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M&F BANCORP INC /NC/ - Quarter Report: 2008 September (Form 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

Commission file number 0-27307

 

 

M&F BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina   56-1980549

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

2634 Durham Chapel Hill Blvd., Durham, NC 27707-2800

(Address of Principal Executive Offices)

(919) 683-1521

 

 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” in rule 12b-2 of the Exchange Act. (Check One)

 

Large accelerated filer  ¨   Accelerated filer  ¨   Non-accelerated filer  ¨   Smaller reporting company  x

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

State the number of shares outstanding of each of the issuer’s class of common equity, as of the latest practicable date:

Common Stock no par value 2,031,337

Outstanding at November 6, 2008

 

 

 


Table of Contents

M&F BANCORP, INC

Table of Contents

 

          Page

PART I.

   FINANCIAL INFORMATION (Unaudited)   
Item 1.    Financial Statements:   
  

Consolidated Balance Sheets

   3
  

Consolidated Statements of Operations

   4
  

Consolidated Statements of Changes in Shareholders’ Equity

   5
  

Consolidated Statements of Cash Flows

   6
   Notes to Consolidated Financial Statements    8
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    18
Item 3.    Quantitative and Qualitative Disclosures about Market Risk    29
Item 4.    Controls and Procedures    29

PART II

   OTHER INFORMATION   
Item 1.    Legal Proceedings    30
Item 1a.    Risk Factors    30
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    30
Item 3.    Defaults upon Senior Securities    30
Item 4.    Submission of Matters to a Vote of Security Holders    30
Item 5.    Other Information    30
Item 6.    Exhibits    30

SIGNATURE PAGES

   31

 

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M&F BANCORP, INC

 

PART I

FINANCIAL

INFORMATION

Item 1 — Consolidated Financial Statements

CONSOLIDATED BALANCE SHEETS

 

     September 30, 2008     December 31, 2007  
dollars in thousands    (Unaudited)        

ASSETS

    

Cash and cash equivalents

   $ 19,961     $ 18,172  

Investment securities available for sale, at fair value

     32,555       43,612  

Other invested assets

     1,702       1,269  

Loans

     204,918       146,080  

Less allowances for loan losses

     (2,637 )     (1,897 )
                

Loans, net

     202,281       144,183  
                

Interest receivable

     1,464       1,235  

Bank premises and equipment, net

     5,065       5,636  

Cash surrender value of bank-owned life insurance

     5,249       4,951  

Other real estate owned

     1,189       338  

Other assets

     4,567       2,822  
                
TOTAL ASSETS    $ 274,033     $ 222,218  
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Liabilities

    

Deposits

    

Interest-bearing deposits

   $ 173,545     $ 142,150  

Noninterest-bearing deposits

     47,375       29,904  
                

Total deposits

     220,920       172,054  

Federal funds purchased

     —         10,000  

Other borrowings

     22,989       14,004  

Other liabilities

     4,721       4,000  
                

Total liabilities

     248,630       200,058  
                

Shareholders’ equity:

    

Common stock, no par value, 5,000,000 shares authorized; 2,031,337 and 1,685,646 shares issued and outstanding as of September 30, 2008 and December 31, 2007, respectively

     8,732       5,901  

Retained earnings

     17,488       16,617  

Accumulated other comprehensive loss

     (817 )     (358 )
                

Total shareholders’ equity

     25,403       22,160  
                
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY    $ 274,033     $ 222,218  
                

See notes to consolidated financial statements.

 

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M&F BANCORP, INC

 

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

     For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,
dollars in thousands except per share data    2008     2007    2008     2007
Interest income:          

Loans, including fees

   $ 3,449     $ 2,750    $ 9,219     $ 8,491

Investment securities, including dividends

         

Taxable

     317       605      942       1,892

Tax-exempt

     140       168      447       503

Other

     28       151      228       794
                             

Total interest income

     3,934       3,674      10,836       11,680
                             
Interest expense:          

Deposits

     887       1,314      2,871       4,343

Borrowings

     227       201      614       618
                             

Total interest expense

     1,114       1,515      3,485       4,961
                             

Net interest income

     2,820       2,159      7,351       6,719

Less provision for loan losses

     137       10      200       59
                             

Net interest income after provision for loan losses

     2,683       2,149      7,151       6,660
                             
Noninterest income:          

Service charges

     431       333      1,129       1,002

Rental income

     79       48      226       187

Cash surrender value of life insurance

     58       49      157       163

Realized gain on sale of loan

     —         —        —         97

Realized gain on sale of securities

     56       —        61       244

Realized gain on sale of other real estate owned

     3       250      —         250

Other income

     86       17      275       174
                             

Total noninterest income

     713       697      1,848       2,117
                             
Noninterest expense:          

Salaries and employee benefits

     1,430       1,234      4,242       3,705

Occupancy and equipment

     578       333      1,787       1,392

Directors fees

     68       57      205       135

Marketing

     33       93      340       273

Professional fees

     387       186      1,205       701

Information technology

     299       153      932       430

Other

     579       264      1,316       994
                             

Total noninterest expense

     3,374       2,320      10,027       7,630
                             

Income (loss) before income taxes

     22       526      (1,028 )     1,147

Income tax (benefit) expense

     (40 )     97      (496 )     213
                             

Income (loss) before extraordinary gain from acquisition

     62       429      (532 )     934

Extraordinary gain, application of credit excess from acquisition

     31       —        1,848       —  
                             

Net income

   $ 93     $ 429    $ 1,316     $ 934
                             

Basic and diluted earnings per share of common stock:

         

Income (loss) before extraordinary gain from acquisition

   $ 0.03     $ 0.25    $ (0.28 )   $ 0.55

Extraordinary gain, application of credit excess from acquisition

   $ 0.02     $ —      $ 0.96     $ —  

Net income

   $ 0.05     $ 0.25    $ 0.69     $ 0.55

Weighted average shares of common stock outstanding:

         

Basic

     2,031,337       1,685,646      1,920,312       1,685,646

Diluted

     2,031,337       1,688,137      1,920,312       1,689,254
Dividends per share of common stock    $ 0.05     $ 0.05    $ 0.15     $ 0.15

See notes to consolidated financial statements.

 

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M&F BANCORP, INC

 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

 

dollars in thousands    Number
of
Shares
   Common
Stock
   Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Total  
Balances as of December 31, 2006    1,685,646    $ 5,901    $ 16,027     $ (166 )   $ 21,762  

Comprehensive income:

            

Net income

           934         934  

Other comprehensive loss

             (202 )     (202 )

Dividends declared ($0.15 per share)

           (253 )       (253 )
                                    
Balances as of September 30, 2007    1,685,646    $ 5,901    $ 16,708     $ (368 )   $ 22,241  
                                    
Balances as of December 31, 2007 (as previously reported)    1,685,646    $ 5,901    $ 16,617     $ (358 )   $ 22,160  

Split-dollar contract life insurance from adoption of accounting principle

   —        —        (158 )     —         (158 )
                                    
Balances as of January 1, 2008, as adjusted    1,685,646      5,901      16,459       (358 )     22,002  
                                    

Comprehensive income:

            

Net income

           1,316         1,316  

Other comprehensive loss

             (459 )     (459 )

Acquisition of Mutual Community Savings Bank, Inc., SSB (“MCSB”)

   345,691      2,831          2,831  

Dividends declared ($0.15 per share)

           (287 )       (287 )
                                    
Balances as of September 30, 2008    2,031,337    $ 8,732    $ 17,488     $ (817 )   $ 25,403  
                                    

See notes to consolidated financial statements.

 

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M&F BANCORP, INC

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

     Nine Months Ended September 30,  
dollars in thousands    2008     2007  

Cash flows from operating activities:

    

Net income

   $ 1,316     $ 934  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Extraordinary gain, application of credit excess from acquisition

     (1,848 )     —    

Provision for loan losses

     200       59  

Depreciation and amortization

     687       435  

Loss from disposals of bank premises and equipment

     25       —    

Investment amortization (accretion), net

     10       (106 )

Purchase accounting amortization and accretion, net

     (19 )     —    

Increase (decrease) in deferred loan origination fees, net

     104       (162 )

Gains on sale of available for sale securities

     (61 )     (244 )

Gain on sale of loan

     —         (97 )

Gain on sale of other real estate owned

     —         (250 )

Increase in cash surrender value of life insurance

     (157 )     (142 )

Impairment of other real estate owned

     —         11  

Changes in:

    

Accrued interest receivable and other assets

     748       218  

Other liabilities

     (943 )     (410 )
                

Net cash provided by operating activities

     62       246  

Cash flows from investing activities:

    

Cash acquired in acquisition of MCSB

     13,916       —    

Activity in available-for-sale securities:

     —         —    

Sales

     2,050       2,568  

Maturities, prepayments and calls

     9,122       20,919  

Principal collections

     4,677       741  

Purchases

     (1,051 )     (26,094 )

Net (increase) decrease in loans

     (16,138 )     14,699  

Proceeds from sale of loans

     —         1,835  

Purchases of bank premises and equipment

     (140 )     (262 )

Proceeds from maturity of bank-owned life insurance policies

     —         473  

Proceeds from sale of other real estate owned

     —         859  
                

Net cash provided by investing activities

     12,436       15,738  

(continued on next page)

See notes to consolidated financial statements.

 

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M&F BANCORP, INC

 

dollars in thousands    2008     2007  

Consolidated Statements of Cash Flows, Continued

    

Cash flows from financing activities:

    

Net decrease in deposits

     (367 )     (40,375 )

Net change in federal funds purchased

     (10,000 )     —    

Proceeds from other borrowings

     825       5,000  

Repayments of other borrowings

     (880 )     (5,078 )

Cash dividends

     (287 )     (253 )
                

Net cash used in financing activities

     (10,709 )     (40,706 )
                

Net increase (decrease) in cash and cash equivalents

     1,789       (24,722 )
Cash and cash equivalents as of the beginning of the period      18,172       37,460  
                
Cash and cash equivalents as of the end of the period    $ 19,961     $ 12,738  
                

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

    

Cash paid during period for:

    

Interest

   $ 3,148     $ 5,011  

Income taxes

     130       312  

See notes to consolidated financial statements.

 

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M&F BANCORP, INC

 

Notes to Consolidated Financial Statements

 

1. Summary of Significant Accounting Policies

Basis of Presentation

The Consolidated Financial Statements include the accounts and transactions of M&F Bancorp, Inc. (the “Company”) and its wholly-owned bank subsidiary, Mechanics and Farmers Bank (the “Bank”). All significant inter-company accounts and transactions have been eliminated in consolidation. The Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial statements and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. The accompanying interim Consolidated Financial Statements are unaudited except for the balance sheet as of December 31, 2007, which was derived from the Company’s audited consolidated Annual Report on Form 10-KSB.

The Consolidated Financial Statements included herein do not include all the information and notes required by U.S. GAAP and should be read in conjunction with the Consolidated Financial Statements and the related notes thereto included in the Company’s Annual Report on Form 10-KSB as of and for the year ended December 31, 2007.

In the opinion of management, the interim financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the financial position, results of operations and cash flows in the accompanying unaudited Consolidated Financial Statements. The unaudited operating results for the periods presented may not be indicative of annual results.

New Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) ratified the Emerging Issues Task Force (“EITF”) conclusion under EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (“EITF 06-4”). EITF 06-4 requires that endorsement split-dollar life insurance arrangements which provide a postretirement benefit to an employee be recorded in accordance with FASB Statement No. 106, Employer’s Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion—1967, based on the substance of the agreement with the employee. Under the provision of these Statements, a liability should be accrued equal to the actuarial present value of the future death benefit over the service period. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. The effects of adopting EITF 06-4 can be recorded either as (i) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity as of the beginning of the year of adoption, or (ii) a change in accounting principle through retrospective application to all prior periods. The Company adopted EITF 06-4 as of January 1, 2008; adoption of these provisions resulted in an increase in other liabilities of approximately $0.2 million with the offset reflected as a cumulative-effect adjustment to retained earnings.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 became effective for the Company beginning January 1, 2008. Certain requirements of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The effective date for other requirements of SFAS No. 157, which is elective, has been deferred for one year by the FASB. On January 1, 2008, the Company adopted SFAS No. 157, which has not had a material impact on the Company’s financial condition or results of operations.

In October 2008, the FASB issued a Staff Position No. 157-3, Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active (“FSP 157-3”), which clarifies the application of SFAS No. 157 in a market that is not active. FSP 157-3 provides an illustrative example to follow in the case of non-forced liquidations or distressed transactions for items requiring significant adjustments using unobservable inputs to determine fair value at the measurement date. FSP 157-3 is effective on issuance, and has not had a material impact on the Company’s financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. The standard also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. On January 1, 2008, the Company adopted SFAS No. 159, which has not had a material impact on the Company’s financial condition or results of operations because the Company has not elected to include any items under its provisions.

 

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M&F BANCORP, INC

 

In December 2007, the FASB issued Statement of SFAS No. 141 (revised 2007), Business Combinations. SFAS No. 141(R), among other things, establishes principles and requirements for how the acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquired business, (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company is required to adopt SFAS No. 141(R) for all business combinations for which the acquisition date is on or after January 1, 2009. This standard will change our accounting treatment for business combinations on a prospective basis.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51. SFAS No. 160 establishes accounting and reporting standards for non-controlling interests in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be re-characterized as non-controlling interests and classified as a component of equity. It also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. This statement is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company does not expect adoption of SFAS No. 160 to have any impact on its financial position, results of operation, or cash flows.

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”). This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP. This Statement shall be effective sixty days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to Auditing (United States) Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not believe the adoption of SFAS No. 162 will have a material impact on its financial condition, results of operations or cash flows.

 

2. Acquisition of Mutual Community Savings Bank, Inc., SSB (“MCSB”)

On March 28, 2008 the Company completed the acquisition of 100% of the outstanding stock of MCSB. The consolidated statements of income do not include the operations for MCSB prior to the acquisition on March 28, 2008.

The acquisition was accounted for as a purchase by the Company of MCSB using the purchase method of accounting; accordingly, the assets and liabilities of MCSB have been recorded at their respective fair values on the date the acquisition was completed. The acquisition was effected by the issuance of shares of the Company’s common stock to MCSB shareholders, subject to the assertion of dissenters’ rights. Except where dissenters’ rights were asserted, each share of MCSB common stock was exchanged for one share of the Company’s common stock. The shares of the Company’s common stock issued were recorded at $8.73 per share. This represented the average of the closing share prices of the Company’s common stock on the day of, and for the period two days prior and two days after August 10, 2007, the day of the announcement of the acquisition.

In the acquisition, shareholders of MCSB received 345,691 shares of the Company’s stock valued at $3.0 million, a liability was established for dissenters’ rights payments totaling $0.2 million, and purchase price consideration was reduced by registration costs of $0.2 million. In addition, the Company incurred $0.8 million in direct acquisition costs. Included in this amount is a severance benefit for Mutual employees terminated within 60 days after the acquisition, equal to two weeks salary plus a further one week’s salary for each year of credited service with MCSB in excess of two years, with the minimum severance of four weeks’ salary. The purchase price allocation is as follows:

 

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M&F BANCORP, INC

 

dollars in thousands    Amount  

Cash and cash equivalents

   $ 13,916  

Investment securities

     4,139  

Loans, gross

     43,844  

Allowance for loan losses

     (681 )
        

Loans, net

     43,163  

Other assets

     3,346  

Deposits

     (49,316 )

Other borrowings

     (9,062 )

Other liabilities

     (1,349 )

Extraordinary gain, credit excess

     (1,848 )
        

Purchase price

   $ 2,989  
        

The aggregate value of the Company common stock exchanged and cash consideration paid was less than the fair value of the net assets of MCSB, resulting in a “credit excess” which was allocated on a pro rata basis against amounts assigned to the acquired assets except (i) financial assets other than investments accounted for by the equity method, (ii) assets to be disposed of by sale, (iii) deferred tax assets, (iv) prepaid assets relating to pension or other postretirement benefits, and (v) any other current assets. The credit excess remaining after reducing to zero the amounts that otherwise would have been assigned to those assets has been recognized as an extraordinary gain in the Company’s statement of operations. In accordance with the purchase method of accounting, the Company’s financial statements for periods before consummation of the acquisition were not restated to reflect MCSB’s historical financial position or results of operations.

The results of the fair market valuation indicated that there were no core deposit intangibles, and in accordance with SFAS No. 141 the fair value of premises and equipment of $1.0 million was eliminated against the initial calculation of the credit excess. Any remaining credit was recorded as extraordinary gain. The allocations made are preliminary and such amounts are subject to adjustments as additional analysis is performed or obtained from other third party sources. Any such adjustments would impact the extraordinary gain recognized herein.

On April 10, 2008, a dissenting MCSB shareholder requested a payout of his 18,028 shares under dissenters’ rights. This shareholder requested a payment per share that was greater than the Company’s estimate of the fair value of its shares, as previously offered and paid by the Company. The dissenting shareholder corresponded with the Company regarding the fair value of MCSB’s shares. The Company believes that the dissenting shareholder did not timely commence court proceedings and has forfeited the right to judicial appraisal to determine the fair value of the shares and accrued interest.

The following pro-forma information, for the three and nine-month periods ended September 30, 2008 and 2007, reflects the Company’s estimated consolidated results of operations as if the acquisition occurred at January 1 of the respective periods, unadjusted for any anticipated cost savings resulting from the acquisition. Unaudited pro forma data is not necessarily indicative of the results that would have occurred had the acquisition taken place at the beginning of the periods presented, nor of future results.

 

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M&F BANCORP, INC

 

     Results of Operations
For the Three Months
Ended September 30,
   Results of Operations
For the Nine Months
Ended September 30,
 
dollars in thousands, except per share data    2008    2007    2008    2007  

Net interest income

   $ 2,820    $ 2,748    $ 7,746    $ 8,458  

Provision for loan losses

     137      9      360      41  

Noninterest income

     713      851      3,714      3,017  

Noninterest expense

     3,374      3,243      11,130      10,563  
                             

Net income (loss) after taxes and before extraordinary gain

     62      229      473      (461 )

Extraordinary gain

     31      31      1,848      1,848  
                             

Net income (loss)

   $ 93    $ 260    $ 2,321    $ 1,387  
                             

Income (loss) per share of common stock before extraordinary gain:

           

Basic and diluted

   $ 0.03    $ 0.11    $ 0.25    $ (0.22 )

Income (loss) per share of common stock after extraordinary gain:

           

Basic and diluted

   $ 0.05    $ 0.13    $ 1.21    $ 0.68  

Weighted average shares of common stock:

           

Basic and diluted

     2,031,337      2,049,365      1,920,312      2,049,365  

 

3. Earnings Per Share

Basic earnings per share (“EPS”) computations are based upon the weighted average number of shares outstanding during the periods. Diluted earnings per share computations are based upon the weighted average number of shares outstanding during each period plus the dilutive effect of outstanding stock options. The weighted average shares and effect of dilutive stock options are included in the following table, which provides a reconciliation of the number of shares between the computation of basic EPS and diluted EPS:

 

     For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,
     2008    2007    2008    2007

Weighted average shares

   2,031,337    1,685,646    1,920,312    1,685,646

Effect of dilutive stock options

   —      2,491    —      3,608
                   

Dilutive potential average common shares

   2,031,337    1,688,137    1,920,312    1,689,254
                   

The Company had 25,200 options outstanding as of September 30, 2008 and 2007. Options outstanding were anti-dilutive for the three and nine-month periods ended September 30, 2008.

 

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4. Loans

Loans are made primarily to customers in the Company’s market areas within North Carolina. The Company’s loans, classified by type were as follows:

 

dollars in thousands    September 30,
2008
   December 31,
2007

Real estate-construction

   $ 2,191    $ 9,170

Real estate-mortgage

     186,544      125,864

Commercial, financial and agricultural

     11,409      5,595

Consumer

     3,993      4,367

All other loans

     1,080      1,279
             
     205,217      146,275

Less: Deferred loan origination fees, net

     299      195
             

Total loans

   $ 204,918    $ 146,080
             

Nonperforming assets were as follows:

 

dollars in thousands    September 30,
2008
    December 31,
2007
 

Nonaccrual loans

   $ 4,133     $ 1,543  

Loans 90 days or more past due and still accruing interest

     —         —    

Other real estate owned

     1,189       338  
                

Total nonperforming assets

   $ 5,322     $ 1,881  
                

Allowance for loan losses as a percent of total loans

     1.29 %     1.30 %

Nonperforming assets as a percent of total assets

     1.94 %     0.85 %

Allowance for loan losses as a percent of nonperforming assets

     49.55 %     100.85 %

The Company’s total allowance for loan losses to nonperforming assets decreased from 100.85% to 49.55%, while nonaccrual loans increased from $1.5 million to $4.1 million between December 31, 2007 and September 30, 2008. The real estate construction and commercial loan portfolios are predominately owner-occupied in a unique market in which the Company has specialized lending expertise. This real estate construction portion of the loan portfolio has decreased from 6.3% of the total loans outstanding as of December 31, 2007 to 1.1% of total loans outstanding as of September 30, 2008, principally because upon completion of the construction, loans are converted to real estate secured loans. The Company’s loan portfolio has no acquisition and development loans.

The Company acquired $1.6 million in nonaccrual loans in the acquisition of MCSB, and evaluated the risk of loss and the underlying collateral for each loan to ensure adequacy of allowance coverage. It is the opinion of management that the allowance adequately addresses the risk of loss for nonaccrual and impaired loans in the Company’s portfolio.

 

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5. Allowances for Loan Losses

Allowances for loan losses consisted of the following:

 

     For the Nine Months
Ended September 30,
 
dollars in thousands    2008     2007  

Balances at beginning of the period

   $ 1,897     $ 2,501  

Loans charged off :

    

Commercial

     —         3  

Real estate

     74       275  

Demand deposit overdraft program

     48       53  

Installment loans to individuals and other

     37       7  
                

Total charge-offs

     159       338  
                

Recoveries of loans previously charged off:

    

Commercial

     —         1  

Real estate

     9       67  

Demand deposit overdraft program

     7       11  

Installment loans to individuals and other

     2       1  
                

Total recoveries

     18       80  
                

Net charge-offs

     141       258  
                

Provision charged to operations

     200       59  
                

Balances at end of the period

     1,956       2,302  

Allowance for loan losses acquired from MCSB

     681       —    
                

Balances at the end of the period

   $ 2,637     $ 2,302  
                

Ratio of net charge-offs during the nine-month period to average loans outstanding during the period

     0.08 %     0.17 %

 

6. Common Stock Dividends

Dividends have been declared and paid quarterly as follows:

 

For the Quarter Ended:    March 31, 2008    June 30, 2008    September 30, 2008    Year to Date

Declaration date

     3/25/2008      6/13/2008      9/23/2008   

Record date

     3/25/2008      7/3/2008      10/2/2008   

Payment date

     4/10/2008      7/10/2008      10/9/2008   

Dividend per share

   $ 0.05    $ 0.05    $ 0.05    $ 0.15

 

7. Benefit Plans

The Company sponsors a non-contributory qualified defined benefit retirement (pension) plan for substantially all full-time employees. The Company also sponsors a non-qualified, unfunded supplemental executive retirement plan that provides benefits to certain current and former executives.

 

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The components of the net periodic benefit cost are reflected in salaries and benefits expense for the nine months ended September 30, 2008 and 2007 were as follows:

 

     Qualified
Defined Benefit Plan
    Non-qualified Supplemental
Benefit Plan
dollars in thousands    2008     2007     2008    2007

Service cost

   $ 80     $ 96     $ —      $ —  

Interest cost

     187       160       86      83

Expected return on plan assets

     (227 )     (230 )     —        —  

Amortization of prior service cost

     (11 )     (11 )     3      3

Amortization of net loss

     22       1       —        —  
                             

Net periodic cost

   $ 51     $ 16     $ 89    $ 86
                             

The Company provides post-retirement benefits to certain former executive officers. In 2008, a liability was established to record certain split-dollar insurance contract benefits to specified current and former executive officers. As of September 30, 2008, the amount of this liability was $0.2 million and is reflected in other liabilities.

 

8. Comprehensive (Loss) Income

Comprehensive loss includes net income (loss) and all other changes to the Company’s equity, with the exception of transactions with shareholders. The Company’s other comprehensive (loss) income and accumulated other comprehensive (loss) income are comprised of unrealized gains and losses on certain investments in debt securities.

 

     For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,
 
dollars in thousands (unaudited)    2008     2007    2008     2007  

Net income

   $ 93     $ 429    $ 1,316     $ 934  
                               

Items of other comprehensive (loss) income, before tax:

         

Unrealized (losses) gains on securities available for sale, net

     (241 )     589      (685 )     (86 )

Reclassification adjustments for net unrealized gains included in income before income tax benefit

     (56 )     —        (61 )     (244 )
                               

Other comprehensive (loss) gain, before tax benefit

     (297 )     589      (746 )     (330 )

Less: Changes in deferred income taxes related to change in unrealized (losses) gains on securities available for sale

     (186 )     226      (287 )     (128 )
                               

Other comprehensive (loss) income, net of taxes

     (111 )     363      (459 )     (202 )
                               

Comprehensive (loss) income

   $ (18 )   $ 792    $ 857     $ 732  
                               

 

9. Bank Premises and Equipment

During the second quarter of 2008, management conducted an in-depth review of the Company’s fixed assets and identified an error in its disclosure of the Company’s estimate of the useful lives for premises, erroneously stating that the estimated useful lives for premises, “range from 15 to 30 years”, whereas in practice the estimated useful lives for premises has ranged from 40 to 50 years. As such, this error had no impact on the Company’s financial position or results of operation. The Board of the Company’s subsidiary has approved an updated policy with estimated useful lives for premises ranging from 30 to 50 years.

In addition, the review of the Company’s fixed assets identified that estimated useful lives of some assets should be revised. This resulted in computer hardware and software being expensed in the quarter ended June 30, 2008 in the aggregate amount of $0.3 million, and other assets expensed in the aggregate amount of $0.03 million, which expenses are reflected in the results of operations in occupancy and equipment for the nine months ended September 30, 2008. These changes in estimate have been applied prospectively, and have reduced net fixed assets by $0.3 million. The adjustment reduced net income by $0.2 million after tax, or $0.11 per share for the nine months ended September 30, 2008.

 

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10. Fair Value Measurement

On January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value under U.S. GAAP, and enhances disclosures about fair value measurements. The Company elected not to delay the application of SFAS No. 157 to non-financial assets and non-financial liabilities, as allowed by FASB Staff Position SFAS 157-2. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value and, therefore, does not expand the use of fair value in any new circumstances. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS No. 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. SFAS No. 157 requires fair value measurements to be separately disclosed by level within the fair value hierarchy. Under SFAS No. 157, the Company bases fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For assets and liabilities recorded at fair value, it is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in SFAS No. 157.

Fair value measurements for assets and liabilities where there exists limited or no observable market data and, therefore, are based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Under SFAS No. 157, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. The Company has none of these instruments at September 30, 2008.

Level 2 — Valuations are obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities. The Company’s principal market for these securities is the secondary institutional markets and valuations are based on observable market data in those markets. Level 2 securities include U. S. Government agency obligations, state and municipal bonds and mortgage-backed securities. The Company has Level 2 securities at September 30, 2008.

Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. The Company has Level 3 assets and liabilities at September 30, 2008.

Impaired loans: Impaired loans are evaluated and valued at the time the loan is identified as impaired, and are carried at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans or net present value of expected future cash flows discounted at the loan’s effective interest rate. Impaired loans are classified at a Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The value of business equipment, inventory, and accounts receivable collateral is based on net book value on the business’ financial statements and, if necessary, discounted based on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

 

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Foreclosed assets: Foreclosed assets are adjusted to fair value, less costs to sell, upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of the carrying value or the fair value, less costs to sell. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. The Company records the foreclosed asset as nonrecurring Level 3.

The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of September 30, 2008.

 

dollars in thousands

Description

   September 30, 2008    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs

(Level 3)
           

Recurring:

           

Available for sale securities

   $ 32,555    $ —      $ 32,555    $ —  

Non-recurring:

           

Other real estate owned

     1,189      —        —        1,189

Impaired loans

     6,267      —        —        6,267
                           

Total

   $ 40,011    $ —      $ 32,555    $ 7,456
                           

The following discussion relates to the fair values of the acquisition of MCSB:

Loans: Management, in connection with valuation experts, performed a discounted cash flow analysis to determine the present value of the loans acquired from MCSB. The discount rate utilized was based on the weighted average coupon rate of each loan category in the acquired portfolio compared to current market rates for similar loans as suggested by SFAS No. 107 – “Disclosures about Fair Value of Financial Instruments” as amended by SFAS No. 157. Since market quotes for the valuation date are not readily available for all of the various categories of loans acquired, the valuation was based on MCSB’s posted rates for similar loan categories as of the acquisition date (Level 1 inputs). For commercial loans, the most current interest rate information on the measurement date for commercial and industrial loans made by small domestic banks was from the Federal Reserve’s E. Survey of Terms of Business Lending released on March 14, 2008 which included averages for more than $19 billion dollars of new loans for the measurement period dated February 4-8, 2008. In addition, Freddie Mac’s weekly Primary Mortgage Market Survey for the week ending March 27, 2008 was utilized (Level 2 inputs).

These assumptions resulted in the fair value shown below, equating to a weighted rate reduction of 17 basis points in a replacement scenario. The Loan portfolio has been reflected in the table below as Level 2.

Fixed assets: Real estate appraisers analyzed the value of the buildings acquired utilizing market and cash flow assumptions. All other fixed assets, which were insignificant, were reflected at book value. With the mix of book and appraised values, fixed assets have been reflected as Level 3 assets.

Deposits: The fair value of core deposits as determined by the valuation experts utilized a discounted cash flow analysis of the deposits acquired from MCSB compared to alternative funding sources available to the Company to support the deposits acquired. Paragraph 12 of SFAS No. 107, for deposit liabilities with no defined maturities, defines the fair value of deposits as the amount payable on demand at the reporting date; therefore no mark-to-market adjustment is required. The fair value determination involves a number of underlying inputs and input levels:

 

 

Current Rate Cost – The Company provided summary deposit information by deposit account as of the closing date of the transaction with accompanying rate information. Weighted average interest rates were calculated based on the weighted average account balance in each deposit category multiplied by the rate being paid on each account on the date of acquisition (Level 2 input).

 

 

Non-interest expense – These depict the cost of providing/servicing deposit balances, expressed as a percent of those balances per year. In a typical transaction, the entire cost structure of the acquired bank would be allocated between lending and deposit

 

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activities. Relative costs in this instance were significantly below industry norms insomuch as the absolute core deposits were low with a significant branch infrastructure requiring overhead support. Therefore, the valuation was based on 64% of the amount determined to a level at the highest end of what the valuation experts would consider the normal expected range as a percentage of the deposit balances. In light of this adjustment, this is a Level 3 input in the core deposit valuation.

 

 

Immediate balance flow – This is the percentage of acquired balances that are expected to run off within 90 days of acquisition. Because of the unusually strong cultural and racial component and close proximity of many of the branches, a lower than normal immediate outflow percentage of 5% was utilized, half of the industry standard of 10%. This is a Level 2 input.

 

 

Expected Average Economic (Useful) Life – SFAS No. 142 defines the useful life of an intangible asset as “the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.” If the asset has a finite useful life, but the precise length of that life is not known, that intangible asset shall be amortized over the best estimate of its useful life. MCSB did not provide meaningful historical data for useful lives of deposit categories. Consequently, the expected average economic life of core deposits was determined from historical deposit account data from the valuation experts’ internal database developed from other deposit studies including another African-American owned institution with a long operating history and several years of operating problems prior to a similar transfer of ownership. In these circumstance, the valuation report indicates that they would expect a higher than normal average economic life of deposits. The terminal life logically follows as twice the expected average economic life for use in calculating the present value of the deposits (Level 3 Input).

 

 

SFAS No. 142 states that the method of amortization shall reflect the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. If that pattern cannot be reliably determined, a straight line amortization shall be used. In this valuation, the valuation experts utilized an L0 or Left Modal Iowa Survivor curve to decay (amortize) each of the acquired deposit categories using a terminal point of two times the expected average economic life of the deposit category. An L0 curve was selected because it closely approximates a straight line amortization yet meets the industry standards suggested by previous reviews of other core deposit evaluations (Level 2 input).

 

 

Alternative funding rates are based on Federal Home Loan Bank (“FHLB”) of Atlanta “Fixed Rate Credit Advance” rates for terms equal to the expected average economic life of deposits. Lower comparable rates have the effect of reducing the calculated core deposit intangible premium (Level 2 input).

 

 

The discount rate used for calculating the present value of the alternative funding differential as 14.5% based on the build-up approach described above. The discount rate represents an adjustment for risk that market participants would include in pricing the related asset or liability, even though the adjustment is difficult to precisely determine as described in SFAS 157 (Level 3 Input).

 

 

The assumed marginal tax rate was 35% (Level 2 input).

 

 

Non-interest expenses on certificates of deposit utilized a standard cost assumption of 25 basis points for retail and jumbo CD’s (Level 2 input).

These assumptions did not provide a positive core deposit intangible premium value primarily as a result of the excessive overhead cost burden associated with multiple branch locations with a very small core deposit base. Given the mix of Level 2 and Level 3 inputs, the full fair value for deposits has been reflected in the table below as Level 3.

FHLB of Atlanta Borrowing Valuation: A discounted cash flow analysis was utilized to determine the present value of the borrowings from the FHLB acquired in the transaction pursuant to SFAS No. 107 as amended by SFAS No. 157. The fair value of borrowed funds due within one year is the amount payable at the reporting date. The fair value of long term borrowed funds is estimated by discounting the future cash flows using the current rates at which similar loans could be obtained with similar credit ratings and for the same remaining maturities. FHLB advances are unique in that funds are available to member banks based on established size limitations and are not subject to pricing variations based on traditional credit ratings of the borrower as in a typical borrower/lender relationship. Consequently, the fair value adjustment only needs to take into account interest rate variations from the last date of pricing until the next re-pricing date in the case of adjustable rate credits and the next maturity date in the case of a fixed rate credit. Given the ready market information available to all member banks, this has been reflected in the table below as a Level 2.

 

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The following table gives the fair values as of the acquisition date of MCSB:

 

dollars in thousands

Description

   MCSB
Acquisition at
March 31, 2008
    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable
Inputs

(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
 

Loans, gross

   $ 43,844     $ —      $ 43,844     $ —    

Fixed assets

     1,012       —        —         1,012  

Time deposits

     (20,633 )     —        —         (20,633 )

Borrowings

     (9,062 )     —        (9,062 )     —    
                               

Total

   $ 15,161     $ —      $ 34,782     $ (19,621 )
                               

Note: Fair values as provided in appraisal reports prepared by external valuation experts for the acquisition of MCSB.

11. Commitments and Contingent Liabilities

Commitments to Extend Credit

In the normal course of business, the Company has various commitments to extend credit, which are not reflected in the Consolidated Financial Statements. As of September 30, 2008 and December 31, 2007, the Company had outstanding loan commitments (including available lines of credit) of approximately $30.8 million and $17.2 million, respectively. Commitments under standby letters of credit and financial guarantees amounted to approximately $0.8 million and $3.3 million as of September 30, 2008 and December 31, 2007, respectively. These lines of credit and financial guarantees represent agreements whereby the Company commits to lend funds to customers up to a predetermined maximum amount during a certain period.

The Company approves lines of credit to consumer customers through home equity and consumer overdraft protection loans, all of which are included in the above commitments to extend credit. As of September 30, 2008 and December 31, 2007, in addition to actual advances made on such loans, the Company’s consumer customers have available additional lines of credit on home equity and consumer overdraft protection loans. Available amounts on home equity lines as of September 30, 2008 and December 31, 2007 were approximately $2.2 million and $0.8 million, respectively. In addition, the available amounts on consumer overdraft protection loans were $1.1 million and $0.7 million as of September 30, 2008 and December 31, 2007, respectively.

No significant losses are anticipated as a result of these transactions.

Fed Funds Line

As of September 30, 2008, the Company has available for use Federal Funds Lines (“Fed Funds Lines”) aggregating $13.6 million from four money center banks. The Fed Funds Lines are renewed annually. Interest rates are stated as variable on a daily basis. No amounts were outstanding under the Fed Funds Lines as of September 30, 2008. The Company utilized a Fed Funds Line in the three months ending September 30, 2008.

Letters of Credit

In October 2008, the Company secured a $2.0 million letter of credit with FHLB of Atlanta to use as collateral for public deposits. The letter of credit is secured by the Company’s collateral with FHLB of Atlanta and is renewable annually.

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Management’s Discussion and Analysis is provided to assist readers in understanding and evaluating the Company’s results of operations and financial condition. The following discussion is intended to provide a general overview of the Company’s performance for the three and nine month periods ended September 30, 2008, with the same periods in 2007. Readers seeking a more in-depth discussion are invited to read the more detailed discussions below, as well as the Consolidated Financial Statements and related notes included under Item 1 of this Quarterly Report on Form 10-Q. All information presented is consolidated data unless otherwise specified.

 

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Financial Highlights for the Three Month and Nine Month Periods

 

(Unaudited)    Three Months Ended September 30,     Nine Months Ended September 30,  
dollars in thousands, except per share data    2008     2007     2008     2007  

Earnings:

        

Net interest income

   $ 2,820     $ 2,159     $ 7,351     $ 6,719  

Provision for loan losses

     137       10       200       59  

Total noninterest income

     713       697       1,848       2,117  

Total noninterest expense

     3,374       2,320       10,027       7,630  

Income tax (benefit) expense

     (40 )     97       (496 )     213  

Income (Loss) before extraordinary gain

     62       429       (532 )     934  

Extraordinary gain

     31       —         1,848       —    

Net income

     93       429       1,316       934  

Net income (loss) per share before extraordinary gain:

        

Basic and diluted

   $ 0.03     $ 0.25     $ (0.28 )   $ 0.55  

Net income per share after extraordinary gain:

        

Basic and diluted

     0.05       0.25       0.69       0.55  

Average for period:

        

Assets

   $ 264,576     $ 235,694     $ 252,951     $ 250,242  

Loans

     202,218       147,354       181,523       151,329  

Deposits

     211,585       192,535       204,044       208,017  

Shareholders’ equity

     25,312       21,892       24,490       21,872  

Ratios before extraordinary gain (loss):

        

Return (loss) on average assets (annualized)

     0.09 %     0.73 %     (0.28 )%     0.50 %

Return (loss) on average equity (annualized)

     0.98 %     7.84 %     (2.90 )%     5.69 %

Average equity to average assets

     9.57 %     9.29 %     9.68 %     8.74 %

Efficiency ratio (annualized)

     95.50 %     81.23 %     109.00 %     86.35 %

Ratios after extraordinary gain:

        

Return on average assets (annualized)

     0.14 %     0.73 %     0.69 %     0.50 %

Return on average equity (annualized)

     1.47 %     7.84 %     7.16 %     5.69 %

Average equity to average assets

     9.57 %     9.29 %     9.68 %     8.74 %

Efficiency ratio (annualized)

     94.67 %     81.23 %     90.77 %     86.35 %

 

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Forward-Looking Statements

When used in this Quarterly Report on Form 10-Q, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or other similar expressions or the negative thereof are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market areas, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans and deposits in the Company’s market areas, and competition that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which are only as of the date they were made. The Company wishes to advise readers that such risks and uncertainties, including the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect events or occurrences after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Critical Accounting Policies

The accounting and reporting policies of the Company are in accordance with U.S. GAAP and conform to general practices within the banking industry. The significant accounting policies of the Company are discussed in detail in Note 1 to the Consolidated Financial Statements included in the Company’s 2007 Annual Report on Form 10-KSB. The following is a summary of certain of those policies.

Certain accounting policies require the Company to make significant estimates and assumptions, which have a material impact on the carrying value of certain assets and liabilities, and it considers these to be critical accounting policies. Four of the more critical accounting and reporting policies include the Company’s accounting for the allowances for loan losses, investment securities, periodic cost attributable to certain employees’ benefits and income taxes. The estimates and assumptions used by the Company are based on historical experience, current information and other factors, which it believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities as of the balance sheet dates and the results of operations for the reporting periods.

Allowance for Loan Losses

In originating loans, the Company recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the collateral for the loan, as well as general economic conditions. It is management’s policy to maintain an adequate allowance for loan losses based on, among other things, the Company’s historical loan loss experience, evaluation of economic conditions and regular review of delinquencies and loan portfolio quality.

The Company prepares a quarterly analysis of the allowance for loan losses, with the objective of quantifying portfolio risk as a dollar amount. The determination of the allowance for loan losses is based on eight qualitative factors and one quantitative factor for each category and type of loan, along with any specific allowance for adversely classified loans within each category. Each factor is assigned a percentage weight and that total weight is applied to each loan category. Factors and associated weighting are different for each category. Qualitative factors include: levels and trends of delinquencies and non-accrual loans; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; national and local economic trends and conditions; concentrations of credit; quality of the Company’s loan review system; and regulatory requirements. The total allowance thus changes as the percentage weight assigned to each factor is increased or decreased due to the particular circumstances, as the various types and categories of loans change as a percentage of total loans and as specific allowances are required due to increases in adversely classified loans. See Note 1 to the Consolidated Financial Statements for the year ended December 31, 2007 in the Company’s 2007 Annual Report on Form 10-KSB for additional information regarding the determination of the provision and allowance for loan losses.

The Company follows the guidance of SFAS No. 5, Accounting for Contingencies and SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures. SFAS No. 5 requires that losses be accrued when they are probable of occurring and estimable. SFAS No. 114 requires that impaired loans, within its scope, be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market

 

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price, or the fair value of the collateral, if the loan is collateral dependent. SFAS No. 114 excludes, from impairment reporting, smaller balance and homogeneous loans, which are collectively evaluated for impairment. Therefore, the Company has designated consumer and residential mortgage loans to be excluded for this purpose. From the remaining loan portfolio, loans rated as substandard, doubtful, non-accrual, or troubled debt restructurings are evaluated for impairment.

Loans are evaluated for non-accrual status when principal or interest is delinquent for 90 days or more and are placed on non-accrual status when a loan is specifically determined to be impaired. Any unpaid interest previously accrued on those loans is reversed from income. Any subsequent payments are applied to income on a cash basis unless, in management’s opinion, a potential for loss remains, until such loans are restored to accrual status. The loan will return to accrual status once the borrower has given evidence of the ability to resume payment on the impaired loan, as stated in the original contract.

Management actively monitors the Company’s asset quality, charges off loans against the allowance for loan losses and provides specific loss reserves when appropriate. Although management believes it uses the best current information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic or other qualitative and quantitative factors differ substantially from the conditions in the assumptions used in making the initial determinations.

Investment Securities

Debt securities, not classified as either “held to maturity” securities or “trading” securities, and equity securities, not classified as trading securities, are classified as “available for sale securities” and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of consolidated shareholders’ equity in accumulated other comprehensive income (loss). The fair values of these securities are based on quoted market prices, dealer quotes and prices obtained from independent pricing services. Available for sale and held to maturity securities, as well as investments included within other invested assets, are reviewed quarterly for possible other-than-temporary decline in value. The review is inherently subjective as it requires material estimates and judgments, including an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer and the Company’s ability and intent to hold the security to maturity. Declines in the fair value of the securities classified as held to maturity or available for sale below their costs that are other than temporary, would result in write-downs of the individual securities to their respective fair value. Any related write-downs would be included in the consolidated results of operations as realized losses. As of September 30, 2008 and December 31, 2007, the Company had no held to maturity or trading securities.

Defined Benefit Plans

The Company sponsors a qualified defined benefit cash balance pension plan (the “Qualified Plan”), which covers substantially all full-time employees and a supplemental executive retirement plan (“SERP”), a non-qualified, unfunded plan to provide benefits to a select group of current and former, highly compensated employees. The SERP provides benefits that would otherwise be provided under the Qualified Plan but for maximum benefit and compensation limits applicable under the Internal Revenue Code of 1986, as amended.

The benefit cost and obligation are dependent on numerous factors resulting from actual plan experience and assumptions of future experiences. The assumptions include discount rates, inflation, salary growth and long-term return on plan assets.

Income Taxes

The Company makes judgments regarding the recoverability of its recorded deferred tax assets. In accordance with SFAS 109, Accounting for Income Taxes, the carrying value of the net deferred tax assets is based on the belief that it is “more likely than not” that the Company will generate sufficient future taxable income to realize these deferred tax assets after consideration of all available evidence. The Company regularly reviews its deferred tax assets for recoverability considering historical profitability, projected future taxable income, and the expected timing of the reversals of existing temporary differences and tax planning strategies.

Valuation allowances for deferred tax assets which the Company believes do not meet the “more likely than not” criteria established by SFAS 109 have been established. If the Company is subsequently able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been established, then the Company may be required to recognize these deferred tax assets through a reduction of the valuation allowance which would result in a benefit to its results of operations in the period in which the benefit is determined, excluding the recognition of the portion of the valuation allowance which relates to net deferred tax assets acquired in a business combination.

 

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Executive Overview

The Company generated the majority of its interest and non-interest income in the first nine months of 2008 and 2007 from traditional banking services: lending and deposit services. The Company continued to execute management’s strategy of targeting commercial business, diversifying the customer base, and pursuing strategic relationships for deposits.

In September 2008, the Company completed the closure and consolidations of three branches. One branch was a limited service drive-up facility in Charlotte, NC. The services provided by that branch are now provided at the Company’s existing Charlotte branches. Two other branches in Durham, NC were consolidated into a nearby branch. One of the closed branches was a limited service facility. The other, the former main office of MCSB, was located in a leased space within a building sold by MCSB prior to the Company’s acquisition of MCSB. The Company has three full service branches in the city of Durham. The closure and consolidations are expected to reduce costs in the fourth quarter of 2008.

Financial Condition

The asset, liability, and capital growth are primarily the result of the acquisition of MCSB in March 2008, as outlined in Note 2 to the Consolidated Financial Statements.

Total assets increased 23.3%, or $51.8 million, to $274.0 million as of September 30, 2008 from $222.2 million at December 31, 2007. Total assets acquired from MCSB were $64.6 million. Cash and cash equivalents increased $1.8 million or 9.8%, to $20.0 million as of September 30, 2008, compared to $18.2 million at December 31, 2007. Cash acquired from MCSB was $13.9 million. Loans increased 40.3%, or $58.8 million, to $204.9 million as of September 30, 2008, from $146.1 million as of December 31, 2007. Gross loans acquired from MCSB were $43.8 million. The Company continues to increase its loan portfolio through organic growth, achieving a net increase of $16.1 million year to date.

The investment portfolio balance as of September 30, 2008 was $32.6 million compared to $43.6 million as of December 31, 2007, a net decrease of $11.1 million, or 25.4%. The entire investment portfolio was classified as available-for-sale and was comprised of investment-grade securities. No securities were purchased during the three months ended September 30, 2008. Investments acquired from MCSB were $4.1 million.

Deposits increased 28.4%, or $48.9 million, to $220.9 million as of September 30, 2008 from $172.1 million at December 31, 2007. Total deposits acquired from MCSB were $49.3 million.

Federal funds purchased decreased $10.0 million, and other borrowings increased a net of $9.0 million or 64.2% at September 30, 2008 as compared to December 31, 2007. The Company assumed $9.1 million of borrowings from MCSB.

Total shareholders’ equity increased to $25.4 million as of September 30, 2008, compared to $22.2 million as of December 31, 2007. The increase was primarily composed of net income of $1.3 million for the nine months ended September 30, 2008, and an increase in shares issued, net of registration costs, valued at $2.8 million in connection with the MCSB acquisition. The increase was offset by dividends declared of $0.3 million and a change in accounting principle related to split-dollar contract life insurance of $0.2 million, and other comprehensive loss of $0.4 million.

Results of Operations, Three Months Ended September 30, 2008 and 2007

Net income for the three months ended September 30, 2008, decreased $0.3 million, to net income of $0.1 million, compared to net income of $0.4 million for the same period in 2007. For the three months ended September 30, 2008 when compared to the three month period ended September 30, 2007, interest income increased $0.3 million and interest expense decreased $0.4 million resulting in an improvement in net interest income of $0.7 million. The primary driver of the decrease in net income was increased non-interest expense of $1.1 million in the quarter ended September 30, 2008 over the same period in 2007.

Total interest income increased $0.3 million or 7.1%, to $3.9 million for the three months ended September 30, 2008, compared to $3.7 million for the comparable period in 2007. Interest income on loans increased $0.7 million primarily due to an increase in average loans outstanding to $202.2 million from $147.3 million, partially offset by a decrease in yield to 6.8% from 7.5% for the three months ended September 30, 2008 and 2007, respectively. Interest income on securities decreased $0.3 million or 40.9%, when comparing the three months ended September 30, 2008 with the same period in 2007, primarily due to the lower average balances in 2008, partially offset by differences in yields. During 2007 the Company decreased its investment portfolio, with the proceeds used to decrease the Company’s high cost brokered deposit portfolio, resulting in the impact on interest income from investments. In 2008, several of the higher yielding investments have been called by the issuers on call dates, and those investments have been utilized to fund organic loan growth. In addition, in the quarter ended September 30, 2008, the Company sold some out of its municipal bonds at

 

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a small gain. Total interest expense decreased by $0.4 million for the three months ended September 30, 2008 as compared to the same period in 2007, a combination of the decrease in the average cost of interest-bearing deposits of 126 basis points (“bp”) from 3.34% and the 63 bp decrease in the average cost of borrowings from 4.53% to 3.90%.

During the three months ended September 30, 2008, the Company increased its expense for loan loss provision by $0.1 million from the three months ended September 30, 2007. The provision for loan losses is the result of management’s assessment of the Company’s delinquency ratios, non-performing assets, charge-off history, and composition of loans in the portfolio. Management has performed a thorough review of both the loan portfolio acquired from MCSB as well as its own loan portfolio, with the assistance of an outside loan review firm. As of September 30, 2008, 41.2% of the total loans outstanding were commercial loans within a unique owner-occupied market in which the Company has specialized lending expertise. This unique market has had minimal historic losses, for example in the last five years, the realized losses to the Company from lending in this market has been less than 9 bp of the average balance outstanding for this portion of the total loan portfolio. In the acquisition, the provision from MCSB was reflected as an increase in the allowances for loan losses on the consolidated balance sheets, but did not affect the expense recorded.

Non-interest income increased slightly in the three months ended September 30, 2008 as compared to the same period in 2007. The increase was primarily a result of a $0.1 million increase in service charge income on the larger deposit base, increased rental income, the gain on sale of securities, and miscellaneous other income during the three months ended September 30, 2008, partially offset by $0.2 million realized gain on the sale of other real estate owned in the quarter ended September 30, 2007.

Non-interest expense increased $1.1 million for the three months ended September 30, 2008 as compared to the same period in 2007. For the quarter ended September 30, 2008, wages and salaries were higher by $0.2 million, occupancy and equipment costs were higher by $0.2 million, professional fees were higher by $0.2 million, information technology was higher by $0.1 million, and miscellaneous other expenses were higher by $0.3 million, compared to the respective expenses in 2007 reflecting the higher costs associated with the larger institution after the acquisition of MCSB, as well as the added costs of dual operating systems and operating facilities that were closed or consolidated in September 2008. The tax benefit was the result of tax-exempt interest income from the investment portfolio as well as tax-exempt bank-owned life insurance income.

 

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     AVERAGE BALANCES AND INTEREST INCOME ANALYSIS
For The Three Months Ended September 30,
     2008    2007
dollars in thousands    Average
Balance
    Average
Yield/ Cost
    Interest
Income/
Expense
   Average
Balance
    Average
Yield/ Cost
    Interest
Income/
Expense

Assets

             

Loans(1)

   $ 202,218     6.82 %   $ 3,449    $ 147,354     7.47 %   $ 2,750

Taxable securities

     22,751     5.57 %     317      43,185     5.60 %     605

Nontaxable securities(2)

     13,523     6.27 %     212      15,781     6.49 %     256

Other

     5,289     2.12 %     28      12,060     5.01 %     151
                                 

Total interest-earning assets

     243,781     6.57 %     4,006      218,380     6.89 %     3,762

Cash and due from banks

     5,009            4,111      

Allowances for loan loss

     (2,633 )          (2,530 )    

All other assets

     18,419            15,733      
                         

Total assets

   $ 264,576          $ 235,694      
                         

Liabilities and Shareholders’ equity

             

Demand deposits

   $ 51,333     1.39 %   $ 179    $ 40,244     2.61 %   $ 263

Savings deposits

     29,844     0.44 %     33      29,662     0.63 %     47

Time deposits

     89,596     3.01 %     675      87,511     4.59 %     1,004
                                 

Interest-bearing deposits

     170,773     2.08 %     887      157,417     3.34 %     1,314

Borrowings

     23,296     3.90 %     227      17,752     4.53 %     201
                                 

Total interest-bearing liabilities

     194,069     2.30 %     1,114      175,169     3.46 %     1,515
                     

Noninterest-bearing deposits

     40,812            35,118      

Other liabilities

     4,383            3,515      

Shareholders’ equity

     25,312            21,892      
                         

Total liabilities and shareholders’ equity

   $ 264,576          $ 235,694      
                         

Net interest income

       $ 2,892        $ 2,247
                     

Net yield on earning assets (2)(3)

     4.75 %        4.12 %  

Interest rate spread(4)

     4.27 %        3.43 %  

 

1. Non-accrual loans have been included.
2. Yields on nontaxable securities have been adjusted to a tax equivalent basis using the federal rate of 34.00%.
3. Net yield on earning assets is computed by dividing net interest earned by total average interest earning assets.
4. The interest rate spread is the interest earning assets rate less the interest earning liabilities rate.

 

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Results of Operations, Nine Months Ended September 30, 2008 and 2007

Net income for the nine months ended September 30, 2008, increased $0.4 million, or 40.9%, to $1.3 million, compared to net income of $0.9 million for the same period in 2007. The increase is primarily a result of a $1.8 million extraordinary gain from application of a credit excess in the purchase of MCSB. Net income from operations decreased $1.5 million to a loss of $0.5 million primarily as a result of a $2.4 million increase in noninterest expense during the nine month period ended September 30, 2008 compared to the same period in 2007.

Total interest income decreased $0.8 million or 7.2%, to $10.8 million for the nine months ended September 30, 2008, compared to $11.7 million for the comparable period in 2007. Interest income on loans increased $0.7 million in the nine months ended September 30, 2008 compared to the same period in 2007. Interest income on securities decreased $1.0 million or 42.0%, when comparing the nine months ended September 30, 2008 with the same period in 2007. During 2007 the Company decreased its investment portfolio, with the proceeds used to decrease the Company’s high cost brokered deposit portfolio, resulting in the impact on interest income from investments. In 2008, several of the higher yielding investments have been called by the issuers on call dates, and those investments have been used to fund organic loan growth. In addition, in the nine months ended September 30, 2008, the Company sold some out of state municipal bonds at a small gain. Total interest expense decreased by $1.5 million or 30.0% for the nine months ended September 30, 2008 as compared to the same period in 2007. As the result of the balance sheet changes mentioned above, the interest cost of high yield deposits held in 2007 and not in 2008 was the primary driver of this reduction, thus improving the Company’s net interest spread by 47 bp.

During the nine months ended September 30, 2008, the Company increased the loan loss provision by $0.1 million compared with the same period ended September 30, 2007. The provision for loan losses is the result of management’s assessment of the Company’s delinquency ratios, non-performing assets, charge-off history, and composition of loans in the portfolio. Management has performed a thorough review of both the loan portfolio acquired from MCSB as well as its own loan portfolio, with the assistance of an outside loan review firm. As of September 30, 2008, 41.2% of the total loans outstanding were commercial loans within a unique owner-occupied market in which the Company has specialized lending expertise. This unique market has had minimal historic losses, for example in the last five years, the realized losses to the Company from lending in this market has been less than 9 bp of the average balance outstanding for this portion of the total loan portfolio. In the acquisition, the provision from MCSB was reflected as an increase in the allowances for loan losses on the consolidated balance sheets, but did not affect the expense recorded.

Non-interest income decreased $0.3 million or 12.7% for the nine months ended September 30, 2008 as compared to the same period in 2007. The decrease in non-interest income was primarily a result of a $0.2 million decrease in realized gain on the sale of other real estate owned and a $0.2 million decrease in net realized gains on sale of available for sale securities, another impact of the balance sheet changes in 2007.

Non-interest expense increased $2.4 million or 31.4% for the nine months ended September 30, 2008 as compared to the same period in 2007. This increase was in part the result of the addition of former MCSB employees, together with Company’s decision to reassess its staffing needs after the acquisition of MCSB, resulting in increased salary expense and the accrual for severance benefits for those employees whose positions were eliminated effective June 30, 2008 totaling $0.4 million. During the nine months ended September 30, 2008, the Company completed a review of premises and equipment and recorded an expense of $0.3 million ($0.2 million net of taxes, or $0.11 per share), for a change in estimated useful lives of long-lived assets. Noninterest expenses also increased due to duplication of systems during the integration of MCSB resulting in increased information technology costs of $0.5 million in the nine months ended September 30, 2008 compared to the same period in 2007. Legal and audit fees increased professional fees by approximately $0.5 million in the nine months ended September 30, 2008.

 

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     AVERAGE BALANCES AND INTEREST INCOME ANALYSIS
For The Nine Months Ended September 30,
     2008    2007
dollars in thousands    Average
Balance
    Average
Yield/
Cost
    Interest
Income/
Expense
   Average
Balance
    Average
Yield/
Cost
    Interest
Income/
Expense

Assets

             

Loans(1)

   $ 181,523     6.77 %   $ 9,219    $ 151,329     7.48 %   $ 8,491

Taxable securities

     23,631     5.32 %     942      44,863     5.62 %     1,892

Nontaxable securities(2)

     14,653     6.16 %     677      15,917     6.38 %     762

Other

     13,046     2.33 %     228      21,134     5.01 %     794
                                 

Total interest-earning assets

     232,853     6.34 %     11,066      233,243     6.82 %     11,939

Cash and due from banks

     4,867            4,277      

Allowances for loan loss

     (2,364 )          (2,506 )    

All other assets

     17,595            15,228      
                         

Total assets

   $ 252,951          $ 250,242      
                         

Liabilities and Shareholders’ equity

             

Demand deposits

   $ 50,637     1.70 %   $ 647    $ 45,165     2.48 %   $ 839

Savings deposits

     29,104     0.48 %     104      34,405     1.02 %     262

Time deposits

     85,198     3.32 %     2,120      93,898     4.60 %     3,242
                                 

Interest-bearing deposits

     164,939     2.32 %     2,871      173,468     3.34 %     4,343

Borrowings

     20,150     4.06 %     614      17,887     4.61 %     618
                                 

Total interest-bearing liabilities

     185,089     2.51 %     3,485      191,355     3.46 %     4,961
                     

Noninterest-bearing deposits

     39,105            34,549      

Other liabilities

     4,267            2,466      

Shareholders’ equity

     24,490            21,872      
                         

Total liabilities and shareholders’ equity

   $ 252,951          $ 250,242      
                         

Net interest income

       $ 7,581        $ 6,978
                     

Net yield on earning assets (2)(3)

     4.34 %        3.99 %  

Interest rate spread(4)

     3.83 %        3.36 %  

 

1. Non-accrual loans have been included.
2. Yields on nontaxable securities have been adjusted to a tax equivalent basis using the federal rate of 34.00%.
3. Net yield on earning assets is computed by dividing net interest earned by total average interest earning assets.
4. The interest rate spread is the interest earning assets rate less the interest earning liabilities rate.

 

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Asset Quality

Loan Portfolio and Adequacy of the Allowances for Loan Losses

The allowance for loan losses was calculated based upon an evaluation of pertinent factors underlying the types and qualities of the Company’s loans. Management considers such factors as the repayment status of a loan, the estimated net realizable value of the underlying collateral, the borrower’s current ability to repay the loan, current and anticipated economic conditions which might affect the borrower’s ability to repay the loan and the Company’s past statistical history concerning charge-offs. The allowance for loan losses as of September 30, 2008, was $2.6 million or 1.29% of total loans outstanding, compared with $1.9 million or 1.30% of total loans outstanding as of December 31, 2007. The loan loss allowance as of September 30, 2008, increased $0.7 million from the December 31, 2007 level, as a result of the assumption of loan loss reserves in connection with the MCSB acquisition. Management makes a quarterly assessment of the Company’s delinquency ratios, charge-off history, and the composition of loans in the portfolio, as well as the impact of certain loans achieving unclassified status as of the end of the period. Management also considers nonperforming assets and total classified assets in establishing the allowance for loan losses. As of September 30, 2008, 41.2% of total loans outstanding were commercial loans within a unique market of predominantly owner-occupied real estate. This unique market has had minimal historic losses, for example in the last five years, the realized losses to the Company from lending in this market has been less than 9 bp of the average balance outstanding for this portion of the total loan portfolio. In addition, 17.0% of the total loans outstanding at September 30, 2008, were residential mortgage loans. The Company’s five year history of realized losses in residential mortage markets is 11 bp.

The allowance for loan losses is maintained at a level considered by management to be sufficient to absorb loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of a provision for loan losses and recoveries of previous charge-offs, and decreased by loans charged off. The provision is calculated to bring the allowance to a level, which according to a systematic process of measurement, reflects the amount management estimates is needed to absorb losses inherent within the portfolio. Loans are charged against the allowance when management determines that a loan is uncollectible based on approved corporate loan policies. Loans determined to be classified as loss are charged to the allowance at 100% of the remaining principal balance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

For additional information regarding the allowances for loan losses for the quarter ended September 30, 2008 see Note 5 to the Consolidated Financial Statements.

Nonperforming Assets

The ratio of nonperforming assets to total assets is one indicator of the exposure to credit risk. Nonperforming assets of the Company consist of non-accrual loans, accruing loans delinquent 90 days or more, and foreclosed assets, which have been acquired as a result of foreclosure or deed-in-lieu-of foreclosure.

For additional information regarding nonperforming assets as of September 30, 2008 and December 31, 2007, see Note 4 to the Consolidated Financial Statements.

Non-accrual loans increased from $1.5 million as of December 31, 2007 to $4.1 million as of September 30, 2008. Management considers the allowance for loan losses of $2.6 million as of September 30, 2008 to be sufficient to cover the probable loan losses for these loans. Management will continue to monitor all non-accrual loan relationships to gain visibility to improvement or deterioration in borrowers’ cash flow and to maintain the value of any underlying collateral. In addition, significant loans in non-accrual status or in excess of 90 days delinquent for a period of one year or more are required to have a new appraisal performed to reevaluate the underlying collateral.

No loans were restructured during the nine month periods ended September 30, 2008 and September 30, 2007.

 

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Liquidity and Capital Resources

Liquidity, Interest Rate Sensitivity and Market Risks

The objectives of the Company’s liquidity management policy include providing adequate funds to meet the needs of depositors and borrowers at all times, providing funds to meet the basic needs for on-going operations of the Company, and to meet regulatory requirements. The liquidity ratio is defined as the sum of cash, overnight funds, and un-pledged, marketable U.S. Government and agency securities with remaining stated maturities of less than one year divided by the sum of deposits and short-term borrowings (less the full amount of pledged deposits). The Company’s liquidity position decreased from 14.97% as of December 31, 2007 to 10.87% as of September 30, 2008. Management believes that core deposit activity, available borrowing capacity from the FHLB and Fed Funds accommodations will be adequate to meet the short-term and long-term liquidity needs of the Company. The Company participates in the Certificate of Deposit Account Registry Service® (“CDARS”) which enables depositors to receive Federal Deposit Insurance Corporation insurance coverage for deposits otherwise exceeding the maximum insurable amount. Through the CDARS program, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. As of September 30, 2008, the Company had $24.8 million in deposits through this program, of which four deposits totaling $19 million mature in November 2008. In November, the depositor committed to renewing the deposits for one year in the total amount of $20 million.

Capital Resources

The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements may result in certain mandatory and additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s Consolidated Financial Statements. As of September 30, 2008, the regulatory capital levels of the Bank were as indicated below:

 

     September 30, 2008  
     Actual     For Capital
Adequacy

Purposes
    To Be Well
Capitalized
 
dollars in thousands    Amount    Ratio     Amount    Ratio     Amount    Ratio  

Total capital ( to risk weighted assets)

   $ 25,704    10.96 %   $ 18,756    8.00 %   $ 23,445    10.00 %

Tier 1 (to risk weighted assets)

   $ 23,067    9.84 %   $ 9,378    4.00 %   $ 14,067    6.00 %

Tier 1 (to Average total assets)

   $ 23,067    8.81 %   $ 10,470    4.00 %   $ 13,087    5.00 %

 

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Item 3 — Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4 — Controls and Procedures

The Company’s management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer (its principal executive officer and principal financial officer, respectively), has concluded, based on its evaluation as of the end of the period covered by this report, that the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, (“the Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms.

There were no changes in internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

OTHER INFORMATION

Item 1 — Legal Proceedings

Not applicable.

Item 1a – Risk Factors

Not applicable.

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

Not applicable.

Item 3 — Defaults Upon Senior Securities

Not applicable.

Item 4 — Submission of Matters to a Vote of Security Holders

None

Item 5 — Other Information

Not applicable.

Item 6 — Exhibits

 

Exhibit No.

 

Description

Exhibit (3)(i)   Articles of Incorporation of the Company, incorporated by reference to Exhibit (3) to the Form 10-QSB for the quarter ended September 30, 1999, filed with the SEC on November 12, 1999.
Exhibit (3)(ii)   Bylaws of the Company, incorporated by reference to Exhibit (3) to the Form 10-QSB for the quarter ended September 30, 1999, filed with the SEC on November 12, 1999.
Exhibit (3)(iii)   Amended and Restated Article III, Section 5 of the Bylaws of the Company, adopted by the shareholders of M & F Bancorp, Inc. on April 20, 2002, incorporated by reference to Exhibit 3(iii) to the Form 10-QSB for the quarter ended March 31, 2002, filed with the SEC on May 14, 2002.
Exhibit (3)(iv)   Amended Bylaws of the Company, adopted by the Board of the Company on September 22, 2004, incorporated by reference to Exhibit 3 (iv) to the Form 10-KSB for the year ended December 31, 2005, filed with the SEC on March 31, 2006.
Exhibit (3)(v)   Amended Articles of Incorporation of the Company, adopted by the Shareholders of the Company on May 3, 2000, incorporated by reference to Exhibit 3(v) to the Form 10-KSB for the year ended December 31, 2005, filed with the SEC on March 31, 2006.
Exhibit (4)   Specimen Stock Certificate, incorporated by reference to Exhibit 4 to the Form 10-KSB for the year ended December 31, 2000, filed with the SEC on April 2, 2001.
Exhibit (10)(i)   Employment Agreement dated January 12, 2007 among Kim D. Saunders, the Company and the Bank, incorporated by reference to Exhibit 99.1 to the Form 8-K, filed with the SEC on January 18, 2007.
Exhibit (10)(ii)   Agreement of Plan of Reorganization and Acquisition by and among the Company, the Bank and MCSB dated August 9, 2007 and incorporated by reference to Exhibit 2.1 to the Form 8-K, filed with the SEC on August 10, 2007.

 

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Exhibit (31.1)   Certification of Kim D. Saunders.
Exhibit (31.2)   Certification of Lyn Hittle.
Exhibit (32)   Certification pursuant to 18 U.S.C 1350.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

      M&F Bancorp, Inc.
Date: November 10, 2008     By:  

/s/ Kim D. Saunders

      Kim D. Saunders
      President and Chief Executive Officer
Date: November 10, 2008     By:  

/s/ Lyn Hittle

      Lyn Hittle
      Chief Financial Officer

 

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