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BANK OF SOUTH CAROLINA CORP - Quarter Report: 2019 June (Form 10-Q)

 

 

 

United States
Securities and Exchange Commission

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2019

 

  Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission file number: 0-27702

 

Bank of South Carolina Corporation  

(Exact name of registrant issuer as specified in its charter)

 

South Carolina   57-1021355
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification Number)

 

256 Meeting Street, Charleston, SC 29401  

(Address of principal executive offices)

 

(843) 724-1500  

(Registrant’s telephone number)

 

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  ☒   No  ☐ 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). 

Yes  ☒   No  ☐ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):

 Large accelerated filer            ☐   Accelerated filer
Non-accelerated filer              ☐   Smaller reporting company
(Do not check if a smaller reporting company)   Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act ☐

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading symbol(s) Name of each exchange on which registered
Common stock BKSC NASDAQ

As of July 15, 2019, there were 5,525,278 Common Shares outstanding.

 

 

   

 

 

Part I. Financial Information Page
   
Item 1. Financial Statements  
Consolidated Balance Sheets – June 30, 2019 and December 31, 2018 3
Consolidated Statements of Income – Three months ended June 30, 2019 and 2018  4
Consolidated Statements of Income – Six months ended June 30, 2019 and 2018 5
Consolidated Statements of Comprehensive Income – Six months ended June 30, 2019 and 2018 6
Consolidated Statements of Shareholders’ Equity – Six months ended June 30, 2019 and 2018 7
Consolidated Statements of Cash Flows – Six months ended June 30, 2019 and 2018 8
Notes to Consolidated Financial Statements 9
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 25
Off-Balance Sheet Arrangements 29
Liquidity 30
Capital Resources 30
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
   
Item 4. Controls and Procedures 31
   
Part II. Other Information  
   
Item 1. Legal Proceedings 32
Item 1A. Risk Factors 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 3. Defaults Upon Senior Securities 32
Item 4. Mine Safety Disclosure 32
Item 5. Other Information 32
Item 6. Exhibits 32
   
Signatures 34
Certifications 35

 

   

 

 

Part I. Financial Information

 

Item 1. Financial Statements

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

 

    (Unaudited)
June 30, 2019
   

(Audited) 

December 31,  2018 

 
ASSETS      
Cash and due from banks  $9,843,665   $6,325,457 
Interest-bearing deposits at the Federal Reserve   35,252,826    25,506,784 
Investment securities available for sale   101,430,963    119,668,874 
Mortgage loans to be sold   2,874,982    1,199,438 
Loans   283,847,630    274,664,267 
  Less: Allowance for loan losses   (4,130,548)   (4,214,331)
Net loans   279,717,082    270,449,936 
Premises, equipment and leasehold improvements,  net   2,689,314    2,335,207 
Right of use asset   7,218,644    —   
Accrued interest receivable   1,565,145    1,561,915 
Other assets   1,781,824    2,087,587 
           
Total assets  $442,374,445   $429,135,198 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Liabilities          
  Deposits:          
     Non-interest bearing demand  $138,577,128   $130,940,138 
     Interest bearing demand   102,905,495    94,207,731 
     Money market accounts   85,539,479    87,300,433 
     Time deposits over $250,000   8,176,688    15,909,991 
     Other time deposits   17,841,257    18,558,734 
     Other savings deposits   30,769,858    35,461,361 
Total deposits   383,809,905    382,378,388 
           
Accrued interest payable and other liabilities   1,951,281    1,294,249 
Lease liability   7,218,644    —   
Total liabilities   392,979,830    383,672,637 
           
Shareholders' equity          
Common stock - no par 12,000,000 shares authorized; Issued 5,794,313 shares at
    June 30, 2019 and 5,777,474 shares at December 31, 2018. Shares outstanding
    5,525,278 and 5,510,917 at June 30, 2019 and December 31, 2018,
    respectively.
   —      —   
Additional paid in capital   47,041,739    46,857,734 
Retained earnings   4,413,687    2,650,296 
Treasury stock 269,035 shares at June 30, 2019 and 266,557 shares at December 31, 2018    (2,314,107)   (2,268,264)
Accumulated other comprehensive income (loss), net of income taxes   253,296    (1,777,205)
Total shareholders' equity   49,394,615    45,462,561 
           
Total liabilities and shareholders' equity  $442,374,445   $429,135,198 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

    Three Months Ended
June 30,
 
    2019     2018  
Interest and fee income      
Loans, including fees  $4,090,423   $3,704,752 
Taxable securities   423,211    470,411 
Tax-exempt securities   137,115    175,674 
Other   162,596    73,030 
Total interest and fee income   4,813,345    4,423,867 
           
Interest expense          
Deposits   245,226    139,697 
Total interest expense   245,226    139,697 
           
Net interest income   4,568,119    4,284,170 
Provision for loan losses   135,000    75,000 
Net interest income after provision for loan losses   4,433,119    4,209,170 
           
Other income          
Service charges and fees   300,553    296,372 
Mortgage banking income   256,379    250,554 
Gain on sales of securities   28,900    387 
Other non-interest income   6,907    7,783 
Total other income   592,739    555,096 
           
Other expense          
Salaries and employee benefits   1,664,436    1,576,452 
Net occupancy expense   427,247    422,059 
Other operating expenses   543,099    628,867 
Net other real estate owned expenses   —      24,137 
Total other expense   2,634,782    2,651,515 
           
Income before income tax expense   2,391,076    2,112,751 
Income tax expense   550,229    386,394 
           
Net income  $1,840,847   $1,726,357 
           
Weighted average shares outstanding          
Basic   5,517,236    5,492,896 
Diluted   5,587,985    5,586,585 
           
Basic income per common share  $0.33   $0.31 
Diluted income per common share  $0.33   $0.31 

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

    Six Months Ended
June 30,
 
    2019     2018  
Interest and fee income      
Loans, including fees  $8,042,142   $7,263,738 
Taxable securities   886,665    940,914 
Tax-exempt securities   298,836    403,741 
Other   278,535    135,483 
Total interest and fee income   9,506,178    8,743,876 
           
Interest expense          
Deposits   488,984    249,527 
Total interest expense   488,984    249,527 
           
Net interest income   9,017,194    8,494,349 
Provision for loan losses   145,000    130,000 
Net interest income after provision for loan losses   8,872,194    8,364,349 
           
Other income          
Service charges and fees   580,486    591,663 
Mortgage banking income   380,041    390,469 
Gain on sales of securities   28,900    4,735 
Other non-interest income   12,095    16,174 
Total other income   1,001,522    1,003,041 
           
Other expense          
Salaries and employee benefits   3,320,960    3,149,172 
Net occupancy expense   814,379    805,391 
Other operating expenses   1,158,804    1,314,649 
Net other real estate owned expenses   —      24,137 
Total other expense   5,294,143    5,293,349 
           
Income before income tax expense   4,579,573    4,074,041 
Income tax expense   1,049,462    735,454 
           
Net income  $3,530,111   $3,338,587 
           
Weighted average shares outstanding          
Basic   5,515,832    5,339,187 
Diluted   5,586,813    5,433,360 
           
Basic income per common share  $0.64   $0.63 
Diluted income per common share  $0.63   $0.61 

 

See accompanying notes to consolidated financial statements.

 

 

 5 

 

 

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

    Three Months Ended  
    June 30,  
    2019     2018  
Net income  1,840,847   $ 1,726,357 
Other comprehensive income          
Unrealized gain (loss) on securities arising during the period   1,343,539    (477,253)
Reclassification adjustment for securities gains realized in net income   (28,900)   (387)
Other comprehensive income (loss) before tax   1,314,639    (477,640)
Income tax effect related to items of other comprehensive income before tax   (276,074)   88,186 
Other comprehensive income (loss) after tax   1,038,565    (389,454)
Total comprehensive income  2,879,412   1,336,903 

 

    Six Months Ended  
    June 30,  
    2019     2018  
Net income  3,530,111   3,338,587 
Other comprehensive income          
Unrealized gain (loss) on securities arising during the period   2,599,154    (1,814,824)
Reclassification adjustment for securities gains realized in net income   (28,900)   (4,735)
Other comprehensive income (loss) before tax   2,570,254    (1,819,559)
Income tax effect related to items of other comprehensive income before tax   (539,753)   382,107 
Other comprehensive income (loss) after tax   2,030,501    (1,437,452)
Total comprehensive income  5,560,612    $1,901,135 

 

See accompanying notes to consolidated financial statements.

 

 6 

 

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2019 AND 2018 (UNAUDITED) 

 

   Shares Outstanding  Additional Paid in Capital  Retained Earnings  Treasury Stock  Accumulated Other Comprehensive Income (Loss)  Total
December 31, 2018   5,510,917   46,857,734   2,650,296   (2,268,264)  (1,777,205)  45,462,561 
Net income   —      —      1,689,264    —      —      1,689,264 
Other comprehensive income   —      —      —      —      991,936    991,936 
Exercise of stock options   5,808    51,265    —      —      —      51,265 
Stock-based compensation expense   —      18,881    —      —      —      18,881 
Cash dividends ($0.16 per common share)   —      —      (882,676)   —      —      (882,676)
March 31, 2019   5,516,725   46,927,880   $ 3,456,884   $ (2,268,264)  $ (785,269)  $ 47,331,231 
                               
Net income   —      —      1,840,847    —      —      1,840,847 
Other comprehensive income   —      —      —      —      1,038,565    1,038,565 
Exercise of stock options   8,553    94,977    —      (45,843)   —      49,134 
Stock-based compensation expense   —      18,882        —      —      18,882 
Cash dividends ($0.16 per common share)   —      —      (884,044   —      —      (884,044)
June 30, 2019   5,525,278   $ 47,041,739   $ 4,413,687   $ (2,314,107)  $ 253,296   $ 49,394,615 

 

   Shares Outstanding  Additional Paid in Capital  Retained Earnings  Treasury Stock  Accumulated Other Comprehensive Income (Loss)  Total
December 31, 2017   4,989,279   37,236,566   $ 8,847,164   $ (2,247,415)  $ (1,071,680)  $ 42,764,635 
Net income   —      —      1,612,230    —      —      1,612,230 
Other comprehensive loss   —      —      —      —      (1,047,998)   (1,047,998)
Exercise of stock options   1,600    18,768    —      —      —      18,768 
Stock-based compensation expense   —      18,882    —      —      —      18,882 
Cash dividends ($0.14 per common share)   —      —      (749,668)   —      —      (749,668)
Common stock dividend, 10%   499,088    9,334,342    (9,334,342)   —      —      —   
March 31, 2018   5,489,967   $ 46,608,558   $ 375,384   $ (2,247,415)  $ (2,119,678)  $ 42,616,849 
                               
Net income   —      —      1,726,357    —      —      1,726,357 
Other comprehensive loss   —      —      —      —      (389,454)   (389,454)
Exercise of stock options   10,649    104,528    —      (20,849)   —      83,679 
Stock-based compensation expense   —      18,881    —      —      —      18,881 
Cash dividends ($0.15 per common share)   —      —      (831,578)   —      —      (831,578)
June 30, 2018   5,500,616   $ 46,731,967   $ 1,270,163   $ (2,268,264)  $ (2,509,132)  $ 43,224,734 

 

See accompanying notes to consolidated financial statements.

 

 7 

 

 

 

BANK OF SOUTH CAROLINA CORPORATION AND SUBSIDIARY 

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

    Six Months Ended  
    June 30,  
    2019     2018  
Cash flows from operating activities:      
Net income  $3,530,111   $3,338,587 
Adjustments to reconcile net income net cash provided by operating activities:          
Depreciation expense   109,132    94,347 
Gain on sale of investment securities   (28,900)   (4,735)
Valuation and other adjustments to other real estate owned   —      23,637 
Provision for loan losses   145,000    130,000 
Stock-based compensation expense   37,763    37,763 
Deferred income taxes   (21,966)   (289,099)
Net amortization of unearned discounts on investment securities available for sale   140,730    152,517 
Origination of mortgage loans held for sale   (27,140,026)   (29,065,349)
Proceeds from sale of mortgage loans held for sale   25,464,482    27,507,922 
(Increase) decrease in accrued interest receivable and other assets   (215,254)   152,106 
Increase in accrued interest payable and other liabilities   599,626    208,777 
Net cash provided by operating activities   2,620,698    2,286,473 
           
Cash flows from investing activities:          
Proceeds from calls and maturities of investment securities available for sale   5,743,835    5,995,000 
Proceeds from sale of investment securities available for sale   14,952,500    21,434,634 
Purchase of investment securities available for sale   —      (9,978,050)
Net increase in loans   (9,412,146)   (7,921,831)
Purchase of premises, equipment, and leasehold improvements, net   (463,239)   (128,838)
Net cash provided by investing activities   10,820,950    9,400,915 
           
Cash flows from financing activities:          
Net increase (decrease) in deposit accounts   1,431,517    (20,548,691)
Dividends paid   (1,709,314)   (1,497,024)
Stock options exercised   100,399    102,447 
Net cash used in financing activities   (177,398)   (21,943,268)
Net increase (decrease) in cash and cash equivalents   13,264,250    (10,255,880)
Cash and cash equivalents at the beginning of the period   31,832,241    32,520,219 
Cash and cash equivalents at the end of the period  $45,096,491   $22,264,339 
           
Supplemental disclosure of cash flow data:          
Cash paid during the period for:          
Interest  $589,058   $210,971 
Income taxes  $627,642   $636,760 
           
Supplemental disclosures for non-cash investing and financing activity:          
Change in unrealized gain on securities available for sale, net of income taxes  $(2,030,501)  $1,437,452 
Change in dividends payable  $57,406   $84,222 
Right of use assets obtained in exchange for lease obligations  $7,334,079   $—   
Change in right of use assets and lease liabilities  $(115,435)  $—   

 

See accompanying notes to consolidated financial statements.

 

 8 

 

 

BANK OF SOUTH CAROLINA CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1: Nature of Business and Basis of Presentation

 

Organization

 

The Bank of South Carolina (the “Bank”) was organized on October 22, 1986 and opened for business as a state-chartered financial institution on February 26, 1987, in Charleston, South Carolina. The Bank was reorganized into a wholly-owned subsidiary of Bank of South Carolina Corporation (the “Company”), effective April 17, 1995. At the time of the reorganization, each outstanding share of the Bank was exchanged for two shares of Bank of South Carolina Corporation Stock.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. In consolidation, all significant intercompany balances and transactions have been eliminated.

 

References to “we”, “us”, “our”, “the Bank”, or “the Company” refer to the parent and its subsidiary that are consolidated for financial purposes.

 

Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for the interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, our interim consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”) on March 4, 2019. In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

 

Accounting Estimates and Assumptions

 

The consolidated financial statements are prepared in conformity with GAAP, which require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ significantly from these estimates and assumptions. Material estimates generally susceptible to significant change are related to the determination of the allowance for loan losses, impaired loans, other real estate owned, deferred tax assets, the fair value of financial instruments and other-than-temporary impairment of investment securities.

 

Reclassification

 

Certain amounts in the prior years’ financial statements have been reclassified to conform to the current period’s presentation. Such reclassifications had no effect on shareholders’ equity or the net income as previously reported.

 

Income per share

 

Basic income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Dilutive income per share is computed by dividing net income by the weighted-average number of common shares and potential common shares outstanding. Potential common shares consist of dilutive stock options determined using the treasury stock method and the average market price of common stock. Retroactive recognition has been given for the effects of all stock dividends.

 

Subsequent Events

 

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. We have reviewed events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

 

 9 

 

 

Recent Accounting Pronouncements

 

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting and/or disclosure of financial information by the Company.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which revises certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842 – Leases. This update clarifies how to apply certain aspects of the new leases standard. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which gives entities another option for transition and to provide lessors with a practical expedient. In December 2018, the FASB issued ASU 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors, providing narrow-scope improvements for lessors, that provides relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components. The amendments became effective for January 1, 2019. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. The Bank has chosen to use the effective date, January 1, 2019, as its date of initial application; therefore, the financial information will not be provided for dates or periods prior to January 1, 2019. The Bank considered all relevant contractual provisions, including renewal and termination options, and determined the remaining lease terms of each respective lease. The Bank considered past practices, market area, and contract terms of all leases and assumed all renewal options will be exercised. The weighted average remaining lease term is 18.10 years. To determine the incremental borrowing rate, the Bank used the rate of interest it would pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment, which the Bank determined was 5.50% at the time of implementation. The Bank does not have any finance leases or material subleases or leasing arrangements in which it is the lessor of the property or equipment. The adoption of this standard did not materially affect the change in the Bank's recognition of lease expense in future periods. For the six months ended June 30, 2019, the Bank had total lease expense of $317,859, of which $30,840 is for a short-term lease. The most significant impact was the recognition of right of use assets and lease liabilities for operating leases of approximately $7.3 million on January 1, 2019.

 

 10 

 

 

In June 2016, the FASB issued ASU 2016-13, Financial instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for all organizations for periods beginning after December 15, 2018. In May 2019, the FASB issued guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows. It will be influenced by the quality, composition, and characteristics of our loan and investment portfolios, as well as the expected economic conditions and forecasts at the time of enactment and future reporting periods.

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization of Purchased Callable Debt Securities, which shortens the amortization period for the premium to the earliest call date. The amendment became effective for the Company on January 1, 2019 and did not have a material effect on the financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The amendments remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its financial statements.

 

 11 

 

 

In August 2018, the FASB issued ASU 2018-15, Intangibles and Goodwill and Other-Internal Use Software (Subtopic 350-40):Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract),which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes, which expands the list of U.S. benchmark interest rates permitted in the application of hedge accounting. The amendments will be effective for the Company for fiscal years beginning after December 15, 2018. The amendment did not have a material effect on the financial statements.

 

In October 2018, the FASB issued ASU 2018-07, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, determining whether a decision-making fee is a variable interest. The amendments require organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company will apply a full retrospective approach in which financial statements for each individual prior period presented and the opening balances of the earliest period presented are adjusted to reflect the period-specific effects of applying the amendments. The Company does not expect these amendments to have a material effect on its financial statements. 

 

In April 2019, the FASB issued guidance that clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement of financial instruments. The amendments related to credit losses will be effective for the Company for the reporting period beginning after December 15, 2019. The amendments related to hedging became effective January 1, 2019. The amendments related to recognition and measurement of financial instruments will be effective for the Company for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on our financial position, results of operations or cash flows.

   

Note 2: Investment Securities

 

The amortized cost and fair value of investment securities available for sale are summarized as follows:

 

   June 30, 2019
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Estimated
Fair
Value
U.S. Treasury Notes  $28,054,029   $101,804   $(9,430)  $28,146,403 
Government-Sponsored Enterprises   50,582,908    248,635    (114,198)   50,717,345 
Municipal Securities   22,473,399    166,156    (72,340)   22,567,215 
                     
Total  $101,110,336   $516,595   $(195,968)  $101,430,963 

 

    December 31, 2018  
   

Amortized 

Cost 

   

Gross 

Unrealized 

Gains 

   

Gross 

Unrealized 

Losses 

   

Estimated 

Fair

Value 

 
U.S. Treasury Notes   $ 32,965,693     $     $ (609,059 )   $ 32,356,634  
Government-Sponsored Enterprises     60,684,878             (1,315,598 )     59,369,280  
Municipal Securities     28,267,930       112,971       (437,941 )     27,942,960  
                                 
Total   $ 121,918,501     $ 112,971     $ (2,362,598 )   $ 119,668,874  

 

 12 

 

 

The amortized cost and estimated fair value of investment securities available for sale as of June 30, 2019 and December 31, 2018, by contractual maturity are in the following table.

 

    June 30, 2019     December 31, 2018  
   

Amortized 

Cost

   

Estimated 

Fair Value 

   

Amortized 

Cost 

   

Estimated 

Fair Value 

 
Due in one year or less   $ 3,314,449       $ 3,318,732      $ 4,246,325     $ 4,249,570  
Due in one year to five years     82,244,256        82,503,885        99,753,174       97,915,185  
Due in five years to ten years     15,551,630        15,608,346        17,504,456       17,128,425  
Due in ten years and over     —          —          414,546       375,694  
Total   $ 101,110,335       $ 101,430,963      $ 121,918,501     $ 119,668,874  

 

Securities pledged to secure deposits at both June 30, 2019 and December 31, 2018, had a fair value of $37.7 million and $41.5 million, respectively. 

 

The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2019 and December 31, 2018. We believe that all unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

 

   Less Than 12 Months  12 Months or Longer  Total

June 30, 2019

Available for sale

  #  Fair Value  Gross Unrealized Loss  #  Fair Value  Gross Unrealized Loss  #  Fair Value  Gross Unrealized Loss
U.S. Treasury Notes   1   $5,048,240   $(702)   2   $8,025,118   $(8,728)   3   $13,073,358   $(9,430)
Government-Sponsored Enterprises   —      —      —      3    10,397,565    (114,198)   3    10,397,565    (114,198)
Municipal Securities   —      —      —      25    9,267,063    (72,340)   25    9,267,063    (72,340)
Total   1   $5,048,240   $(702)   30   $27,689,746   $(195,266)   31   $32,737,986   $(195,968)

 

   Less Than 12 Months  12 Months or Longer  Total
December 31, 2018 Available for sale  #  Fair Value  Gross Unrealized Loss  #  Fair Value  Gross Unrealized Loss  #  Fair Value  Gross Unrealized Loss
U.S. Treasury Notes   —     $—     $—     7   $32,356,634   $(609,059)   7   $32,356,634   $(609,059)
Government-Sponsored Enterprises   2    9,967,000    (14,302)   11    49,402,280    (1,301,296)   13    59,369,280    (1,315,598)
Municipal Securities   2    1,362,286    (7,547)   31    11,840,912    (430,394)   33    13,203,198    (437,941)
Total   4   $11,329,286   $(21,849)   49   $93,599,826   $(2,340,749)   53   $104,929,112   $(2,362,598)

 

 13 

 

 

The tables below show the proceeds from sales of securities available for sale and gross realized gains and losses.

 

   Three Months Ended
   June 30,
   2019  2018
       
Gross proceeds  $14,952,500   $11,970,378 
Gross realized gains   59,512    25,490 
Gross realized losses  $(30,612)  $(25,103)

 

   Six Months Ended
   June 30,
   2019  2018
       
Gross proceeds  $14,952,500   $21,434,634 
Gross realized gains   59,512    104,634 
Gross realized losses  $(30,612)  $(99,899)

 

For the three months ended June 30, 2019 and 2018, the tax provision related to these gains was $6,069 and $81, respectively. For the six months ended June 30, 2019 and 2018, the tax provision related to these gains was $6,069 and $994, respectively.

 

Note 3: Loans and Allowance for Loan Losses

 

Major classifications of loans (net of deferred loan fees of $165,854 at June 30, 2019 and $156,309 at December 31, 2018) are as follows:

 

    June 30,
2019
 
    December 31,
2018
 
Commercial   $ 56,270,330      $ 54,829,078  
Commercial real estate:                
Construction     11,204,997        7,304,300  
Other     148,569,431        143,703,401  
Consumer:                
Real estate     62,167,172        63,787,411  
Other     5,635,700        5,040,077  
      283,847,630        274,664,267  
Allowance for loan losses     (4,130,548  )     (4,214,331 )
Loans, net   $ 279,717,082      $ 270,449,936  

 

We had $94.0 million and $101.9 million of loans pledged as collateral to secure funding with the Federal Reserve Bank (“FRB”) Discount Window at June 30, 2019 and at December 31, 2018, respectively.

 

Our portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Our internal credit risk grading system is based on experience with similarly graded loans, industry best practices, and regulatory guidance. Our portfolio is graded in its entirety.

 

Our internally assigned grades pursuant to the Board-approved lending policy are as follows:

 

  Excellent (1) The borrowing entity has more than adequate cash flow, unquestionable strength, strong earnings and capital and, where applicable, no overdrafts.

 

  Good (2) The borrowing entity has dependable cash flow, better than average financial condition, good capital and usually no overdrafts.

 

  Satisfactory (3) The borrowing entity has adequate cash flow, satisfactory financial condition, and explainable overdrafts (if any).

 

  Watch (4) The borrowing entity has generally adequate, yet inconsistent cash flow, cyclical earnings, weak capital, loan to/from stockholders, and infrequent overdrafts. The borrower has consistent yet sometimes unpredictable sales and growth.

 

  OAEM (5) The borrowing entity has marginal cash flow, occasional past dues, and frequent and unexpected working capital needs.

 

  Substandard (6) The borrowing entity has a cash flow barely sufficient to service debt, deteriorated financial condition, and bankruptcy is possible. The borrowing entity has declining sales, rising costs, and may need to look for secondary source of repayment.

 

 14 

 

 

  Doubtful (7) The borrowing entity has negative cash flow. Survival of the business is at risk, full repayment is unlikely, and there are frequent and unexplained overdrafts. The borrowing entity shows declining trends and no operating profits.

 

  Loss (8) The borrowing entity has negative cash flow with no alternatives. Survival of the business is unlikely.

 

The following tables illustrate credit quality by class and internally assigned grades at June 30, 2019 and December 31, 2018. “Pass” includes loans internally graded as excellent, good and satisfactory.

 

    June 30, 2019
   Commercial  Commercial
Real Estate - Construction
  Commercial
Real Estate -
Other
  Consumer
Real Estate
  Consumer
Other
  Total
Pass  $51,732,759   $11,204,997   $141,999,065   $58,154,814   $5,147,378   $268,239,013 
Watch   2,533,865    —      4,557,264    2,615,352    394,714    10,101,195 
OAEM   322,858    —      660,784    517,254    77,780    1,578,676 
Sub-standard   1,680,848    —      1,352,318    879,752    15,828    3,928,746 
Doubtful   —      —      —      —      —      —   
Loss   —      —      —      —      —      —   
Total  $56,270,330   $11,204,997   $148,569,431   $62,167,172   $5,635,700   $283,847,630 

 

    December 31, 2018
   Commercial  Commercial
Real Estate - Construction
  Commercial
Real Estate -
Other
  Consumer
Real Estate
  Consumer
Other
  Total
Pass  $50,663,356   $7,304,300   $136,804,420   $60,480,317   $4,726,494   $259,978,887 
Watch   1,973,675    —      4,938,711    2,077,341    226,117    9,215,844 
OAEM   157,300    —      590,294    350,000    —       1,097,594 
Sub-standard   2,034,747    —      1,369,976    879,753    87,466    4,371,942 
Doubtful   —      —      —      —      —      —   
Loss   —      —      —      —      —      —   
Total  $54,829,078   $7,304,300   $143,703,401   $63,787,411   $5,040,077   $274,664,267 

 

The following tables include an aging analysis of the recorded investment in loans segregated by class.

 

    June 30, 2019
   30-59 Days Past Due  60-89 Days Past Due  Greater than 90 Days  Total Past Due  Current  Total Loans Receivable  Recorded Investment ≥
90 Days and Accruing
Commercial  $49,948   $194,058   $—     $244,006   $56,026,324   $56,270,330   $—   
Commercial Real Estate - Construction   —      —      —      —      11,204,997    11,204,997    —   
Commercial Real Estate - Other   409,860    273,190    571,292    1,254,342    147,315,089    148,569,431    —   
Consumer Real Estate   271,691    —      —      271,691    61,895,481    62,167,172    —   
Consumer Other   25,603    —      678    26,281    5,609,419    5,635,700    —   
Total  $757,102   $467,248   $571,970   $1,796,320   $282,051,310   $283,847,630   $—   

 

 15 

 

 

    December 31, 2018
    30-59 Days Past Due   60-89 Days Past Due  

Greater Than

90 Days

  Total Past Due   Current   Total Loans Receivable   Recorded
Investment >
90 Days and Accruing
Commercial   $ 266,567     $ 17,492     $ 229,395     $ 513,454     $ 54,315,624     $ 54,829,078     $  
Commercial Real Estate - Construction                             7,304,300       7,304,300        
Commercial Real Estate - Other     35,000       215,049       571,292       821,341       142,882,060       143,703,401        
Consumer Real Estate                             63,787,411       63,787,411        
Consumer Other     24,621                   24,621       5,015,456       5,040,077        
Total   $ 326,188     $ 232,541     $ 800,687     $ 1,359,416     $ 273,304,851     $ 274,664,267     $  

 

There were no loans as of June 30, 2019 and December 31, 2018 over 90 days past due and still accruing. 

 

The following table summarizes the balances of non-accrual loans:

 

    Loans Receivable on Non-Accrual  
    June 30, 2019     December 31, 2018  
Commercial   $ 13,210      $ 251,219  
Commercial Real Estate - Construction              
Commercial Real Estate - Other     571,292        571,292  
Consumer Real Estate              
Consumer Other     678        1,023  
Total   $ 585,180      $ 823,534  

 

The following tables set forth the changes in the allowance for loan losses and an allocation of the allowance for loan losses by loan category for the three and six months ended June 30, 2019 and 2018. The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors.

 

    Three Months Ended June 30, 2019
   Commercial  Commercial Real Estate - Construction  Commercial Real Estate - Other  Consumer Real Estate  Consumer Other  Total
Allowance for Loan Losses:                  
Beginning Balance $1,528,577   $81,047   $1,318,918   $377,641   $683,239   $3,989,422 
Charge-offs   —      —      —      —      (2,009)   (2,009)
Recoveries   5,500    —      —      —      2,635    8,135 
Provisions   5,575    16,940    13,885    150,888    (52,288)   135,000 
Ending Balance  1,539,652   97,987   1,332,803    $528,529   $ 631,577   4,130,548 

 

    Six Months Ended June 30, 2019
   Commercial  Commercial Real Estate - Construction  Commercial Real Estate - Other  Consumer Real Estate  Consumer Other  Total
Allowance for Loan Losses:                  
Beginning Balance $1,665,413   $63,876   $1,292,346   $386,585   $806,111   $4,214,331 
Charge-offs   (229,395)   —      —      —      (8,342)   (237,737)
Recoveries   6,000    —      —      —      2,954    8,954 
Provisions   97,634    34,111    40,457    141,944    (169,146)   145,000 
Ending Balance  $1,539,652   $97,987   $1,332,803   $528,529   $631,577   $4,130,548 

 

 16 

 

 

    Three Months Ended June 30, 2018
   Commercial  Commercial Real Estate - Construction  Commercial Real Estate - Other  Consumer Real Estate  Consumer Other  Total
Allowance for Loan Losses:                  
Beginning Balance  $1,326,246   $11,136   $1,041,088   $567,075   $884,975   $3,830,520 
Charge-offs   —      —      —      —      —      —   
Recoveries   1,000    —      55,252    45,412    280    101,944 
Provisions   16,514    17,955    (124,302)   (23,436)   188,269    75,000 
Ending Balance  $1,343,760   $29,091   $972,038   $589,051   $1,073,524   $4,007,464 

 

    Six Months Ended June 30, 2018
   Commercial  Commercial Real Estate - Construction  Commercial Real Estate - Other  Consumer Real Estate  Consumer Other  Total
Allowance for Loan Losses:                  
Beginning Balance  $1,403,588   $23,638   $1,549,755   $796,918   $101,499   $3,875,398 
Charge-offs   (31,250)   —      —      —      (71,843)   (103,093)
Recoveries   2,500    —      56,827    45,412    420    105,159 
Provisions   (31,078)   5,453    (634,544)   (253,279)   1,043,448    130,000 
Ending Balance  $1,343,760   $29,091   $972,038   $589,051   $1,073,524   $4,007,464 

 

The following tables present, by portfolio segment and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans, for the periods indicated.

 

   June 30, 2019
   Commercial  Commercial Real Estate - Construction  Commercial
Real Estate - Other
  Consumer Real Estate  Consumer
Other
  Total
Allowance for Loan Losses                  
Individually evaluated for impairment  $870,073   $—     $31,082   $—     $7,510   $908,665 
Collectively evaluated for impairment   669,579    97,987    1,301,721    528,529    624,067    3,221,883 
Total Allowance for Loan Losses  $1,539,652   $97,987   $1,332,803   $528,529   $631,577   $4,130,548 
Loans Receivable                              
Individually evaluated for impairment  $1,680,847   $—     $1,360,884   $879,753   $15,828   $3,937,312 
Collectively evaluated for impairment   54,589,483    11,204,997    147,208,547    61,287,419    5,619,872    279,910,318 
Total Loans Receivable  $56,270,330   $11,204,997   $148,569,431   $62,167,172   $5,635,700   $283,847,630 

 

     December 31, 2018
    Commercial  

Commercial Real Estate -

Construction

 

Commercial 

Real Estate - Other 

  Consumer Real
Estate
 

Consumer

Other

  Total
Allowance for Loan Losses                                                
Individually evaluated for impairment   $ 1,132,805     $     $ 37,416     $     $ 21,324     $ 1,191,545  
Collectively evaluated for impairment     532,608       63,876       1,254,930       386,585       784,787       3,022,786  
Total Allowance for Loan Losses   $ 1,665,413     $ 63,876     $ 1,292,346     $ 386,585     $ 806,111     $ 4,214,331  
Loans Receivable                                                
Individually evaluated for impairment   $ 1,996,579     $     $ 1,280,890     $ 879,753     $ 21,324     $ 4,178,546  
Collectively evaluated for impairment     52,832,499       7,304,300       142,422,511       62,907,658       5,018,753       270,485,721  
Total Loans Receivable   $ 54,829,078     $ 7,304,300     $ 143,703,401     $ 63,787,411     $ 5,040,077     $ 274,664,267  

  

 17 

 

As of June 30, 2019 and December 31, 2018, loans individually evaluated and considered impaired are presented in the following table.

 

  Impaired Loans As of  
    June  30, 2019     December 31, 2018  
    Unpaid Principal Balance     Recorded Investment     Related Allowance     Unpaid Principal Balance     Recorded Investment     Related Allowance  
With no related allowance recorded:                                                
Commercial   $ 111,591       $ 111,591      $ —        $ 115,983     $ 115,983     $  
Commercial Real Estate - Construction     —          —          —                       
Commercial Real Estate - Other     860,975        860,975        —          974,249       974,249        
Consumer Real Estate     879,753        879,753        —          879,753       879,753        
Consumer Other     —          —          —                       
Total     1,852,319        1,852,319        —          1,969,985       1,969,985        
                                                 
With an allowance recorded:                                                
Commercial     1,569,256        1,569,256        870,073        1,880,596       1,880,596       1,132,805  
Commercial Real Estate - Construction     —         —         —                       
Commercial Real Estate - Other     499,909        400,108         31,082        406,442       306,641       37,416  
Consumer Real Estate     —          —          —                       
Consumer Other     15,828        15,828        7,510        21,324       21,324       21,324  
Total     2,084,993        1,985,192        908,665        2,308,362       2,208,561       1,191,545  
                                                 
Commercial     1,680,847        1,680,847        870,073        1,996,579       1,996,579       1,132,805  
Commercial Real Estate - Construction     —          —          —                       
Commercial Real Estate - Other     1,360,884        1,261,083        31,082        1,380,691       1,280,890       37,416  
Consumer Real Estate     879,753        879,753        —          879,753       879,753        
Consumer Other     15,828        15,828        7,510        21,324       21,324       21,324  
Total    $ 3,937,312      $ 3,837,511      $ 908,665      $ 4,278,347     $ 4,178,546     $ 1,191,545  

 

The following table presents average impaired loans and interest income recognized on those impaired loans, by class segment, for the periods indicated.

 

   Three Months Ended June 30,
   2019  2018
   Average Recorded Investment  Interest Income Recognized  Average Recorded Investment  Interest Income Recognized
With no related allowance recorded:            
Commercial  $117,741   $2,071   $137,684   $2,227 
Commercial Real Estate - Construction   —      —      —      —   
Commercial Real Estate - Other   863,351    10,354    916,094    10,518 
Consumer Real Estate   879,753    14,257    249,754    3,548 
Consumer Other   —      —      —      —   
    1,960,646    26,682    1,303,532    16,293 
                     
With an allowance recorded:                    
Commercial   1,582,324    25,869    1,563,849    19,438 
Commercial Real Estate - Construction   —      —      —      —   
Commercial Real Estate - Other   501,279    2,735    517,936    1,840 
Consumer Real Estate   —      —      —      —   
Consumer Other   17,108    224    39,396    483 
    2,100,711    28,828    2,121,181    21,761 
Total                    
Commercial   1,700,065    27,940    1,701,533    21,665 
Commercial Real Estate - Construction   —      —      —      —   
Commercial Real Estate - Other   1,364,630    13,089    1,434,030    12,358 
Consumer Real Estate   879,753    14,257    249,754    3,548 
Consumer Other   17,108    224    39,396    483 
   $4,061,357   $55,510   $3,424,713   $38,054 

 

   Six Months Ended June 30,
   2019  2018
   Average Recorded Investment  Interest Income Recognized  Average Recorded Investment  Interest Income Recognized
With no related allowance recorded:            
Commercial  123,509   4,334   $ 141,909   $ 4,430 
Commercial Real Estate - Construction   —      —      —      —   
Commercial Real Estate - Other   967,076    20,700    917,140    14,233 
Consumer Real Estate   879,753    28,357    249,754    7,007 
Consumer Other   —      —      —      —   
    1,970,338    53,391    1,308,803    25,670 
                     
With an allowance recorded:                    
Commercial   1,597,013    51,983    1,584,430    48,660 
Commercial Real Estate - Construction   —      —      —      —   
Commercial Real Estate - Other   403,001    5,498    523,141    5,507 
Consumer Real Estate   —      —      —      —   
Consumer Other   18,279    478    41,823    1,131 
    2,018,293    57,959    2,149,394    55,298 
Total                    
Commercial   1,720,522    56,317    1,726,339    53,090 
Commercial Real Estate - Construction   —      —      —      —   
Commercial Real Estate - Other   1,370,077    26,198    1,440,281    19,740 
Consumer Real Estate   879,753    28,357    249,754    7,007 
Consumer Other   18,279    478    41,823    1,131 
   3,988,631    $111,350   $ 3,458,197   $ 80,968 

 

 18 

 

 

In general, the modification or restructuring of a loan is considered a troubled debt restructuring (“TDR”) if we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise consider. There were no TDRs as of June 30, 2019 and December 31, 2018. As of March 31, 2019, there was one TDR with a balance of $2,185. During the quarter ended June 30, 2019, the loan in the amount of $2,008 was charged-off and the Bank received a recovery of $439. Not other TDRs defaulted during the six months ended June 30, 2019 and 2018, which were modified within the previous twelve months.

 

Note 4: Disclosure Regarding Fair Value of Financial Statements

 

Fair value measurements apply whenever GAAP requires or permits assets or liabilities to be measured at fair value either on a recurring or nonrecurring basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs, which are developed based on market data we have obtained from independent sources, are ones that market participants would use in pricing an asset or liability. Unobservable inputs, which are developed based on the best information available in the circumstances, reflect our estimate of assumptions that market participants would use in pricing an asset or liability.

 

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

  Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.

 

  Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.

 

  Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

 

Fair value estimates are made at a specific point of time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale our entire holdings of a particular financial instrument. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based on judgements regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value also would affect significantly the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

 

The following paragraphs describe the valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis.

 

Investment Securities Available for Sale

 

Investment securities are recorded at fair value on a recurring basis and are based upon quoted prices if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, or by dealers or brokers in active over-the counter markets. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. 

 

 19 

 

 

Derivative Instruments

 

Derivative instruments include interest rate lock commitments and forward sale commitments. These instruments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. We classify these instruments as Level 3.

 

We had no embedded derivative instruments requiring separate accounting treatment. We had freestanding derivative instruments consisting of fixed rate conforming loan commitments as interest rate locks and commitments to sell fixed rate conforming loans on a best efforts basis. We do not currently engage in hedging activities. Based on short term fair value of the mortgage loans held for sale (derivative contract), our derivative instruments were immaterial to our consolidated financial statements as of June 30, 2019 and December 31, 2018.

 

Assets and liabilities measured at fair value on a recurring basis at June 30, 2019 and December 31, 2018 are as follows:

 

   Balance as of June 30, 2019
   Quoted
Market Price
in active
markets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
U.S. Treasury Notes  $28,146,403   $—     $—     $28,146,403 
Government-Sponsored Enterprises   —      50,717,345    —      50,717,345 
Municipal Securities   —      18,032,698    4,534,517    22,567,215 
Total  $28,146,403   $68,750,043   $4,534,517   $101,430,963 

 

 

 

 

Balance as of December 31, 2018

    Quoted
Market Price
in active
markets
(Level 1)
  Significant
Other
Observable
Inputs

(Level 2)
 

Significant

Unobservable

Inputs
(Level 3)

  Total
U.S. Treasury Notes   $ 32,356,634     $     $     $ 32,356,634  
Government-Sponsored Enterprises           59,369,280             59,369,280  
Municipal Securities           21,701,005       6,241,955       27,942,960  
Total   $ 32,356,634     $ 81,070,285     $ 6,241,955     $ 119,668,874  

 

There were no liabilities recorded at fair value on a recurring basis as of June 30, 2019 or December 31, 2018.

 

The following table reconciles the changes in assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2019 and 2018:

 

   Three Months Ended June 30,  Six Months Ended June 30,
   2019  2018  2019  2018
Beginning balance  $5,738,618   $7,483,696   $6,241,955   $11,458,889 
Total gains or (losses) (realized/unrealized)                    
Included in net income   —      —      —      —   
Included in other comprehensive income (loss)   44,734   2,660    101,397   67,467 
Purchases, issuances, and settlements net of maturities   (1,248,835)   (390,000)   (1,808,835)   (4,430,000)
Transfers in and/or out of level 3   —      —      —      —   
Ending balance  $4,534,517   $7,096,356   $4,534,517   $7,096,356 

 

There were no transfers between fair value levels during the six months ended June 30, 2019 or 2018.

 

The following paragraphs describe the valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis.

 

 20 

 

 

Other Real Estate Owned (“OREO”)

 

Loans secured by real estate are adjusted to the lower of the recorded investment in the loan or the fair value of the real estate upon transfer to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral, or our estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraisal, we record the asset as nonrecurring Level 2. When an appraised value is not available or we determine the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the asset as nonrecurring Level 3.

 

Impaired Loans

 

Impaired loans are carried at the lower of recorded investment or fair value. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, we review the most recent appraisal and if it is over 12 to 18 months old we may request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, we may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of our primary market area, we would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where we are familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, we may perform an internal analysis whereby the previous appraisal value would be reviewed considering recent current conditions, and known recent sales or listings of similar properties in the area, and any other relevant economic trends. This analysis may result in the call for a new appraisal. These valuations are reviewed and updated on a quarterly basis.

 

In accordance with ASC 820, Fair Value Measurement, impaired loans, where an allowance is established based on the fair value of collateral, require classification in the fair value hierarchy. These impaired loans are classified as Level 3. Impaired loans measured using discounted future cash flows are not deemed to be measured at fair value. 

 

Mortgage Loans to be Sold

 

Mortgage loans to be sold are carried at the lower of cost or market value. The fair values of mortgage loans to be sold are based on current market rates from investors within the secondary market for loans with similar characteristics. Carrying value approximates fair value. These loans are classified as Level 2.

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

 

The following table presents information about certain assets and liabilities measured at fair value on a nonrecurring basis at June 30, 2019 and December 31, 2018:

 

June 30, 2019
             
   Quoted Market Price in active markets
(Level 1)
  Significant Other Observable Inputs (Level 2)  Significant Unobservable Inputs
 (Level 3)
  Total
Impaired loans  $—     $—     $2,209,555   $2,209,555 
Other real estate owned   —      —      —      —   
Loans held for sale   —      2,874,982    —      2,874,982 
Total  $—     $2,874,982   $2,209,555   $5,084,537 

 

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December 31, 2018
 
      Quoted
Market Price
in active
markets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
    Total
Impaired loans   $         2,223,028     2,223,028  
Other real estate owned                        
Loans held for sale           1,199,438             1,199,438  
Total   $     1,199,438     2,223,028     3,422,466  

 

There were no liabilities measured at fair value on a nonrecurring basis as of June 30, 2019 or December 31, 2018.

 

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at June 30, 2019 and December 31, 2018:

 

        Inputs
    Valuation Technique   Unobservable Input   General Range of Inputs
             
 Impaired Loans   Appraisal Value/ Comparison Sales/Other Estimates   Appraisals and/or Sales of Comparable Properties   Appraisals Discounted 10% to 20% for Sales Commissions and Other Holding Costs
             
 Other Real Estate Owned   Appraisal Value/ Comparison Sales/Other Estimates   Appraisals and/or Sales of Comparable Properties   Appraisals Discounted 10% to 20% for Sales Commissions and Other Holding Costs

 

Accounting standards require disclosure of fair value information for all of our assets and liabilities that are considered financial instruments, whether or not recognized on the balance sheet, for which it is practicable to estimate fair value.

 

Under the accounting standard, fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of the assets and liabilities that are not financial instruments. Accordingly, the aggregate fair value amounts of existing financial instruments do not represent the underlying value of those instruments on our books.

 

The following paragraphs describe the methods and assumptions we use in estimating the fair values of financial instruments:

 

a. Cash and due from banks, interest-bearing at the Federal Reserve 

The carrying value approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.

 

b. Investment securities available for sale 

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

 

c. Loans, net 

The fair value of the Company’s loan portfolio includes a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: variable rate loans, impaired loans and all other loans. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. Additionally, in accordance with ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, this consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio. 

 

For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated based on the fair value of the underlying collateral. Impaired loans measured using discounted future cash flows are not deemed to be measured at fair value.

 

 22 

 

 

d. Deposits 

The estimated fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is estimated by discounting contractual cash flows, using interest rates currently being offered on the deposit products. The fair value estimates for deposits do not include the benefit that results from the low cost funding provided by the deposit liabilities as compared to the cost of alternative forms of funding (deposit base intangibles).

 

e. Accrued interest receivable and payable 

Since these financial instruments will typically be received or paid within six months, the carrying amounts of such instruments are deemed to be a reasonable estimate of fair value.

 

f.  Loan commitments 

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

 

The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of our financial instruments as of June 30, 2019 and December 31, 2018.

 

Fair Value Measurements at June 30, 2019
   Carrying
Amount
  Estimated
Fair Value
  Level 1  Level 2  Level 3
Financial Assets:               
Cash and due from banks  9,843,665   $ 9,843,665   $ 9,843,665   $ —     $ —   
Interest-bearing deposits at the Federal Reserve   35,252,826    35,252,826    35,252,826    —      —   
Investment securities available for sale   101,430,963    101,430,963    28,146,403    68,750,043    4,534,517 
Mortgage loans to be sold   2,874,982    2,874,982    —      2,874,982    —   
Loans, net   279,717,082    275,600,697    —      —      275,600,697 
Accrued interest receivable   1,565,145    1,565,145    —      1,565,145    —   
Financial Liabilities:                         
Demand deposits   357,791,960    357,791,960    —      357,791,960    —   
Time deposits   26,017,945    29,473,494    —      29,473,494    —   
Accrued interest payable   63,802    63,802    —      63,802    —   

 

Fair Value Measurements at December 31, 2018
      Carrying
Amount
 

Estimated

Fair Value

  Level 1   Level 2   Level 3
Financial Assets:                                        
Cash and due from banks   $ 6,325,457     $  6,325,457   $  6,325,457    $   $   
 Interest-bearing deposits at the Federal Reserve     25,506,784       25,506,784       25,506,784              
 Investment securities available for sale     119,668,874       119,668,874       32,356,634       81,070,285       6,241,955  
Mortgage loans to be sold     1,199,438       1,199,438             1,199,438       —    
 Loans, net     270,449,936       263,780,751             —        263,780,751  
Accrued interest receivable     1,561,915       1,561,915             1,561,915        
Financial Liabilities:                                        
Demand deposits     347,909,663       347,909,663             347,909,663        
Time deposits     34,468,725       38,747,898        —       38,747,898        
Accrued interest payable     163,876       163,876             163,876        

 

Note 5: Income Per Common Share

 

Basic income per share is computed by dividing net income by the weighted-average number of common shares outstanding, after giving retroactive effect to a stock dividend payable May 31, 2018. Diluted earnings per share is computed by dividing net income by the weighted-average number of common shares and potential common shares outstanding. Potential common shares consist of dilutive stock options determined using the treasury stock method and the average market price of common stock.

 

 23 

 

 

The following table is a summary of the reconciliation of average shares outstanding for the three months ended June 30:

 

   2019  2018
Net income  $1,840,847   $1,726,357 
           
Weighted average shares outstanding   5,517,236    5,492,896 
Effect of dilutive shares   70,749    93,689 
Weighted average shares outstanding - diluted   5,587,985    5,586,585 
           
Earnings per share - basic  $0.33   $0.31 
Earnings per share - diluted  $0.33   $0.31 

 

 The following table is a summary of the reconciliation of average shares outstanding for the six months ended June 30:

 

   2019  2018
Net income  $3,530,111   $3,338,587 
           
Weighted average shares outstanding   5,515,832    5,339,187 
Effect of dilutive shares   70,981    94,173 
Weighted average shares outstanding - diluted   5,586,813    5,433,360 
           
Earnings per share - basic  $0.64   $0.63 
Earnings per share - diluted  $0.63   $0.61 

 

 

 24 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, including information included or incorporated by reference in this document, contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1934. We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1996 and are including this statement for the express purpose of availing the Company of protections of such safe harbor with respect to all “forward-looking statements” contained in this Form 10-Q. Forward-looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors that are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitations, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018 as filed with the SEC and the following:

 

  Risk from changes in economic, monetary policy, and industry conditions

  Changes in interest rates, shape of the yield curve, deposit rates, the net interest margin and funding sources

  Market risk (including net income at risk analysis and economic value of equity risk analysis) and inflation

  Risk inherent in making loans including repayment risks and changes in the value of collateral

  Loan growth, the adequacy of the allowance for loan losses, provisions for loan losses, and the assessment of problem loans

  Level, composition, and re-pricing characteristics of the securities portfolio

  Deposit growth, change in the mix or type of deposit products and services

  Continued availability of senior management and ability to attract and retain key personnel

  Technological changes

  Ability to control expenses

  Changes in compensation

  Risks associated with income taxes including potential for adverse adjustments

  Changes in accounting policies and practices

  Changes in regulatory actions, including the potential for adverse adjustments

  Recently enacted or proposed legislation
  Reputational risk

 

We will undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings with the SEC, in our press releases, and in oral and written statements, which are not statements of historical fact, constitute forward-looking statements.

 

Overview 

Bank of South Carolina Corporation (the “Company”) is a financial institution holding company headquartered in Charleston, South Carolina, with $442.4 million in assets as of June 30, 2019 and net income of $3.5 million for the six months ended June 30, 2019. The Company offers a broad range of financial services through its wholly-owned subsidiary, The Bank of South Carolina (the “Bank”). The Bank is a state-chartered commercial bank which operates primarily in the Charleston, Dorchester and Berkeley counties of South Carolina. The Bank’s original and current concept is to be a full service financial institution specializing in personal service, responsiveness, and attention to detail to foster long standing relationships.

 

We derive most of our income from interest on loans and investments (interest-earning assets). The primary source of funding for making these loans and investments is our interest and non-interest bearing deposits. Consequently, one of the key measures of our success is the amount of net interest income, or the difference between the income on our interest-earning assets 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.

 

A consequence of lending activities is that we may incur credit losses. The amount of such losses will vary depending upon the risk characteristics of the loan and lease portfolio as affected by economic conditions such as rising interest rates and the financial performance of borrowers. The reserve for credit losses consists of the allowance for loan losses (the “allowance”) and a reserve for unfunded commitments (the “unfunded reserve”). The allowance provides for probable and estimable losses inherent in our loan portfolio while the unfunded reserve provides for potential losses related to unfunded lending commitments.

 

 25 

 

 

In addition to earning interest on loans and investments, we earn income through fees and other expenses we charge to the customer. The various components of non-interest income as well as non-interest expense are described in the following discussion. The discussion and analysis also identifies significant factors that have affected our financial position and operating results as of and for the periods ending June 30, 2019 and December 31, 2018, and should be read in conjunction with the financial statements and the related notes included in this report. In addition, a number of tables have been included to assist in the discussion.

 

Critical Accounting Policies

Our critical accounting policies which involve significant judgements and assumptions that have a material impact on the carrying value of certain assets and liabilities, and used in the preparation of the Consolidated Financial Statements as of June 30, 2019, have remained unchanged from the disclosures presented in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

Balance Sheet

Cash and Cash Equivalents 

Total cash and cash equivalents increased 41.67% or $13.3 million to $45.1 million as of June 30, 2019, from $31.8 million at December 31, 2018. Funds are placed in interest bearing deposits at the Federal Reserve until opportunities arise for investment in higher yielding assets.

 

Investment Securities Available for Sale

Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies and the assessment of potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk.

 

We use the investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income from investment of funds, to provide liquidity to meet funding requirements, and to provide collateral for pledging of public funds.

 

As of June 30, 2019, our available for sale investment portfolio included U. S. Treasury Notes, Government-Sponsored Enterprises and Municipal Securities with a fair market value of $101.4 million and an amortized cost of $101.1 million for a net unrealized loss of approximately $0.3 million. As of June 30, 2019 and December 31, 2018, our investment securities portfolio represented approximately 22.93% and 27.89% of our total assets, respectively. The average yield on our investment securities was 2.04% and 2.08% at June 30, 2019 and December 31, 2018, respectively.

 

During the first quarter of 2019, five Municipal Securities totaling $3.0 million matured and one Municipal Security in the amount of $0.5 million was called. During the second quarter of 2019, six Municipal Securities totaling $1.4 million were called, two Municipal Securities totaling $0.9 million matured, two Government-Sponsored Enterprise securities were sold for $10.0 million, and one U.S. Treasury Note in the amount of $5.0 million was sold.

 

Loans 

We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic markets. Substantially all of our loans are to borrowers located in our market area of Charleston, Dorchester and Berkeley Counties of South Carolina.

 

Net loans increased $9.3 million, or 3.43%, to $279.7 million as of June 30, 2019 from $270.4 million as of December 31, 2018. The increase in loans is related to increased loan demand due to the growing economy in Charleston.  The following table is a summary of our loan portfolio composition (net of deferred fees of $165,854 at June 30, 2019 and $156,309 at December 31, 2018) and the corresponding percentage of total loans as of the dates indicated.

 

   June 30, 2019  December 31, 2018
   Amount  Percent  Amount  Percent
             
Commercial   $56,270,330    19.82%  $54,829,078    19.96%
Commercial Real Estate - Construction   11,204,997    3.95%   7,304,300    2.66%
Commercial Real Estate - Other   148,569,431    52.34%   143,703,401    52.32%
Consumer Real Estate   62,167,172    21.90%   63,787,411    23.23%
Consumer Other   5,635,700    1.99%   5,040,077    1.83%
Total loans   283,847,630    100.00%   274,664,267    100.00%
Allowance for loan losses   (4,130,548)        (4,214,331)     
Total loans, net  $279,717,082        $270,449,936      

 

 

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Nonperforming Assets 

Nonperforming Assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure, loans on nonaccrual status and TDRs. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms and to show capacity to continue performing into the future before that loan can be placed back on accrual status. As of June 30, 2019, we had no loans 90 days past due still accruing interest.

 

We consider a loan to be a TDR when the debtor experiences financial difficulties and we provide concessions such that we will not collect all principal and interest in accordance with the original terms of the agreement. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges. As of June 30, 2019 and December 31, 2018, there were no TDRs.

 

Nonperforming loans include all loans past due 90 days and over, certain impaired loans (some of which may be contractually current), and TDR loans that have not yet established a satisfactory period of payment performance (some of which may be contractually current). Nonperforming assets include other real estate owned, which remained unchanged compared to December 31, 2018.

 

The following table is a summary of our nonperforming assets:

 

   June 30, 2019  December 31, 2018
Commercial  $13,210   $251,219 
Commercial Real Estate - Other   571,292    571,292 
Consumer Other   678    1,023 
Total nonaccruing loans   585,180    823,534 
Other real estate owned   —      —   
Total nonperforming assets  $585,180   $823,534 

  

Allowance for Loan Losses 

The allowance for loan losses was $4.1 million as of June 30, 2019 and $4.2 million as of December 31, 2018, or 1.46% and 1.53% of outstanding loans for each respective period. At June 30, 2019 and December 31, 2018, the allowance for loan losses represented 705.86% and 511.74% of the total amount of nonperforming loans, respectively. Based on the level of coverage on nonperforming loans and analysis of our loan portfolio, we believe the allowance for loan losses at June 30, 2019 is adequate.

 

At June 30, 2019, impaired loans totaled $3.9 million, for which $2.0 million of these loans had a reserve of approximately $0.9 million allocated in the allowance for loan losses. Comparatively, impaired loans totaled $4.2 million at December 31, 2018, and $2.2 million of these loans had a reserve of approximately $1.2 million allocated in the allowance for loan losses.

 

During the six months ended June 30, 2019, we recorded $237,737 of charge-offs and $8,954 of recoveries on loans previously charged-off, for net charge-offs of $228,783. Comparatively, we recorded $103,093 of charge-offs and $105,159 of recoveries on loans previously charged-off, for net recoveries of $2,066 for the six months ended June 30, 2018.

 

Deposits

Deposits remain our primary source of funding for loans and investments. Average interest bearing deposits provided funding for 58.98% of average earning assets for the six months ended June 30, 2019, and 60.13% for the six months ended June 30, 2018. The Company encounters strong competition from other financial institutions as well as consumer and commercial finance companies, insurance companies and brokerage firms located in the primary service area of the Bank. However, the percentage of funding provided by deposits has remained stable.

 

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The breakdown of total deposits by type and the respective percentage of total deposits are as follows:

 

   June 30, 2019  December 31, 2018
   Amount  Percent  Amount  Percent
Deposits            
Non-interest bearing demand  $138,577,128    36.11%  $130,940,138    34.24%
Interest bearing demand   102,905,495    26.81%   94,207,731    24.64%
Money market accounts   85,539,479    22.29%   87,300,433    22.83%
Time deposits over $250,000   8,176,688    2.13%   15,909,991    4.16%
Other time deposits   17,841,257    4.65%   18,558,734    4.85%
Other savings deposits   30,769,858    8.01%   35,461,361    9.28%
Total deposits
  $383,809,905    100.00%  $382,378,388    100.00%

  

Deposits increased 0.37% or $1.4 million from December 31, 2018 to June 30, 2019 primarily due to seasonal fluctuations.

 

At June 30, 2019 and December 31, 2018, deposits with an aggregate deficit balance of $28,692 and $43,118, respectively, were re-classified as other loans.

 

Comparison of Three Months Ended June 30, 2019 to Three Months Ended June 30, 2018

Net income increased $114,490 or 6.63% to $1.8 million, or basic and diluted earnings per share of $0.33, for the three months ended June 30, 2019, from $1.7 million, or basic and diluted earnings per share of $0.31, for the three months ended June 30, 2018. Our annualized return on average assets and average equity for the three months ended June 30, 2019 were 1.70% and 15.23%, respectively, compared with 1.64% and 16.11%, respectively, for the three months ended June 30, 2018.

 

Net Interest Income

Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities. Net interest margin is a measure of the difference between interest income on earning assets and interest paid on interest bearing liabilities relative to the amount of interest bearing assets. Net interest income increased $283,949 or 6.63% to $4.6 million for the three months ended June 30, 2019 from $4.3 million for the three months ended June 30, 2018. This increase was primarily due to interest and fee income on loans related to increases in market interest rates. Average loans increased $7.9 million or 2.86% to $282.8 million for the three months ended June 30, 2019, compared to $274.9 million for the three months ended June 30, 2018. The yield on average loans (including fees) was 6.15% and 5.71% for the three months ended June 30, 2019 and June 30, 2018, respectively. Interest income on loans increased $385,671 for the three months ended June 30, 2019 to $4.1 million from $3.7 million for the three months ended June 30, 2018.

 

The average balance of interest bearing deposits in other banks increased $11.4 million or 71.59% to $27.3 million for the three months ended June 30, 2019, with a yield of 2.38% as compared to $15.9 million for the three months ended June 30, 2018, with a yield of 1.84%.

 

Provision for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements 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 our allowance for loan losses. For the three months ended June 30, 2019, we had a provision of $135,000 of loan losses compared to a provision of $75,000 for the same period in the prior year. The increase in the provision for loan losses was based on our analysis of the adequacy of the allowance for loan losses.

 

Non-Interest Income

Other income increased $37,643 or 6.78% to $592,739 for the three months ended June 30, 2019, from $555,096 for the three months ended June 30, 2018. This increase was primarily due to gains on sales of investment securities in the amount of $28,900 for the three months ended June 30, 2019 compared to gains on sales of investment securities of $387 during the same period in the prior year.

 

Non-Interest Expense

Non-interest expense decreased $16,733 or 0.63% to $2.6 million for the three months ended June 30, 2019 from $2.7 million for the three months ended June 30, 2018. This decrease was primarily due to net other real estate owned expenses incurred during the three months ended June 30, 2018 of $24,137 as compared to no net other real estate owned expenses incurred during the three months ended June 30, 2019.

 

Income Tax Expense

We incurred income tax expense of $550,229 for the three months ended June 30, 2019 as compared to $386,394 during the same period in 2018. Our effective tax rate was 23.01% and 18.29% for the three months ended June 30, 2019 and 2018, respectively. The increase in the effective tax rate during the 2019 period is a result of the expiration of historic tax credits during 2018.

 

Comparison of Six Months Ended June 30, 2019 to Six Months Ended June 30, 2018 

Net income increased $191,524 or 5.74% to $3.5 million, or basic and diluted earnings per share of $0.64 and $0.63, respectively, for the six months ended June 30, 2019, from $3.3 million, or basic and diluted earnings per share of $0.63 and $0.61, respectively, for the six months ended June 30, 2018. Our annualized returns on average assets and average equity for the six months ended June 30, 2019 were 1.65% and 14.99%, respectively, compared with 1.57% and 15.59%, respectively, for the six months ended June 30, 2018.

 

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Net Interest Income 

Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities. Net interest margin is a measure of the difference between interest income on earning assets and interest paid on interest bearing liabilities relative to the amount of interest bearing assets. Net interest income increased $522,845 or 6.16% to $9.0 million for the six months ended June 30, 2019 from $8.5 million for the six months ended June 30, 2018. This increase was primarily due to interest and fee income from loans related to increases in market interest rates. Average loans increased $5.6 million or 2.03% to $279.7 million for the six months ended June 30, 2019, compared to $274.1 million for the six months ended June 30, 2018. The yield on average loans (including fees) was 6.09% and 5.61% for the six months ended June 30, 2019 and 2018, respectively. Interest income on loans increased $778,404 for the six months ended June 30, 2019 to $8.0 million from $7.3 million for the six months ended June 30, 2018.

 

The average balance of interest bearing deposits at the Federal Reserve increased $6.9 million or 42.57% to $23.1 million for the six months ended June 30, 2019, with a yield of 2.43% as compared to $16.2 million for the six months ended June 30, 2018, with a yield of 1.18%.

 

Provision for Loan Losses 

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio of loan losses and the adequacy\ of our allowance for loan losses. For the six months ended June 30, 2019, we had a provision of $145,000 compared to a provision of $130,000 for the same period in the prior year. The increase in the provision for loan losses was based on our analysis of the adequacy of the allowance for loan losses.

 

Non-Interest Income

Other income decreased $1,519 or 0.15% to $1.0 million for the six months ended June 30, 2019, from $1.0 million for the six months ended June 30, 2018. This decrease was primarily due to a reduction in mortgage banking income and service charges and fees offset by gains on sales of securities. Service charges and fees decreased $11,177 or 1.89%. Mortgage banking income decreased $10,428 or 2.67% due to fewer originations. For the six months ended June 30, 2019, we realized gains of $28,900 from the sale of investment securities compared to gains of $4,735 for the six months ended June 30, 2018.

 

Non-Interest Expense 

Non-interest expense increased $794 or 0.01% to $5.3 million for the six months ended June 30, 2019 from $5.3 million for the six months ended June 30, 2018.

 

Income Tax Expense 

We incurred income tax expense of $1.0 million for the six months ended June 30, 2019 as compared to $735,454 during the same period in 2018. Our effective tax rate was 22.92% and 18.05% for the six months ended June 30, 2019 and 2018, respectively. The increase in the effective tax rate during the 2019 period is a result of the expiration of historic tax credits during 2018.

 

Off Balance Sheet Arrangements 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on our credit evaluation of the borrower. Collateral held varies but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate. Commitments to extend credit, including unused lines of credit, amounted to $92.9 million and $96.1 million at June 30, 2019 and December 31, 2018, respectively.

 

Standby letters of credit represent our obligation to a third party contingent upon the failure of our customer to perform under the terms of an underlying contract with the third party or obligates us to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation. Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended. We can seek recovery of the amounts paid from the borrower. The majority of these standby letters of credit are unsecured. Commitments under standby letters of credit are usually for one year or less. The maximum potential amount of undiscounted future payments related to standby letters of credit at June 30, 2019 and December 31, 2018 was $1.1 million and $1.2 million, respectively.

 

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We originate certain fixed rate residential loans and commit these loans for sale. The commitments to originate fixed rate residential loans and the sales commitments are freestanding derivative instruments. We had forward sales commitments on mortgage loans held for sale totaling $2.9 million and $1.2 million at June 30, 2019 and December 31, 2018, respectively. The fair value of these commitments was not significant at June 30, 2019 or December 31, 2018. We had no embedded derivative instruments requiring separate accounting treatment.

 

Once we sell certain fixed rate residential loans, the loans are no longer reportable on our balance sheet. With most of these sales, we have an obligation to repurchase the loan in the event of a default of principal or interest on the loan. This recourse period ranges from three to nine months. Misrepresentation or fraud carries unlimited time for recourse. The unpaid principal balance of loans sold with recourse was $1.7 million at June 30, 2019 and $0.7 million at December 31, 2018. For the six months ended June 30, 2019 and June 30, 2018, there were no loans repurchased.

 

Liquidity 

Historically, we have maintained our liquidity at levels believed to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets.

 

We manage our assets and liabilities to ensure there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses, dividends and to manage daily operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings.

 

Proper liquidity management is crucial to ensure that we are able to take advantage of new business opportunities as well as meet the credit needs of our existing customers. Investment securities are an important tool in our liquidity management. Our primary liquid assets are cash and due from banks, interest-bearing deposits in other banks, federal funds sold, investments available for sale, other short-term investments and mortgage loans held for sale. Our primary liquid assets accounted for 33.77% and 35.58% of total assets at June 30, 2019 and December 31, 2018, respectively. Securities classified as available for sale, which are not pledged, may be sold in response to changes in interest rates and liquidity needs. All of the securities presently owned are classified as available for sale. Net cash provided by operations and deposits from customers have been the primary sources of liquidity. At June 30, 2019, we had unused short-term lines of credit totaling approximately $23.0 million (which can be withdrawn at the lender’s option). Additional sources of funds available to us for additional liquidity needs include borrowing on a short-term basis from the Federal Reserve System, increasing deposits by raising interest rates paid and sale of mortgage loans held for sale. We established a Borrower-In-Custody arrangement with the Federal Reserve. This arrangement permits us to retain possession of assets pledged as collateral to secure advances from the Federal Reserve Discount Window. At June 30, 2019, we could borrow up to $74.7 million. There have been no borrowings under this arrangement.

 

Our core deposits consist of non-interest bearing accounts, NOW accounts, money market accounts, time deposits and savings accounts. We closely monitor our level of certificates of deposit greater than $250,000 and other large deposits. We maintain a Contingency Funding Plan (“CFP’) that identifies liquidity needs and weighs alternate courses of action designed to address these needs in emergency situations. We perform a quarterly cash flow analysis and stress test the CFP to evaluate the expected funding needs and funding capacity during a liquidity stress event. We believe our liquidity sources are adequate to meet our operating needs and do not know of any trends, events or uncertainties that may result in a significant adverse effect on our liquidity position. At June 30, 2019 and December 31, 2018, our liquidity ratio was 33.68% and 34.27%, respectively.

 

Capital Resources 

Our capital needs have been met to date through the $10.6 million in capital raised in our initial offering, the retention of earnings less dividends paid and the exercise of stock options to purchase stock. Total shareholders’ equity as of June 30, 2019 was $49.4 million. The rate of asset growth since our inception has not negatively impacted this capital base.

 

On July 2, 2013, the Federal Reserve Board approved the final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for US banks (“Basel III”). Following the actions by the Federal Reserve, the FDIC also approved regulatory capital requirements on July 9, 2013. The FDIC’s rule is identical in substance to the final rules issued by the Federal Reserve Bank.

 

Basel III became effective on January 1, 2015. The purpose is to improve the quality and increase the quantity of capital for all banking organizations. The minimum requirements for the quantity and quality of capital were increased. The rule includes a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and requires a minimum leverage ratio of 4%. In addition, the rule also implements strict eligibility criteria for regulatory capital instruments and improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. Full compliance with all of the final rule requirements has be phased in over a multi-year schedule. The Bank’s total risk-based capital ratio at June 30, 2019 and December 31, 2018 was 16.25% and 16.69%, respectively.

 

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At June 30, 2019, the Company and the Bank were categorized as “well capitalized” under Basel III. To be categorized as “well capitalized” the Company and the Bank must maintain minimum total risk based, Tier 1 risk based, common equity Tier 1 risk based capital and Tier 1 leverage ratios of 10%, 8.0%, 6.5% and 5%, respectively, and to be categorized as “adequately capitalized,” the Company and the Bank must maintain minimum total risk based, Tier 1 risk based, common equity Tier 1 risk based capital, and Tier 1 leverage ratios of 8%, 6%, 4.5%, and 4.0%, respectively.

 

We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a material effect on the financial statements. We must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Current and previous quantitative measures established by regulation to ensure capital adequacy require that we maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and to average assets. Management expects that the capital ratios for the Company and the Bank under Basel III will continue to exceed the well-capitalized minimum capital requirements.

 

We intend to open a branch in North Charleston in the fourth quarter of 2019. The Bank of South Carolina will be the anchor tenant of a two-story building located at 9403 Highway 78, occupying the entire first floor. At this time, we estimate the capital expenditures associated with building the branch to be approximately $2.0 million.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Not required.

 

Item 4. Controls and Procedures

 

Evaluation of disclosure controls and procedures and internal controls and procedures for financial reporting

 

An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities and Exchange Act of 1934 as amended (the “Act”) was carried out as of June 30, 2019 under the supervision and with the participation of the Bank of South Carolina Corporation’s management, including its President/Chief Executive Officer and the Chief Financial Officer/Executive Vice President and several other members of the Company’s senior management. Based upon that evaluation, Bank of South Carolina Corporation’s management, including the President/Chief Executive Officer and the Chief Financial Officer/Executive Vice President concluded that, as of June 30, 2019, the Company’s disclosure controls and procedures were effective in ensuring that the information the Company is required to disclose in the reports filed or submitted under the Act has been (i) accumulated and communicated to management (including the President/Chief Executive Officer and Chief Financial Officer/Executive Vice President) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

The Company’s management is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.

 

Under the supervision and with the participation of management, including the President/Chief Executive Officer and the Chief Financial Officer/Executive Vice President, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of June 30, 2019, based on the 2013 framework established in a report entitled “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2019. Based on this assessment, management believes that as of June 30, 2019, the Company’s internal control over financial reporting was effective. There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

The Audit and Compliance Committee, composed entirely of independent Directors, meets periodically with management, the Bank’s Compliance Officer, Risk Management Officer and Elliott Davis, LLC (separately and jointly) to discuss audit, financial and related matters. Elliott Davis, LLC, the Compliance Officer, and the Risk Management Officer have direct access to the Audit and Compliance Committee.

 

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Part II. Other Information

 

Item 1. Legal Proceedings

In our opinion, there are no other legal proceedings pending other than routine litigation incidental to our business involving amounts which are not material to our financial condition.

 

Item 1A. Risk Factors 

Not required.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3. Defaults Upon Senior Securities 

None.

 

Item 4. Mine Safety Disclosure

None.

 

Item 5. Other Information 

None.

 

Item 6. Exhibits

 

1. The Consolidated Financial Statements are included in this Form 10-Q and listed on pages as indicated.
      Page
       
  (1) Consolidated Balance Sheets 3
  (2) Consolidated Statements of Income 4
  (3) Consolidated Statements of Comprehensive Income 5
  (4) Consolidated Statements of Shareholders’ Equity 6
  (5) Consolidated Statements of Cash Flows 7
  (6) Notes to Consolidated Financial Statements 8-24

 

Exhibits  
  2.0 Plan of Reorganization (Filed with 1995 10-KSB)
  3.0 Articles of Incorporation of the Registrant (Filed with 1995 10-KSB)
  3.1 By-laws of the Registrant (Filed with 1995 10-KSB)
  3.2 Amendments to the Articles of Incorporation of the Registrant (Filed with Form S on June 23, 2011)
  4.0 2019 Proxy Statement (Filed with 2018 10-K)
  10.0 Lease Agreement for 256 Meeting Street (Filed with 1995 10-KSB)
  10.1 Sublease Agreement for Parking Facilities at 256 Meeting Street (Filed with 1995 10-KSB)
  10.2 Lease Agreement for 100 N. Main Street, Summerville, SC (Filed with 1995 10-KSB)
  10.3 Lease Agreement for 1337 Chuck Dawley Blvd., Mt. Pleasant, SC (Filed with 1995 10-KSB)
  10.4 Lease Agreement for 1071 Morrison Drive, Charleston, SC (Filed with 2010 10-K)
    Lease Agreement for 1071 Morrison Drive, Charleston, SC (Filed with June 30, 2013 10-Q)
  10.5 1998 Omnibus Stock Incentive Plan (Filed with 2008 10-K/A)
  10.6 Employee Stock Ownership Plan (Filed with 2008 10-K/A)
    Employee Stock Ownership Plan, Restated (Filed with 2011 Proxy Statement)
    Employee Stock Ownership Plan, Restated (Filed with 2016 10-K)
  10.7 2010 Omnibus Incentive Stock Option Plan (Filed with 2010 Proxy Statement)
  10.8 Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2013 10-K)
  10.9 Assignment and Assumption of Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2015 10-K)
  10.10 First Amendment to Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2015 10-K)
  10.11 Second Amendment to Lease Agreement for Highway 78 Ingleside Boulevard North Charleston, SC (Filed with 2015 10-K)
  10.12 Extension to Lease Agreement for 256 Meeting Street (Filed with September 30, 2017 10-Q)
  10.13 North Charleston Lease Agreement (Filed with June 30, 2017 10-Q)
  10.14 Sublease Amendment for Parking Facilities at 256 Meeting Street (Filed with September 30, 2017 10-Q)

 

 32 

 

 

  14.0 Code of Ethics (Filed with 2004 10-KSB)
  21.0 List of Subsidiaries of the Registrant (Filed with 1995 10-KSB)
    The Registrant’s only subsidiary is The Bank of South Carolina (Filed with 1995 10-KSB)
  31.1 Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Executive Officer
  31.2 Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Financial Officer
  32.1 Certification pursuant to Section 1350
  32.2 Certification pursuant to Section 1350
  101.INS XBRL Instance Document
  101.SCH XBRL Taxonomy Extension Schema Document
  101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
  101.DEF XBRL Taxonomy Extension Definition Linkbase Document
  101.LAB XBRL Taxonomy Extension Label Linkbase Document
  101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

 33 

 

 

Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  Bank of South Carolina Corporation
     
August 5, 2019    
  By: /s/ Fleetwood S. Hassell
    Fleetwood S. Hassell
    President/Chief Executive Officer
     
  By: /s/ Eugene H. Walpole, IV
    Eugene H. Walpole, IV
    Chief Financial Officer/Executive Vice President

 

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