Beach First National Bancshares 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number: 000-22503
BEACH FIRST NATIONAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
3751 Robert M. Grissom Parkway, Suite 100, Myrtle Beach, South Carolina 29577
(Address of principal executive offices)
(Registrants telephone number)
(Former name, former address and former fiscal year, if changed since last report)
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 o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: On August 8, 2008, 4,845,018 shares of the issuers common stock, par value $1.00 per share, were issued and outstanding.
Item 1. Financial Statements.
Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
The accompanying notes are an integral part of these consolidated condensed financial statements.
Beach First National Bancshares, Inc, and Subsidiaries
Consolidated Condensed Statements of Income
The accompanying notes are an integral part of these consolidated condensed financial statements.
Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Statements of Changes in Shareholders Equity and Comprehensive Income
The accompanying notes are an integral part of these consolidated condensed financial statements.
Beach First National Bancshares, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows
The accompanying notes are an integral part of these consolidated condensed financial statements.
Beach First National Bancshares, Inc.
Notes to Consolidated Condensed Financial Statements (Unaudited)
1. Basis of Presentation
The accompanying consolidated condensed financial statements for Beach First National Bancshares, Inc. (Company) were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for fair presentation of the interim consolidated financial statements have been included. The results of operations for the six month period ended June 30, 2008 are not necessarily indicative of the results that may be expected for the entire year. These consolidated financial statements do not include all disclosures required by generally accepted accounting principles and should be read in conjunction with the Companys audited consolidated financial statements and related notes for the year ended December 31, 2007.
Certain previously reported amounts have been reclassified to conform to the current years presentations. Such changes had no effect on previously reported net income or shareholders equity.
2. Principles of Consolidation
The accompanying consolidated condensed financial statements include the accounts of the Company and its subsidiaries, Beach First National Bank and BFNM Building, LLC (LLC) (See No. 4 Investment in LLC below). The Company also owns two grantor trusts, Beach First National Trust and Beach First National Trust II. All significant inter-company items and transactions have been eliminated in consolidation. In accordance with current accounting guidance, the financial statements of the trusts have not been included in the Companys financial statements.
3. Earnings Per Share
The Company calculates earnings per share in accordance with Statement of Financial Accounting Standard No. 128, Earnings per Share (SFAS 128). SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities, or contingent stock agreements if those securities trade in a public market.
This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Companys stock option plan is reflected in diluted earnings per share by application of the treasury stock method.
RECONCILIATION OF THE NUMERATORS AND DENOMINATORS OF THE BASIC AND DILUTED EPS COMPUTATIONS:
4. Investment in LLC
The LLC is a partnership with our legal counsel, Nelson Mullins Riley & Scarborough LLP (NMRS), for purposes of acquiring a parcel of land and constructing an office building on the property. The Company owns two-thirds of the LLC and NMRS owns the remaining one-third. The building is a three-story, 46,066 square foot office building located on 3.5 acres at the southwest corner of Robert M. Grissom Parkway and 38th Avenue North in Myrtle Beach, South Carolina. The Company leases two-thirds of the building (approximately 30,000 square feet) from the LLC. Because the Company occupies approximately 12,500 square feet of space, it intends to lease the other 17,500 square feet of its portion to outside tenants. NMRS also leases one-third of the building from the LLC. As of June 30, 2008, 4,700 square feet is available for lease.
Upon completion of construction, the construction financing note from the third-party lender was converted to a term loan payable by the LLC to the third-party bank and is secured by the building. The loan requires 107 installments of principal and interest based on a fifteen year amortization, with all remaining principal and interest due on June 15, 2015. The interest rate is variable based on one-month LIBOR plus 1.40%. The outstanding balance on the loan at June 30, 2008 is $6,745,299 and is shown as other borrowings in the accompanying balance sheet.
5. Derivative Financial Instruments Interest Rate SWAP
The Company has two types of derivative instruments. One is an interest rate swap on the LLC building loan, which is discussed below, and the other is created as part of residential mortgage lending activities when the Company enters into a rate-locked loan commitment with a prospective borrower and, at the same time, arranges to sell the loan to an investor. The Company has determined that this latter derivative activity is not material.
In June 2005, the LLC obtained a $7,235,000 loan from a bank for the construction of the building that serves as the Companys corporate office. The interest on this loan floats based on LIBOR plus 1.40%. At the same time, the LLC entered into an interest rate swap agreement in the same notional amount as a risk management tool to lock the interest cash outflows on the floating-rate debt. Under the terms of the swap (which expires upon maturity of the building loan in June 15, 2015), the Company pays monthly a fixed interest rate of 4.62% and receives interest payments equal to LIBOR. As there are no differences between the critical terms of the interest rate swap and the hedged debt obligation, the Company assumes no ineffectiveness in the hedging relationship.
The estimated fair value of this agreement at June 30, 2008 was a liability of approximately $130,015, which is included in the Companys balance sheet. Changes in the fair value are recorded as a separate component in other comprehensive income. The fixed rate of 4.62% paid under the swap agreement, when added to the loans margin above LIBOR of 1.40%, converts the building loans interest (and cash flows) from a variable rate to a fixed rate of 6.12%, resulting in interest expense of $209,764 and $217,515 for the six months ended June 30, 2008 and 2007, respectively.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedged transactions. This process includes linking all derivatives that are designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedges inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in cash flows of a hedged item (including forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is no longer designated as a hedge instrument because is it unlikely that a forecasted transaction will occur; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with subsequent changes in its fair value recognized in current earnings.
6. Fair Value Measurements
Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS 157) which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. SFAS 157 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).
SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes six levels of inputs that may be used to measure fair value:
Level 1: Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets, and money market funds.
Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds, and corporate debt securities. This category generally includes certain derivative contracts and impaired loans.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly-structured or long-term derivative contracts.
Assets and liabilities measured at fair value on a recurring basis are as follows as of June 30, 2008:
The Company is predominantly an asset based lender with real estate serving as collateral on a substantial majority of loans. Loans which are deemed to be impaired are primarily valued at the fair values of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be level 2 inputs. The aggregate carrying amount of impaired loans at June 30, 2008 was $13,003,335. The Company has no assets or liabilities whose fair values are measured using level 3 inputs.
FASB Staff Position No. FAS 157-2 delays the implementation of SFAS 157 until the first quarter of 2009 with respect to goodwill, other intangible assets, real estate and other assets acquired through foreclosure and other non-financial assets measured at fair value on a nonrecurring basis.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiary, Beach First National Bank, during the periods included in the accompanying financial statements. This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.
This report contains forward-looking statements relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words may, will, anticipate, should, would, believe, contemplate, expect, estimate, continue, and intend, as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission (the SEC), including, without limitation:
· significant increases in competitive pressure in the banking and financial services industries;
· changes in the interest rate environment which could reduce anticipated or actual margins;
· changes in political conditions or the legislative or regulatory environment;
· general economic conditions, either nationally or regionally and especially in our primary service area, continuing to be weak resulting in, among other things, a deterioration in credit quality;
· changes occurring in business conditions and inflation;
· changes in management;
· changes in technology;
· changes in deposit flows;
· the level of allowance for loan loss;
· the rate of delinquencies and amounts of charge-offs;
· the rates of loan growth;
· adverse changes in asset quality and resulting credit risk-related losses and expenses;
· higher than anticipated levels of defaults on loans;
· the amount of our real estate-based loans and the weakness in the commercial real estate market:
· misperceptions by depositors about the safety of their deposits;
· changes in monetary and tax policies;
· loss of consumer confidence and economic disruptions resulting from terrorist activities;
· changes in the securities markets;
· other risks and uncertainties detailed from time to time in our filings with the SEC; and
· natural disasters, such as a hurricane or flooding in our footprint.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our consolidated financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2007 as filed on our Form 10-K.
Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates. These differences could have a material impact on our carrying values of assets and liabilities and our results of operations.
We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from managements estimates provided in our consolidated financial statements. Refer to the subsection entitled
Allowance for Loan Losses below for a more complete discussion of our processes and methodology for determining our allowance for loan losses.
The following discussion describes our results of operations for the quarter ended June 30, 2008 as compared to the quarter ended June 30, 2007, as well as results for the six months ended June 30, 2008 and 2007, along with our financial condition as of June 30, 2008 as compared to December 31, 2007. Like most community banks, we derive most of our income from interest we receive on our portfolio loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.
In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.
The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.
Results of Operations
Our net income was $1,220,220 or $0.25 diluted net income per common share, for the six months ended June 30, 2008 as compared to $3,310,817, or $0.67 diluted net income per common share, for the same period in 2007. Our net income was $336,507 or $0.07 per diluted common share, for the three month ended June 30, 2008 as compared to net income of $1,698,433 or $0.34 per diluted common share for the same period in 2007. The decrease in net income is attributed to the challenging financial environment facing all banks. The net interest margin declined to 3.27% at June 30, 2008, due in part to rate reductions since September 2007 of 3.25% in the prime lending rate. We expect continued pressure on the net interest margin throughout 2008. The return on average assets for the six month period ended June 30, 2008 was 0.38% as compared to 1.20% for the same period in 2007. The return on average equity was 4.56% for the six month period ended June 30, 2008 versus 14.12% for the same period in 2007.
Over the past 24 months, real estate values have fallen and the rate of default on mortgage loans has risen. There has been a resulting disruption in secondary markets for mortgages, especially in non-conforming loan products. The Federal Reserve Bank has reduced short-term rates to stimulate the economy. As a result of inflationary pressures coming from oil, food and certain other sectors, the long end of the yield curve has not dropped as fast as the short end, resulting in a steepening of the yield curve. The Company has been affected by these events in areas such as mortgage banking; land acquisition, development and construction lending; and consumer lending. The Company has seen an increase in delinquencies and non-performing loans during 2007 and the first half of 2008, and it continues to monitor its portfolio of real estate loans closely. The reduction in short-term rates has adversely impacted the Companys net interest margin. In the current economic, market and credit environment, there can be no assurance that the Companys portfolio will continue to perform at current levels.
Net Interest Income
Our primary source of revenue is net interest income, which represents the difference between the income on interest-earning assets and expense on interest-bearing liabilities. During the first six months of 2008, net interest income decreased 10.7% to $10,042,964 from $11,245,505 for the same period of 2007. For the three months ended June 30, 2008, net interest income decreased 16.3% to $4,822,590 from $5,763,758 during the comparable period of 2007. The decline in net interest income for the first six months of 2008 resulted from a decrease of $563,882 in interest income offset by an increase in interest expense of $638,659. Our level of net interest income is determined by the level of our earning assets
and our net interest margin. The impact on net interest income from the continued growth of our loan portfolio was offset by the decrease in the prime lending rate which reduced our net interest margin. Average total loans increased from $442.2 million in the first six months of 2007 to $537.6 million in the same period in 2008. Average total loans increased $78.9 million from $458.7 million for the year ended December 31, 2007 as compared to $537.6 million for the six months ended June 30, 2008. In addition, average securities decreased to $73.1 million in the first six months of 2008 compared to $73.7 million for the first six months of 2007, and decreased $0.3 million from $73.4 million for the year ended December 31, 2007. Net interest spread, the difference between the rate we earn on interest-earning assets and the rate we pay on interest-bearing liabilities, was 3.78% in the first six months of 2007 compared to 2.84% during the same period of 2008, and 3.63% for the year ended December 31, 2007. The net interest margin was 3.27% for the six month period ended June 30, 2008 compared to 4.35% for the same period of 2007, and 4.20% for the year ended December 31, 2007. The decline in the net interest spread and the net interest margin can be attributed to the challenging financial environment facing banks including the reduction in the prime lending rate and an increase in nonaccrual loans. Because we are asset-sensitive over a one year period, the rate cuts immediately impact approximately 60% of our portfolio loans. Since our deposit rates have not declined as quickly, this has put pressure on our net interest margin. We anticipate that some of this pressure may be eased as we are able to re price our deposits to current market rates. For example, over the next three months, one-third of our CD portfolio will mature. These CDs currently yield approximately 4.08% and we anticipate replacing these CDs with lower rate deposits. However, there is risk we may not be able to replace these CDs with lower rate deposits, or replace all of these deposits at all, especially given our intent to reduce our reliance on brokered deposits and not to accept or renew additional brokered deposits in the near future.
The following table sets forth, for the periods indicated, information related to our average balance sheet and average yields on assets and average rates paid on liabilities. The yield or rates were derived by dividing annualized income or expense by the average balance of the corresponding assets or liabilities. The average balances are calculated from the daily balances from the periods indicated.
The following table sets forth the impact of the varying levels of earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. The provision for loan losses was $1,314,000 for the first six months of 2008 as compared to $622,000 for the same period of 2007. The provision for loan losses was $568,000 for the three months ended June 30, 2008 and $320,800 for the same period in 2007. The increase in the provision was the result of managements assessment of the adequacy of the reserve for possible loan losses given the size, mix, and quality of the current loan portfolio, the increases in non performing loans, and the current economic environment. Please see the discussion below under Allowance for Loan Losses for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.
Noninterest income decreased to $2,846,861 for the six months ended June 30, 2008, down 36.6% from $4,487,262 for the same period in 2007. For the three months ended June 30, 2008, noninterest income decreased to $1,466,838 million as compared to $2,200,639 in 2007. This decrease in noninterest income is primarily attributable to the decrease in income from our mortgage operation, which fell from $3,287,803 for the first six months of 2007 to $1,663,699 for the first six months of 2008. The reduction in noninterest income from our mortgage operation is a reflection of the downturn in the economy in general and the real estate and mortgage markets in particular.
Total noninterest expense decreased 2.9% to $9,676,353 for the six month period ended June 30, 2008 from $9,968,791 for the same period in 2007, and increased 3.8% to $5,197,601 million for the three months ended June 30, 2008 from $5,007,614 million in the same period of 2007. Salary and wages and employee benefits expense decreased $681,176 to $4,473,541 during the six month period ended June 30, 2008 compared to the same period in 2007. The reduction in salary and benefits relates to the decline in mortgage production related income as well as reduced staffing in the mortgage operation.
We had 157 and 180 full-time equivalent employees (FTE) at June 30, 2008 and 2007, respectively. The mortgage operation FTE declined from 95 FTE to 57 FTE. Excluding our mortgage operation staff, FTE increased from 85 at June 30, 2007 to 100 FTE at June 30, 2008. Staffing increases were primarily due to overall growth and the addition of our 73rd Avenue branch that opened in the first quarter of 2008.
For the six months ended June 30, 2008, advertising and public relations costs increased $1,890 to $318,942 as compared to the same period in 2007, and decreased $36,904 to $136,542 for the three months ended June 30, 2008 compared to the same period in 2007. Professional fees increased $66,336 to $339,160 for the six month period ended June 30, 2008 compared to the same period in 2007. These fees continue to increase due to our growth, the regulatory fees associated with such growth, and the escalating cost of accounting, auditing, and legal services for a public company.
Occupancy expenses decreased $59,303 to $806,242 during the six months ended June 30, 2008 compared to the same period in 2007, and by $5,635 for the three months ended June 30, 2008 compared to the same period in 2007.
Data processing fees increased during the six months ended June 30, 2008 to $636,525 from $353,062 during the same period in 2007. For the three months ended June 30, 2008, data processing costs totaled $450,225 compared to $181,605 for June 30, 2007. Data processing costs are primarily related to the volume of loan and deposit accounts and transaction activity. During April 2008, we converted to a new core operating system. The one time conversion cost of $225,760 was expensed in the second quarter of 2008.
Other operating expenses increased 28.5% to $1,661,621 during the six months ended June 30, 2008 compared to $1,293,140 during the same period in 2007. Other operating expenses increased 10.8%, to $852,257, for the three months ended June 30, 2008 compared to the same period in 2007. These increases are primarily the result of increased operating expenses related to the growth of the Company, including our new branch, along with other expenses associated with the expansion of loans and deposits. The increase in other operating expenses was primarily due to increases in FDIC fees, director and advisory fees, credit and collections, and software maintenance.
Specifically, FDIC fees increased $125,867, director and board advisory fees increased $162,351, credit and collections expense increased $92,111, and software maintenance increased $77,821 collectively totaling an increase of $458,150. The total increase in other operating expenses was $368,481 during the six months ended June 30, 2008 as compared to the same period in 2007.
The following table presents a comparison of other operating expenses:
Balance Sheet Review
We had total assets of $669.5 million at June 30, 2008, an increase of 14.6% from $584.3 million at June 30, 2007, and an increase of 10.5% from $606.0 million at December 31, 2007. Total assets at June 30, 2008 consisted primarily of $559.9 million in loans including mortgage loans held for sale, $69.1 million in investments, and $10.4 million in cash and due from banks. Our liabilities at June 30, 2008 totaled $616.4 million, consisting primarily of $533.3 million in deposits, $55.0 million in Federal Home Loan Bank (FHLB) advances, and $10.3 million of junior subordinated debentures. Our total deposits increased to $533.3 million at June 30, 2008, up 16.4% from $458.3 million at June 30, 2007, and up 14.9%
from $464.2 million at December 31, 2007. Shareholders equity increased $0.5 million to $53.1 million at June 30, 2008 from $52.6 million at December 31, 2007, and increased $4.2 million from $48.9 million at June 30, 2007.
Total investment securities averaged $68.7 million during the first six months of 2008 and totaled $69.1 million at June 30, 2008. Total investment securities averaged $70.2 million during the first six months of 2007 and totaled $69.7 million at June 30, 2007. Total investment securities averaged $69.0 million for the year ended December 31, 2007 and totaled $65.7 million at December 31, 2007. At June 30, 2008, our total investment securities portfolio had a book value of $70.6 million and a fair market value of $69.1 million, for an unrealized net loss of $1.5 million. We primarily invest in short term U.S. Government Sponsored Enterprises and Federal Agency securities.
At June 30, 2008, federal funds sold and short-term investments totaled $3.1 million, compared to $26.1 million at June 30, 2007 and $566,404 at December 31, 2007. These funds are one source of our banks liquidity and are generally invested in an earning capacity on an overnight or short-term basis. This decline in short-term investments is due to loan demand during this quarter and a more competitive market for deposits.
Since loans typically provide higher yields than other types of earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. As of June 30, 2008, loans represented 87.1% of average earning assets as compared to 84.8% at June 30, 2007, and 85.2% at December 31, 2007. At June 30, 2008, net portfolio loans (portfolio loans less the allowance for loan losses and deferred loan fees) totaled $545.7 million, an increase of $106.8 million, or 24.3%, from June 30, 2007 and an increase of $49.2 million, or 9.92% from December 31, 2007. Average gross loans increased to $537.6 million with a yield of 7.28% during the first six months of 2008 from $442.2 million with a yield of 9.13% during the same period in 2007. Average gross loans were $458.7 million with a yield of 8.95% for the year ended December 31, 2007. The decrease in yield on loans during these periods is due to the interest rate declines in 2007 and 2008. The interest rates charged on loans vary with the degree of risk, the maturity, the guarantees, and the collateral on each loan. Competitive pressures, money market rates, availability of funds, and government regulations also influence interest rates.
The following table shows the composition of the loan portfolio and mortgage loans held for sale by category at June 30, 2008, December 31, 2007, and June 30, 2007.
The principal component of our portfolio loans at June 30, 2008, December 31, 2007, and June 30, 2007, was mortgage loans, which represented 76.8%, 73.6%, and 76.9%, respectively. In the context of this discussion, a real estate mortgage loan is defined as any loan, other than loans for construction purposes, secured by real estate, regardless of the purpose of the loan. We follow the common practice of financial institutions in our market area of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. The collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan portfolio component. Generally, we limit the loan-to-value ratio to 80%. We attempt to maintain a relatively diversified loan
portfolio to help reduce the risk inherent in concentrations of collateral. Loans held for sale are consumer real estate loans that are pending sale to investors.
Allowance for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of income. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans and may be adjusted for other risk factors. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segments range of probable loss levels. Certain nonperforming loans are individually assessed for impairment under SFAS No. 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations.
The general allocation also includes a component for probable losses inherent in the portfolio, based on managements analysis that is not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address managements evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors include the current general economic and business conditions; geographic, collateral, or other concentrations of credit; system, procedural, policy, or underwriting changes; experience of the lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations.
Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.
The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. In addition, the allowance is subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. Such regulatory agencies could require us to adjust the allowance based on information available to them at the time of their examination.
At June 30, 2008, the allowance for loan losses was $7.6 million, or 1.37% of total outstanding loans, compared to an allowance for loan losses of $6.3 million, or 1.38% of total outstanding loans, at June 30, 2007, and $6.9 million, or 1.36% of total outstanding loans, at December 31, 2007. During the first six months of 2008, we had net charge-offs totaling $603,563. During the same period in 2007, we had net charge-offs totaling $178,246. We had non-performing loans totaling $13.0 million, $1.4 million, and $2.9 million at June 30, 2008, June 30, 2007, and December 31, 2007, respectively. While there can be no assurances, we do not expect significant losses relating to these nonperforming loans because we believe that the collateral supporting these loans is sufficient to cover the outstanding loan balance. Nevertheless, the recent downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these trends are likely to continue. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.
The following table sets forth certain information with respect to our allowance for loan losses and the composition of charge-offs and recoveries for the six months ended June 30, 2008, June 30, 2007, and the full year ended December 31, 2007.
The following table sets forth the breakdown of the allowance for loan losses by loan category and the percentage of loans in each category to gross loans as of June 30, 2008. We believe that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of further losses and does not restrict the use of the allowance to absorb losses in any category.
Nonperforming Assets/Other Real Estate Owned
We discontinue accrual of interest on a loan when we conclude it is doubtful that we will be able to collect interest from the borrower. We reach this conclusion by taking into account factors such as the borrowers financial condition, economic and business conditions, and the results of our previous collection efforts. Generally, we will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. When we place a loan in nonaccrual status, we reverse all interest which has been accrued on the loan but remains unpaid and we deduct this interest from earnings as a reduction of reported interest income. We do not accrue any additional interest on the loan balance until we conclude the collection of both principal and interest is reasonably certain. At June 30, 2008, there were no loans accruing interest which were 90 days or more past due and we had no restructured loans.
Nonaccrual loans were $13,003,335, $1,431,960, and $2,902,888 as of June 30, 2008, June 30, 2007, and December 31, 2007, respectively. As the economy continues to weaken, some of our borrowers find that they do not have sufficient cash flow to make payments on time, and we place their loans on non-accrual status. There are currently 30 loans that are on non accrual at June 30, 2008. Five of those borrowers amount to 61% of the total nonaccrual amount.
If the bank takes properties from a loan work-out, it places it in the other real estate owned asset account (OREO). The properties that are received are recorded at the lower of cost or the current value of the loan in OREO. Any write-down in value, before being placed into OREO, is included as a charge-off in the allowance for loan loss. Any subsequent gain or loss, including expenses related to the sale, is recorded through the income statement.
At June 30, 2008 we had $2,365,000 in OREO, compared to $328,775 at June 30, 2007, and $15,000 at December 31, 2007. As of June 30, 2008, there are six properties in OREO, one of which is under contract. The properties in OREO
at June 30, 2008 include two small parcels of undeveloped land, two developed residential lots, and two completed residential units.
Average total deposits were $508.9 million for the six months ended June 30, 2008, up 17.4% from $433.4 million during the same period in 2007 and up 15.6% from $440.2 million at December 31, 2007. Average interest-bearing deposits were $474.2 million for six months ended June 30, 2008, up 18.9% from $398.8 million during the same period of 2007 and up 17.4% from $404.1 million at December 31, 2007.
The following table sets forth our deposits by category as of June 30, 2008, June 30, 2007, and December 31, 2007.
Deposit growth was attributable to brokered funds, internal growth, and the generation of new deposit accounts due primarily to special promotions and increased advertising.
Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $398.3 million at June 30, 2008, compared to $341.9 million at June 30, 2007, and $321.4 million at December 31, 2007. Our brokered deposits were $75.6 million as of June 30, 2008, $39.6 million as of June 30, 2007, and $46.1 million as of December 31, 2007. We expect a stable base of deposits to be our primary source of funding to meet both our short-term and long-term liquidity needs. Core deposits as a percentage of total deposits were 74.7% at June 30, 2008, 74.6% at June 30, 2007, and 69.2% at December 31, 2007. Our loan-to-deposit ratio was 105.0% at June 30, 2008 versus 99.8% at June 30, 2007 and 109.8% at December 31, 2007. The average loan-to-deposit ratio was 105.7% during the first six months of 2008, 102.0% during the same period of 2007, and 104.2% at December 31, 2007.
Advances from Federal Home Loan Bank
In addition to deposits, we obtained funds from the FHLB to help fund our loan growth. Average borrowings from the FHLB were $55.0 million during the second quarter of 2008 and 2007 and $48.7 million for the year ended December 31, 2007. The following table reflects the current borrowing terms.