014 Balance at beginning of year $ 5,678 $ 7,528 Loan disbursements 1,692 3,514 Loan repayments (3,735) (5,364) Balance at end of year $ 3,635 $ 5,678 At December 31, 2015 and 2014, the Bank had pre-approved but unused lines of credit totaling approximately $1.1 million and $1.4 million, respectively, to executive officers, directors and their related interests. 13
The following describes 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 Bank s commercial real estate portfolio are principally secured by owner-occupied buildings including professional practices, office and church properties, single family rental properties, and multi-family 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 precommitted 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. 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 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 Consumer loans consist of home equity lines of credit, unsecured consumer, and secured consumer loans. Consumer loans are typically underwritten after analyzing the borrowers personal financial condition and ability to generate income sufficient to support the loans and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not materialize as expected and the collateral securing these loans may fluctuate in value. The combined loan value on these loans generally does not exceed 90%. In connection with consumer lending in general, the success of our loan collection efforts is highly dependent on the continuing financial stability of our borrowers, and our collection of consumer installment loans may be more likely to be adversely affected by a borrower s job loss, illness, personal bankruptcy or other change in personal circumstances than is the case with other types of loans. 14
The ending balances of loans and the related allowance presented by portfolio class and allowance methodology as of December 31, 2015 and 2014 are as follows (in thousands). December 31, 2015 Multi Family Residential Home 1 4 Family and Equity Residential Commercial - Construction Lines of Commercial Real Estate Real Estate Real Estate Credit & Industrial Consumer Total Allowance for credit losses Beginning balance $ 412 $ 1,306 $ 604 $ 156 $ 177 $ 5 $ 2,660 Charge-offs (59) - - - - (11) (70) Recoveries - - 1 - - 1 2 Provision 166 (194) 251 15 (40) 15 213 Ending balance $ 519 $ 1,112 $ 856 $ 171 $ 137 $ 10 $ 2,805 Ending balance: individually evaluated for impairment $ 174 $ - $ - $ 21 $ - $ - $ 195 Ending balance: collectively evaluated for impairment 345 1,112 856 150 137 10 2,610 Financing receivables: Ending balance $ 28,843 $ 121,702 $ 19,975 $ 12,242 $ 21,502 $ 1,010 $ 205,274 Ending balance: individually evaluated for impairment 677 36-57 - - 770 Ending balance: collectively evaluated for impairment 28,166 121,666 19,975 12,185 21,502 1,010 204,504 15
December 31, 2014 Multi Family Residential Home 1 4 Family and Equity Residential Commercial - Construction Lines of Commercial Real Estate Real Estate Real Estate Credit & Industrial Consumer Total Allowance for credit losses Beginning balance $ 396 $ 1,184 $ 570 $ 148 $ 178 $ 6 $ 2,482 Charge-offs - - - - - - - Recoveries - - 20 - - - 20 Provision 16 122 14 8 (1) (1) 158 Ending balance $ 412 $ 1,306 $ 604 $ 156 $ 177 $ 5 $ 2,660 Ending balance: individually evaluated for impairment $ 22 $ - $ - $ 25 $ - $ - $ 47 Ending balance: collectively evaluated for impairment 390 1,306 604 131 177 5 2,613 Financing receivables: Ending balance $ 27,880 $ 109,510 $ 17,401 $ 11,902 $ 19,588 $ 908 $ 187,189 Ending balance: individually evaluated for impairment 119-1,124 64 - - 1,307 Ending balance: collectively evaluated for impairment 27,761 109,510 16,277 11,838 19,588 908 185,882 16
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 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). December 31, 2015 Multi Family Residential Home 1 4 Family and Equity Residential - Commercial - Construction Lines of Commercial Real Estate Real Estate Real Estate Credit & Industrial Consumer Total Grade: Superior $ - $ 8 $ - $ 25 $ 2,441 $ 374 $ 2,848 Minimal 40 530-394 3,702-4,666 Average 8,131 37,777 7,423 5,861 3,093-62,285 Acceptable 20,096 82,891 12,458 5,816 12,168 594 134,023 Special Mention - - 159-64 - 223 Substandard 563 36-57 - - 656 Doubtful - - - - - - - Loss - - - - - - - Total $ 28,830 $ 121,242 $ 20,040 $ 12,153 $ 21,468 $ 968 204,701 Overdrafts 20 Net Deferred Costs 553 Total $ 205,274 17
December 31, 2014 Multi Family Residential Home 1 4 Family and Equity Residential - Commercial - Construction Lines of Commercial Real Estate Real Estate Real Estate Credit & Industrial Consumer Total Grade: Superior $ - $ 12 $ - $ - $ 1,947 $ 232 $ 2,191 Minimal - 1,400-375 3,263-5,038 Average 8,195 27,658 3,892 5,650 2,489-47,884 Acceptable 19,390 79,917 11,978 5,733 11,783 643 129,444 Special Mention 164-455 - 69-688 Substandard 119-1,124 64 - - 1,307 Doubtful - - - - - - - Loss - - - - - - - Total $ 27,868 $ 108,987 $ 17,449 $ 11,822 $ 19,551 $ 875 186,552 Overdrafts 10 Net Deferred Costs 627 Total $ 187,189 18
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. This risk grade classification 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 Credits in this category are sound and collectible but contain risk. Although asset quality remains acceptable, the borrower could have a smaller and/or less diverse asset base, lower liquidity and limited debt capacity. The borrower may also have the following characteristics: Earnings performance is satisfactory but the borrower might not be strong enough to sustain major setbacks. Limited management experience and depth. These credits may have a reliance for a secondary repayment source placed on a guarantor who exhibits the ability and willingness to repay. These credits may need supervision by the lender and covenants structured to ensure adequate protection. These credits may also include satisfactory borrowers/guarantors 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. 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. 19
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, 2015 and 2014 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. December 31, 2015 Greater than 30-59 Days 60-89 Days 90 Days Total Total Past Due Past Due Past Due Past Due Current Loans 1 4 Family Residential Real Estate $ - $ - $ - $ - $ 28,843 $ 28,843 Multi-Family Residential & Commercial - Real Estate 151-36 187 121,515 121,702 Construction Real Estate - 44-44 19,931 19,975 Home Equity Lines of Credit - - 57 57 12,185 12,242 Commercial and industrial - - - - 21,502 21,502 Consumer loans - - - - 1,010 1,010 Total $ 151 $ 44 $ 93 $ 288 $ 204,986 $ 205,274 December 31, 2014 Greater than 30-59 Days 60-89 Days 90 Days Total Total Past Due Past Due Past Due Past Due Current Loans 1 4 Family Residential Real Estate $ - $ - $ - $ - $ 27,880 $ 27,880 Multi-Family Residential & Commercial - Real Estate - - - - 109,510 109,510 Construction Real Estate - - 1,124 1,124 16,277 17,401 Home Equity Lines of Credit - - 64 64 11,838 11,902 Commercial and industrial - - - - 19,588 19,588 Consumer loans 4 - - 4 904 908 Total $ 4 $ - $ 1,188 $ 1,192 $ 185,997 $ 187,189 As of December 31, 2015 and 2014, there were no loans greater than 90 days past due and accruing interest. 20
Impaired Loans The following tables provide information on impaired loans at December 31, 2015 and 2014, 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 December 31, 2015 With no related allowance recorded: Multi-Family Residential & Commercial - Real Estate $ 36 36 $ - $ 36 $ 3 Subtotal impaired loans with no related allowance recorded: 36 36-36 3 With an allowance recorded: 1 4 Family Residential Real Estate 677 790 173 684 21 Home Equity Lines of Credit 57 106 22 60 6 Subtotal impaired loans with an allowance recorded: 734 896 195 744 27 Total: 1 4 Family Residential Real Estate 677 790 173 684 21 Multi-Family Residential & Commercial - Real Estate 36 36-36 3 Home Equity Lines of Credit 57 106 22 60 6 Construction Real Estate - - - - - Total $ 770 $ 932 $ 195 $ 780 $ 30 Average Interest Recorded Legal Related Recorded Income Investment Balance Allowance Investment Recognized December 31, 2014 With no related allowance recorded: Construction Real Estate $ 1,124 $ 2,396 $ - $ 1,240 $ - Subtotal impaired loans with no related allowance recorded: 1,124 2,396-1,240 - With an allowance recorded: 1 4 Family Residential Real Estate 119 160 22 124 - Home Equity Lines of Credit 64 106 25 66 - Subtotal impaired loans with an allowance recorded: 183 266 47 190 - Total: 1 4 Family Residential Real Estate 119 160 22 124 - Home Equity Lines of Credit 64 106 25 66 - Construction Real Estate 1,124 2,396-1,240 - Total $ 1,307 $ 2,662 $ 47 $ 1,430 $ - 21
Financing Receivables on Nonaccrual Status The recorded investment, by class, in loans on nonaccrual status at December 31, 2015 and 2014 is as follows (in thousands): 2015 2014 1 4 Family Residential Real Estate $ 563 $ 119 Multi-Family Residential and Commercial 36 - Home Equity Lines of Credit 57 64 Construction Real Estate - 1,124 $ 656 $ 1,307 There were no loans modified as troubled debt restructurings within the previous twelve months. 5. Bank Premises And Equipment Following is a summary of bank premises and equipment at December 31, 2015 and 2014 (in thousands): 2015 2014 Land $ 94 $ 94 Buildings 255 255 Furniture and equipment 660 610 Vehicles 103 101 Leasehold improvements 305 296 1,417 1,356 Accumulated depreciation (751) (666) Total $ 666 $ 690 Depreciation and amortization amounting to $117 thousand and $131 thousand for the years ended December 31, 2015 and 2014, respectively is included in occupancy and equipment expense, data processing and outside service fees, and other expenses. The Bank has noncancellable operating leases for three branch locations. These leases have various expiration dates through 2018 and generally contain renewal option periods ranging from two to four years. Rental expense for operating leases during 2015 and 2014 was $146 thousand and $136 thousand, respectively. A summary of the minimum future rental payments under the leases described above is as follows at December 31, 2015 (in thousands): 2016 $ 135 2017 154 2018 98 $ 387 22
6. Deposits Deposits consist of the following (in thousands): 2015 2014 Non-interest bearing demand $ 20,490 $ 16,409 Savings 3,274 2,019 Money market and NOW 76,165 76,976 Time 117,198 108,291 Total $ 217,127 $ 203,695 The aggregate amount of time deposits in denominations that may exceed FDIC insurance limits of $250 thousand or more at December 31, 2015 and 2014 was $18.2 million and $17.6 million, respectively. Interest expense on such deposits aggregated approximately $182 thousand and $215 thousand, respectively, in 2015 and 2014. 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 $ 49,924 $ 9,521 $ 59,445 2017 17,862 8,130 25,992 2018 9,020 250 9,270 2019 10,515 256 10,771 2020 3,572-3,572 Thereafter 8,148-8,148 Total $ 99,041 $ 18,157 $ 117,198 7. Borrowings Advances from the Federal Home Loan Bank consist of the following (in thousands): Maturing in Interest December 31, Type Year Ending Rate 2015 2014 Short term borrowings: Daily 2016 0.490% $ 1,500 $ - Total short term borrowings 1,500 - Long term borrowings: Convertible 2018 2.245% 2,000 2,000 Convertible 2018 3.090% 2,000 2,000 Total long term borrowings 4,000 4,000 $ 5,500 $ 4,000 23
Pursuant to collateral agreements with the Federal Home Loan Bank ( FHLB ) at December 31, 2015 and 2014, advances are secured by pledged loans with a carrying amount of $31.0 million and $33.1 million, respectively. At December 31, 2015 and 2014, the Bank s maximum borrowing availability was equal to 30% of total assets. 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 December 31, 2015 and 2014, the Bank had a balance outstanding of $998 thousand and $635 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 $25.8 million and $25.1 million at December 31, 2015 and 2014, respectively. There were no federal funds purchased outstanding under these lines of credit at December 31, 2015 and 2014. 8. 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 $ 1,059 $ 84 Pay variable / receive fixed swap 1,059 (84) Total $ 2,118 $ - 9. Non-Cumulative Perpetual Preferred Stock On September 15, 2011, the Bank issued 4,250 shares of senior non-cumulative perpetual preferred stock ( Series C ) for $4.25 million to the U.S. Treasury as a condition to its participation in the Treasury s Small Business Lending Fund program ( SBLF ). The series is non-voting, other than having class voting rights on certain matters. Series C pays dividends quarterly starting at a rate of 5% which will fluctuate based on the qualified small business lending of the Bank. The preferred shares are redeemable at the option of the Bank. As presented in the accompanying financial statements, $4.25 million was assigned to the Series C preferred stock. On February 1, 2016 the Bank redeemed all 4,250 shares for $4.25 million. 24