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BNC Bancorp 10-K 2010
Form 10-K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

Commission File Number: 000-50128

 

 

BNC BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina   47-0898685

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

1226 Eastchester Drive

High Point, North Carolina

  27265
(Address of Principal Executive Offices)   (Zip Code)

(336) 476-9200

(Registrant’s telephone number, including area code)

 

 

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common stock, no par value

(Title of Class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated file, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Large Accelerated filer   ¨    Accelerated filer   ¨
Non-Accelerated filer   ¨    Smaller Reporting Company   x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

$47,896,000

(Aggregate value of voting and non-voting common equity held by non-affiliates of the registrant based on the price at which the registrant’s common stock, no par value per share was sold on June 30, 2009)

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date. 7,341,901 shares of common stock, no par value, as of March 25, 2010.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report to stockholders of BNC Bancorp for the year ended December 31, 2009 (“2009 Annual Report”), are incorporated by reference into Part II.

Portions of the Proxy Statement for the 2010 Annual Meeting of Stockholders of BNC Bancorp to be held on June 15, 2010, are incorporated by reference into Part III.

 

 

 


PART I

 

ITEM 1. BUSINESS

General

BNC Bancorp (the “Company”) was formed in 2002 to serve as a one-bank holding company for Bank of North Carolina (the “Bank”). The Company is registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”) and the bank holding company laws of North Carolina. The Company’s administrative office is located at 1226 Eastchester Drive, High Point, North Carolina 27265 and the Bank’s main office is located at 831 Julian Avenue, Thomasville, North Carolina 27360. The Company’s only business at this time is owning the Bank and its primary source of income is any dividends that are declared and paid by the Bank on its capital stock.

The Bank is a full service commercial bank that was incorporated under the laws of the State of North Carolina on November 15, 1991, and opened for business on December 3, 1991. The Bank operates under the rules and regulations of and is subject to examination by the Federal Deposit Insurance Corporation (“FDIC”) and the North Carolina Commissioner of Banks, North Carolina Department of Commerce (the “Commissioner”). The Bank is also subject to certain regulations of the Federal Reserve governing the reserves to be maintained against deposits and other matters.

The Bank provides a wide range of banking services tailored to the particular banking needs of the communities it serves. It is principally engaged in the business of attracting deposits from the general public and using such deposits, together with other funding from the Bank’s lines of credit, to make primarily consumer and commercial loans. The Bank has pursued a strategy that emphasizes its local affiliations. This business strategy stresses the provision of high quality banking services to individuals and small to medium-sized local businesses. Specifically, the Bank makes business loans secured by real estate, personal property and accounts receivable; unsecured business loans; consumer loans, which are secured by consumer products, such as automobiles and boats; unsecured consumer loans; commercial real estate loans; and other loans. The Bank also offers a wide range of banking services, including checking and savings accounts, commercial, installment and personal loans, safe deposit boxes, and other associated services.

Since January 1, 1996, the Company has grown assets, deposits and net loans at a compounded annual growth rate of 28.5%, 28.4% and 27.0% respectively. The Company targets business professionals and small to mid-size business customers with superior customer service, excellent branch locations and long-term, experienced bankers. The Company believes that the markets it operates in provide a unique opportunity for the Bank, as the Company is able to target customers with credit relationships in the $250,000 to $5 million range that are too small for regional community banks but too large for smaller community banks with lower legal lending limits. The Company has been able to grow assets, deposits and loans at these impressive rates while maintaining above peer asset quality with non-performing assets to total assets of 2.04% at December 31, 2009. In large part, the Company’s superior asset quality relative to peers is due to our strong team of lenders and asset quality management; most of our asset quality personnel have been in the banking industry for more than 20 years and several members of our senior credit team have experienced several economic and real estate cycles during their banking careers.

Lending involves credit risk. Credit risk is controlled and monitored through active asset quality management including the use of lending standards, thorough review of potential borrowers, and active asset quality administration. Credit risk management is discussed under See Item 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Sections “Executive Summary”, “Asset/Liability Management”, “Lending Activities”, “Asset Quality”, “Nonperforming Assets” and “Analysis of Allowance for Loan Losses”. Also see Item 1A, “Risk Factors.”

Deposits are the primary source of the Bank’s funds for lending and other investment purposes. The Bank attracts both short-term and long-term deposits from the general public locally and out-of-state by offering a variety of accounts and rates. The Bank offers statement savings accounts, negotiable order of withdrawal accounts, money market demand accounts, noninterest-bearing accounts, and fixed interest rate certificates with varying maturities.

 

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Deposit flows are greatly influenced by economic conditions, the general level of interest rates, competition, and other factors. The Bank’s deposits are obtained both from its primary market area and through wholesale sources throughout the United States. The Bank uses traditional marketing methods to attract new customers and savings deposits, including print media advertising and direct mailings.

The Company’s primary sources of revenue are interest and fee income from its lending and investing activities, primarily consisting of making business loans for small, to medium-sized businesses, and, to a lesser extent, from its investment portfolio. In prior years, investments have not been a primary source of income for the Company. In November and December of 2008, the Company purchased $265 million in government agency sponsored mortgage-backed securities and an additional $76 million of bank-qualified municipal government securities during the fourth quarter of 2008 and first quarter of 2009, to leverage the $31.3 million of proceeds from the U.S. Department of the Treasury (“UST”) Capital Purchase Program (“CPP”). Under the CPP, the Company sold shares of preferred stock and issued a warrant to purchase common stock to the Treasury. During the first quarter of 2009, the Company negotiated an unsecured $250 million money market funding arrangement and interest rate swap agreement to effectively fix the interest cost at 2.95% for this funding over a five year period. This leverage transaction has provided sufficient net interest income to offset the cost of dividends on the CPP preferred stock and provide additional operational income to the Company. The major expenses of the Company are interest paid on deposits and borrowings and general administrative expenses such as salaries, employee benefits, advertising and office occupancy.

The Bank has experienced steady growth over its nineteen-year history. The Company’s assets totaled $1.63 billion and $1.57 billion as of December 31, 2009 and 2008, respectively. Net income for the year ended December 31, 2009 was $6.5 million compared to $4.0 million for the year ended December 31, 2008. Net income available to common shareholders for the year ended December 31, 2009 totaled $4.6 million, or $0.62 per diluted common share, as compared to $3.8 million, or $0.52 per diluted common share, for the year ended December 31, 2008.

Because the Bank is the sole banking subsidiary of the Company, the Company’s operations are located at the Bank level. Throughout this Annual Report, results of operations will relate to the Bank’s operation, unless a specific reference is made to the Company and its operating results other than through the Bank’s business and activities.

Competition and Market Area

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and internet banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

The Company operates in markets that have not experienced the tremendous property value increases recognized in other parts of the country and as a result the property valuation declines have not been as severe. Based on SNL Financial data, the Company’s markets had population growth of 16.4% from 2000-2009, versus 10.1% nationwide. The Company’s markets have a projected population growth rate of 8.1% for 2009 to 2014, which is higher than the projected growth rate of 6.3% for the U.S.

The Company has a market share of 40.7% in its largest market, Davidson County. Rowan and Cabarrus Counties are located in the growing Piedmont region of North Carolina between the Charlotte metro market and the High Point and Thomasville markets. Rowan and Cabarrus Counties offer a premier location for warehouses, manufacturing and distribution facilities because the largest consolidated rail system in the country is centered in

 

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the region. Rowan County is home to over 45 freight companies. Cabarrus County is the home to Lowes Motor Speedway, and numerous NASCAR related suppliers and team headquarters. Lexington, High Point, Archdale and Thomasville’s traditional economic base includes furniture and textile manufacturing, which have been negatively impacted by the recession. Greensboro’s economic base is more diversified and service oriented and is also home to several colleges and universities.

Employees

At December 31, 2009, the Bank had 249 full-time and 13 part-time employees.

Subsidiaries

The Company is a one-bank holding company for Bank of North Carolina. In addition, the Company has wholly owned subsidiaries to issue trust preferred securities: BNC Bancorp Capital Trust I, BNC Bancorp Capital Trust II, BNC Bancorp Capital Trust III and BNC Bancorp Capital Trust IV. These long-term obligations, which qualify as Tier I capital for the Company, constitute a full and unconditional guarantee by the Company of the trusts’ obligations under the preferred securities.

The Bank has three subsidiaries that operate in the mortgage and real estate areas: BNC Credit Corp. serves as the Bank’s trustee on deeds of trust and Sterling Real Estate Holdings, LLC and Sterling Real Estate Development of North Carolina, LLC hold and dispose of the Bank’s real estate owned.

Supervision and Regulation

Bank holding companies and state commercial banks are extensively regulated under both federal and state law. The following is a brief summary of certain statutes and rules and regulations that affect or will affect the Company and the Bank. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company and the Bank. Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than shareholders of the Company. The Company cannot predict whether or in what form any proposed statute or regulation will be adopted or the extent to which the business of the Company and the Bank may be affected by a statute or regulation.

General. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance funds in the event the depository institution becomes in danger of default or in default. For example, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the bank’s total assets at the time the bank became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all acceptable capital standards as of the time the bank fails to comply with such capital restoration plan. The Company, as a registered bank holding company, is subject to the regulation of the Federal Reserve. Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve under the BHCA also has the authority to require a bank holding company to terminate any activity or to relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

In addition, insured depository institutions under common control are required to reimburse the FDIC for any loss suffered by its deposit insurance funds as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the deposit insurance funds. The FDIC’s claim for damages is superior to claims of stockholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

 

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As a result of the Company’s ownership of the Bank, the Company is also registered under the bank holding company laws of North Carolina. Accordingly, the Company is also subject to regulation and supervision by the Commissioner.

Emergency Economic Stabilization Act of 2008. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (“EESA”), giving the UST authority to take certain actions to restore liquidity and stability to the U.S. banking markets. Based upon its authority in the EESA, a number of programs to implement EESA have been announced. The first program implemented by the UST is the Capital Purchase Program CPP. Pursuant to this program, the UST, on behalf of the US government, will purchase preferred stock, along with warrants to purchase common stock, from certain financial institutions, including bank holding companies, savings and loan holding companies and banks or savings associations not controlled by a holding company. The investment will have a dividend rate of 5% per year, until the fifth anniversary of the UST’s investment and a dividend of 9% thereafter. During the time the UST holds securities issued pursuant to this program, participating financial institutions will be required to comply with certain provisions regarding executive compensation and corporate governance. Participation in this program also imposes certain restrictions upon an institution’s dividends to common shareholders and stock repurchase activities. As described further herein, we elected to participate in the CPP and received $31.3 million pursuant to the program.

American Recovery and Reinvestment Act of 2009. On February 17, 2009 the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted and includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, ARRA imposes certain new executive compensation and corporate governance obligations on all current and future CPP recipients, including the Company, until the institution has redeemed the preferred stock, which CPP recipients are now permitted to do under ARRA without regard to the three year holding period and without the need to raise new capital, subject to approval of its primary federal regulator.

Additionally, ARRA amends Section 111 of EESA to require the Treasury to adopt additional standards with respect to executive compensation and corporate governance for CPP recipients, which are set forth in the TARP Standards for Compensation and Corporate Governance: Interim Final Rule (“Interim Final Rule”), adopted by the Treasury on June 15, 2009. Among the executive compensation and corporate governance provisions included in ARRA and the Interim Final Rule are the following:

 

   

an incentive compensation “clawback” provision to cover “senior executive officers” (defined in this instance and below to mean the “named executive officers” for whom compensation disclosure is provided in the company’s proxy statement) and the next 20 most highly compensated employees;

 

   

a prohibition on certain golden parachute payments to cover any payment related to a departure for any reason (with limited exceptions) made to any senior executive officer (as defined above) and the next five most highly compensated employees;

 

   

a limitation on incentive compensation paid or accrued to the five most highly compensated employees of the financial institution, subject to limited exceptions for pre-existing arrangements set forth in written employment contracts executed on or prior to February 11, 2009, and certain awards of restricted stock which may not exceed one-third of annual compensation, are subject to a two year holding period and cannot be transferred until the Treasury’s preferred stock is redeemed in full;

 

   

a requirement that a company’s chief executive officer and chief financial officer provide in annual securities filings, a written certification of compliance with the executive compensation and corporate governance provisions of the Interim Final Rule;

 

   

an obligation for the compensation committee of the board of directors to evaluate with a company’s chief risk officer certain compensation plans to ensure that such plans do not encourage unnecessary or excessive risks or the manipulation of reported earnings;

 

   

a requirement that companies adopt a company-wide policy regarding excessive or luxury expenditures;

 

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a requirement that companies permit a separate, non-binding shareholder vote to approve the compensation of executives; and

 

   

a provision that allows the Treasury to review compensation paid prior to enactment of ARRA to senior executive officers and the next 20 most highly-compensated employees to determine whether any payments were inconsistent with the executive compensation restrictions of EESA, CPP or otherwise contrary to the public interest.

Capital Adequacy Guidelines for Holding Companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies and banks that are members of the Federal Reserve System and have consolidated assets of $150 million or more. Bank holding companies subject to the Federal Reserve’s capital adequacy guidelines are required to comply with the Federal Reserve’s risk-based capital guidelines. Under these regulations, the minimum ratio of total capital to risk-weighted assets is 8%. At least half of the total capital is required to be “Tier I capital,” principally consisting of common stockholders’ equity, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less certain intangible items. The remainder (“Tier II capital”) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and the allowance for loan losses, subject to certain restrictions. In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the stated minimum. At December 31, 2009, the Company’s Tier I risk-based capital and total risk-based capital were 9.71% and 11.60%, respectively.

Capital Requirements for the Bank. The Bank, as a North Carolina commercial bank, is required to maintain a surplus account equal to 50% or more of its paid-in capital stock. As a North Carolina chartered, FDIC-insured commercial bank which is not a member of the Federal Reserve System, the Bank is also subject to capital requirements imposed by the FDIC. Under the FDIC’s regulations, state nonmember banks that (a) receive the highest rating during the examination process and (b) are not anticipating or experiencing any significant growth, are required to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio of not less than 4%. At December 31, 2009, the Bank’s leverage ratio was 8.32%.

Dividend and Repurchase Limitations. The Company must obtain Federal Reserve approval prior to repurchasing common stock in excess of 10% of its net worth during any twelve-month period unless the Company (i) both before and after the redemption satisfies capital requirements for “well capitalized” state member banks; (ii) received a one or two rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues. As long as the UST holds equity in the Company pursuant to the CPP, UST approval is required for the Company to repurchase shares of outstanding common stock.

Although the payment of dividends and repurchase of stock by the Company are subject to certain requirements and limitations of North Carolina corporate law, except as set forth in this paragraph, neither the Commissioner nor the FDIC have promulgated any regulations specifically limiting the right of the Company to pay dividends and repurchase shares. However, the ability of the Company to pay dividends or repurchase shares may be dependent upon the Company’s receipt of dividends from the Bank.

North Carolina commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay. Dividends may be paid by the Bank from undivided profits, which are determined by deducting and charging certain items against actual profits, including any contributions to surplus required by North Carolina law. Also, an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations).

Under the terms of the CPP, the UST has a preferential right to the payment of cumulative dividends on the CPP Series A preferred stock. No dividends are permitted to be paid to common shareholders unless all accrued and unpaid dividends for all past dividend periods on the CPP preferred stock were fully paid. In the case of the Company, any increase in dividends to common shareholders above $0.05 per share quarterly is subject to the consent of the UST for the first three years of the CPP preferred stock investment.

 

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Deposit Insurance. The deposit accounts of the Bank are insured by the Deposit Insurance Fund (“DIF”) for the FDIC. Pursuant to EESA and ARRA, the maximum deposit insurance amount per depositor was increased from $100,000 to $250,000 until December 31, 2013. The FDIC maintains the DIF by assessing depository institutions an insurance premium on a quarterly basis. The amount of the assessment is a function of the institution’s risk category and assessment base. An institution’s risk category is determined according to its supervisory ratings and capital levels, and is used to determine the institution’s assessment rate. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category (Risk Category I) the assessment rate is calculated according to a formula, which relies on supervisory ratings and either certain financial ratios or long-term debt ratings. An insured bank’s assessment base is determined by the balance of its insured deposits. This system is risk-based and allows banks to pay lower assessments to the FDIC as their capital level and supervisory ratings improve. By the same token, if these indicators deteriorate, the institution will have to pay higher assessments to the FDIC.

Under the Federal Deposit Insurance Act (“FDIA”), the FDIC Board has the authority to set the annual assessment rate range for the various risk categories within certain regulatory limits. Pursuant to this authority, risk-based assessment rates were uniformly increased 7 cents per $100 of assessable deposits by the FDIC Board in December 2008 for the first quarter of 2009. On May 22, 2009, the FDIC adopted a final rule imposing a five basis point special assessment on each insured depository institution’s qualifying assets less Tier 1 capital as of June 30, 2009. The FDIC collected this special assessment on September 30, 2009, that amounted to $750,000. On November 12, 2009, the FDIC adopted a final rule that required insured financial institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for the following three years. Such prepaid assessments were collected on December 30, 2009 at a rate based on the insured institution’s modified third quarter 2009 assessment rate. The Company’s prepaid assessment was $8.5 million.

The FDIC is authorized to terminate a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency. The termination of deposit insurance for our national bank subsidiary would have a material adverse effect on our earnings, operations and financial condition.

FDIC Temporary Liquidity Guarantee Program. On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLGP”). The TLGP was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by Treasury, as an initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLGP the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts held at participating FDIC-insured institutions through December 31, 2009. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. The Company elected to participate in both guarantee programs. On August 26, 2009, the FDIC extended the Transaction Account Guarantee (“TAG”) portion of the TLGP through June 30, 2010. As of December 31, 2009, no debt has been issued under the TLGP.

Federal Home Loan Bank System. The FHLB system provides a central credit facility for member institutions. As a member of the FHLB of Atlanta and under the its capital plan, the Bank is required to own capital stock in the FHLB of Atlanta in an amount at least equal to 0.20% (or 20 basis points) of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta under the new activity-based stock ownership requirement. On December 31, 2009, the Bank was in compliance with this requirement.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the FDIC, an insured institution has a continuing and affirmative obligation consistent with its safe

 

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and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination which was conducted during February 2008.

Prompt Corrective Action. The FDIC has broad powers to take corrective action to resolve the problems of insured depository institutions. The extent of these powers will depend upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Under the regulations, an institution is considered “well capitalized” if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An “adequately capitalized” institution is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with the highest examination rating). An institution is considered (A) “undercapitalized” if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of an institution with the highest examination rating); (B) “significantly undercapitalized” if the institution has (i) a total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C) “critically undercapitalized” if the institution has a ratio of tangible equity to total assets equal to or less than 2%.

Changes in Control. The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or savings bank or merging or consolidating with another bank holding company or savings bank holding company without prior approval of the Federal Reserve. Similarly, Federal Reserve approval (or, in certain cases, non-disapproval) must be obtained prior to any person acquiring control of the Company. Control is conclusively presumed to exist if, among other things, a person acquires more than 25% of any class of voting stock of the Company or controls in any manner the election of a majority of the directors of the Company. Control is presumed to exist if a person acquires more than 10% of any class of voting stock and the stock is registered under Section 12 of the Securities Exchange Act of 1934 as amended (the “Exchange Act”) or the acquiror will be the largest shareholder after the acquisition.

Federal Securities Law. The Company has registered its common stock with the Securities and Exchange Commission (the “SEC”) pursuant to Section 12(g) of the Exchange Act. As a result of such registration, the proxy and tender offer rules, insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to the Company.

Transactions with Affiliates. Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans-to-one-borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The FDIC has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits on the amount a bank can loan to an executive officer.

 

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Loans to One Borrower. The Bank is subject to the Commissioner’s loans to one borrower limits which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any borrower outstanding at one time and not fully secured by readily marketable collateral shall exceed 15% of the unimpaired capital and unimpaired surplus of the bank. Loans and extensions of credit fully secured by readily marketable collateral may comprise an additional 10% of unimpaired capital and unimpaired surplus.

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act (the “GLB Act”) dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act has expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, this expanded authority also may present us with new challenges as our larger competitors are able to expand their services and products into areas that are not feasible for smaller, community oriented financial institutions. The GLB Act likely will have a significant economic impact on the banking industry and on competitive conditions in the financial services industry generally.

USA Patriot Act of 2001. In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the “Patriot Act”). The Patriot Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 is sweeping federal legislation addressing accounting, corporate governance and disclosure issues. The impact of the Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and imposes significant new requirements for public company governance and disclosure requirements.

In general, the Sarbanes-Oxley Act mandates important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It establishes new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process and creates a new regulatory body to oversee auditors of public companies. It backs these requirements with new SEC enforcement tools, increases criminal penalties for federal mail, wire and securities fraud, and creates new criminal penalties for document and record destruction in connection with federal investigations. It also increases the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.

Section 404 of the Sarbanes-Oxley Act of 2002 requires the Company to include in its Annual Report, a report stating management’s responsibility to establish and maintain adequate internal controls over financial reporting and management’s conclusion on the effectiveness of the internal controls at year end. Additionally, the Company’s independent registered public accounting firm is required to attest to and report on management’s evaluation of internal control over financial reporting.

Government Monetary Policies and Economic Controls. Our earnings and growth, as well as the earnings and growth of the banking industry, are affected by the credit policies of monetary authorities, including the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, changes in reserve requirements against member bank deposits, and changes in the Federal Reserve discount rate. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.

In view of changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, and loan demand, or their effect on our business and earnings or on the financial condition of our various customers.

 

9


Other. The federal banking agencies, including the FDIC, have developed joint regulations requiring annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small, well-capitalized institutions and state chartered institutions examined by state regulators, and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards when such compensation would endanger the insured depository institution or would constitute an unsafe practice.

In addition, the Bank is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit and equal credit, fair credit reporting laws and laws relating to branch banking. The Bank, as an insured North Carolina commercial bank, is prohibited from engaging as a principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.

Under Chapter 53 of the North Carolina General Statutes, if the capital stock of a North Carolina commercial bank is impaired by losses or otherwise, the Commissioner is authorized to require payment of the deficiency by assessment upon the bank’s shareholders, pro rata, and to the extent necessary, if any such assessment is not paid by any shareholder, upon 30 days notice, to sell as much as is necessary of the stock of such shareholder to make good the deficiency.

 

ITEM 1A. RISK FACTORS

Risks Related to Recent Economic Conditions and Governmental Response Efforts

Our business has been and may continue to be adversely affected by current conditions in the financial markets and economic conditions generally. The global, U.S. and North Carolina economies are experiencing significantly reduced business activity and consumer spending as a result of, among other factors, disruptions in the capital and credit markets. Dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business:

 

   

a decrease in the demand for loans or other products and services offered by us;

 

   

a decrease in the value of our loans or other assets secured by consumer or commercial real estate;

 

   

a decrease to deposit balances due to overall reductions in the accounts of customers;

 

   

an impairment of certain intangible assets or investment securities;

 

   

a decreased ability to raise additional capital on terms acceptable to us or at all; or

 

   

an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and provision for credit losses, which would reduce our earnings.

Until conditions improve, we expect our business, financial condition and results of operations to be adversely affected.

Recent and future legislation and regulatory initiatives to address current market and economic conditions may not achieve their intended objectives, including stabilizing the U.S. banking system or reviving the overall economy. Recent and future legislative and regulatory initiatives to address current market and economic conditions, such as the EESA, or the ARRA, may not achieve their intended objectives, including stabilizing the U.S. banking system or reviving the overall economy. EESA was enacted in October 2008 to restore confidence and stabilize the volatility in the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Treasury and banking regulators have implemented, and likely will continue to implement, various other programs under this legislation to address capital and liquidity issues in the banking system, including the Troubled Asset Relief Program (“TARP”), the CPP, President Obama’s Financial Stability Plan announced in February 2009, the ARRA and the FDIC’s TLGP. There can be no assurance as to the actual impact that any of the recent, or future, legislative and regulatory initiatives will have on

 

10


the financial markets and the overall economy. Any failure of these initiatives to help stabilize or improve the financial markets and the economy, and a continuation or worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

Additional requirements under our regulatory framework, especially those imposed under ARRA, EESA or other legislation intended to strengthen the U.S. financial system, could adversely affect us. Recent government efforts to strengthen the U.S. financial system, including the implementation of ARRA, EESA, the TLGP and special assessments imposed by the FDIC, subject participants to additional regulatory fees and requirements, including corporate governance requirements, executive compensation restrictions, restrictions on declaring or paying dividends, restrictions on share repurchases, limits on executive compensation tax deductions and prohibitions against golden parachute payments. These requirements, and any other requirements that may be subsequently imposed, may have a material and adverse affect on our business, financial condition, and results of operations.

Our participation in the CPP imposes restrictions and obligations on us that limit our ability to increase dividends, repurchase shares of our common stock and access the equity capital markets. On December 5, 2008, we issued and sold (i) 31,260 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) and (ii) a warrant to purchase 543,337 shares of our common stock (“Warrant”) to the UST as part of its CPP. Prior to December 5, 2011, unless we have redeemed all of the Series A Preferred Stock or the UST has transferred all of the Series A Preferred Stock to a third party, the Securities Purchase Agreement pursuant to which such securities were sold, among other things, limits the payment of dividends on our common stock to a maximum quarterly dividend of $0.05 per share without prior regulatory approval, limits our ability to repurchase shares of our common stock (with certain exceptions, including the repurchase of our common stock to offset share dilution from equity-based compensation awards), and grants the holders of such securities certain registration rights which, in certain circumstances, impose lock-up periods during which we would be unable to issue equity securities. In addition, unless we are able to redeem the Series A Preferred Stock during the first five years, the dividends on this capital will increase substantially at that point, from 5% to 9%. Depending on market conditions at the time, this increase in dividends could significantly impact our liquidity.

The limitations on incentive compensation contained in the ARRA may adversely affect our ability to retain our highest performing employees. In the case of a company such as BNC Bancorp that received CPP funds, the ARRA, and subsequent regulations issued by Treasury, contain restrictions on bonus and other incentive compensation payable to the company’s senior executive officers. As a consequence, we may be unable to create a compensation structure that permits us to retain our highest performing employees and attract new employees of a high caliber. If this were to occur, our businesses and results of operations could be adversely affected.

The soundness of other financial institutions could adversely affect us. Since mid-2007, the financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. Financial institutions in particular have been subject to increased volatility and an overall loss in investor confidence.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, and other institutional clients.

From time to time, we utilize derivative financial instruments, primarily to hedge our exposure to changes in interest rates, but also to hedge cash flow. By entering into these transactions and derivative instrument contracts, we expose ourselves to counterparty credit risk in the event of default of our counterparty or client. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to us, which creates credit risk for us. We attempt to minimize this risk by selecting counterparties with investment grade credit ratings, limiting our exposure to any single counterparty and regularly monitoring our market position with each counterparty. Nonetheless, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. In addition, our credit risk may be exacerbated when the

 

11


collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan due us. There is no assurance that any such losses would not materially and adversely affect our businesses, financial condition or results of operations.

Risks Associated to Our Business

We rely on dividends from the Bank for most of our revenue. The Company is a separate and distinct legal entity from the Bank. The Company receives substantially all of its revenue from dividends received from the Bank. These dividends are the principal source of funds to pay dividends on our common and preferred stock, and interest and principal on our outstanding debt securities. Various federal and state laws and regulations limit the amount of dividends that the Bank may pay to the Company. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations, or pay dividends on its common stock. The inability to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Bank is exposed to risks in connection with the loans it makes. A significant source of risk for the Company and the Bank arises from the possibility that losses will be sustained by the Bank because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that it believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying its loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect the Bank’s results of operations.

We are in the process of improving our policies and procedures relating to the administration of both performing and non-performing loans, however, this process is not currently complete. The administration of loans is an important function in attempting to mitigate any future losses related to our non-performing assets. We are currently in the process of improving and centralizing our credit administration function. While we are making efforts to complete this process in a timely manner, we can give you no assurances that we will be able to successfully update and improve our credit administration policies and procedures. If we are unable to do so in a timely manner or at all, our loan losses could increase and this could have a material adverse effect on our results of operations and the value of, or market for, our common stock.

Loss of key personnel could adversely impact results. The success of the Bank has been and will continue to be greatly influenced by the ability to retain the services of existing senior management. The Bank has benefited from consistency within its senior management team, with its top five executives averaging over 15 years of service with the Bank. The Company has entered into employment contracts with each of these top management officials. Nevertheless, the unexpected loss of the services of any of the key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse impact on the business and financial results of the Bank.

Changes in interest rates affect profitability and assets. Changes in prevailing interest rates may hurt the Bank’s business. The Bank derives its income primarily from the difference or “spread” between the interest earned on loans, securities and other interest earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the larger the spread, the more the Bank earns. When market rates of interest change, the interest the Bank receives on its assets and the interest the Bank pays on its liabilities will fluctuate. This can cause decreases in the “spread” and can adversely affect the Bank’s income. Changes in market interest rates could reduce the value of the Bank’s financial assets. Fixed-rate investments, mortgage-backed and related securities and mortgage loans generally decrease in value as interest rates rise. In addition, interest rates affect how much money the Bank lends. For example, when interest rates rise, the cost of borrowing increases and the loan originations tend to decrease. If the Bank is unsuccessful in managing the effects of changes in interest rates, the financial condition and results of operations could suffer.

The Company and the Bank compete with much larger companies for some of the same business. The banking and financial services business in our market areas continues to be a competitive field and it is becoming more competitive as a result of:

 

   

Changes in regulations;

 

   

Changes in technology and product delivery systems; and

 

12


   

The accelerating pace of consolidation among financial services providers.

Negative publicity could damage our reputation. Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.

The Company is subject to environmental liability risk associated with lending activities. A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company’s financial condition and results of operations.

Financial services companies depend on the accuracy and completeness of information about customers and counterparties. In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

Liquidity is essential to our businesses. Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition. Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

From time to time the Financial Accounting Standards Board (FASB) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.

Impairment of investment securities, goodwill, other intangible assets, or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations. In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Under current accounting standards, goodwill and certain other

 

13


intangible assets with indeterminate lives are no longer amortized but, instead, are assessed for impairment periodically or when impairment indicators are present. Assessment of goodwill and such other intangible assets could result in circumstances where the applicable intangible asset is deemed to be impaired for accounting purposes. Under such circumstances, the intangible asset’s impairment would be reflected as a charge to earnings in the period during which such impairment is identified. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.

We rely on other companies to provide key components of our business infrastructure. Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

Our information systems may experience an interruption or breach in security. We rely heavily on communications and information systems to conduct our business. Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of our information systems, we cannot assure you that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

Government regulations may prevent or impair the Company’s ability to pay dividends, engage in mergers or operate in other ways. Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. The Bank is subject to supervision and periodic examination by the FDIC and the Commissioner. The Company is subject to regulation by the Federal Reserve and the Commissioner. Banking regulations, designed primarily for the protection of depositors, may limit the growth and the return to the Company’s stockholders by restricting certain activities, such as:

 

   

The payment of dividends to our stockholders;

 

   

Possible mergers with or acquisitions of or by other institutions;

 

   

Our desired investments;

 

   

Loans and interest rates on loans;

 

   

Interest rates paid on our deposits;

 

   

The possible expansion of our branch offices; and

 

   

Our ability to provide securities or trust services.

The Bank also is subject to capitalization guidelines set forth in federal legislation, and could be subject to enforcement actions to the extent that it is found by regulatory examiners to be undercapitalized. The Company cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on the Company’s future business and earnings prospects. The cost of compliance with regulatory requirements may adversely affect our ability to operate profitably.

The FDIC has imposed a special assessment on all FDIC-insured institutions, which decreased our earnings in 2009, and future special assessments could adversely affect our earnings in future periods. In May 2009, the FDIC announced that it had voted to levy a special assessment on insured institutions in order to facilitate the rebuilding of the Deposit Insurance Fund. The assessment is equal to five basis points of our subsidiary bank’s total assets minus Tier 1 capital as of June 30, 2009. This additional charge of $750,000 increased operating expenses during the second quarter of 2009. The FDIC has indicated that future special assessments are possible, although it has not determined the magnitude or timing of any future assessments. Any such future assessments will decrease our earnings

 

14


Our allowance for loan losses may be insufficient. All borrowers carry the potential to default and our remedies to recover (seizure and/or sale of collateral, legal actions, guarantees, etc.) may not fully satisfy money previously lent. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable credit losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance for loan losses reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of additional loan charge offs, based on judgments different than those of management. An increase in the allowance for loan losses results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our financial condition and results of operations.

Risks Related to our Common Stock

Our stock price can be volatile. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

   

Actual or anticipated variations in quarterly results of operations;

 

   

Recommendations by securities analysts;

 

   

Operating results and stock price performance of other companies that investors deem comparable to us;

 

   

News reports relating to trends, concerns, and other issues in the financial services industry;

 

   

Perceptions in the marketplace regarding us and/or our competitors;

 

   

New technology used or services offered by competitors;

 

   

Significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors; and

 

   

Changes in government regulations.

The Company’s trading volume has been low compared with larger national and regional banks. The Company’s common stock is traded on the NASDAQ Global Market. However, the trading volume of the Company’s common stock is relatively low when compared with more seasoned companies listed on the NASDAQ Capital Market, NASDAQ Global Select Market, or other consolidated reporting systems or stock exchanges. Thus, the market in the Company’s common stock may be limited in scope relative to other larger companies. In addition, the Company cannot say with any certainty that a more active and liquid trading market for its common stock will develop.

Our common stock is not FDIC insured. The Company’s common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, holders of our common stock may lose some or all of their investment.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTY

At December 31, 2009, the Company conducted its business from its headquarters located in High Point, North Carolina, the Bank’s main office in Thomasville and 15 other branch offices and one limited services office. The following list sets forth certain information regarding the Company’s and Bank’s properties.

 

Owned properties:   
   Main Office: 831 Julian Avenue, Thomasville, NC 27360.
   Archdale Branch Office: 113 Trindale Road, Archdale, NC 27263.
   Lexington Branch Office: 115 East Center Street, Lexington, NC 27292.
   North Thomasville Branch Office: 1317 National Highway, Thomasville, NC 27360.
   Kernersville Branch Office: 211 Broad Street, Kernersville, NC 27284.
   Oak Ridge Branch Office: 8000 Linville Road, Oak Ridge, NC 27310.
   Elm Street Branch Office: 801 North Elm Street, High Point, NC 27262.
   Eastchester Branch Office: 2630 Eastchester Dr., High Point, NC 27265.
   Salisbury Branch Office: 415 Jake Alexander Boulevard West, Salisbury, NC 28147.
   Harrisburg Branch Office: 3890 Main Street, Harrisburg, NC 28075.
   N. Davidson Branch Office: 5744 Old US Hwy 52, Lexington, NC 27295.
   Concord Branch Office: 271 Copperfield Blvd., NE Concord, NC 28025
Leased properties:   
   High Point Administrative Offices: 1224/1226 Eastchester Drive, High Point, NC 27265.
   Friendly Center Branch Office: 3202 Northline Avenue, Greensboro, NC 27408.
   Dover Road Branch Office: 1110 Dover Road, Greensboro, NC 27408.
   Elm Street Branch Office: 112 N. Elm Street, Greensboro, NC 27404.
   Winston Salem Branch Office: 1551 Westbrook Plaza Drive, Suite 90, Greentree II Building, Winston Salem, NC 27103.
   Mooresville Limited Service Office: 125 Commerce Park Road, Mooresville, NC 28117.

The total net book value of the Company’s premises and equipment on December 31, 2009 was $27.7 million. All properties are considered by the Company’s management to be in good condition and adequately covered by insurance.

Any property acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as “real estate owned” until it is sold or otherwise disposed of by the Company to recover its investment. As of December 31, 2009, the Company had $14.3 million of assets classified as real estate owned.

 

ITEM 3. LEGAL PROCEEDINGS

In the opinion of management, the Company is not involved in any material pending legal proceeding.

PART II

 

ITEM 4. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCK HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock is listed in the NASDAQ Global Market under the symbol “BNCN”. Scott & Stringfellow, Inc., Morgan Keegan, Sandler O’Neill & Partners, L.P., Raymond James & Associates, Howe Barnes, McKinnon and Company, and Monroe Securities are the market makers in the Company’s stock. Wachovia Securities is not a market maker; however, they do attempt to match-up buyers and sellers through their local offices.

See table 19 for certain market and dividend information for the last two fiscal years.

As of December 31, 2009, the Company had approximately 1352 shareholders of record not including persons or entities whose stock is held in nominee or “street” name and by various banks and brokerage firms.

 

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See “ITEM 1. BUSINESS — Supervision and Regulation” above for regulatory restrictions which limit the ability of the Bank to pay dividends. The Company has paid seven annual cash dividends, with the most recent being a cash dividends of $0.20 per share of common stock on February 22, 2008. In 2009, the Company began paying quarterly dividends, with the last being a cash dividend of $0.05 paid on February 26, 2010.

There were no purchases made by or on behalf of the Company or any “affiliated purchases” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Company’s common stock during the three months ended December 31, 2009. The maximum amount of shares that may be purchased in the stock repurchase program will be limited to 10% of the outstanding common stock. As of December 31, 2009, the maximum of stock able to be purchased by the Company amounted to 734,190 shares, with 247,904 shares repurchased. Because of the Company’s participation in the CPP, there are restrictions on the Company’s ability to repurchase its shares.

The information required to be disclosed under Item 201(d) of Regulation S-K “Securities Authorized for Issuance Under Equity Compensation Plans” is presented in Item 12 of this Form 10-K.

On December 5, 2008, we issued 31,260 shares of our Series A Senior Preferred Stock to the UST pursuant to the CPP, including a warrant to purchase 543,337 shares of the Company’s common stock. While any Senior Preferred Stock is outstanding, we may pay dividends on our common stock, provided that all accrued and unpaid dividends for all past dividend periods on the Senior Preferred Stock are fully paid. Prior to the third anniversary of the UST’s purchase of the Senior Preferred Stock, unless the Senior Preferred Stock has been redeemed or the UST has transferred all of the Senior Preferred Stock to third parties, the consent of the UST will be required for us to increase our common stock dividend from its current quarterly amount of $0.05 per share.

See Item 11 for information regarding securities authorized for issuance under equity compensation plans.

Performance Graph

The following graph compares the Company’s cumulative stockholder return on its Common Stock with a NASDAQ index and with a southeastern bank index. The graph was prepared by SNL Financial, LC using data as of December 31, 2009.

 

17


LOGO

 

     Period Ending

Index

   12/31/04    12/31/05    12/31/06    12/31/07    12/31/08    12/31/09

BNC Bancorp

   100.00    129.89    144.45    132.74    59.73    62.07

NASDAQ Composite

   100.00    101.37    111.03    121.92    72.49    104.31

S&P 500

   100.00    104.91    121.48    128.16    80.74    102.11

SNl Bank Index

   100.00    101.36    118.57    92.14    52.57    52.03

SNL Southeast Bank index

   100.00    102.36    120.03    90.42    36.60    36.75

 

18


ITEM 5. SELECTED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

The following table sets forth our historical consolidated financial data and operating information for the periods indicated. The selected historical annual consolidated statement of operations and balance sheet data as of and for each of the five fiscal years presented are derived from our consolidated financial statements. Historical results are not necessarily indicative of the results to be expected in the future. You should read the following data together with “Item 1. Business,” “Item 6. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the related notes appearing in “Item 7. Financial Statements.” (Dollars in thousands, except share and per share data).

BNC Bancorp

Table 1

Selected Consolidated Financial Information and Other Data

($ in thousands, except per share and nonfinancial data)

 

     At or for the Year Ended December 31,
     2009     2008    2007    2006    2005

Operating Data:

             

Total interest income

   $ 79,082      $ 71,034    $ 73,670    $ 53,211    $ 33,373

Total interest expense

     32,867        37,426      41,265      26,481      14,593
                                   

Net interest income

     46,215        33,608      32,405      26,730      18,780

Provision for loan losses

     15,750        7,075      3,090      2,655      2,515
                                   

Net interest income after provision for loan losses

     30,465        26,533      29,315      24,075      16,265

Non-interest income

     8,686        5,651      5,249      3,821      2,982

Non-interest expense

     32,899        27,783      24,068      19,110      13,023
                                   

Income before income taxes

     6,252        4,401      10,496      8,786      6,224

Income tax expense (benefit)

     (285     414      3,058      2,616      1,719
                                   

Net income

     6,537        3,987      7,438      6,170      4,505

Less preferred stock dividends and discount accretion

     1,984        142      —        —        —  
                                   

Net income available to common shareholders

   $ 4,553      $ 3,845    $ 7,438    $ 6,170    $ 4,505
                                   

Per Common Share Data: (1)

             

Basic earnings per share

   $ 0.62      $ 0.53    $ 1.08    $ 1.09    $ 0.94

Diluted earnings per share

     0.62        0.52      1.05      1.04      0.88

Cash dividends paid

     0.20        0.20      0.18      0.15      0.12

Book value

     13.20        12.49      11.90      11.89      7.58

Tangible common book value (2)

     9.43        8.69      8.02      7.23      6.78

Weighted average shares outstanding:

             

Basic

     7,340,015        7,322,723      6,865,204      5,658,196      4,798,869

Diluted

     7,347,700        7,396,170      7,088,218      5,957,478      5,093,327

Year-end shares outstanding

     7,341,901        7,350,029      7,257,532      6,709,007      4,804,748

Selected Year-End Balance Sheet Data:

             

Total assets

   $ 1,634,185      $ 1,572,876    $ 1,130,112    $ 951,731    $ 594,550

Investment securities available for sale

     360,506        416,564      86,683      76,700      42,489

Loans

     1,079,179        1,007,788      932,562      774,664      499,247

Allowance for loan losses

     17,309        13,210      11,784      10,400      6,140

Goodwill

     26,129        26,129      26,129      26,129      3,423

Deposits

     1,349,878        1,146,013      855,130      786,777      490,892

Short-term borrowings

     50,283        194,143      80,928      4,673      7,061

Long-term debt

     100,713        105,713      101,713      81,713      59,496

Shareholders’ equity

     126,206        120,680      86,392      72,523      33,114

 

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BNC Bancorp

Table 1

Selected Consolidated Financial Information and Other Data

($ in thousands, except per share and nonfinancial data)

 

     At or for the Year Ended December 31,  
     2009     2008     2007     2006     2005  

Selected Average Balances:

          

Total assets

   $ 1,617,744      $ 1,227,246      $ 1,041,018      $ 747,997      $ 549,654   

Investment securities available for sale

     424,684        117,531        79,727        58,519        40,251   

Loans, including loans held for sale

     1,026,635        981,069        849,271        615,689        454,395   

Total interest-earning assets

     1,496,230        1,116,766        943,756        685,981        503,013   

Deposits, interest-bearing

     1,257,333        890,058        782,755        564,084        404,384   

Total interest-bearing liabilities

     1,418,935        1,063,171        891,695        643,325        475,254   

Shareholders’ Equity

     123,641        86,858        76,065        48,949        31,061   

Selected Performance Ratios:

          

Return on average assets (3)

     0.40     0.32     0.71     0.82     0.82

Return on average common equity (4)

     4.81     4.54     9.78     12.60     14.50

Return on average tangible common equity (5)

     6.82     6.79     15.58     15.86     16.34

Net interest margin (6)

     3.39     3.17     3.60     4.08     3.92

Average equity to average assets

     7.64     7.08     7.31     6.54     5.65

Efficiency ratio (7)

     55.36     67.66     61.36     60.07     57.33

Dividend payout ratio

     32.26     38.09     16.61     13.34     12.43

Asset Quality Ratios:

          

Nonperforming loans to period-end loans

     1.77     1.32     0.39     0.16     0.37

Allowance for loan losses to period-end loans

     1.60     1.31     1.26     1.34     1.23

Allowance for loan losses to nonperforming loans

     90.86     99.18     327.42     839.39     335.70

Nonperforming assets to total assets (8)

     2.04     1.17     0.54     0.24     0.45

Net loan charge-offs to average loans

     1.13     0.58     0.20     0.20     0.38

Capital Ratios: (9)

          

Total risk-based capital

     12.79     11.46     10.31     10.23     11.27

Tier 1 risk-based capital

     10.87     9.60     8.26     8.00     8.61

Leverage ratio

     8.32     8.44     7.40     7.40     7.92

Other Data:

          

Number of full service banking offices

     17        15        14        13        8   

Number of limited service offices

     1        1        1        1        2   

Number of full time equivalent employees

     249        221        218        196        140   

 

(1) All per share data has been restated to reflect the dilutive effect of a 10% stock dividend distributed on January 22, 2007, a stock split effected in the form of a 25% stock dividend in 2005.
(2) Calculated by dividing common equity less intangibles by year-end shares outstanding. Intangibles include core deposit intangibles of $1.6 million, $1.8 million, $2.1 million, $2.3 million and $60,000 at December 31, 2009, 2008, 2007, 2006 and 2005, respectively.
(3) Calculated by dividing net income by average assets.
(4) Calculated by dividing net income available to common shareholders by average common equity.
(5) Calculated by dividing net income available to common shareholders by average common equity less intangibles.
(6) Calculated by dividing tax equivalent net interest income by average interest-earning assets.
(7) Calculated by dividing non-interest expense by the sum of tax-equivalent net interest income plus non-interest income. The tax-equivalent adjustment was $4.5 million, $1.8 million, $1.6 million, $1.3 million and $953,000 for the years ended December 31, 2009, 2008, 2007, 2006 and 2005, respectively.
(8) Nonperforming assets consist of non-accrual loans, restructured loans in non-accrual, and real estate owned, where applicable.
(9) Capital ratios are for the bank.

 

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ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is intended to assist readers in understanding and evaluating of the consolidated financial condition and results of operations of the Company. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this annual report. Additional discussion and analysis related to fiscal 2009 is contained in our Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2009, June 30, 2009 and September 30, 2009, respectively.

FORWARD LOOKING STATEMENTS

This report contains certain forward-looking statements with respect to the financial condition, results of operations and business of the Company and the Bank. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on the information available to management at the time that these disclosures were prepared. These statements can be identified by the use of words like “expect,” “anticipate,” “estimate” and “believe,” variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the Bank’s markets, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectability of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environment and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in “Risk Factors” in this Form 10-K and the Company’s other filings with the SEC. The Company undertakes no obligation to update any forward-looking statements.

The Company is a one-bank holding company incorporated under the laws of North Carolina to serve as the holding company for the Bank. The Company acquired all of the outstanding capital stock of the Bank on December 16, 2002. The Bank is a full service commercial bank that was incorporated under the laws of the State of North Carolina on November 15, 1991, and opened for business on December 3, 1991. The Bank concentrates its marketing and banking efforts to serve the citizens and business interests of the cities and communities located in Davidson, Randolph, Rowan, Forsyth, Guilford, Iredell and Cabarrus Counties. The Bank has three subsidiaries: BNC Credit Corp. serves as the Bank’s trustee on deeds of trust and Sterling Real Estate Holdings, LLC and Sterling Real Estate Development of North Carolina, LLC hold and dispose of the Bank’s real estate owned. See “PART I, ITEM 1 — BUSINESS” for an overview of the business operations of the Company and the Bank.

EXECUTIVE SUMMARY

Net income for the year ended December 31, 2009 was $6.5 million compared to $4.0 million for the year ended December 31, 2008. Net income available to common shareholders for the year ended December 31, 2009 totaled $4.6 million, or $0.62 per diluted common share, as compared to $3.8 million, or $0.52 per diluted common share, for the year ended December 31, 2008. Preferred stock dividends and accretion of the discount on the Company’s preferred stock reduced net income by $2.0 million ($0.27 per common share) and $142,000 ($0.02 per common share) for the years ended December 31, 2009 and 2008, respectively.

The increases in net income was largely due to: (i) a $12.6 million increase in net interest income resulting from higher average interest earning assets and a decline in the Company’s cost of funds, (ii) a $3.4 million increase in net gains on sales of investment securities, partially offset by (iii) a $8.7 million increase in the provision for loan losses due to higher net charge-offs and non-performing loans caused by deterioration in economic conditions, and (iv) a $2.2 million increase in the FDIC insurance assessment due to higher assessment rates during 2009 and a special one-time $750,000 assessment in the second quarter of 2009.

The most significant factor affecting the Company’s financial condition in 2009 was the broad economic slowdown in both the real estate sector and the general economy in our state and local communities. Weaknesses in residential development and rising unemployment levels in our market areas resulted in higher charge-offs and

 

21


a higher allowance for loan losses in 2009 also impacted earnings. As a result of these difficult issues, the Company recorded a provision for loan losses of $15.8 million, which represents an increase of $8.7 million compared to 2008. The weak economy also impacted our allowance for loan losses, which increased to $17.3 million at December 31, 2009 from $13.2 million recorded at December 31, 2008. Nonperforming assets increased to $33.4 million at December 31, 2009 representing 2.04% of nonperforming assets to total assets, compared to $18.3 million at December 31, 2008 representing 1.17% of nonperforming assets to total assets.

Net charge-offs for 2009 were $11.7 million, or 1.13% of average loans and were up $6.0 million compared to 2008’s net charge-offs of $5.7 million, or 0.58% of average loans. Of the $11.7 million in net charge-offs in 2009, $5.0 million and $1.2 million were related to commercial construction and residential construction loans, respectively. The Company’s portfolio of construction loans represents 21.7% of the total loan portfolio. During 2009, management has actively reduced its exposure in construction loans by $73.6 million, or 24.0%. At December 31, 2009, the Company’s exposure in larger acquisition and development loans within the construction loan portfolio had been minimized in comparison to the prior year and the remaining portfolio is diversified across the Company’s market area. Additionally, the Company has seen an increase in the velocity related to remaining viable projects and lots with completed infrastructure, and the remaining speculative inventory has continued to decline at a rate above the market average.

During 2008, the Company received $31.3 million from the UST for participation in the CPP. The CPP gave us the opportunity to raise capital quickly, at low cost, with little shareholder dilution, and continue to support the credit needs of our communities. We considered it our responsibility to participate in the CPP, rewarding the taxpayers of our communities with an even healthier, more highly capitalized company, better enabling us to serve our customers and communities with access to affordable and reasonably underwritten consumer and commercial credit, supporting economic growth in our communities with loans to creditworthy businesses, and supplying affordable financing to individuals at a time when secondary markets remain in turmoil.

The additional capital provided by the CPP has enhanced the Company’s ability to fund responsible lending and has enabled the Company to better satisfy the credit needs of households and businesses in our markets. The first program initiated after receiving CPP funds was our Builder Participation Program. This Program makes available up to $50 million of in-house credit to qualified buyers who purchase residential housing inventory currently being financed as part of our residential construction loan portfolio. With the secondary mortgage market functioning inefficiently, we have increased our in-house commitment to fill this credit vacuum, providing builders in our market with a source of qualified buyers and making affordable and rational credit more readily accessible. The Builder Participation Program is a major commitment on our part to help stabilize the housing market in our communities and provide credit locally. To date, $22.9 million of affordable mortgage loans have been provided under the Builder Participation Program.

In conjunction with the funds received from the CPP, management began implementing a strategy to deploy these funds into government agency sponsored entity mortgage-backed securities, well before rates in this sector began to decline due to aggressive purchases by the Federal Reserve, UST, and other community banks seeking to leverage their new CPP funds. That strategy resulted in the Company purchasing $265 million of FNMA and FHLMC sponsored mortgage-backed securities in November and December of 2008, and an additional $76 million of bank-qualified municipal government securities during the fourth quarter of 2008 and the first quarter of 2009. The tax equivalent yield on these investments was 5.70%. These security purchases were funded by short-term deposits at rates below 1.0% and by an unsecured $250 million money market funding arrangement, which allowed us to pay down short-term borrowings that required over $270 million of our investment portfolio to be pledged as collateral. This collateral is now unencumbered, and available to meet certain unforeseen liquidity demands that may arise. To minimize exposure to changes in interest rates from this funding arrangement, we entered into a hedging transaction to fix the effective interest cost at 2.95% over a five-year period. This leverage transaction has provided sufficient net interest income to offset the cost of the CPP dividend payments, and provide additional operational income to the Company. During 2009, to meet our loan and asset growth demands, we sold approximately $90 million of investment securities that were purchased as part of the above leverage strategy, described above; recognizing gains in excess of $3.7 million.

Our balance sheet showed growth during 2009. At year end, total assets reached $1.63 billion, an increase of $61.3 million, or 3.9%, from December 31, 2008. The average balances of interest-earning assets increased $379.5 million to $1.50 billion during 2009, compared to $1.12 billion during 2008 due primarily to our above mentioned leverage strategy. Period-end loans were up $71.4 million, or 7.1%, from December 31, 2008. Loan growth increased primarily in the loan categories of commercial real estate loans and residential mortgage

 

22


loans in the amounts of $98.7 million and $34.4 million, respectively. During 2009, the Company made significant strides in reducing the amount of loans in the commercial and residential construction categories in the amount of $73.6 million. We will continue to divest exposure in certain loan categories as warranted. We also experienced strong growth in deposits over the past year. Period-end deposits at December 31, 2009 were $1.35 billion, an increase of $203.9 million from December 31, 2008. Deposit growth increased primarily in interest-bearing demand deposits in the amount of $393.5 million, with decreases of $196.0 million in time deposits. We continue to remain well capitalized with total shareholder equity of $126.2 million.

The Company’s net interest margin and net interest spread expanded in 2009 after falling in 2008 due to the aggressive competitive pricing for deposits, the effect of the Federal Reserve’s action in lowering short-term rates in 2008 and the financial industry-wide actions to build up liquidity. The Company’s net interest margin increased 22 basis points to 3.39% for the year ended December 31, 2009, from 3.17 % in 2008. This increase was primarily from significantly lower cost of funds, from both demand deposits and lower wholesale funding costs. The average cost of funds decreased by 120 basis points during 2009, offset by the decrease in the average yield of interest-earning assets of 93 basis points. The average balances of interest-bearing liabilities increased by $355.8 million during 2009, consistent with the increase in our interest-earning assets. The Company’s net interest spread increased 27 basis points to 3.27% for the year ended December 31, 2009, from 3.00% in 2008.

During 2009, the Company began investing in many of the critical infrastructure areas that are helping the Company best manage through this economic slowdown, as well as position the Company to be ready to take advantage of value creation opportunities as they arise. The Company has invested significant resources in the credit department during 2009 that have better prepared our Company to identify and manage problem credits with an emphasis towards minimizing losses over both the short and long-term. This additional depth helps position our Company not only to provide the necessary enhanced oversight and credit review during this economic downturn, but puts the strength in the field to provide the service required for growth and expansion we expect of our franchise over the next several years. These changes have resulted in the addition of nine new seasoned credit and special assets professionals and a greater level of interconnectivity between the loan officers and the credit administration area. The Company has also created and enhanced its capabilities in the areas of retail banking, treasury and corporate cash management, private banking, and wealth management. Each of these areas has benefitted from significant investments in people, systems, training and marketing to better acquire and service a growing customer and potential customer base in each of our markets.

The Company has also completed the construction of a permanent banking office for our North Davidson operation during 2009, as well as taking advantage of a value creation opportunity by our entry into the Concord market. We were able to attract a seasoned team of bankers with over 100 years of banking experience in that market. We are pleased with the early success of this team and are excited about the future of this partnership with the Concord community.

As management and the Board look ahead to 2010, it is uncertain how long and at what pace the economic slowdown will persist, and what impact future movements in interest rates or fiscal policies will have on the slope of the yield curve. We are positioning our balance sheet and interest income stream to partially participate in future rate moves, while reducing our exposure to pronounced movements in rates in either direction. Management believes these strategic initiatives now in place are a prudent way to protect the long-term income stream of our Company.

FINANCIAL CONDITION

DECEMBER 31, 2009 AND 2008

Total assets at December 31, 2009 were $1.63 billion, an increase of $61.3 million, or 3.9%, from $1.57 billion at December 31, 2008. This growth primarily was a result of the Company’s continued focus to lend to our customers during this economic downturn. Total loans increased by $71.4 million in 2009, with this increase composed principally of increases in the Company’s commercial and residential real estate mortgage loans, being offset by decreases in both the commercial and residential construction portfolios. The Company has actively and aggressively reduced the overall exposure to the acquisition, development and construction sector during 2009. New loan originations in this area during 2009 carried much higher credit standards for liquidity, contingencies, net worth, loan-to-value and management expertise.

The Company continually monitors liquidity levels in relation to the market conditions, and adjusts levels to what we deem to be an appropriate level for the current operating environment. Historically, liquid assets,

 

23


consisting of cash and demand balances due from banks, interest-earning deposits in other banks and investment securities available for sale have been managed towards a target of 10% of total assets. With debt markets becoming less liquid, unsecured credit availability through correspondent institutions less reliable, and customers shifting funds to maximize their FDIC insurance protection, management began maintaining higher levels of liquid assets throughout 2009 and 2008. At December 31, 2009, liquid assets totaled $408.7 million, or 25.0% of total assets, with the majority being available to meet short-term liquidity needs. At December 31, 2008, liquid assets totaled $453.3 million, or 28.8% of total assets.

The Company, as a member of the FHLB, had an investment of $6.2 million in FHLB stock at December 31, 2009, a decrease of $7.2 million from $13.4 million at December 31, 2008. During 2009, the Company had repaid overnight advances with the FHLB and reduced its required stock investment. This action was taken in advance of a growing concern that this investment may ultimately be considered impaired or be a nonperforming asset for an undeterminable period. The Company’s investment in premises and equipment increased by $1.9 million, primarily as a result of the completion of our North Davidson branch office and the purchase of a facility to accommodate our entry into the Concord market. At December 31, 2009, the Company had goodwill of $26.1 million that is not amortizable and core deposit intangibles, associated with prior acquisitions, amounted to $1.6 million. Other assets increased by $40.1 million, primarily from the purchase of $24.0 million in interest rate derivative contracts, increases in other real estate owned of $9.3 million and the required prepayment of FDIC insurance assessment in the amount of $8.5 million.

Funding to support higher total assets held at year-end was provided by an increase of $203.9 million in deposit accounts, partially offset by a decrease of $148.9 million in short-term borrowings. During 2009, there was $5.0 million of long-term debt that was reclassified to short-term borrowings since the maturity of the debt was within one year. The increase in deposit accounts was due to an increase of $393.5 million in interest-bearing demand accounts, with $273.7 million of the increase coming from brokered money market accounts and the remaining $119.8 million from our local markets. Large denomination time deposits decreased by $ 240.4 million during 2009, with the majority of maturities coming from wholesale sources, being offset by an increase of $44.4 million in other time deposits that were primarily issued within our local markets. At year-end 2009, the Company had $472.4 million in large denomination time deposits, the majority of which has been obtained through the wholesale markets, compared to $712.8 million at the end of 2008. These time deposits had maturities ranging from three months to eight years at rates at or below those being quoted in the local markets at the time of closing. Included in short-term borrowings was $15.5 million outstanding on a $25 million line of credit to the Company, which has been drawn up to increase the Company’s equity investment in and augment capital levels of the Bank.

During 2009, total shareholders’ equity increased by $5.5 million, or 4.6%, to $126.2 million. The Company’s retained earnings increased by $3.5 million for the year ended December 31, 2009, which was comprised of net income of $6.5 million, offset by common share dividends of $1.1 million and dividend and discount accretion on preferred stock of $2.0 million. Accumulated other comprehensive income increased $1.7 million to $5.1 million for the year ended December 31, 2009 compared to $3.4 million for the year ended December 31, 2008. The Company and the Bank are subject to minimum capital requirements. The Company repurchased 15,066 common shares in January 2009 as part of the stock repurchase plan approved by the Board of Directors and the UST. All capital ratios continue to place the Company and the Bank in excess of the minimum required to be deemed a “well-capitalized” bank by regulatory measures.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2009 AND 2008

Overview. The Company reported net income of $6.5 million and net income available to common shareholders of $4.6 million, or $0.62 per diluted common share for the year ended December 31, 2009, as compared to net income of $4.0 million and net income available to common shareholders of $3.8 million, or $0.52 per diluted common share for 2009. Net interest income increased by $12.6 million in 2009, while non-interest income increased by $3.0 million. The increases in income were partially offset by the increases in the provision for loan losses and non-interest expenses in the amounts of $8.7 million and $5.1 million, respectively. Included in non-interest expenses was an increase of $2.2 million in FDIC insurance assessments for 2009. Also reducing income available to common shares for the year ended December 31, 2009 were dividends and discount accretion on the Company’s preferred stock, issued as part of the UST’s CPP, totaling $2.0 million, or $0.27 per diluted common share.

 

24


Net Interest Income. Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, “volume” refers to the average dollar level of interest-earning assets and interest-bearing liabilities, “spread” refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and “margin” refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities.

Table 2 and Table 3 following this discussion, “Average Balances and Net Interest Income” and “Volume and Rate Variance Analysis,” respectively, presents an analysis of the Bank’s net interest income and rate/volume activity for 2009 and 2008.

As described above, the primary component of earnings for the Company is net interest income. Net interest income increased to $46.2 million for the year ended December 31, 2009, a $12.6 million, or 37.5%, increase from the $33.6 million earned in 2008 due to an increase in net interest-earning assets and improvement in the net interest margin. The average balance of interest-earning assets increased $379.5 million to $1.50 billion during 2009, compared to $1.12 billion during 2008 due primarily to growth in the investment securities portfolio. For the year ended December 31, 2009, the net interest margin increased 22 basis points to 3.39% from 3.17% in 2008, resulting primarily from an increase in demand deposits, which are typically among the Company’s lowest cost of funds, combined with lower wholesale funding costs.

Total interest income increased $8.0 million, or 11.3%, to $79.1 million for the year ended December 31, 2009 compared to $71.0 million for the year ended December 31, 2008. Average total interest-earning assets increased $379.5 million during 2009 as compared to 2008, while the average yield decreased by 93 basis points from 6.52% to 5.59%. The increase in interest income was due to the $311.2 million increase in the average balance of investment securities, with corresponding interest income increasing by $15.7 million, from $5.8 million in 2008 to $21.5 million in 2009. This increase was slightly offset by 22 basis point decline in the tax-effected average yield. Interest income on loans decreased $7.3 million primarily due to a 100 basis point decline in average yields resulting from lower market rates, being partially offset by a rise in the average balance of loans, which increased $45.6 million to $1.03 billion for the year ended December 31, 2009.

Total interest expense decreased $4.6 million, or 12.2%, to $32.9 million for the year ended December 31, 2009 when compared to the year ended December 31, 2008. Average total interest-bearing liabilities increased by $355.8 million during 2009, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities decreased by 120 basis points from 3.52% to 2.32%. This decrease is primarily due to a decline in the average cost of funds partially offset by an increase in the average balance of interest-bearing liabilities. The increased average balances of interest-bearing liabilities resulted from increases in the average balances of demand and time deposits, which were used to fund asset growth. The average balance on demand deposits increased by $271.0 million, with an average yield of 1.24% for the year ended December 31, 2009, compared to an average yield of 1.51% in 2008. The average balances of time deposits increased by $95.5 million during 2009, while the average yield on time deposits decreased by 107 basis points to 2.93% from 4.00% in 2008. At December 31, 2009, time deposits comprised 52.2% of total deposits.

Interest expense on borrowings decreased $2.7 million to $4.0 million for the year ended December 31, 2009 compared to $6.7 million for the year ended December 31, 2008. The average yield on borrowings, including FHLB advances, subordinated debt and other short-term borrowings, decreased 142 basis points to 2.46% from 3.88% in 2008. The decrease reflects the effects of lower market interest rates during 2009 on the Company’s variable-rate borrowings.

Provision for Loan Losses. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. The provision for loan losses for the year ended December 31, 2009 was $15.8 million, representing an increase of

 

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$8.7 million from the $7.1 million provision made in 2008. The allowance for loan losses, as a percentage of loans outstanding, increased from 1.31% at the beginning of 2009 to 1.60% at the end of the year. At December 31, 2009, the allowance for loan losses was $17.3 million, an increase of $4.1 million, or 31.0% from the $13.2 million at the end of 2008. The increases in the provision and the allowance for loan losses over the last two years were due to an increase in nonperforming loans, continued weakness in the residential construction and housing markets, and the recessionary economic environment, as well as overall loan growth.

Net loan growth totaled $67.3 million in 2009 and $73.8 million in 2008. At December 31, 2009, the Company had $19.1 million in nonaccrual and restructured loans compared to $13.3 million at the end of 2008. The nonaccrual balance at December 31, 2009 has been written down to a balance that management believes is collectible under current market conditions. Net loan charge-offs for 2009 were $11.7 million, or 1.13% of average loans outstanding during the year. Net charge-offs for 2008 were $5.7 million, resulting in a 0.58% ratio of average loans outstanding for the year.

Non-Interest Income. Non-interest income increased to $8.7 million for the year ended December 31, 2008 as compared with $5.7 million for the year ended December 31, 2008, an increase of $3.0 million, or 53.7%. The increase resulted primarily from the $3.4 million increase in net gain on sales of investment securities, and fee income from the Company’s mortgage origination unit increased in 2009 by $325,000, due to increased volume from the low interest rate environment. Offsetting these increases were decreases in service charges on deposits, investment brokerage fees and earnings on bank-owned life insurance decreasing, in aggregate, by $669,000. These decreases were a result of tightened consumer spending and the continued effects of the current economic environment. Table 4 following this discussion presents a comparative analysis of the components of non-interest income.

Non-Interest Expenses. Non-interest expenses totaled $32.9 million for the year ended December 31, 2009, an increase of $5.1 million over the $27.8 million reported for 2008. Salaries and employee benefits increased by $1.2 million, attributable to the development of a treasury and support team for core deposit generation, the expansion of the retail banking team, the staffing associated with the new Eastchester Road branch office in High Point and the new Concord office that opened in the third quarter of 2009, the formation of a special assets team and further expansion of our credit underwriting and review areas. FDIC insurance assessments increased $2.2 million as a result of increased annual assessment fees imposed by the FDIC and the $750,000 special deposit insurance assessment that was levied on all insured depository institutions. Advertising and business development expenses increased by $683,000 as part of the Company’s strategy to grow core deposits and increase visibility during a period when many of the larger competitors were being acquired or in a defensive posture. Data processing and supply and furniture and equipment expense categories increased by $148,000 and $391,000, respectively, largely from the opening of new branch offices and overall growth of the Company during 2009. Insurance, professional and other services increased by $341,000, attributable to strategic related expenditures, increased corporate governance and the overall growth of the Company. The remaining non-interest expense category increases resulted from the Company’s continued growth and development during 2009 and 2008. Table 5 following this discussion presents a comparative analysis of the components of non-interest expenses.

Income Taxes. The Company generates significant amounts of non-taxable income from tax exempt investment securities and from investments in bank-owned life insurance. Accordingly, the level of such income in relation to income before income taxes significantly affects our effective tax rate. For the year ended December 31, 2009, non-taxable income exceeded income before income taxes, resulting in a reduction of total income subject to income taxes for the year. For 2009, the provision for income taxes reflects a tax benefit of $285,000, or 4.6% of income before income taxes. For 2008, the provision for income taxes reflects a charge of $414,000, or 9.4% of income before income taxes.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2008 AND 2007

Overview. The Company reported net income of $3.99 million and net income available to common shareholders of $3.85 million, or $0.52 per diluted share for the year ended December 31, 2008, as compared with net income of $7.44 million, or $1.05 per diluted share for 2007. Net interest income increased by $1.2 million, or 3.7%, in 2008, while non-interest income increased by $402,000, or 7.7%. The increases in income are less than the $3.7 million increase in non-interest expenses, which totaled $27.8 million in 2008 as compared with $24.1 million in 2007.

 

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The most significant factors affecting the Bank’s performance in 2008 was a further decline in the Company’s net interest margin from 3.60% to 3.17%, an increase in credit losses which resulted in the provision for loan losses increasing from $3.1 million in 2007 to $7.1 million in 2008. Operating expenses were higher in 2008 compared to 2007, primarily due to a $625,000 one-time separation from employment settlement with one of our former executive officers, the opening of our second High Point office, operating the Harrisburg full service office for a full year, a $395,000 increase in FDIC insurance premiums, and the additional cost associated with a 34% increase in deposits and an 8% increase in loans.

Net Interest Income. Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, “volume” refers to the average dollar level of interest-earning assets and interest-bearing liabilities, “spread” refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and “margin” refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2008 and 2007, average interest-earning assets were $1.12 billion, and $943.8 million, respectively. During these same years, the Company’s tax-effected net yields on average interest-earning assets were 3.17% and 3.60%, respectively. The decrease in the net interest margin from 2007 to 2008 was due primarily when the Federal Reserve began aggressively reducing short-term rates in the second half of 2007. Over an 18 month period, the Federal Reserve dropped the short-term benchmark rates by 500 basis points, while much of the deposit funding cost declined by considerably less, resulting in an 18 month downward trend in net interest margin.

Table 2 and Table 3 following this discussion, “Average Balances and Net Interest Income” and “Volume and Rate Variance Analysis,” respectively, presents an analysis of the Company’s net interest income and rate/volume activity for 2008 and 2007.

As described above, the primary component of earnings for the Company is net interest income. Net interest income increased to $33.6 million for the year ended December 31, 2008, a $1.2 million or 3.7% increase from the $32.4 million earned in 2007. Total interest income benefited from strong growth in the level of average earning assets which offset the marked decline in the Company’s net interest margin. Average total interest-earning assets increased $173.0 million, or 18.3%, during 2008 as compared to 2007, while the average yield decreased by 145 basis points from 7.97% to 6.52%. Average total interest-bearing liabilities increased by $171.5 million, or 19.2%, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities decreased by 111 basis points from 4.63% to 3.52%. With the yield on earning assets declining by 34 basis points more than the cost on funding, the Bank’s net interest margin decreased by 43 basis points. For the year ended December 31, 2008 the net interest margin was 3.17%, while for the year ended December 31, 2007, the net interest margin was 3.60%.

Provision for Loan Losses. The Company recorded a $7.1 million provision for loan losses in 2008, representing an increase of $4.0 million from the $3.1 million provision made in 2007. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. In both 2008 and 2007 the provision for loan losses was made principally in response to growth in loans and to cover net charge-offs. Net loan growth totaled $73.8 million in 2008 and $156.5 million in 2007. The allowance for loan losses, as a percentage of loans outstanding, increased from 1.26% at the beginning of 2008 to 1.31% at the end of the year. At December 31, 2008, the allowance for loan losses was $13.2 million, an increase of $1.4 million, or 12.1% from the $11.8 million at the end of 2007. At December 31, 2008, the Bank had $13.3 million in nonaccrual and restructured loans compared to $3.6 million at the end of 2007. The nonaccrual balance at December 31, 2008 has been written down to a balance that management believes is collectible under current market conditions. Net loan charge-offs for 2008 were $5.7 million or 0.58% of average loans outstanding during the year. Net charge-offs for 2007 were $1.7 million, resulting in a 0.20% ratio of average loans outstanding for the year.

 

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Non-Interest Income. Non-interest income increased to $5.6 million for the year ended December 31, 2008 as compared with $5.2 million for the year ended December 31, 2007, an increase of $402,000 or 7.7%. The increase resulted from securities gains of $223,000 in 2008, and a $210,000 increase in cash surrender value of life insurance. The fee income from the Company’s mortgage origination unit decreased in 2008 by $56,000, while service charges on deposits and other services increased by $111,000, or 3.8%. Table 4 following this discussion presents a comparative analysis of the components of non-interest income.

Non-Interest Expenses. Non-interest expenses totaled $27.8 million for the year ended December 31, 2008, an increase of $3.7 million over the $24.1 million reported for 2007. Substantially all of this increase resulted from the Bank’s growth and development during 2008 and 2007, including the expanded staffing of several offices, a $625,000 one-time separation from employment settlement with one of our former executive officers, the opening of our second High Point office, operating the Harrisburg full service office for a full year, a $395,000 increase in FDIC insurance premiums, and the additional cost associated with a 34% increase in deposits and an 8% increase in loans. Personnel costs increased by $1.6 million, or 10.6%, with the $625,000 one time employment separation charge accounting for 39% of the increase. Included in this increase in personnel costs were the effects of the adoption of accounting for post retirement split dollar expense, which added $142,000 in 2008, whereas there was no such expense in 2007. Table 5 following this discussion presents a comparative analysis of the components of non-interest expenses.

Income Taxes. The provision for income taxes of $414,000 in 2008 and $3.1 million in 2007 represents 9.4% and 29.1%, respectively, of income before income taxes. These effective rates are lower than the blended federal/North Carolina statutory rate of 38.55% principally due to tax-exempt income from municipal bonds and bank-owned life insurance.

LIQUIDITY

Liquidity management involves the ability to meet and ensure the cash flow requirements of the Company’s depositors and borrowers, as well as the Company’s various needs, including operating, strategic and capital. In addition, the Company’s principal source of liquidity is dividends from the Bank and an unsecured revolving line of credit with another financial institution. Liquidity is required at the parent holding company level for the purpose of paying dividends declared for its common and preferred shareholders, servicing debt, as well as general corporate expenses. The Company’s Asset/Liability Committee meets on a regular basis to consider the operating needs of the Company and the Bank, reviewing internal analysis of its liquidity, knowledge of current economic and market trends and forecasts of future conditions.

The asset portion of the balance sheet provides liquidity primarily through loan principal repayments, maturities of investment securities, interest-earning deposits in other banks and occasional sales of various assets. These funds are used to make loans and to fund continuing operations. At December 31, 2009, these sources totaled $408.7 million, or 25% of total assets.

The liability portion of the balance sheet provides liquidity primarily through various interest-bearing and non-interest-bearing deposit accounts. The Company may purchase federal funds through unsecured federal funds guidance lines of credit totaling $45.0 million, with $13.3 million outstanding at December 31, 2009. In addition, the Company had credit availability with the FRB and FHLB of approximately $383.0 million, with $74.0 million outstanding. The Company also has access to the wholesale deposit markets for additional liquidity.

Management anticipates that the Company will rely primarily upon wholesale funding sources, customer deposits, loan repayments and current earnings to provide liquidity, fund loans and to purchase investment securities. Investment securities will be primarily issued by the federal government and its agencies, municipal securities and government agency sponsored mortgage-backed securities. See “SOURCES OF FUNDS” below in this Item 6 for an overview of the deposit activities and borrowings of the Company and the Bank.

In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require future cash outflows. Table 6 following this discussion, “Contractual Obligations and Commitments”, summarizes the Company’s contractual obligations and commitments as of December 31, 2009.

 

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CAPITAL RESOURCES

At December 31, 2009 and 2008, the Company’s tangible shareholders’ equity totaled $98.5 million and $92.7 million, respectively. The Company’s tangible equity to asset ratio on those dates was 6.03% and 5.90%, respectively. The Company’s Tier I Leverage ratio as of December 31, 2009 and 2008 was 7.43% and 8.77%, respectively. These ratios are above regulatory minimums necessary to be classified as well-capitalized. The Company and the Bank are subject to minimum capital requirements. See “PART 1, ITEM 1 — BUSINESS” — Supervision and Regulation.”

On December 5, 2008, the Company issued 31,260 shares of Series A preferred stock and a warrant to purchase 543,337 shares of the Company’s common stock to the UST through a private placement. This issuance of shares was not registered under the Securities Act of 1933, as amended, in reliance on the exemption set for in Section 4(2) thereof. The Series A preferred stock qualifies as Tier I capital under risk-based capital guidelines and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. The Series A preferred stock is non-voting except for class voting rights on matters that would adversely affect the rights of the holders of the Series A preferred stock.

The Company also utilizes alternative forms of regulatory capital to supplement our shareholders’ equity in order to remain “well capitalized” for regulatory purposes. The Company has issued four blocks of 30 year variable rate junior subordinated debentures to its wholly owned capital trusts: $5.2 million in April of 2003 priced at 3 month LIBOR + 3.25%; $6.2 million in March of 2004 priced at 3 month LIBOR + 2.80%; $5.2 million in September of 2004 priced at 3 month LIBOR + 2.40%; and $7.2 million in September of 2006 priced at 3 month LIBOR + 1.70%. In addition, during 2005 the Bank issued $8.0 million of subordinated debentures at 3 month LIBOR + 1.80%, which counts as Tier II capital for regulatory purposes. These instruments are classified as long-term debt on our Company’s financial statements.

Note J to the accompanying consolidated financial statements presents an analysis of the Company’s and Bank’s regulatory capital position as of December 31, 2009 and 2008. Management expects that the Company and the Bank will remain “well-capitalized” for regulatory purposes throughout 2010, although there can be no assurance that the Bank or Company will not fall into the “adequately-capitalized” classification.

ASSET/LIABILITY MANAGEMENT

The Company’s results of operations depend substantially on its net interest income. Like most financial institutions, the Company’s interest income and cost of funds are affected by general economic conditions and by competition in the marketplace. The purpose of asset/liability management is to provide stable net interest income growth by protecting the Company’s earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. The Company maintains, and has complied with, an asset/liability management policy approved by the Board of Directors of the Company that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities, earnings at risk, and economic value at risk. This policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a narrow range around an earnings neutral position, which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

When suitable lending opportunities are not sufficient to utilize available funds, the Company has generally invested such funds in investment securities, primarily U.S. Treasury securities, securities issued by governmental agencies, government agency sponsored mortgage-backed securities and securities issued by local governmental municipalities. The investment securities portfolio contributes to the Company’s profits, and plays an important part in the overall interest rate management. However, management of the investment securities portfolio alone cannot balance overall interest rate risk. The investment securities portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in the overall management of the investment securities portfolio are safety, yield, liquidity, asset/liability management (interest rate risk), and investing in securities that can be pledged for public deposits or as collateral for FHLB advances or borrowings through the Federal Reserves Discount Window.

 

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In reviewing the needs of the Company with regard to proper management of its asset/liability program, the Company’s management estimates its future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing), and forecasted interest rate changes. A number of measures are used to monitor and manage interest rate risk, including income simulations and interest sensitivity analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayments on loan and loan-backed assets, cash flows and maturities of other investment securities, loan and deposit volumes and pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Based on the results of the income simulation model as of December 31, 2009, looking forward for 12 months, the Company would expect an increase in net interest income of $146,000 if interest rates increase from current rates by 300 basis points and a decrease in net interest income of $1.8 million million if applicable interest rates decrease from current rates by 300 basis points. However, in today’s economic environment, simulation models may not be as reliable as in the past.

The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the exposure to interest rate risk. Management believes that because interest rate gap analysis does not address all factors that can affect earnings performance, it should be used in conjunction with other methods of evaluating interest rate risk.

Table 7 following this discussion, “Interest Rate Sensitivity Analysis” sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2009, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts are considered rate sensitive and are placed in the shortest period, while negotiable order of withdrawal or other transaction accounts are assumed to be more stable sources that are less price elastic and have been placed in the longest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments, which will be received throughout the lives of the loans. The interest rate sensitivity of the Company’s assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.

Table 7 illustrates that if assets and liabilities reprice in the time intervals indicated in the table, the Company is asset sensitive within twelve months, and asset sensitive thereafter. As stated above, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. For instance, while the table is based on the assumption that money market accounts are immediately sensitive to movements in rates, the Company expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in categories of assets that are considered to be immediately sensitive. The same is true for all other interest bearing transaction accounts. Additionally, certain assets have features that restrict changes in the interest rates of such assets both on a short-term basis and over the lives of such assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. Due to these shortcomings, the Company places primary emphasis on its income simulation model when managing its exposure to changes in interest rates.

LENDING ACTIVITIES

General. The Company provides to its customers a full range of short- to medium-term commercial, mortgage, construction and personal loans, both secured and unsecured. The Company also makes real estate mortgage and construction loans.

 

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The Company’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans that the Company seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Company, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Boards of Directors of the Company. The Company supplements its own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work. The Company has focused its portfolio lending activities on higher yielding commercial loans.

Table 8 following this discussion provides an analysis of the Company’s loan portfolio composition by type of loan as of the end of each of the last five years.

Table 9 following this discussion presents, at December 31, 2009, (i) the aggregate maturities or repricing of loans in the named categories of the Company’s loan portfolio and (ii) the aggregate amounts of variable and fixed rate loans that mature or reprice after one year.

Commercial Loans. Commercial business lending is a major focus of the Company’s lending activities. At December 31, 2009, the Company’s commercial and industrial loan portfolio and lease portfolio equaled $125.9 million or 11.7% of total loans, as compared with $113.8 million or 11.3% of total loans at December 31, 2008. Commercial and industrial loans and leases include both secured and unsecured loans for working capital, expansion, and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. The Company also makes term commercial loans secured by real estate, which are categorized as real estate loans. Lending decisions are based on an evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment.

Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans. More frequent repricing means that yields on our commercial loans adjust with changes in interest rates.

Real Estate Loans. Real estate loans are made for purchasing and refinancing 1-4 family, multi-family and commercial properties. Real estate loans also include home equity credit lines. The Bank offers fixed and adjustable rate options and provides customers access to long-term conventional real estate loans through its mortgage loan department which makes secondary market conforming loans that are originated with a commitment from a correspondent financial institution to purchase the loan within 30 days of closing.

Residential real estate loans amounted to $257.4 million and $223.1 million at December 31, 2009 and 2008, respectively. The Company’s residential mortgage loans are generally secured by properties located within the Bank’s market area. The financing of residential properties, both 1-4 family and multi-family, for rental purposes has historically been the predominant portion of the residential real estate portfolio, as Thomasville and Lexington have a high ratio of renters per capita.

Many of the residential mortgage loans that the Company makes are originated for the account of third parties. Such loans are classified as loans held for sale in the financial statements. At December 31, 2009 and 2008, loans held for sale amounted to $2.8 million and $560,000, respectively. The Company receives fees for each such loan originated, with such fees aggregating $1.1 million for the year ended December 31, 2009 and $783,000 for the year ended December 31, 2008. The Company anticipates that it will continue to be an active originator of residential loans for the account of third parties. The Company does not originate sub-prime mortgages, unless through a correspondent who has full underwriting authority. In these cases, since the Company is not involved in the credit decision, there is limited exposure to defaults and buy back provisions.

Commercial real estate loans totaled $449.5 million and $350.8 million at December 31, 2009 and 2008, respectively. This lending has involved loans secured principally by commercial buildings for office, storage and warehouse space, and by agricultural properties. Generally in underwriting commercial real estate loans, the

 

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Company requires the personal guaranty of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate may be in greater amount and involve a greater degree of risk than 1-4 family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

Real Estate Construction Loans. Real estate loans are made for constructing 1-4 family and multi-family residential properties, the acquisition and development of land for the purpose of providing residential and commercial lots for sale, and the construction of commercial properties. The Company primarily offers a variable rate option and provides customers access to short-term conventional real estate financing through a reasonable construction and development process. At December 31, 2009, the real estate construction loan portfolio was $233.7 million, which consisted of the following categories:

 

•   Acquisition and development

   $41.6 million

•   Residential construction

   $49.1 million

•   Commercial construction

   $41.2 million

•   1-4 buildable lots

   $41.1 million

•   Commercial buildable lots

   $14.9 million

•   Land held for development

   $28.5 million

•   Raw/Agricultural land

   $17.3 million

Management closely monitors residential real estate, specifically its Acquisition, Development and Construction loans, since these loans are generally considered most vulnerable to economic downturns. We attempt to mitigate this risk by employing experienced real estate lenders, providing real estate underwriting standards within the Credit Policy Manual, engaging an outside firm to conduct ongoing credit reviews and, most recently, contracting with a firm to provide quarterly real estate updates and trends for communities in which where we have credit exposure. Most residential construction loans require full personal guarantees from the principals of the borrowing entity and maturities are typically limited to 12 months. Trends within the bank’s real estate portfolio have followed the general trends within our markets including increases in average time houses are on the market for sale and housing inventory available for sale with a slight decrease in average home prices. Increases in 2009 and 2008 non-performing assets were primarily due to specific adjustments within the real estate portfolio.

The first program we initiated after receiving CPP funds was our Builder Participation Program. This Program makes available up to $50 million of in-house credit to qualified buyers who purchase residential housing inventory currently being financed as part of our residential construction loan portfolio. With the secondary mortgage market functioning inefficiently, we have increased our in-house commitment to fill this credit vacuum, providing builders in our market with a source of qualified buyers and making affordable and rational credit more readily accessible. The Builder Participation Program is a major commitment on our part to help stabilize the housing market in our communities and provide credit locally. To date, $22.9 million of affordable mortgage loans have been provided under the Builder Participation Program.

Loans to Individuals. Loans to individuals include automobile loans, boat and recreational vehicle financing and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if secured, because the collateral often consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Company attempts to manage the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

COMMITMENTS TO EXTEND CREDIT

In the ordinary course of business, the Company enters into various types of transactions that include commitments to extend credit that are not included in loans receivable, net, presented on the Company’s consolidated balance sheets. The Company applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The Company’s exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. The Company does not expect that all such commitments will fund. See Table 6 and Note N to the accompanying consolidated financial statements.

 

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ASSET QUALITY

The Company considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to its lending policy as approved by the Company’s and the Bank’s Boards of Directors. It is the responsibility of each lending officer to assign an appropriate risk grade to every loan originated. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, it is Credit Administration’s and the Lender’s responsibility to change the borrower’s risk grade accordingly. The function of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in the Company’s market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio.

The Company’s policy regarding past due loans normally requires a prompt charge-off to the allowance for loan losses following timely collection efforts and a thorough review. Further efforts are then pursued through various means available. Loans carried in a non-accrual status are generally collateralized and probable losses are considered in the determination of the allowance for loan losses.

 

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NONPERFORMING ASSETS

The Company’s nonperforming assets, which consist of loans past due 90 days or more, real estate acquired in the settlement of loans, restructured loans and loans in nonaccrual status, increased to $33.4 million, or 2.04% of total assets, at December 31, 2009 from $18.3 million, or 1.17% of total assets at December 31, 2008. This increase was primarily due to a continued softening in the real estate market due to the severe economic downturn. Our allowance for loan losses, expressed as a percentage of gross loans, was 1.60% and 1.31% at December 31, 2009 and 2008, respectively.

Table 10 following this discussion sets forth, for the periods indicated, information with respect to the Bank’s nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual loans plus restructured loans plus loans ninety days past due and still accruing), and total nonperforming assets.

The Company’s consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan on nonaccrual basis. The Company accounts for loans on a nonaccrual basis when it has serious doubts about the ability to collect principal or interest in full. Generally, the Company’s policy is to place a loan on nonaccrual status before the loan becomes past due 90 days. Loans are also placed on nonaccrual status in cases where management is uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. The Company accrues interest on restructured loans at the restructured rates when management anticipates that no loss of original principal will occur. Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans above, but about which management has serious doubts as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or restructured loans, so they are considered by management in assessing the adequacy of the Company’s allowance for loan losses. At December 31, 2009, the Company had $19.1 million in nonaccrual and renegotiated loans, an increase of $5.7 million from $13.3 million at the end of 2008. There were no loans ninety-days past due and still accruing interest at the end of either 2009 or 2008. Real estate acquired in the settlement of loans consists of foreclosed, repossessed and idled properties, both residential and commercial. At December 31, 2009 and 2008, there were $14.3 million and $5.0 million, respectively, in assets classified as real estate owned. The carrying values of real estate owned represent the lower of the carrying amount or fair value less costs to sell.

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Management increases allowance for loan losses by provisions charged to operations and by recoveries of amounts previously charged off. The allowance is reduced by loans charged off. Management evaluates the adequacy of the allowance at least monthly. In addition, on a monthly basis our Board of Directors reviews the loan portfolio, conducts an evaluation of credit quality and reviews the computation of the loan loss allowance. In evaluating the adequacy of the allowance, management considers the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors deriving from the Bank’s history of operations. In addition to the Company’s history, management also considers the loss experience and allowance levels of other similar banks and the historical experience encountered by our management and senior lending officers prior to joining us. In addition, regulatory agencies, as an integral part of their examination process, periodically review allowance for loan losses and may require us to make additions for estimated losses based upon judgments different from those of management. No regulatory agency asked for a change in our allowance for loan losses during 2009 or 2008.

Management uses the risk-grading program, as described under “Asset Quality,” to facilitate evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by loan officers and reviewed by Credit Administration, and tested by the Company’s internal auditor. The testing program includes an evaluation of a sample of new loans, large loans, loans that are identified as having potential credit weaknesses, loans past due 90 days or more and still accruing, and nonaccrual loans. The Company strives to maintain the loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of the Company’s market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies. The Company has no foreign loans and does not engage in significant lease financing or highly leveraged transactions.

 

34


Management follows a loan review program designed to evaluate the credit risk in our loan portfolio. Through this loan review process, we maintain an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as substandard, doubtful or loss and reserves are allocated based on management’s judgment and historical experience.

Loans classified as “substandard” are those loans with clear and defined weaknesses such as unfavorable financial ratios, uncertain repayment sources or poor financial condition that may jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some losses if the deficiencies are not corrected. A reserve range of 5% - 45% is generally allocated to these loans, depending on credit quality. Loans classified as “doubtful” are those loans that have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable. A reserve of 50% or greater is generally allocated to loans classified as doubtful. Loans classified as “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this asset even though partial recovery may be achieved in the future. As a practical matter, when loans are identified as loss they are charged off against the allowance for loan losses. In addition to the above classification categories, the Company also categorizes loans based upon risk grade and loan type, assigning an allowance allocation based upon each category.

Growth in loans outstanding has, throughout the Company’s history, been the primary reason for increases in the Company’s allowance for loan losses and the resultant provisions for loan losses necessary to provide for those increases. This growth has been spread among the Company’s major loan categories, with the concentrations of major loan categories being relatively consistent from 2000 through 2003. Over the five-year period from 2004 through 2008, there has been an increase in the concentration of real estate construction loans and real estate loans while there has been a decline in the percentage of the portfolio made up of commercial and industrial loans. This reflects the real estate lending background and experience of our lenders and the growth opportunities in the Salisbury, Harrisburg, Greensboro and High Point markets.

For the five fiscal years 2004 through 2008, the Bank’s loan loss experience has seen net loan charge-offs in each year range from 0.12% to 0.58% of average loans outstanding. For 2009, net charge-offs were 1.13% of average loans outstanding as compared to 0.58% in the prior year. This increase in the amount of net charge-offs in 2009, compared to 2008 and historical ranges, was due primarily to a significant softening of both the local housing market and local economy.

The Company’s allowance for loan losses at December 31, 2009 of $17.3 million represents 1.60% of total loans outstanding, excluding loans held for sale. The Company’s allowance for loan losses at December 31, 2008 of $13.2 million represented 1.31% of total loans outstanding, excluding loans held for sale. This increase in the allowance relative to our gross loans was primarily due to a higher level of perceived risk in this environment, and a greater amount of specific credits where impairment assessments have been assigned.

The allowance for loan losses represents management’s estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. The Company makes specific allowances that are allocated to certain individual loans and pools of loans based on risk characteristics, as discussed below. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations.

Furthermore, while management believes it has established the allowance for loan losses in conformity with U.S. generally accepted accounting principles, there can be no assurance that regulators, in reviewing our portfolio, will not require an adjustment to the allowance for loan losses. No regulatory agency asked for a change in our allowance for loan losses during 2009 or 2008. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect the Company’s financial condition and results of operations.

 

35


The Company’s primary markets, including the counties of Davidson, Guilford, Randolph, Forsyth, Iredell, Rowan and Cabarrus have historically been very heavily concentrated in textile, furniture, and heavy manufacturing. With the competition from overseas, these industries have experienced significant plant closings and layoffs in our markets. To this point, the retraction in the manufacturing base has had a minimal impact on our loan quality, except in the Thomasville and Archdale markets. However, if this trend continues, it could negatively impact the Company’s asset quality.

Table 11 following this discussion shows the allocation of the allowance for loan losses at the dates indicated. The allocation is based on an evaluation of defined loan problems, historical ratios of loan losses and other factors that may affect future loan losses in the categories of loans shown.

Table 12 following this discussion sets forth for the periods indicated information regarding changes in the Company’s allowance for loan losses.

INVESTMENT ACTIVITIES

The Company’s portfolio of investment securities, the majority of which are available for sale, consists primarily of securities issued by government sponsored agencies, and local governmental municipalities. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value with any unrealized gains or losses, net of related taxes, reflected as an adjustment to stockholders’ equity. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. It is the Company’s policy to classify all investment securities as available for sale, except in the case with certain corporate bond investments in other local community banks. Table 13 following this discussion summarizes investment securities available for sale and held to maturity.

Table 13 following this discussion summarizes the amortized costs, gross unrealized gains and losses and estimated fair values of investment securities available for sale at December 31, 2009, 2008 and 2007.

Table 14 following this discussion summarizes the amortized costs, fair values and weighted average yields of investment securities available for sale at December 31, 2009, by contractual maturity groups.

The Company’s investment security portfolio is an important source of liquidity and earnings. A stated objective in managing the securities portfolio is to provide consistent liquidity to support balance sheet growth but also to provide a safe and consistent stream of earnings.

The Company does not engage in, nor does it presently intend to engage in, securities trading activities and therefore does not maintain a trading account. At December 31, 2009, there were no securities of any issuer (other than governmental agencies) that exceeded 10% of the Company’s shareholders’ equity.

SOURCES OF FUNDS

Deposit Activities. The Company provides a range of deposit services, including non-interest bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. During 2009, the Company’s deposit mix shifted more towards interest-bearing demand accounts, primarily provided through wholesale sources and from our local markets. Interest-bearing demand accounts increased by $393.5 million, or 228.1%, primarily due to a shifting of large denomination time deposits to large balance money market accounts. Time deposits of $100,000 and greater decreased by $240.4 million, or 33.7%. Other time deposits increased $44.4 million, or 23.6%, largely due to our efforts to attract local market deposits.

Total deposits were $1.35 billion and $1.15 billion at December 31, 2009 and 2008, respectively. As a result of the Company’s loan growth exceeding local deposit growth, the Company utilized its wholesale funding sources, such as borrowings from the FRB and FHLB, correspondent banks and the wholesale deposit market.

 

36


During 2009, the Company secured a brokered money market relationship which enabled the Company to pay down borrowings at the FHLB that required over $270 million of our investment securities to be pledged as collateral. This collateral is now unencumbered, and available to meet certain unforeseen liquidity demands that may arise. At December 31, 2009, the outstanding money market relationship totaled $273.7 million. Due to the availability of funds and a wide range of terms available in the wholesale CD market, the Company maintains a portfolio of out-of-market time deposits of $336.7 million at December 31, 2009, compared to $639.1 million in 2008. At December 31, 2009 and 2008, time deposits represented 52.2% and 78.6%, respectively, of the Company’s total deposits. Time deposits of $100,000 or more represented 35.0% and 62.2%, respectively, of the Company’s total deposits at December 31, 2009 and 2008. With many of the national and regional banks experiencing liquidity challenges during the 2009 and 2008, deposit rates in our local markets were at times up to 100 basis points higher than comparable terms in the wholesale markets. While our first choice is always to raise funds in our local markets, with this substantial pricing disparity, management chose to continue to utilize the wholesale deposit markets during 2009. Management believes that most other time deposits are relationship-oriented. While the Company will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, the Company anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity. While the Company has utilized wholesale deposits and overnight advances from the FRB and FHLB as its primary funding source during 2009, these sources are not unlimited, and therefore may not be available to fund future growth in 2010 and beyond.

Borrowings. Borrowings provide an additional source of funding for the Company and the Bank. The Bank may purchase federal funds through unsecured federal funds guidance lines of credit totaling $45.0 million at December 31, 2009. In addition, the Company has an unsecured revolving line of credit of $25 million that is available to utilize at management’s discretion. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate plus a small spread. At December 31, 2009, outstanding balances for federal funds purchased and the revolving line of credit amounted to $13.3 million and $15.5 million, respectively. At December 31, 2008, there was no outstanding balance for federal funds purchased and the revolving line of credit had an outstanding balance of $500,000.

As an additional source of borrowings the Bank utilizes securities sold under agreements to repurchase, with balances outstanding of $16.5 million and $14.0 million at December 31, 2009 and 2008, respectively. Securities sold under agreements to repurchase generally mature within one day from the transaction date and are collateralized by either U.S. Government Agency obligations, government agency sponsored mortgage-backed securities or securities issued by local governmental municipalities.

In addition, the Bank has the ability to borrow funds from the FRB of Richmond utilizing the discount window and the borrower-in-custody of collateral arrangement. As of December 31, 2009, the Company had approximately $185.6 million in additional borrowing capacity available under these arrangements with no outstanding balances for 2009 or 2008.

The Bank also uses advances from the FHLB of Atlanta under a line of credit equal to 30% of the Bank’s total assets, subject to qualifying collateral being pledged. Outstanding advances totaled $74.0 million and $253.6 million at December 31, 2009 and 2008, respectively. These advances are secured by a blanket-floating lien on qualifying first mortgage loans, equity lines of credit, certain commercial real estate loans, and certain government agency sponsored mortgage-backed securities pledged to the FHLB. A more detailed analysis of FHLB advances is presented in Note G and Note H to the accompanying consolidated financial statements.

Table 15 following this discussion sets forth for the periods indicated the average balances outstanding and average interest rates for each major category of deposits.

Table 16 following this discussion sets forth at the dates indicated the amounts and maturities of certificates of deposit with balances of $100,000 or more at December 31, 2009.

Table 17 following this discussion sets forth for the periods indicated information regarding the Company’s borrowed funds.

 

37


MARKET RISK

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. Our market risk arises primarily from interest rate risk inherent in our lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the bank’s asset/liability management function. See “ASSET/LIABILITY MANAGEMENT” section of this Item 6.

Table 7 following this discussion sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2009, which is projected to reprice or mature in each of the future time periods shown.

Table 18 following this discussion presents information about the contractual maturities, average interest rates and estimated fair values of our financial instruments that are considered market risk sensitive at December 31, 2009.

DERIVATIVE FINANCIAL INSTRUMENTS

A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or reference rate. These instruments primarily consist of interest rate swaps, caps, floors, financial forward and futures contracts and options written or purchased. Derivative contracts are written in amounts referred to as notional amounts. Notional amounts only provide the basis for calculating payments between counterparties and do not represent amounts to be exchanged between parties and are not a measure of financial risk. Credit risk arises when amounts receivable from a counterparty exceed amounts payable. We control our risk of loss on derivative contracts by subjecting counterparties to credit reviews and approvals similar to those used in making loans and other extensions of credit.

The Company utilizes interest rate swaps and caps in the management of interest rate risk. Interest rate swaps are contractual agreements between two parties to exchange a series of cash flows representing interest payments. A swap allows both parties to alter the repricing characteristics of assets or liabilities without affecting the underlying principal positions. Through the use of a swap, assets and liabilities may be transformed from fixed to floating rates, from floating rates to fixed rates, or from one type of floating rate to another. At December 31, 2009, swap derivatives with a total notional value of $55.0 million, with remaining terms ranging up to two years, were outstanding. During 2009, the Company entered into a five-year interest rate cap. The interest rate cap assists in minimizing the exposure of risk of rising interest rates. This derivative contract, with a notional amount of $250 million, was executed to offset the effects of interest rate changes on an unsecured $250 million variable rate money market funding arrangement. Under this cash flow hedge relationship, the cap’s objective is to offset the effect of interest rate changes, whenever funding rates are higher than the strike rate of the cap.

Although off-balance sheet derivative financial instruments do not expose us to credit risk equal to the notional amount, such agreements generate credit risk to the extent of the fair value gain in an off-balance sheet derivative financial instrument if the counterparty fails to perform. We minimize such risk by evaluating the creditworthiness of the counterparties and consistently monitoring these agreements. The counterparties to these arrangements are primarily large commercial banks and investment banks. Where appropriate, master netting agreements are arranged or collateral is obtained in the form of rights to securities. At December 31, 2009, the Company’s derivatives reflected a net unrealized loss, net of tax, of $1.6 million.

Other risks associated with interest-sensitive derivatives include the effect on fixed rate positions during periods of changing interest rates. Indexed amortizing swaps’ notional amounts and maturities change based on certain interest rate indices. Generally, as rates fall the notional amounts decline more rapidly, and as rates increase notional amounts decline more slowly. As of December 31, 2009, we had no indexed amortizing swaps outstanding. Under unusual circumstances, financial derivatives also increase liquidity risk, which could result from an environment of rising interest rates in which derivatives produce negative cash flows while being offset by increased cash flows from variable rate loans. The Company considers such risk to be insignificant due to the relatively small derivative positions we hold. A discussion of derivatives is presented in Note M to our consolidated financial statements, which are presented under Item 7 of Part II in this Form 10-K.

 

38


QUARTERLY FINANCIAL INFORMATION

Table 19 following this discussion sets forth, for the periods indicated, certain of our consolidated quarterly financial information. This information is derived from our unaudited financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with our consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note A to the accompanying Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Critical accounting estimates and policies are those management believes are both most important to the portrayal of the Company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. The allowance for loan losses represents a particularly sensitive accounting estimate. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the maturity of the loan portfolio, credit concentration, trends in historical loss experience, specific impaired loans and general economic conditions. For further discussion of the allowance for loan losses and a detailed description of the methodology used in determining the adequacy of the allowance, see the sections of this discussion titled “ASSET QUALITY” and “ANALYSIS OF ALLOWANCE FOR LOAN LOSSES” and Note C to the consolidated financial statements contained in this Annual Report.

Additionally, intangible assets are subject to sensitive accounting estimate. Intangible assets include goodwill and other identifiable assets, such as core deposit premiums, resulting from acquisitions. Core deposit premiums are amortized primarily on a straight-line basis over a ten-year life based upon historical studies of core deposits. Goodwill is not amortized but is tested annually for impairment or at any time an event occurs or circumstances change that may trigger a decline in the value of the reporting unit. Examples of such events or circumstances include a decline in the value of the Company’s common stock below book value, adverse changes in legal factors, business climate, unanticipated competition, change in regulatory environment, or loss of key personnel.

The Company tests for impairment in accordance with Accounting Standards Codification Topic 350, Intangibles – Goodwill and Other. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. Management first estimates the fair value of the Company in a business combination using one of two approaches. The Comparable Transaction Approach utilizes a regional transaction group and a national transaction group. For each group, average and median pricing ratios were applied to provide a range of values along with several qualitative factors being considered. The Discounted Cash Flow Approach is derived from the present value of future dividends over a five year time horizon and the projected terminal value at the end of the fifth year. The goodwill that would arise from this estimate is compared to the carrying value of the goodwill currently on the books to determine impairment. See Note E to the accompanying consolidated financial statements for information on goodwill.

 

39


To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired, and a second step of impairment testing will be performed. In the second step, the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test, will be determined. If the implied fair value of reporting unit goodwill is lower than its carrying amount, goodwill is impaired and is written down to its implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.

OFF-BALANCE SHEET ARRANGEMENTS

Information about the Company’s off-balance sheet risk exposure is presented in Note N to the accompanying consolidated financial statements. As part of the Company’s ongoing business, the Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (SPEs), which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2009, our SPE activity is limited to our capital trust subsidiaries: BNC Bancorp Capital Trust I, BNC Bancorp Capital Trust II , BNC Bancorp Capital Trust III and BNC Bancorp Capital Trust IV, which in aggregate issued 23,000,000 Trust Preferred Securities.

 

ITEM 6A. QUANTITATIVE AND QUALIATATIVE DISCLOSURES ABOUT MARKET RISK

See “Market Risk” under Item 6.

 

40


BNC Bancorp

Table 2

Average Balances and Net Interest Income

($ in thousands)

 

    Year Ended December 31,
2009
    Year Ended December 31,
2008
    Year Ended December 31,
2007
 
    Average
Balance
    Interest   Average
Rate
    Average
Balance
    Interest   Average
Rate
    Average
Balance
    Interest   Average
Rate
 

Interest-earning assets:

                 

Loans (1)

  $ 1,026,635        $57,556   5.61   $ 981,069      $ 64,855   6.61   $ 849,271      $ 69,280   8.16

Investment securities, tax effected (2)

    430,684        25,982   6.03     119,531        7,616   6.37     79,727        5,291   6.64

Interest-earning balances

    31,765        52   0.16     2,243        92   4.10     8,353        393   4.70

Other

    7,146        14   0.20     13,923        276   1.98     6,405        275   4.29
                                               

Total interest-earning assets

    1,496,230        83,604   5.59     1,116,766        72,839   6.52     943,756        75,239   7.97
                                         

Other assets

    121,514            110,480            97,262       
                                   

Total assets

  $ 1,617,744          $ 1,227,246          $ 1,041,018       
                                   

Interest-bearing liabilities:

                 

Deposits:

                 

Demand deposits

    451,317        5,592   1.24     180,353        2,725   1.51     195,542        6,175   3.16

Savings deposits

    11,835        14   0.12     11,058        13   0.12     10,725        48   0.45

Time deposits

    794,181        23,292   2.93     698,647        27,978   4.00     576,488        29,280   5.08

Borrowings

    161,602        3,969   2.46     173,113        6,710   3.88     108,940        5,762   5.29
                                               

Total interest-bearing liabilities

    1,418,935        32,867   2.32     1,063,171        37,426   3.52     891,695        41,265   4.63
                                         

Non-interest-bearing deposits

    63,604            72,008            67,774       

Other liabilities

    11,564            5,209            5,484       

Shareholders’ equity

    123,641            86,858            76,065       
                                   

Total liabilities and stockholders’ equity

  $ 1,617,744          $ 1,227,246          $ 1,041,018       
                                   

Net interest income and interest rate spread (3)

    $ 50,737   3.27     $ 35,413   3.00     $ 33,974   3.34
                                         

Net interest margin (4)

      3.39       3.17       3.60
                             

Ratio of average interest-earning assets to average interest-bearing liabilities

    105.45         105.04         105.84    
                                   

 

(1) Average loans include non-accruing loans and loans held for sale.
(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $4.5 million, $1.8 million, and $1.6 million for the years 2009, 2008 and 2007, respectively.
(3) Interest rate spread equals the earning asset yield minus the interest-bearing liability rate.
(4) Net interest margin is computed by dividing net interest income by total earning assets.

 

41


BNC Bancorp

Table 3

Volume and Rate Variance Analysis

(In Thousands)

 

     Year Ended December 31, 2009 vs. 2008     Year Ended December 31, 2008 vs. 2007  
     Increase (Decrease) Due to     Increase (Decrease) Due to  
     Volume     Rate     Total     Volume     Rate     Total  

Interest income:

            

Loans

   $ 2,783      $ (10,082   $ (7,299   $ 9,732      $ (14,157   $ (4,425

Investment securities, tax effected

     19,296        (930     18,366        2,589        (268     2,325   

Interest-earning balances

     630        (670     (40     (269     (32     (301

Other

     (74     (188     (262     236        (235     1   
                                                

Total interest income

     22,635        (11,870     10,765        12,288        (14,692     (2,400
                                                

Interest expense:

            

Deposits

            

Demand deposits

     3,726        (859     2,867        (355     (3,095     (3,450

Savings deposits

     1        —          1        1        (36     (35

Time deposits

     3,314        (8,000     (4,686     5,548        (6,850     (1,302

Borrowings

     (364     (2,377     (2,741     2,941        (1,993     948   
                                                

Total interest expense

     6,677        (11,236     (4,559     8,135        (11,974     (3,839
                                                

Net interest income increase (decrease)

   $ 15,958      $ (634   $ 15,324      $ 4,152      $ (2,718   $ 1,439   
                                                

 

42


BNC Bancorp

Table 4

Non-Interest Income

(In thousands)

 

     Year Ended December 31,
     2009    2008    2007

Mortgage fees

   $ 1,108    $ 783    $ 839

Service charges

     2,707      3,021      2,910

Investment brokerage fees

     249      434      490

Increase in cash surrender value of life insurance

     931      1,101      891
                    

Core non-interest income

     4,995      5,339      5,130

Gain on sales of investment securities available for sale, net

     3,610      223      —  

Other non-interest income

     81      89      119
                    

Total non-interest income

   $ 8,686    $ 5,651    $ 5,249
                    

 

43


BNC Bancorp

Table 5

Non-Interest Expense

(In thousands)

 

     Year Ended December 31,
     2009    2008    2007

Salaries and employee benefits

   $ 17,499    $ 16,293    $ 14,738

Occupancy expense

     1,913      2,155      1,848

Furniture and equipment expense

     1,475      1,084      1,018

Data processing and supply expense

     1,261      1,113      1,063

Advertising and business development

     1,156      473      522

Insurance, professional and other services

     2,452      2,111      1,580

FDIC insurance assessments

     2,844      642      247

Loan, foreclosure and collection expense

     1,078      1,173      509

Other

     3,221      2,739      2,543
                    

Total non-interest expense

   $ 32,899    $ 27,783    $ 24,068
                    

 

44


BNC Bancorp

Table 6

Contractual Obligations and Commitments

(In thousands)

The following table reflects contractual cash obligations of the Company outstanding as of December 31, 2009:

 

     Payments Due by Period

Contractual Obligations

   Total    On Demand
or Within

1 Year
   2 - 3 Years    4 - 5 Years    After
5 Years

Short-term borrowings

   $ 50,283      50,283    $ —      $ —      $ —  

Long-term debt

     100,713      —        7,000      17,000      76,713

Deposits

     1,349,878      752,505      203,551      357,205      36,617
                                  

Total contractual cash obligations

   $ 1,500,874    $ 802,788    $ 210,551    $ 374,205    $ 113,330
                                  

The following table reflects other commitments of the Company outstanding as of December 31, 2009:

 

     Amount of Commitment Expiration Per Period

Commitments

   Total
Amounts
Committed
   Within
1 Year
   2 - 3 Years    4 - 5 Years    After
5 Years

Lines of credit and loan commitments

   $ 156,538    $ 74,839    $ 17,265    $ 7,778    $ 56,656

Standby letters of credit

     13,091      12,745      346      —        —  

Commitments to sell loans held for sale

     2,766      2,766      —        —        —  
                                  

Total commitments

   $ 172,395    $ 90,350    $ 17,611    $ 7,778    $ 56,656
                                  

 

45


BNC Bancorp

Table 7

Interest Rate Sensitivity Analysis

($ in thousands)

 

     At December 31, 2009  
     3 Months
or Less
    Over 3 Months
to 12 Months
    Total Within
12 Months
    Over 12
Months
    Total  

Interest-earning assets:

          

Loans

   $ 644,430      $ 129,178      $ 773,608      $ 305,571      $ 1,079,179   

Interest Rate Swap

     (55,000     25,000        (30,000     30,000        —     

Loans held for sale

     2,766        —          2,766        —          2,766   

Investment securities available for sale

     4,144        23,964        28,108        321,532        349,640   

Other earning assets

     50,204        —          50,204        —          50,204   
                                        

Total interest-earning assets

   $ 646,544      $ 178,142      $ 824,686      $ 657,103      $ 1,481,789   
                                        

Interest-bearing liabilities

          

Interest-bearing demand deposits

   $ 516,404      $ —        $ 516,404      $ 49,568      $ 565,972   

Interest Rate Cap

   $ (250,000     —          (250,000     250,000        —     

Time deposits and savings

     192,854        175,652        368,506        348,599        717,105   

Borrowings

     82,284        8,000        90,284        60,712        150,996   
                                        
   $ 541,542      $ 183,652      $ 725,194      $ 708,879      $ 1,434,073   
                                        

Interest sensitivity gap

   $ 105,002      $ (5,510   $ 99,492      $ (51,776   $
47,716
  

Cumulative interest sensitivity gap

     105,002        99,492        99,492        47,716        47,716   

Cumulative interest sensitivity gap as a percent of total interest-earning assets

     7.09     6.71     6.71     3.22     3.22

Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities

     119.39     113.72     113.72     103.33     103.33

 

46


BNC Bancorp

Table 8

Loan Portfolio Composition

($ in thousands)

 

     At December 31,  
     2009     2008     2007     2006     2005  
     Amount    % of
Total
Loans
    Amount    % of
Total
Loans
    Amount    % of
Total
Loans
    Amount    % of
Total
Loans
    Amount    % of
Total
Loans
 

Commercial (secured by real estate)

     449,528    41.7     350,849    34.8     306,450    32.9     269,096    34.7     178,751    35.7

Residential mortgage

     257,445    23.9     223,053    22.1     197,904    21.2     175,628    22.7     137,639    27.6

Commercial construction

     183,509    17.0     228,330    22.7     196,105    21.0     141,398    18.3     75,721    15.2

Residential construction

     50,156    4.6     78,942    7.8     89,897    9.7     62,297    8.1     32,451    6.5

Commercial and industrial

     113,670    10.5     98,595    9.8     109,869    11.8     97,071    12.5     63,423    12.7

Loans to individuals

     12,655    1.2     12,829    1.3     17,967    1.9     18,140    2.3     11,262    2.3

Leases

     12,216    1.1     15,190    1.5     14,370    1.5     11,034    1.4     —      0.0
                                                                 

Total loans

   $ 1,079,179    100.0   $ 1,007,788    100.0   $ 932,562    100.0   $ 774,664    100.0   $ 499,247    100.0
                                                                 

These classifications are based upon Call Report Classification codes.

 

47


BNC Bancorp

Table 9

Loan Maturities

(In thousands)

 

     At December 31, 2009
     Due within
one year
   Due after
one year but
within five
   Due after
five years
   Total

By loan type:

           

Commercial (secured by real estate)

   $ 61,936    $ 322,820    $ 64,772    $ 449,528

Residential mortgage

     60,495      117,135      79,815      257,445

Commercial construction

     115,540      66,384      1,585      183,509

Residential construction

     42,170      5,961      2,025      50,156

Commercial and industrial and leases

     73,332      49,488      3,066      125,886

Loans to individuals

     2,079      5,787      4,789      12,655
                           

Total

   $ 355,552    $ 567,575    $ 156,052    $ 1,079,179
                           

By interest rate type:

           

Fixed rate loans

   $ 54,053    $ 357,279    $ 54,495    $ 465,827

Variable rate loans

     301,499      210,296      101,557      613,352
                           
   $ 355,552    $ 567,575    $ 156,052    $ 1,079,179
                           

The above table is based on contractual scheduled maturities. Early repayment of loans or renewals at maturity are not considered in this table.

 

48


BNC Bancorp

Table 10

Nonperforming Assets

($ in thousands)

 

     At December 31,  
     2009     2008     2007     2006     2005  

Nonaccrual loans:

          

Commercial (secured by real estate)

   $ 3,201      $ 1,033      $ 515      $ 58      $ —     

Residential mortgage

     3,257        416        279        626        324   

Commercial construction

     4,979        9,019        —          —          —     

Residential construction

     2,191        2,070        —          390        —     

Commercial and industrial

     5,055        100        163        —          —     

Leases

     19        16        —          —          —     
                                        

Total nonaccrual loans

     18,702        12,654        957        1,074        324   
                                        

Accruing loans past due 90 days or more:

          

Commercial (secured by real estate)

     —          —          —          165        100   

Residential construction

     —          —          —          —          605   

Residential mortgage

     —          —          —          —          481   

Loan to individuals

     —          —          —          —          7   
                                        

Total accruing loans past due 90 days or more

     —          —          —          165        1,193   
                                        

Restructured loans

     348        665        2,642        —          312   
                                        

Total nonperforming loans

     19,050        13,319        3,599        1,239        1,829   

Other real estate owned

     14,325        5,022        2,509        1,078        855   
                                        

Total nonperforming assets

   $ 33,375      $ 18,341      $ 6,108      $ 2,317      $ 2,684   
                                        

Commercial loans restructured/modified not included in categories above

   $ 4,168      $ —        $ —        $ —        $ —     

Allowance for loan losses

   $ 17,309      $ 13,210      $ 11,784      $ 10,400      $ 6,140   

Nonperforming loans to year end loans

     1.77     1.32     0.39     0.16     0.37

Allowance for loan losses to year end loans

     1.60     1.31     1.26     1.34     1.23

Nonperforming assets to loans and other real estate

     3.05     1.81     0.60     0.30     0.35

Nonperforming assets to total assets

     2.04     1.17     0.54     0.24     0.45

Allowance for loan losses to nonperforming loans

     90.86     99.18     327.42     839.39     335.70

 

49


BNC Bancorp

Table 11

Allocation of the Allowance for Loan Losses

(In thousands)

 

     2009     2008     2007     2006     2005  
     Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
 

Real estate loans

   $ 11,355    65.6   $ 7,516    56.9   $ 6,375    54.1   $ 5,970    57.4   $ 3,891    63.4

Real estate construction loans

     3,739    21.6     4,029    30.5     3,618    30.7     2,735    26.3     1,330    21.7

Commercial and industrial loans

     1,817    10.5     1,295    9.8     1,391    11.8     1,303    12.5     780    12.7

Loans to individuals

     208    1.2     172    1.3     223    1.9     249    2.3     139    2.2

Leases

     190    1.1     198    1.5     177    1.5     143    1.4     —      0.0
                                                                 
   $ 17,309    100.0   $ 13,210    100.0   $ 11,784    100.0   $ 10,400    100.0   $ 6,140    100.0
                                                                 

 

(1) Represents total of all outstanding loans in each category as a percent of total loans outstanding, grouped by collateral type.

 

50


BNC Bancorp

Table 12

Loan Loss and Recovery Experience

($ in thousands)

 

     At or for the Year Ended December 31,  
     2009     2008     2007     2006     2005  

Loans outstanding at the end of the year

   $ 1,079,179      $ 1,007,788      $ 932,562      $ 774,664      $ 499,247   
                                        

Average loans outstanding during the year

   $ 1,026,635      $ 981,069      $ 849,271      $ 615,689      $ 454,395   
                                        

Allowance for loan losses at beginning of year

   $ 13,210      $ 11,784      $ 10,400      $ 6,140      $ 5,361   

Provision for loan losses

     15,750        7,075        3,090        2,655        2,515   

Allowance acquired in merger of SterlingSouth Bank

     —          —          —          2,816        —     
                                        
     28,960        18,859        13,490        11,611        7,876   
                                        

Loans charged off:

          

Commercial (secured by real estate)

     (3,171     (516     —          —          —     

Residential mortgage

     (1,262     (816     (310     (738     (645

Commercial construction

     (5,046     (875     (1,107     —          (235

Residential construction

     (1,183     (790     —          —          —     

Commercial and industrial

     (941     (2,529     (248     (352     (290

Loans to individuals

     (204     (257     (90     (199     (618

Leases

     (60     —          —          —          —     
                                        

Total charge-offs

     (11,867     (5,783     (1,755     (1,289     (1,788
                                        

Recoveries of loans previously charged off:

          

Commercial (secured by real estate)

     4        23        —          —          —     

Residential mortgage

     20        33        30        64        1   

Commercial construction

     —          —          —          —          —     

Residential construction

     32        —          —          —          —     

Commercial and industrial

     133        54        —          8        4   

Loans to individuals

     27        24        19        6        47   
                                        

Total recoveries

     216        134        49        78        52   
                                        

Net charge-offs

     (11,651     (5,649     (1,706     (1,211     (1,736
                                        

Allowance for loan losses at end of year

   $ 17,309      $ 13,210      $ 11,784      $ 10,400      $ 6,140   
                                        

Ratios:

          

Net charge-offs as a percent of average loans

     1.13     0.58     0.20     0.20     0.38

Allowance for loan losses as a percent of loans at end of year

     1.60     1.31     1.26     1.34     1.23

 

51


BNC Bancorp

Table 13

Investment Securities Portfolio Composition

(In thousands)

 

     Amortized
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
   Estimated
fair

value
December 31, 2009            

Available for sale:

           

State and municipals

   $ 186,526    $ 4,328    $ 2,261    $ 188,593

Mortgage-backed

     163,067      8,799      —        171,866

Other

     47      —        —        47
                           
   $ 349,640    $ 13,127    $ 2,261    $ 360,506
                           

Held to maturity:

           
           

Corporate bonds

   $ 6,000    $ —      $ 640    $ 5,360
                           

December 31, 2008

           

Available for sale:

           

U. S. Government agency obligations

   $ 4,980    $ 24    $ —      $ 5,004

State and municipals

     123,623      1,612      4,802      120,433

Mortgage-backed

     286,792      4,297      128      290,961

Other

     166      —        —        166
                           
   $ 415,561    $ 5,933    $ 4,930    $ 416,564
                           

Held to maturity:

           
           

Corporate bonds

   $ 6,000    $ —      $ 600    $ 5,400
                           

December 31, 2007

           

Available for sale:

           

U. S. Government agency obligations

   $ 2,949    $ 39    $ —      $ 2,988

State and municipals

     66,359      993      398      66,954

Mortgage-backed

     16,157      418      —        16,575

Other

     166      —        —        166
                           
   $ 85,631    $ 1,450    $ 398    $ 86,683
                           

 

52


BNC Bancorp

Table 14

Investment Securities Portfolio Expected Maturities

($ in thousands)

 

     Amortized
Cost
   Fair
Value
   Book
Yield (1)
 

Available for sale:

        

State and municipals

        

Due within one year

     1,983      1,941    7.00

After one through five years

     24,654      24,632    6.42

After five through ten years

     64,546      65,451    7.26

Over ten years

     95,343      96,569    7.24
                
     186,526      188,593    7.14
                

Mortgage-backed

        

Due within one year

     24,875      26,167    5.17

After one through five years

     66,958      70,540    5.23

After five through ten years

     34,610      36,411    5.22

Over ten years

     36,624      38,748    5.28
                
     163,067      171,866    5.23
                

Other

        

Over ten years

     47      47    0.00
                

Total available for sale

        

Due within one year

     26,858      28,108    5.30

After one through five years

     91,612      95,172    5.54

After five through ten years

     99,156      101,862    6.53

Over ten years

     132,014      135,364    6.68
                
   $ 349,640    $ 360,506    6.23
                

Held to maturity:

        

Corporate bonds:

        

After five through ten years

     6,000      5,360    4.59
                
   $ 6,000    $ 5,360    4.59
                

 

(1) Based on amortized cost, taxable-equivalent basis

 

53


BNC Bancorp

Table 15

Average Deposits

($ in thousands)

 

     For the Year Ended December 31,  
     2009     2008     2007  
     Average
Amount
   Average
Rate
    Average
Amount
   Average
Rate
    Average
Amount
   Average
Rate
 

Demand deposits

   $ 451,317    1.24   $ 180,353    1.51   $ 195,542    3.16

Savings deposits

     11,835    0.12     11,058    0.12     10,725    0.45

Time deposits

     794,181    2.93     698,647    4.00     576,488    5.08
                           

Total interest-bearing deposits

     1,257,333    2.30     890,058    3.45     782,755    4.54

Non-interest-bearing deposits

     63,604    —          72,008    —          67,774    —     
                           

Total deposits

   $ 1,320,937    2.19   $ 962,066    3.19   $ 850,529    4.17
                           

 

54


BNC Bancorp

Table 16

Maturities of Time Deposits of $100,000 or More

(In thousands)

 

     At December 31, 2009
     3 Months
or Less
   Over 3 Months
to 6 Months
   Over 6 Months
to 12 Months
   Over 12
Months
   Total

Time Deposits of $100,000 or more

   $ 129,175    $ 68,779    $ 28,610    $ 245,804    $ 472,368
                                  

 

55


BNC Bancorp

Table 17

Borrowings

($ in thousands)

The following table sets forth certain information regarding the Company’s borrowed funds for the dates indicated.

 

     For the Year Ended December 31,  
     2009     2008     2007  

Short-term borrowings:

      

Repurchase agreements and FHLB lines of credit

      

Balance outstanding at end of period

   $ 50,283      $ 194,143      $ 80,928   

Maximum amount outstanding at any month end during the period

     176,971        194,143        80,928   

Average balance outstanding

     62,305        56,935        14,823   

Weighted-average interest rate during the period

     1.01     2.56     5.40

Weighted-average interest rate at end of period

     2.68     0.68     4.69

Long-term debt:

      

Federal Home Loan Bank advances and subordinated debentures

      

Balance outstanding at end of period

   $ 100,713      $ 105,713      $ 101,713   

Maximum amount outstanding at any month end during the period

     105,713        119,713        106,713   

Average balance outstanding

     99,297        116,184        94,117   

Weighted-average interest rate during the period

     3.37     4.52     5.27

Weighted-average interest rate at end of period

     3.02     4.24     5.07

Total borrowings:

      

Balance outstanding at end of period

   $ 150,996      $ 299,856      $ 182,641   

Maximum amount outstanding at any month end during the period

     282,684        313,856        187,641   

Average balance outstanding

     161,602        173,113        108,940   

Weighted-average interest rate during the period

     2.46     3.88     5.29

Weighted-average interest rate at end of period

     2.91     2.04     4.95

 

56


BNC Bancorp

Table 18

Market Risk Sensitive Investments

($ in thousands)

 

     Expected Maturities of Market Sensitive Instruments Held
at December 31, 2009 Occuring in the Indicated Year
     2010    2011    2012    2013    2014    Beyond    Total    Average
Interest
Rate
    Fair
Value

Interest-earning assets:

                         

Due from banks

   $ 44,044    $ —      $ —      $ —     </